**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**








**FORM
      10-K**





(Mark
      One)











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


For
      the
      fiscal year ended December 31, 2005








OR











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








For
      the
      transition period from _____________ to








Commission
      file number 00-26363





**IPIX
      CORPORATION**





(Exact
      name of registrant as specified in its charter)






**DELAWARE**                                            
      **52-2213841**


State
      or other
      jurisdiction


incorporation
      or
      organization              (IRS
      Employer Identification No.)






**12120
      Sunset Hills Road, Suite 410, Reston, Virginia 20190**


(Address
      of principal executive offices) (Zip Code)





Registrant’s
      telephone number, including area code: **(703)
      674-4100**





Securities
      registered pursuant to Section 12(b) of the Act: **None.**





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





**Common
      Stock, $0.001 par value**


(Title
      of
      Class)














Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


__YES  X NO









Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.


__YES  X NO









Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. X YES __ NO









Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
      will not be contained, to the best of registrant’s knowledge, in definitive
      proxy or information statements incorporated by reference in Part III of this
      Form 10-K or any amendment to this Form 10-K.__







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


Check
      one: Large
      accelerated filer / / Accelerated filer /X / Non-accelerated filer /
      /





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


__ YES X NO







At
      June
      30, 2005, the aggregate market value of the voting and non-voting common equity
      of the registrant held by non-affiliates of the registrant was approximately
      $65.9 million.








The
      number of shares outstanding of the registrant’s common stock, $0.001 par value,
      as of March 1, 2006 was 27,483,874.








**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the registrant’s Proxy Statement for the Annual Stockholders’ Meeting to be
      held on or about June 23, 2006, to be filed with the Securities and Exchange
      Commission pursuant to Regulation 14A under the Securities Exchange Act of
      1934,
      as amended, are incorporated by reference into Part III of this report on Form
      10-K. Such Proxy Statement, except for the portions thereof which are
      specifically incorporated herein by reference, shall not be deemed “filed” for
      purposes of this report on Form 10-K.








**PART
      I**


*In
      addition to historical information, this Annual Report on Form 10-K contains
      certain forward-looking statements regarding, among other things, the
      anticipated financial and operating results of the Company. Investors are
      cautioned not to place undue reliance on these forward-looking statements,
      which
      speak only as of the date hereof. We do not undertake any obligation to publicly
      release any modifications or revisions to these forward-looking statements
      to
      reflect events or circumstances occurring after the date hereof or to reflect
      the occurrence of unanticipated events. In connection with the “safe harbor”
provisions of the Private Securities Litigation Reform Act of 1995, we caution
      investors that future financial and operating results may differ materially
      from
      those projected in forward-looking statements made by, or on behalf of, us.
      Such
      forward-looking statements involve known and unknown risks, uncertainties and
      other factors that may cause our actual results, performance or achievements
      to
      be materially different from any future results, performance or achievements
      expressed or implied by such forward-looking statements.*





**Item 1.** ***Business.***





**SOURCE
      OF CERTAIN STATISTICAL AND OTHER INFORMATION**





This
      Annual Report on Form 10-K includes certain statistical and other data with
      respect to IPIX and its products, services and industries, derived from publicly
      available reports and other publications referenced in this annual report.
      These
      organizations generally use methodologies and conventions that they deem
      appropriate to measure companies within the relevant industry segment and to
      measure industry size. These organizations generally indicate that they have
      obtained information from sources believed to be reliable, but do not guarantee
      the accuracy or completeness of such information. While IPIX believes this
      information to be reliable, IPIX has not independently verified such data.





**OVERVIEW**





IPIX
      Corporation (“IPIX”) is a leading developer of advanced, 360 ̊ visual
      technologies for government and commercial applications. The Company combines
      experience, patented technology and strategic partnerships to deliver visual
      business intelligence solutions worldwide.





Expanding
      market share, partnering with industry leaders, recruiting talented employees,
      reducing operating costs, and expanding and improving product offerings were
      the
      focus of IPIX Corporation’s activities in 2005. IPIX is leveraging its patents
      and current customer base to broaden its business opportunities as the Internet
      Protocol (IP) video market continues to become more accepted in the industry.
      IPIX also passed a major milestone when in 2005 it was awarded a contract from
      the Defense Advanced Research Projects Agency (DARPA) to create the highest
      resolution video camera in the world. This
      contract, when successfully completed, will further advance IPIX’s reputation as
      a leader in video technologies and visual intelligence.





The
      DARPA
      contract was a major milestone in achieving IPIX’s strategic vision for 2005,
      which included a continued shift of the IPIX business model from a
      software developer and value-added camera reseller to a visualization systems
      and solutions development company. This shift included expansion and improvement
      of IPIX video and digital photography products. Additionally, as a result of
      IPIX’s expanding relationships with technology companies and key distributors,
      IPIX cameras have become widely available in many vertical markets and also
      integrated into a number of specific software platforms -making it a leader
      in
      the emerging IP network video space.





New
      relationships with companies that specialize in network video recorders,
      analytics, and satellite communications have increased IPIX’s market reach
      compared to 2004. IPIX has established new distributor agreements with three
      of
      the largest security product firms in the U.S., ADI, Anixter and ScanSource,
      which have deployed third party sales staff in the field to sell IPIX’s 360 ̊
solutions. In 2005, IPIX solidified partnerships with Aimetis, Object Video
      and
      Vistascape for video analytics; ClickIT, Initsys, Integral, Milestone, ONSSI,
      Petards, and Silicor to offer integrated digital video recorder (DVR)/ network
      video recorder (NVR) solutions.





The
      personnel aspect to IPIX’s strategic repositioning involved the hiring of
      experienced sales professionals and organizing them into market verticals.
      The
      teams were then augmented with a staff of inside sales representatives and
      a
      seasoned proposal developer. The results of this reorganization in the second
      half 2005 were felt immediately, first with strategic sales made in the
      hospitality/gaming/cultural sector; second, with the setup of trial
      installations in three Fortune 50 retail firms; and third through an increased
      level of sales through partners. IPIX expects these trends to gain momentum
      throughout 2006.





The
      new
      market-centric direct sales approach includes IPIX showcasing its expertise
      through a series of regular Webinars in late 2005 and into 2006. These were
      presented to customers in target verticals and featured third party experts
      speaking about unique solutions featuring IPIX products. Webinars staged in
      2005
      tested and proved the concept for 2006 by generating increased leads, creating
      word of mouth references, and enhancing IPIX’s image among prospects. In the
      same vein, IPIX provided its vertical sales teams and scientific staff with
      the
      proposal support needed to pursue large, complex federal, state and local
      opportunities.





1


Outside
      the USA, the Company continued to expand and strengthen its network of resellers
      throughout Canada, Europe and Asia. With the termination in August 2005 of
      NMI
      Security PLC’s exclusive distribution arrangement to operate in the United
      Kingdom, Ireland, Italy and Switzerland, IPIX is now better positioned to
      penetrate the international market.





While
      2005 marked growth in many aspects of IPIX’s business, it was also a time for
      reducing costs and eliminating operational redundancies. In May the Company
      completed its relocation from San Ramon, California. In August, the Company
      reduced its staff in both its Reston, Virginia and Oak Ridge, Tennessee offices.
      In November, further staff and costs were reduced in Oak Ridge, Tennessee.
      Although difficult, these cost-cutting measures enabled IPIX to streamline
      its
      processes and become more strategic in its focus on technology and vertical
      markets.





Investment
      in research and development continued in 2005 resulting in IPIX introducing
      two
      significant product upgrades. The CommandViewTM Day/Night camera was launched at
      ISC-West tradeshow in March. The CommandViewTM Day/Night enables users to see a
      360 ̊ field of view with little to no available light. IPIX also released version
      1.4 of its Interactive StudioTM software for its digital photography products.
      The most significant part of the upgrade is the integration of a new PhotoVistaTM
stitching extension licensed from iseemedia. With this tool, users can take
      advantage of IPIX stitching software without purchasing new cameras. The Company
      also completed work on three-megapixel versions of its CommandView Dome and
      Command View Cameras, which were launched in January, 2006. Built
      in
      response to retail customers’ escalating demand for greater visibility at the
      point of sale, the new three-megapixel product lets users see farther with
      greater clarity and in lower light. The increased precision enhances IPIX’s
      patented 360° technology, which enables multiple users to simultaneously view
      different areas from the same camera.





The
      year
      2005 marked the repositioning of IPIX Corporation. New products, new partners,
      new contracts, the new sales organization, and a new strategic approach to
      the
      marketplace have reshaped IPIX’s opportunities as it moves from a partner-driven
      sales model to a direct sales model (even while the number and quality of
      partners improves). IPIX believes that the work done in 2005 will position
      it to
      increase sales opportunities, increase market visibility, and increase its
      broadly perceived “thought leadership” in video technology and video
      solutions.





**MARKETS**





The
      Company markets its video and stills products and services to government and
      commercial sectors for a variety of visual intelligence applications. According
      to Lehman Brothers, the digital video surveillance market is estimated to be
      $500 million in 2006, and according to J.P. Freeman, network cameras will
      outsell analog cameras by 2008.





IPIX
      targets government agencies with responsibility for security infrastructure
      protection related to ports, harbors, waterways, dams, conventional and nuclear
      power stations, utilities, airports and mass transit rail systems. Our product
      offers solutions to the military in perimeter force protection, unmanned
      vehicles and special operations. Our marketing to the government sphere
      addresses the very real need for better security and surveillance as evidenced
      by the fact that the **** total
      federal market for security was approximately $34 billion in 2005, and will
      reach $52 billion in 2010. **** Security
      equipment **** spending
      was approximately $2.5 billion in 2005 and is projected to be $3.6 billion
      in
      2010.





IPIX
      also
      targets commercial markets such as retail outlets, hotels and casinos, schools
      and cultural properties with solutions for security, loss prevention,
      surveillance and market intelligence. Currently, over $46 billion is lost within
      the retail industry each year in shrinkage, and the average budget for loss
      prevention is 0.52 percent of a retailer’s total sales.





The
      Company has hired a direct sales team to drive end-user demand and manage large
      and national accounts. IPIX also utilizes its network of distributors, resellers
      and manufacturer’s representatives to reach the market. In addition, IPIX
      directly targets the real estate and hospitality market, professional
      photographers, web developers and creators of visual documentation with its
      still photography solutions.





**CERTAIN
      RISKS AND CONCENTRATIONS** .





Accounts
      receivable are derived from revenue earned from customers located in the U.S.
      and abroad. The Company performs ongoing credit evaluations of customers’
financial condition and the Company does not require collateral from customers.





2


The
      following table and paragraph summarize the revenue and accounts receivable
      due
      from customers who provide IPIX more than 10% of total revenues or who owed
      IPIX
      more than 10% of outstanding accounts receivable at December 31:





**Revenues
                for Years ended December 31,****2003**
            
            **2004**
            
            **2005**U.S.
                Government
            
            
            —
            
            
            —
            
            
            26
            %British
                Distributor
            
            
            —
            
            
            41
            %
            
            14
            %Sentry
                360 Security Inc.
            
            
            —
            
            
            —
            
            
            3
            %Homestore
            
            
            3
            %
            
            8
            %
            
            —





At
      December 31, 2005, the U.S. Government and Sentry 360 Security represented
      43.5%
      and 9.8% of accounts receivable, respectively. At December 31, 2004,
      Homestore and our UK Distributor represented 21% and 11% of accounts receivable,
      respectively. At December 31, 2003, Homestore and eBay represented 22% and
      0% of accounts receivable, respectively. The discontinued operations for 2003
      include a one-time $8.0 million license fee from eBay for the Company’s Rimfire
      technology and other services. As announced in June 2003, the Company
      amended its then current commercial agreement with eBay. The Company no longer
      provides any products or services to eBay as of November 1, 2003.





The
      Company relies on a few main vendors from which we receive high quality material
      in a reasonable time to manufacture our products.





On
      October 1, 2004, the license agreement dated January 12, 2001 (the
“License Agreement”) between us and Homestore Virtual Tours, Inc. (“Homestore”)
      was terminated. Under the License Agreement, Homestore had the exclusive right
      to sell our virtual tour technology to the U.S. residential real estate market
      and was required to pay us a royalty for each virtual tour sold. As a result
      of
      the termination, Homestore no longer has the exclusive right to sell our virtual
      tour technology to the U.S. residential real estate market, and we may sell,
      or
      license another third party to sell, our virtual tour technology into this
      market. We mutually released each other from any further obligations under
      the
      License Agreement.





**COMPETITION**





IPIX
      believes it is the recognized brand in the 360° immersive imaging industry. The
      growth in the industry together with increased global competition has validated
      the importance of this part of the imaging market. Since the early 1990’s with
      the introduction of its first video surveillance product, the OMNIviewTM, through
      the late 1990’s with its focus on digital photography based virtual tours, and
      today, with a renewed emphasis on IP enabled digital video cameras, IPIX has
      set
      the standard for immersive imaging systems with its patented technology. Even
      so, the Company faces competition from a wide range of solutions.





**Video
      Surveillance Market**





In
      the
      video surveillance markets, IPIX high-resolution immersive video cameras face
      competition from analog CCTV camera manufacturers, digital camera manufacturers
      and from immersive video technology providers.





In
      the
      analog CCTV marketplace, analog users enjoy less expensive cameras. This is
      offset in part by the expense of technical labor needed to lay video cable
      to
      each camera; additionally, users tend to require salaried staff to monitor
      the
      video feeds from the cameras (except in rare cases where analog cameras feed
      into a high-end digital video recorder - an unlikely combination given this
      type
      of user’s “value” orientation). The IPIX value proposition in the analog space
      is that one 360° camera can provide visual coverage wide enough to replace up to
      four low-priced directional (fixed field-of-view) cameras. Additionally,
      multiple IP cameras can operate on a single network “wire” where analog cameras
      each need extensive individual cabling. Finally, IPIX cameras have built-in
      detection, cueing and notification features that make 24 x 7 staff monitoring
      unnecessary, reducing users’ personnel costs.





A
      single
      IPIX camera can also replace an analog CCTV camera with a mechanical
      pan-tilt-zoom (PTZ) mechanism under certain circumstances. Given the nature
      of
      360° technology, IPIX cameras allow users to not only PTZ in live viewing
      situations, but also on recorded video, whereas mechanical PTZ cameras can
      only
      record images based on where the camera was pointed during the record stage.
      The
      IPIX “digital” PTZ can achieve magnification up to ten times. IPIX cameras are
      complementary to traditional pan-tilt-zoom systems for some outdoor applications
      since they capture everything all of the time. IPIX cameras, therefore, do
      not
      require an operator to notice an incident in order to record it.





In
      the
      IP camera marketplace, IPIX offers a competitively priced product that
      allows a single camera to see an entire environment, unlike competing products
      with a limited field-of-view. Competing IP cameras with a limited field of
      view
      translate into a higher cost solution to achieve the same coverage as an IPIX
      camera. In markets such as retail, customers are interested in not only
      preventing theft or liability, but also gaining forensic knowledge for use
      in
      court cases; the 360° solution offers a record of the total environment on the
      sales floor, at the cash register, in the stockroom, in the parking lot, at
      the
      loading dock—or anywhere the camera is placed.





3


Competitors
      offering 360 ̊ technology solutions in the security marketplace have major
      disadvantages compared to the IPIX patented fisheye lens based approach to
      video
      surveillance. Camera-mirror assemblies construct an immersive view with a host
      of problems: (1) good mirrors are more expensive than good lenses or optics;
      (2)
      mediocre mirrors provide lower resolution image capture and heighten distortion;
      (3) mirrors have significant blind spots; and, (4) the mirror images are not
      de-warped and are therefore difficult to view.





Other
      competitors offer multi-camera heads, which are bandwidth and storage intensive,
      since they require processing data from a large number of cameras. Multi-headed
      camera devices are configurations of typically five or more cameras that are
      synchronized together to capture video. In the minimum configuration, five
      headed cameras are oriented as if in a cube, with the top and four sides each
      being captured by a separate camera. Software or proprietary hardware is then
      required to stitch the separate images together into a single frame. In one
      configuration, 12 cameras are oriented to capture a full sphere whereby no
      stitching is required. Other variations exist that use flat mirrors or other
      types of lenses. The major characteristic of all multi-headed camera devices
      is
      that an extraordinary amount of data must be captured, recorded and processed
      for subsequent playback. Also, depending on the number of cameras and the
      quality of the stitching, there may be artifacts which limit the quality of
      the
      image. In contrast, the IPIX solution requires either one or two cameras at
      most
      to capture a full environment, reducing software support and processor
      requirements. Multi-camera solutions also tend to be more expensive than an
      IPIX
      solution.





**Stills
      Photography Market**





In
      the
      visual media and visual documentation markets for immersive still photography,
      IPIX faces competition from several companies. At the most basic level, options
      for capturing panoramic images are becoming more ubiquitous in the consumer
      photography marketplace. Wide field-of-view camera options such as the Advanced
      Photo System (APS) and tools for stitching multiple images taken by hand
      offer a very rudimentary solution. This type of panoramic photography is a
      simulation of 360 ̊ photography offered by IPIX. The resulting image does not
      capture a full 360° view, and the images captured are not interactively
      navigable. Most often, these images are used to make hard copy prints. IPIX
      believes this type of photography is not suitable for surveillance, visual
      documentation and forensic analysis markets which require visual intelligence.





IPIX’s
      immersive still photography products also face competition from mirror-based
      solutions and from multi-headed cameras systems. These options again fail to
      capture an entire environment or offer a cost effective solution for most
      customers. Additionally, IPIX immersive still photography products face
      competition from panoramic scanning cameras. Scanning cameras are high-quality
      devices that capture very high resolution panoramic images. These cameras
      generally range in cost from five to ten times the price of an IPIX camera.
      They
      utilize a linear sensor, much like those used in flat bed scanners. This sensor
      is rotated 360° to capture a complete panorama. Aside from the high costs, these
      cameras are complex and require the expertise of a professional photographer.
      Additionally, at the highest resolution, these cameras can take up to 15 minutes
      to complete a full scan, which renders them inappropriate for 360 ̊ image capture
      in scenes where there is motion or a fast, easy solution is necessary.





Traditionally,
      most direct competition in the 360 ̊ still photography market has been with
      single-row panorama stitching solutions. An important feature of these software
      “stitchers” is that in order to capture a full panorama, depending on the
      field-of-view of the camera lens, anywhere from 12 to 24 images may be needed
      in
      order to capture a 360° panorama. The large number of images complicates the
      photography process substantially. More images means more files on the computer
      to track and more chances for something to go wrong in the capture phase. Single
      row panorama software products do not capture full spherical images. For those
      professional grade “stitchers” that do support spherical immersive still
      photography, the entire process steps up to an additional level of complication.
      A more complicated process is required and the number of images needed increases
      to 36. Even with the complexities of capture, certain customers do value the
      higher-quality resolution possible by taking a single row panorama of 12 to
      24
      images and stitching them together. Through the IPIX Interactive Studio, the
      Company has strategic partnerships whereby IPIX offers this type of
      functionality integrated into its own solution.





**PRODUCTS**





IPIX’s
      patents and broad product offerings bring to the marketplace the ability to
      build the world’s best visual database. Its solutions include cameras kits,
      software tools, services, infrastructure and training to support immersive
      imaging. Camera systems include all of the components necessary to capture
      high
      quality immersive still photography or video.





IPIX
      products enable users to create 360 ̊ photographic images or video through the
      use of a wide angle or fisheye lens. IPIX still photography or video content
      is
      either a 360 ̊ x 180 ̊ (hemispherical) view taken with a single shot, or a
      360 ̊ x 360 ̊ view, taken by two back-to-back hemispherical shots. Our technology
      can also be used for more than two shots to create higher resolution final
      content.








4














**Immersive
      Video Products**





The
      video
      product portfolio consists of three product lines with various configurations
      within each product line. The product lines are: CommandViewTM, CommandView360TM
and InSightTM camera systems. The core camera electronics and fisheye lens optics
      have been designed to be used across the entire product line to achieve
      economies of scale in manufacturing. These innovative camera systems allow
      the
      user to view live and recorded video at user definable frame rates and
      compression settings to conserve bandwidth and storage
      requirements.





*CommandViewTM*





The
      CommandViewTM camera consists of a two or three mega-pixel sensor, a digital
      signal processor (DSP) module and a power distribution and communication
      module. CommandViewTM utilizes our fisheye lens that has been optimized for the
      image sensor in the camera subassembly to provide a high value, highly
      attractive video surveillance product offering to the security market.
      CommandViewTM comes in multiple configurations: wall-mount, ceiling-mounted dome,
      and for low intrusive monitoring, a flush mount kit and recessed dome kit.





IPIX
      believes the uses and applications of the CommandViewTM are virtually limitless.
      Unlike the cameras it replaces, CommandViewTM provides complete and continuous
      situational awareness. The CommandViewTM camera sees everything at the same time
      and monitors everything in its field of view with no blind spots. Users have
      the
      ability to pan-tilt-zoom on both live and recorded video with no moving parts,
      as well as remotely view and manage cameras from an off-site location.





*CommandView360TM*





CommandView360TM
      utilizes two camera sub-assemblies, mounted back-to-back, and one fisheye lens
      on each camera to provide full 360° coverage of the area of concern. Full 360°
coverage means the camera is monitoring in both the horizontal and vertical
      dimensions at the same time.





This
      optical system integrates an optional off-the-shelf third party mechanical
      pan-tilt-zoom camera that has an optical zoom capability for long range target
      identification and tracking. Operation of the CommandView360TM with the
      mechanical pan-tilt-zoom camera is easy and efficient and allows the operator
      to
      get on target quickly by using the ‘Assisted Cue and Zoom’ feature of the
      CommandView360TM. Targets of interest are seen through the spherical view of the
      CommandView360TM and the operator simply ‘mouse-clicks’ on a target of interest
      in the viewer screen.





The
      CommandView360TM software performs a mathematical calculation and sends the
      coordinates of the pixel that the operator ‘mouse-clicked’ on to the mechanical
      pan-tilt-zoom camera as positioning commands. The mechanical pan-tilt-zoom
      camera moves to the correct position to ‘capture’ the target and the operator
      then zooms in for close-up monitoring. The CommandView360TM offers operators the
      ability to find a target anywhere within a three dimensional space—eliminating
      the guess work commonly associated with traditional mechanical pan-tilt-zoom
      cameras.





Designed
      to provide the highest level of reliable operation for continuous situational
      awareness, the CommandView360TM is rugged in construction and small in size
      making it ideal for fixed, outdoor installations where customers need to protect
      critical infrastructure and key assets.





5


*InSightTM*





InSightTM
      is our entry-level digital camera system using the camera subassembly that
      forms
      the foundation of our entire product portfolio. This camera is capable of
      generating high quality, high resolution images at full motion frame rates
      that
      range from 15 frames per second to 48 frames per second, depending upon
      compression settings and number of users on the network.





The
      product comes in two configurations. In the ceiling-mount configuration, the
      user may select a fixed or a directional camera mount. The directional mount
      allows the user to swivel the camera to adjust the direction in which the camera
      is pointed. The InSightTM camera may be mounted in a parapet or rampart enclosure
      for outdoor use. IPIX believes the InSightTM camera fills a void that currently
      exists in the security video surveillance market for a fixed, high resolution
      network camera that is capable of delivering video at full-motion frame rates.





**Integration
      with Leading Digital/Network Video Recording Solutions**





IPIX
      offers a surveillance technology unlike any other. However, in order for
      consumers to take advantage of it, many need to integrate it into their existing
      surveillance solutions. High-end users of security products need to efficiently
      manage, store and retrieve their image streams. To meet this need, IPIX formed
      strategic relationships with many of the industry’s leading video recording
      providers including ClickIT, Initsys, Integral, Milestone, ONSSI, Petards,
      and
      Silicor. Products from these types of vendors are software based and provide
      a
      user friendly interface to a network camera that allows the user to build,
      manage and control a network of digital cameras and record and playback the
      video outputs of each camera on the network. By integrating the IPIX technology
      with these leading platforms, IPIX has enabled its patented 360° technology to
      be used by customers who have previously made a significant infrastructure
      investment in their CCTV systems or who plan to use these types of systems
      to
      manage their surveillance operations in the future. It also allows DVR and
      NVR
      companies to offer the most advanced solutions for capturing an entire
      environment.





*Immersive
      Still Photography Products*





IPIX
      sells complete 360 ̊ immersive still photography solutions which include fisheye
      enabled camera systems and IPIX software. The Company also serves the real
      estate market with a special IPIX Real Estate Wizard and an on-line virtual
      tour
      hosting service Host@IPIX. The products are based on patented technology for
      capturing a full 360° field of view from a digital camera in a manner that is
      extremely efficient for the user. By integrating the end-to-end process,
      including production workflow and image editing and output options, our platform
      enhances the workflow efficiency to provide high quality results.





*IPIX
      Interactive Studio*





The
      IPIX
      Interactive Studio (“Interactive Studio”) is our strategic platform for creating
      a de facto standard for the creation of 360 ̊ photography. The system is
      compatible with both Windows and Macintosh platforms and is flexible enough
      to
      integrate a wide range of traditional media types such as flat images and
      panoramas into a single workflow. Newly created product enhancements including
      the I-Linker extension allow customers to extend the usability of their
      immersive images by creating hotspots and linking images to other types of
      content such as audio or other immersive images, creating an interactive
      experience.





*IPIX
      GRIDs System*





The
      IPIX
      GRIDs System (Geo-Referenced Image Documentation System) provides commercial
      and
      government customers with a solution for creating immersive hot-spotted maps.
      The product utilizes the IPIX Interactive Studio product for immersive image
      creation and in conjunction with a Global Positioning System receiver, customers
      can create maps with location data embedded within the image.





**SALES
      AND MARKETING**





IPIX
      sales and marketing work together—both internally and externally—to communicate
      value propositions, develop sales, and to optimize opportunities.





According
      to J.P. Freeman, the IP surveillance market is growing at an annual rate of
      48
      percent such that by 2008 IP cameras will outsell analog cameras. We believe
      our
      strong brand recognition positions the Company to capture significant
      opportunities in this emerging market. However, in 2005 it was necessary to
      educate the security and surveillance market about the value of 360 ̊ technology
      solutions, and the emerging standards of IP video. In 2006 IPIX will continue
      to
      educate end users and build its brand through traditional tradeshows, media
      outreach, public relations, and advertising, but less so than in 2005. Our
      value
      proposition will more directly be delivered by our new enterprise sales team
      and
      partners.





6


As
      mentioned, IPIX shifted its strategy in 2005 from having generalist sales staff
      located across the United States and Europe to having a centralized sales force
      with vertical expertise in its Reston, Virginia office. Teams are focused on
      large revenue opportunities targeting early adopters of the IP video technology
      in different vertical markets. Given new solutions offered by vertical focused
      sales representatives, our teams will stimulate market interest for 360 ̊
technologies in opportunities where prospects may have only been aware of
      conventional analog technologies.





The
      Company’s new relationships with three major security distribution
      companies—ADI, Anixter, and ScanSource—will create exposure for our technology
      among large buyers of video technology; IPIX will reach smaller end-users
      through resellers. Our partner outreach programs will continue to serve and
      educate security and architectural and engineering consultants who may recommend
      our technology in new construction and retrofit projects.





IPIX
      still photography products—software, hardware, and training—were sold worldwide
      through a tele-sales model in 2005. The tele-sales team is located in the
      Reston, Virginia office where they handle sales and inquiries. IPIX also manages
      an on-line store through our Web site ( www.ipixstore.com )
      where
      customers may purchase our still photography products. Historically, the
      photography vertical markets have been real estate agents, photographers, and
      Web developers. The Company has previously marketed to such buyers through
      Web-based advertising campaigns. However, after combining all product lines
      under one umbrella in 2005, the Company’s approach is to “cross-sell”
photography products to video users and vice versa. This has led to a number
      of
      opportunities currently under development in new vertical markets such as
      government, critical infrastructure and emergency management.





**INTELLECTUAL
      PROPERTY**





IPIX
      relies on a combination of patent, copyright, trade secret and trademark laws
      and contractual restrictions to establish and protect proprietary rights in
      its
      products. Patents are intended to protect and support current and future
      development of IPIX technology. IPIX currently has over 20 U.S. patents.
      Provisional patents have been filed on the Gigapixel camera being developed
      under the DARPA contract. In addition, it holds international counterparts
      to
      many U.S. patents in selected countries covering various aspects of products.
      IPIX has numerous patent applications pending in the United States as well
      as
      international counterparts to many of these applications. Finally, it has a
      non-exclusive and royalty-free license under numerous U.S. and foreign patents
      from Sarnoff Corporation and from Motorola, Inc. related to immersive imaging
      technologies and techniques. There can be no assurance that our current and
      future patent applications will be granted, or, if granted, that the claims
      covered by the patents will not be reduced from those included in our
      applications.





IPIX’s
      success and ability to compete are dependent on its ability to develop and
      maintain the proprietary aspects of its technology and operate without
      infringing on the proprietary rights of others. It seeks to limit disclosures
      about intellectual property by requiring employees, suppliers and customers
      with
      access to our proprietary information to execute confidentiality agreements
      and
      by restricting access to source code. Despite efforts to protect these
      proprietary rights, unauthorized parties may attempt to copy aspects of services
      or software or to obtain and use information that IPIX regards as proprietary.
      The Company has experienced wrongful use in the past, and although it has taken
      steps to stop that use, more attempts in the future can be expected. The laws
      of
      many countries do not protect proprietary rights to as great an extent as do
      the
      laws of the United States. Litigation may be necessary in the future to enforce
      intellectual property claims, to protect trade secrets, to determine the
      validity and scope of the proprietary rights of others, or to defend against
      claims of infringement or invalidity. There can be no assurance that the
      statutory and contractual arrangements IPIX currently depends upon will provide
      sufficient protection to prevent misappropriation of its technology or deter
      independent third-party development of competing technologies.





Claims
      by
      third parties that current or future IPIX products infringe upon their
      intellectual property rights may have a material adverse effect on us.
      Intellectual property litigation is complex and expensive, and the outcome
      of
      this litigation is difficult to predict. IPIX has been involved in litigation
      relating to the protection of intellectual property rights. Such litigation,
      and
      any future litigation, regardless of outcome, may result in substantial expense
      and significant diversion of management and technical resources. An adverse
      determination in any litigation may subject IPIX to significant liabilities
      to
      third parties, require IPIX to license disputed rights from other parties,
      if
      licenses to these rights could be obtained, or require IPIX to cease using
      the
      disputed technology.





**EMPLOYEES**





As
      of
      March 1, 2006 we employed 34 full-time employees. Our employees are not
      represented by any collective bargaining unit. We believe our relations with
      our
      employees are good.





7


**AVAILABLE
      INFORMATION**





Our
      website is located at www.ipix.com. We make available free of charge through
      this website all of our Securities and Exchange Commission (“SEC”) filings,
      including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
      Current Reports on Form 8-K and all amendments to those reports, as soon as
      reasonably practicable after those reports are electronically filed with the
      SEC
      (www.sec.gov).


**Item 1A.** ***Risk
      Factors.***





*Our
      limited operating history and recent changes in our customer base makes it
      difficult to evaluate our business*





In
      early
      2004, we launched several new products for video surveillance and immersive
      photography. Additionally, in February 2005, we sold our AdMission business
      unit. As a result, we have a limited operating history of the Company in 2005
      and upon which you can base an evaluation of our business and prospects. Our
      prospects must be considered in the light of the risks, uncertainties, expenses
      and difficulties frequently encountered by companies that have undertaken a
      substantial business restructuring. To address these risks and uncertainties,
      we
      must, among other things:





·maintain
                and enhance our brand and expand our immersive product and service
                offerings;·expand
                our customer base for all product offerings;·attract,
                integrate, retain and motivate qualified personnel; and·adapt
                to meet changes in our markets and competitive developments.





We
      may
      not be successful in accomplishing these objectives.





We
      have a
      history of losses, and we expect to continue to incur losses and may not achieve
      or maintain profitability.





The
      extent of our future losses and the timing of profitability are highly
      uncertain, and we may never achieve profitable operations. As of
      December 31, 2005, we had a total accumulated deficit of approximately
      $541 million. Historically, our net sales have varied significantly. We
      will need to generate additional revenue to achieve profitability in the future.
      If we are unable to achieve profitability or to maintain profitability if
      achieved, it may have a material adverse effect on our business and stock price
      and we may be unable to continue operations at the current levels, if at all.
      We
      cannot provide any assurances that we will generate additional revenues or
      achieve profitability.





*Additional
      capital or strategic alternatives may be required for us to continue our
      operations and as a result, our independent registered public accounting firm’s
      report includes an explanatory paragraph that states that significant matters
      exist that raise substantial doubt about our ability to continue as a going
      concern.*





If
      we are
      not successful in increasing our revenues or cutting costs, we may be required
      to reduce operations further, seek additional equity financing or financing
      from
      other sources, or consider other strategic alternatives, including a possible
      merger, sale of assets or other business combination or restructuring
      transactions. There can be no assurances that additional financing or strategic
      alternatives will be obtainable on terms acceptable to us or that any additional
      financing would not be substantially dilutive to existing stockholders. The
      holders of our Series B preferred stock have rights that are senior to
      those of the holders of our common stock in the event of the sale of our Company
      or in the event of our liquidation, dissolution or winding up. We have included
      a “going concern” footnote in our audited financial statements for fiscal 2005.
      See Financial Statements - Note 3.





*Our
      operating results are highly dependent on the development of new products and
      technologies, and marketing them in order to generate revenue from new markets*





Our
      results are subject to risks related to our significant investment in developing
      and introducing new products and services. These risks include:
      (i) difficulties and delays in the development, production, testing and
      marketing of products and services; (ii) customer acceptance;
      (iii) the development of industry standards; (iv) the significant
      amount of resources we must devote to the development of new technology; and
      (v) the ability to differentiate our products or services and compete with
      other companies in the same markets.





We
      may
      not be able to develop and market new products and technologies and generate
      revenues. This could have a material adverse effect on our financial results.





8


*Our
      operating results are highly dependent on obtaining adequate supplies of the
      components of our products*





Our
      ability to meet customer demands depends, in part, on our ability to obtain
      timely and adequate delivery of quality materials, parts and components from
      our
      suppliers and external manufacturing capacity. Although we work closely with
      our
      suppliers to avoid these types of shortages, there can be no assurances that
      we
      will not encounter these problems in the future. A reduction or interruption
      in
      supplies or a significant increase in the price of one or more supplies could
      have a material adverse effect on our revenues and operating results.





*Failure
      to manage expenses would prevent us from achieving profitability*





We
      may
      have to increase our operating expenses in order to increase our customer base,
      enhance our brand image and support our growing infrastructure. In order for
      us
      to become profitable, we must increase our revenues and gross profit margins
      sufficiently to cover current and future operating expenses. If we fail to
      do
      so, we may never achieve sustained profitability.





In
      late
      2003, we reduced the number of employees in the business unit that previously
      supported our largest customer. In February of 2005, we sold this business
      unit
      to AdMission Corporation as previously disclosed. During 2005, we further
      reduced the number of employees in all functional areas of the Company. We
      continue to streamline our cost structure but recognize the need to increase
      some sales and marketing costs that directly benefit the sale of security
      products. As a result, we hope to lower our future break-even revenue level.
      If
      we fail to do so, we may be required to implement further cost reductions that
      could adversely affect our business.





Since
      the
      first half of 2000, we have been reducing costs and simplifying our product
      portfolios in all of our businesses. We discontinued product lines, exited
      businesses, consolidated operations and reduced our employee population. The
      impact of these cost-reduction efforts on our revenues and profitability may
      influence our ability to successfully complete these ongoing efforts; our
      ability to generate the level of cost savings we expect or that are necessary
      to
      enable us to effectively compete; the risk that we may not be able to retain
      key
      employees; and the performance of other parties under outsourcing arrangements.





Another
      cost-reduction action has been to develop outsourcing arrangements for the
      design and/or manufacture of certain products and components. If these third
      parties fail to deliver quality products and components on time and at
      reasonable prices, we could have difficulties fulfilling our orders and our
      revenues and operating results could be negatively impacted.





*Our
      quarterly results may fluctuate, which could make financial forecasting
      difficult and increase volatility in our common stock*





Our
      revenues and operating results may vary significantly from quarter-to-quarter.
      As a result, quarter-to-quarter comparisons of our revenues and operating
      results may not be meaningful. In addition, due to our limited operating history
      and restructuring, it may be difficult to predict our future revenues and
      results of operations accurately. It is likely that, in one or more future
      quarters, our operating results will fall below the expectations of investors.
      If this happens, the trading price of our common stock is likely to be
      materially and adversely affected.





*We
      are dependent on a few products*





We
      anticipate that most of our revenue growth in the future, if any, will come
      from
      our visual intelligence technologies within both the commercial and government
      market segments. We may not be able to successfully increase sales of our
      current product offering. Additionally, our efforts to market new products
      and
      enhancements to our existing products may not be successful. If we are unable
      to
      continue to develop our products or if we are not successful in marketing and
      selling our new products, our financial condition could be materially and
      adversely affected. Additionally, camera technology is changing rapidly and
      we
      cannot be sure that our technology will continue to be attractive to customers
      or that technological advances will not render some inventory items such as
      cameras and lenses obsolete.





*Our
      success depends on our ability to protect our intellectual property*





We
      rely
      on trademark, copyright and patent law, trade secret protection and
      confidentiality or license agreements with our employees, customers, partners
      and others to protect our proprietary rights. If we are not successful in
      protecting our intellectual property, there could be a material adverse effect
      on our business.





While
      we
      believe that our issued patents and pending patent applications help to protect
      our business, there can be no assurance that:





·any
                patent can be successfully defended against challenges by third parties;·pending
                patent applications will result in the issuance of patents;·our
                competitors or potential competitors will not devise new methods
                of
                competing with us that are not covered by our patents or patent
                applications;·new
                prior art will not be discovered which may diminish the value of
                or
                invalidate an issued patent; or·a
                third party will have or obtain one or more patents that prevent
                us from
                practicing features of our business or will require us to pay for
                a
                license to use those features.




9


Also,
      our
      patents, service marks or trademarks may be challenged and invalidated or
      circumvented. In addition, we are exposed to infringement of our intellectual
      property in foreign markets because our intellectual property is protected
      under
      United States laws that may not extend to foreign uses. We have been and are
      currently involved in litigation relating to the protection of intellectual
      property rights and could be involved in future litigation as third parties
      develop products that we believe infringe on our patents and other intellectual
      property rights. We have experienced attempts to misappropriate our technology,
      and we expect those attempts may continue. We have been involved in litigation
      in which our rights to technology have been challenged. The cost of such
      litigation, or the determination against us in this type of lawsuit, could
      have
      a material adverse effect on our business.





*Compliance
      with changing regulation of corporate governance and public disclosure may
      result in additional expenses.*





Changing
      laws, regulations and standards relating to corporate governance and public
      disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and
      NASDAQ National Market rules, are creating uncertainty for companies such as
      ours. These new or changed laws, regulations and standards are subject to
      varying interpretations in many cases due to their lack of specificity, and
      as a
      result, their application in practice may evolve over time as new guidance
      is
      provided by regulatory and governing bodies, which could result in continuing
      uncertainty regarding compliance matters and higher costs necessitated by
      ongoing revisions to disclosure and governance practices. We are committed
      to
      maintaining high standards of corporate governance and public disclosure. As
      a
      result, our efforts to comply with evolving laws, regulations and standards
      have
      resulted in, and are likely to continue to result in, increased general and
      administrative expenses and a diversion of management time and attention from
      revenue-generating activities to compliance activities. In particular, our
      efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and
      the related regulations regarding our required assessment of the effectiveness
      of our internal control over financial reporting and our independent registered
      public accounting firm’s audit of that assessment has required the commitment of
      significant financial and managerial resources. We expect these efforts to
      require the continued commitment of significant resources. Further, our board
      members, chief executive officer and chief financial officer could face an
      increased risk of personal liability in connection with the performance of
      their
      duties. As a result, we may have difficulty attracting and retaining qualified
      board members and executive officers, which could harm our business. If our
      efforts to comply with new or changed laws, regulations and standards differ
      from the activities intended by regulatory or governing bodies due to
      ambiguities related to practice, our reputation may be harmed.





*If
      we
      lose key members of our personnel, our future success could be limited*





Our
      future success depends on our ability to attract and retain key management,
      engineering, technical and other personnel. In addition, we must recruit
      additional qualified management, engineering, technical and marketing and sales
      and support personnel for our operations. Competition for this type of personnel
      is intense, and we may not be successful in attracting or retaining personnel.
      We do not maintain key person life insurance for any of our personnel. The
      loss
      of the services of one or more members of our management group or other key
      employees or the inability to hire additional qualified personnel will limit
      our
      ability to grow our business.





*Our
      success is dependent upon our ability to adapt to technological changes, and
      if
      we fail to do so, our offerings may become obsolete*





We
      compete in a market characterized by rapidly changing technology, evolving
      industry standards, frequent new service and product announcements,
      introductions and enhancements and changing customer demands. These market
      characteristics are intensified by the emerging nature of the Internet and
      the
      multitude of companies offering Internet-based products and services. Thus,
      our
      success depends on our ability to adapt to rapidly changing technologies, to
      adapt our offerings to evolving industry standards and to continually improve
      the performance, features and reliability of our offerings in response to
      competitive products and shifting demands of the marketplace.





*We
      may not be successful in expanding our business into international markets*





A
      part of
      our long-term strategy has been to expand into international markets. The
      success of any additional foreign operations will be substantially dependent
      upon our entering and succeeding in those markets, including through
      distributors, joint ventures or other indirect strategies. We may experience
      difficulty in managing international operations as a result of competition,
      technical problems, distance, language or cultural differences.





As
      we
      manage our international efforts, we will be subject to a number of risks,
      including the following:





·failure
                of foreign countries to rapidly adopt digital imaging or other required
                technologies;·unexpected
                changes in regulatory requirements;·slower
                payment and collection of accounts receivable than in our domestic
                market;
                and·political
                and economic instability.




10


We
      cannot
      assure you that we will be able to successfully market our products in foreign
      markets.





*Conversion
      of Series B Preferred Stock into Common Stock and the payment of accrued
      dividends associated with such Preferred Stock could adversely affect
      stockholders*





The
      holders of our Series B preferred stock may at their election convert each
      share of preferred stock into approximately 9.2 shares of our registered common
      stock. Accrued dividends on the preferred stock become due and payable upon
      such
      conversions. The holder of the preferred stock may elect to receive the
      dividends in additional common stock or cash. As a result, these conversions
      could require us to use available funds to finance dividends or dilute existing
      shareholders by introducing new common stock into the market. As a result,
      our
      financial condition or the market price of our common stock could be adversely
      affected.





*Our
      certificate of incorporation and bylaws contain anti-takeover provisions that
      may make it more difficult or expensive to acquire us in the future, which
      could
      negatively affect our stock price*





Our
      amended and restated certificate of incorporation and amended and restated
      bylaws and applicable provisions of Delaware law contain several provisions
      that
      may make it more difficult for a third party to acquire control of us without
      the approval of our board of directors. In addition, in October of 2000, our
      board of directors approved a stockholder rights plan that has the effect of
      making an acquisition of us prohibitively expensive unless our board of
      directors approves of the acquisition. The provisions of our certificate and
      bylaws and the Delaware General Corporation Law may make it more difficult
      or
      expensive for a third party to acquire a majority of our outstanding voting
      common stock or delay, prevent or deter a merger, acquisition, tender offer
      or
      proxy contest, which may negatively affect our stock price.





*Our
      market is highly competitive, and our business may suffer if we are unable
      to
      compete successfully*





The
      market for our immersive products is rapidly evolving. The market for immersive
      products and services is also highly competitive. We compete with other
      providers of immersive imaging technology who develop and market products and
      services similar to ours. We expect additional competition from other emerging
      and established companies. There can be no assurance that the Company’s current
      and potential competitors will not develop products that are more effective
      than
      our current or future products, or that our products and technology will not
      be
      rendered obsolete by such developments. Some of our competitors have longer
      operating histories, greater name recognition and significantly greater
      financial, technical and marketing resources. As a result, they may be able
      to
      adapt more quickly to new or emerging technologies and changes in customer
      requirements or devote greater resources to promotion and sale of their products
      than us. Our business will suffer if we are unable to compete effectively.





*Terrorist
      activities and resulting military and other actions could adversely affect
      our
      business*





Terrorist
      attacks in recent years have disrupted commerce throughout the United States
      and
      other parts of the world. The continued threat of terrorism within the United
      States and abroad, and the continued military action and heightened security
      measures, may cost significant disruptions to global commerce. Such disruptions
      could result in a general decrease in corporate spending on information
      technology or our ability to effectively market and sell our products and
      services. Such events could have material adverse affect on our business.





**Item 1B.** ***Unresolved
      Staff Comments.***





None.





**Item 2.** ***Properties.***





On
      April
      18, 2005 IPIX Corporation (the "Company") entered into a sublease agreement
      (the
      "Sublease") with Thomas Group, Inc. (the "Sublessor") with respect to the
      Company's new corporate headquarters in Reston, Virginia for our sales,
      marketing, engineering and corporate offices. The Sublease is for a period
      of 31
      months beginning April 15, 2005. The base rent is approximately $297,668 per
      year and will increase by approximately three (3%) percent each year beginning
      April 1, 2006. In addition to the base rent, the Company is responsible for
      any
      increases in operating expenses and property taxes billed to the landlord and
      paid by the Sublessor. The Company is also responsible for the costs of tenant
      improvement. All terms and conditions of the master lease between the Sublessor
      and REC Partners, L.P. dated February 15, 2000 are incorporated into and made
      part of the Sublease.





11


As
      of
      December 31, 2005, we leased approximately 20,000 square feet of space in Oak
      Ridge, Tennessee and approximately 25,500 square feet in San Ramon, California.
      On March 13, 2006, the Company agreed to terminate, effective March 8, 2006,
      the
      lease agreement it entered into on February 3, 2005 with Oak Ridge Technical
      Center Partners - One, L.P. The terms of the agreement to terminate included
      IPIX’s agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a
      one-time, lump-sum payment in the amount of $198,500, due and payable
      immediately; (2) prorated rent through March 8, 2006 - $5,606, and (3) prorated
      Tenant Improvement expense though March 8, 2006 - $596. Oak Ridge Technical
      Center Partners - One, L.P. has agreed to: (1) act as intermediary in the sale
      of IPIX’s furniture to a third party for $40,000; and (2) deduct that amount
      from the above payments due from IPIX.





We
      are
      marketing the San Ramon property for sublease and have sub-let approximately
      6,673 square feet in San Ramon as of December 31, 2005. We are actively
      marketing the remaining space to potential sub-tenants. If we are unable to
      successfully sublease our vacated and unoccupied office space, or if any of
      our
      current sub-tenants fail to make required lease payments, our business,
      financial condition, results of operations and cash flows may be adversely
      affected. (See Note 11 to our consolidated financial statements included
      elsewhere in this Form 10-K.)




**Item 3.** ***Legal
      Proceedings***





On
      June 15, 2003, the Company filed an action against Mr. Ford Oxaal and
      his company, Minds-Eye-View, (together, “Oxaal”) in the United States District
      Court for the Eastern District of Tennessee. In the complaint, the Company
      asserted claims for patent infringement, false designation of origin, false
      description or representation, unfair or deceptive acts and tortious
      interference in connection with Oxaal’s competing software product marketed
      under the name “Click Away.” On August 8, 2003, Oxaal filed its answer
      asserting counterclaims for non-infringement, invalidity, unenforceability,
      breach of contract, patent misuse, Lanham Act violations and tortious
      interference. The Company denied all of Oxaal’s allegations. The case was stayed
      pending settlement negotiations, which have since terminated. On March 15,
      2005, a motion was filed by the Company to vacate the stay so that the lawsuit
      can proceed in due course. In September, 2005, the court decided to continue
      the
      stay until the *Grandeye* litigation is completed.





On
      March
      14, 2005, Grandeye, Ltd. filed suit against IPIX in the U.S. District Court
      for
      the Eastern District of Virginia, Norfolk Division, seeking a declaratory
      judgment that (1) its Halocam products do not infringe any valid claim of U.S.
      Patents No. 5,359,363 (“the ‘363 patent”), 6,603,502 B2 (“the ‘502 patent”), and
      Re 36,207 (“the ‘207 patent”), all three of which are owned by IPIX; (2) these
      three patents are invalid; and (3) these three patents are unenforceable as
      a
      result of inequitable conduct committed during prosecution of the patent
      applications leading to the patents. Grandeye also asserted various state law
      claims alleging damage to its business relationships as a result of alleged
      statements and conduct of IPIX. Grandeye also included in its Complaint a claim
      for antitrust violations but has since dismissed that antitrust claim with
      prejudice. IPIX has asserted substantial defenses to Grandeye’s claims and filed
      a counter-suit against Grandeye for infringement of the ‘363 patent, ‘502
      patent, and ‘207 patent. IPIX has vigorously defended, and continues to defend,
      its positions. IPIX has filed a motion seeking summary judgment as to Grandeye’s
      state law claims, and Grandeye has filed a motion seeking a summary judgment
      that its Halocam SP products do not infringe any claims of the ‘363 patent, ‘502
      patent, or ‘207 patent. The parties have opposed each other’s motions and the
      parties’ arguments regarding both summary judgment motions were heard by the
      Court on January 18, 2006. The Court held a hearing during the period November
      7-10, 2005, at which the parties presented their positions regarding the proper
      construction of the terms in the patents’ claims. The
      Court has vacated the trial date in the case, and stayed all proceedings for
      90
      days, so that it can review and decide the parties’ cross motions for summary
      judgment. The Court indicated that it should have a written decision on these
      motions at the end of the 90 day stay period.





The
      Company intends to vigorously defend each of the above referenced lawsuits.
      Because of the inherent uncertainties related to this type of litigation, the
      Company is unable to predict the ultimate outcome of these cases, or the
      likelihood or amount of our potential liability, if any, of these cases.
      However, if the Company is not successful in defending or settling these
      matters, these cases could have a material adverse effect on the business,
      financial condition, results of operations or cash flows of the Company. The
      Company will incur substantial costs in defending these lawsuits.





Like
      many
      companies whose success is dependent on emerging technologies and intellectual
      property, the Company is subject to potential technology related claims such
      as
      product state-of-the-art technology and associated marketability. The Company
      may be subject to claims from distributors and others regarding their purchases
      from the Company related to subsequent technological advances and the associated
      market price considerations. The Company is not currently a party to any other
      legal proceedings, the adverse outcome of which, individually or in the
      aggregate, is believed could have a material adverse effect on the business,
      financial condition, results of operations or cash flows of the Company.





12


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





No
      matters were submitted to a vote of the Company’s stockholders during the fourth
      quarter of fiscal year 2005.





**Item 4A.*****Executive
      Officers of Registrant***





The
      following sets forth information with respect to our executive officers as
      of
      March 1, 2006:





NAME
            
            AGE
            
            TITLEClara
                M Conti
            
            44
            
            President
                and Chief Executive OfficerCharles
                A. Crew
            
            62
            
            Chief
                Financial Officer and Secretary,
                Treasurer





**CLARA
      M. CONTI** has
      been
      a director and our president and chief executive officer (CEO) since September
      2004. Prior to joining the Company, Ms. Conti was President and CEO of
      ObjectVideo from 2001 to January 2004. ObjectVideo, Inc. is a video
      security business headquartered in Reston, Virginia. From 2000 to 2001,
      Ms. Conti was Vice President of eBusiness Solutions for DynCorp, an
      information technology and outsourcing company headquartered in Reston,
      Virginia. Prior to joining DynCorp, Ms. Conti was President and Chief
      Executive Officer of Aurora Enterprise Solutions, a business-to-business
      internet security products and services firm headquartered in Reston, Virginia.
      Ms. Conti is a graduate of the University of South Alabama.





**CHARLES
      A. CREW** has
      been
      the chief financial officer (CFO), secretary and treasurer of IPIX since
      April 2005.  From
      February 1999 to October 2004, Mr. Crew served as executive vice president,
      CFO
      and a member of the board of directors for Cigital, Inc., a provider of software
      quality and software security solutions, where he developed and executed the
      company's long-term strategic plan, including securing multiple rounds of
      venture capital funding. Prior to Cigital, Crew spent nine years, at Group
      1
      Software, (recently acquired by Pitney Bowes, Inc.) as executive vice president,
      CFO and board member. At Group 1, he successfully managed several business
      units
      and spearheaded the merger and acquisition activities, which repositioned the
      company from a narrow, niche market to an international, specialty software
      provider. Mr. Crew holds a bachelor's degree in accounting from the University
      of Baltimore and an MBA in marketing and finance from Loyola College in
      Baltimore. He earned an MBA upgrade from Syracuse University in Syracuse, N.Y.
      Mr. Crew is a certified public accountant in the state of Maryland.





Mr.
      Crew
      has resigned as CFO of the Company effective April 1, 2006. On February 27,
      2006, the Company entered into a separation agreement with Mr. Crew. The Company
      and Mr. Crew have agreed to terminate the employment agreement between the
      Company and Mr. Crew dated April 1, 2005 effective April, 1, 2006. Under the
      Separation Agreement, the Company will pay any portion of Mr. Crew's base
      salary, vacation time, travel and business expense incurred or accrued through
      April 1, 2006. The Company will also pay total bonus compensation to Mr. Crew
      of
      $20,000 for the fourth quarter of 2005 and first quarter of 2006 as provided
      in
      Mr. Crew's employment agreement. In addition, the Company will pay Mr. Crew
      a
      severance payment of $200,000. Stock options to purchase up to 200,000 shares
      of
      Company common stock granted to Mr. Crew on April 1, 2005 will become fully
      vested on April 1, 2006, and such options must be exercised on or before June
      30, 2006, at which time they will expire. For a period of six months after
      April
      1, 2006, the Company will reimburse Mr. Crew for the amount of any premium
      payments for group health coverage made by Mr. Crew pursuant to the Consolidated
      Omnibus Budget Reconciliation Act of 1985. The Company has commenced a search
      for a replacement for Mr. Crew and intends to appoint a successor as soon as
      practical.





**PART
      II**




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





Our
      common stock is traded on the NASDAQ SmallCap Market (symbol: IPIX). As of
      March
      9, 2006, there were 758 stockholders of record. The following table reflects
      the
      range of the high and low bid information for our common stock for the periods
      indicated:





**High**
            
            **Low****FISCAL
                2005**Fourth
                Quarter
            
            $
            2.89
            
            $
            1.66Third
                Quarter
            
            $
            4.70
            
            $
            2.60Second
                Quarter
            
            $
            3.74
            
            $
            2.43First
                Quarter
            
            $
            5.99
            
            $
            2.85


13





**FISCAL
                2004**Fourth
                Quarter
            
            $
            9.05
            
            $
            5.05Third
                Quarter
            
            $
            13.60
            
            $
            6.19Second
                Quarter
            
            $
            27.34
            
            $
            3.81First
                Quarter
            
            $
            5.31
            
            $
            1.76




We
      currently intend to retain all future earnings to finance the continuing
      development of our business and do not anticipate paying cash dividends on
      our
      common stock in the foreseeable future. Any payment of cash dividends in the
      future will depend upon our financial condition, future loan covenants, capital
      spending requirements and earnings, as well as other factors the board of
      directors may deem relevant. We have not declared cash dividends on our common
      stock during the past two years.





The
      table
      below sets forth information relating to our shareholder approved compensation
      plans as of the end of 2005:





**Plan
                Category**
            
            **Number
                of securities to be issued upon exercises of outstanding options,
                warrants
                and rights**
            
            **Weighted-average
                exercise price of outstanding options, warrants and
                rights**
            
            **Securities
                remaining available for future issuance (excluding securities in
                column
                (a))**(a)
            
            (b)
            
            (c)2005
                Stock Incentive Plan
            
            
            —
            
            
            —
            
            
            5,000,0002001
                Equity Compensation
            
            
            2,000,635
            
            $
            4.31
            
            
            —2000
                Equity Compensation
            
            
            2,195
            
            $
            101.59
            
            
            —1998
                Employee, Director and Consultant Stock Option
            
            
            172
            
            $
            300.00
            
            
            —1997
                Equity Compensation
            
            
            5,238
            
            $
            148.38
            
            
            —Prior
                option plans
            
            
            425,100
            
            $
            2.70
            
            
            —Employee
                Stock Purchase
            
            
            —
            
            
            —
            
            
            289,469**Total**
            
            
            2,433,340
            
            $
            4.45
            
            
            5,289,469





**Item 6.*****Selected
      Financial Data***





**Selected
      Historical Financial Information**





The
      statement of operations data presented below for the years ended
      December 31, 2003, 2004 and 2005 and the balance sheet data as of
      December 31, 2004 and 2005 have been derived from our audited consolidated
      financial statements that are included elsewhere in this report. The statement
      of operations data for the years ended December 31, 2001 and 2002 and the
      balance sheet data as of December 31, 2001, 2002, and 2003 are derived from
      audited consolidated financial statements that are not included in this report.
      These results are not necessarily indicative of results to be expected for
      any
      future period. You should read the data presented below together with our
      consolidated financial statements and related notes to those statements and
      with
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” included in this report.




14
 
  Fiscal
                    Years Ended December 31,2001*
                
                2002*
                
                2003*
                
                2004
                
                2005(In
                    thousands)Statement
                    of Operations DataRevenue:Hardware
                
                $
                1,789
                
                $
                1,911
                
                $
                1,159
                
                $
                2,476
                
                $
                2,523Services
                
                
                11,071
                
                
                3,197
                
                
                357
                
                
                189
                
                
                1,728License
                    & other
                
                
                1,740
                
                
                1,063
                
                
                1,078
                
                
                1,199
                
                
                1,148Total
                    revenue:
                
                
                14,600
                
                
                6,171
                
                
                2,594
                
                
                3,864
                
                
                5,399Cost
                    of revenue:Hardware
                
                
                1,763
                
                
                1,636
                
                
                1,320
                
                
                2,320
                
                
                2,172Services
                
                
                4,637
                
                
                116
                
                
                159
                
                
                108
                
                
                1,382Licenses
                    & other
                
                
                72
                
                
                148
                
                
                101
                
                
                98
                
                
                31Total
                    cost of revenue
                
                
                6,472
                
                
                1,900
                
                
                1,580
                
                
                2,526
                
                
                3,585Gross
                    profit
                
                
                8,128
                
                
                4,271
                
                
                1,014
                
                
                1,338
                
                
                1,814Operating
                    expenses:Sales
                    and marketing
                
                
                19,184
                
                
                3,618
                
                
                3,621
                
                
                4,305
                
                
                7,125Research
                    and development
                
                
                2,501
                
                
                1,170
                
                
                1,694
                
                
                2,065
                
                
                2,493General
                    and administrative
                
                
                14,593
                
                
                2,933
                
                
                3,452
                
                
                4,490
                
                
                10,125Loss
                    on disposal of assets
                
                
                1,655
                
                
                —
                
                
                —
                
                
                —
                
                
                —Restructuring
                    and impairment
                
                
                11,655
                
                
                687
                
                
                89
                
                
                170
                
                
                3,053Total
                    operating expenses
                
                
                49,588
                
                
                8,408
                
                
                8,856
                
                
                11,030
                
                
                22,796Loss
                    from operations
                
                
                (41,460
                )
                
                (4,137
                )
                
                (7,842
                )
                
                (9,692
                )
                
                (20,982
                )Interest
                    expense
                
                
                (10,667
                )
                
                (183
                )
                
                (158
                )
                
                (235
                )
                
                (58
                )Interest
                    income
                
                
                305
                
                
                456
                
                
                65
                
                
                115
                
                
                240Patent
                    infringement award
                
                
                —
                
                
                1,000
                
                
                —
                
                
                —
                
                
                —Loss
                    on foreign currency
                
                
                —
                
                
                —
                
                
                (491
                )
                
                —
                
                
                —Other
                    income (expense)
                
                
                (380
                )
                
                (12
                )
                
                (8
                )
                
                2
                
                
                140Loss
                    from continuing operations before income taxes
                
                
                (52,202
                )
                
                (2,876
                )
                
                (8,434
                )
                
                (9,810
                )
                
                (20,660
                )Income
                    tax benefit
                
                
                —
                
                
                197
                
                
                3,764
                
                
                —
                
                
                —Loss
                    from continuing operations after income taxes
                
                
                (52,202
                )
                
                (2,679
                )
                
                (4,670
                )
                
                (9,810
                )
                
                (20,660
                )Income
                    (loss) from discontinued operations, net of tax
                
                
                (2,377
                )
                
                1,536
                
                
                6,056
                
                
                (4,925
                )
                
                (1,360
                )Extraordinary
                    gain
                
                
                901
                
                
                —
                
                
                —
                
                
                —
                
                
                —Net
                    income (loss)
                
                
                (53,678
                )
                
                (1,143
                )
                
                1,386
                
                
                (14,735
                )
                
                (22,020
                )Preferred
                    stock dividends
                
                
                —
                
                
                (1,784
                )
                
                (1,778
                )
                
                (874
                )
                
                (439
                )Net
                    loss available to common stockholders
                
                $
                (53,678
                )
                $
                (2,927
                )
                $
                (392
                )
                $
                (15,609
                )
                $
                (22,459
                )Basic
                    and diluted net loss per share available to common stockholders:Continuing
                    operations
                
                $
                (7.99
                )
                $
                (0.65
                )
                $
                (0.87
                )
                $
                (0.65
                )
                $
                (0.85
                )Discontinued
                    operations
                
                
                (0.37
                )
                
                0.22
                
                
                0.82
                
                
                (0.30
                )
                
                (0.06
                )Extraordinary
                    gain
                
                
                0.14
                
                
                —
                
                
                —
                
                
                —
                
                
                —Basic
                    and diluted net loss per common share available to common stockholders
                
                $
                (8.22
                )
                $
                (0.43
                )
                $
                (0.05
                )
                $
                (0.95
                )
                $
                (0.91
                )Weighted
                    average common shares - basic and diluted
                
                
                6,534
                
                
                6,794
                
                
                7,365
                
                
                16,470
                
                
                24,799
 *
          As
          adjusted for discontinued operations (See Note 4 to our consolidated financial
          statements included elsewhere in this Annual Report on Form
          10-K)







15


**As
                of December 31,**2001
            
            2002
            
            2003
            
            2004
            
            2005**Balance
                Sheet Data:**
            
            (In
                thousands)Cash
                and cash equivalents, short term and long term restricted cash and
                short-term investments and securities available for sale
            
            $
            13,401
            
            $
            5,992
            
            $
            12,303
            
            $
            14,859
            
            $
            6,341Working
                capital
            
            
            3,506
            
            
            2,418
            
            
            9,216
            
            
            13,923
            
            
            5,127Total
                assets
            
            
            23,078
            
            
            18,435
            
            
            16,284
            
            
            20,244
            
            
            12,291Long-term
                liabilities
            
            
            2,392
            
            
            1,769
            
            
            181
            
            
            142
            
            
            53Total
                stockholders’ equity
            
            $
            8,770
            
            $
            8,392
            
            $
            11,465
            
            $
            15,215
            
            $
            6,345





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





*Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations* ****** *contains
      certain forward-looking statements regarding, among other things, the
      anticipated financial and operating results of the Company. Investors are
      cautioned not to place undue reliance on these forward-looking statements,
      which
      speak only as of the date hereof. We do not undertake any obligation to publicly
      release any modifications or revisions to these forward-looking statements
      to
      reflect events or circumstances occurring after the date hereof or to reflect
      the occurrence of unanticipated events. In connection with the “safe harbor”
provisions of the Private Securities Litigation Reform Act of 1995, we caution
      investors that future financial and operating results may differ materially
      from
      those projected in forward-looking statements made by, or on behalf of, us.
      Such
      forward-looking statements involve known and unknown risks, uncertainties and
      other factors that may cause our actual results, performance or achievements
      to
      be materially different form any future results, performance or achievements
      expressed or implied by such forward-looking statements. The following
      discussion is intended to assist in the understanding and assessment of
      significant changes and trends related to our results of operations and our
      financial condition together with our consolidated subsidiaries. This discussion
      and analysis should be read in conjunction with the consolidated financial
      statements and notes thereto included elsewhere in this Annual Report on
      Form 10-K. Historical results and percentage relationships set forth in the
      statement of operations, including trends which might appear, are not
      necessarily indicative of future operations.*





**OVERVIEW**




**Our
      Business**





During
      the last quarter of 2004, a fundamental restructuring of the Company was
      undertaken in order to position IPIX as the leader in immersive imaging
      technologies for visual intelligence applications. The Company develops
      immersive video and still photography products for major markets in
      surveillance, visual documentation and forensic analysis. This restructuring
      included the merging of the InfoMedia and the Security business units and a
      change in sales structure which broadened the Company’s emphasis on direct sales
      and indirect sales channel development. The new structure also enables the
      Company to develop product offerings that include both video and still products
      for customers in the same market. IPIX has aligned its product lines with its
      core competencies in immersive video and still technology. The restructuring
      was
      completed with the sale of the AdMission business unit in February of 2005.
      In
      accordance with FAS 144, the assets and liabilities related to the AdMission
      business unit were classified as held for sale at December 31, 2004, and
      the operations of this business unit were considered discontinued operations
      for
      all periods presented.





**Products**





The
      Company currently has two main product lines: Immersive Video and Immersive
      Stills.





Immersive
      Video Product Line: develops and delivers products and services that provide
      customers with enhanced situational awareness. The main product in this line
      is
      the CommandView Video. The product line consists of multi-mega-pixel, digital
      cameras, fisheye lens, patented 360° viewing technology and camera management
      software to provide a unique award-winning “see everything” video surveillance
      and security camera system that can see in all directions, simultaneously with
      no moving parts and no blind spots. Features include low light performance;
      remote, secure monitoring; digital pan-tilt-zoom; and weather reliability.





Immersive
      Stills Product Line: provides for the creation of 360° panoramic photography and
      movie content. The main product in this line is the Interactive Studio Still
      Photography product. This product provides a single integrated solution for
      panorama photographers that can automate a wide variety of tasks previously
      requiring separate tools. The technology in this product makes creating multiple
      360° images as simple as a drag-and-drop of fisheye source images into the
      application, selecting the output file formats desired and hitting the save
      button. Features include image editors, image format converter tools and high
      dynamic range image compositors.





**Target
      Markets**





The
      Company markets its immersive video and immersive stills products to commercial
      and government clients for a variety of visual intelligence applications. We
      target retail, casino and cultural properties as well as government agencies
      with responsibility for security infrastructure protection related to ports,
      harbors, waterways, dams, conventional and nuclear power stations, utilities,
      airports and mass transit rail systems. Our product offers solutions to the
      military in perimeter force protection, unmanned vehicles and special
      operations. Our products are used for facilities management as well as by
      vertical market data warehouse solutions providers such as insurance and
      mapping. In addition, we historically have targeted the real estate and
      hospitality market, professional photographers, web developers and creators
      of
      visual documentation.







16


**Business
      Models**





We
      market
      our products through a direct sales force and through channel distributors
      and
      resellers. Additionally, we sell our immersive stills software platform and
      supporting hardware over the internet.





**Business
      Trends and Conditions**





In
      March 2004, the Company launched a new family of 360° real-time video
      camera systems. Shipment of these products to distributors began in late
      June 2004. These new camera systems generate revenues from sales to both
      end-users and resellers. In April 2005, the Company launched the
      CommandViewTM Day/Night Dome camera that combines 360° views in low-light,
      no-light and infrared lighting-assisted environments. The Company continues
      to
      develop additional products and features for the security and surveillance
      market. Also in April 2005 the Company announced an OEM agreement with
      ObjectVideo to market software for intelligent video surveillance. In
      April 2005, a partnership with VistaScape was announced to integrate their
      SiteIQTM surveillance software with the Company’s CommandViewTM cameras. These
      products became available for shipment in the third quarter of 2005. A three
      megapixel version of the CommandViewTM camera was released in January
      2006.





IPIX
        still photography products primarily generate revenues through: licenses
        of
        software and the sale of camera equipment. In the past, “keys” were utilized to
        license the Company’s technology to capture and save a single immersive image.
        With the launch of the IPIX Interactive Studio, IPIX now offers time-based
        seats
        or user licenses which permit an unlimited number of immersive images to
        be
        captured and saved within a specific time period, usually a year.





In
      response to the change in sales structure, the Company hired additional sales
      staff focused on direct and channel sales to market immersive video products.
      The Company currently has approximately 87 resellers in the U.S. and eight
      distributors and resellers internationally.





The
      immersive still photography products for the virtual tour photography solution
      and the IPIX Interactive Studio are sold directly to the U.S. real estate
      market. The Host@IPIX product is being expanded to support a wider range of
      imaging technologies. As a result, the Company believes that real estate
      agents/brokers and photographers will benefit from a broader choice of panoramic
      imaging solutions and enhanced marketing capabilities.





Professional
      services are also provided to customers that request specific customizations
      or
      integrations of the Company’s products and services.





**CRITICAL
      ACCOUNTING POLICIES**





The
      following discussion and analysis of financial condition and results of
      operations is based upon the Company’s audited consolidated financial
      statements, which have been prepared in accordance with U.S. GAAP. The
      preparation of these financial statements 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. On an
      on-going basis, we evaluate our estimates, including those related to revenue
      recognition, uncollectible receivables, inventory reserves, intangible and
      other
      long-lived assets and contingencies. We base our estimates on historical
      experience and on various other assumptions that are believed 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 under different assumptions or conditions.





We
      believe the following critical accounting policies affect our more significant
      judgments and estimates used in the preparation of our consolidated financial
      statements: revenue recognition; valuation allowances, specifically the
      allowance for doubtful accounts and inventory reserves; valuation of goodwill
      and other long-lived assets; and significant accruals. We believe that full
      consideration has been given to all relevant circumstances that we may be
      subject to, and our financial statements accurately reflect Management’s best
      estimate of the results of operations, financial position and cash flows for
      the
      periods presented.







17


Management
      has discussed the development and selection of the following critical accounting
      policies, estimates and assumptions with the Audit Committee of our Board of
      Directors and the Audit Committee has reviewed these disclosures.





**Revenue
      Recognition**





We
      recognize revenue when persuasive evidence of an arrangement exists, delivery
      has occurred or services have been rendered, the contract price is fixed or
      determinable, and collectibility is reasonably assured.





We
      derive
      revenue from sales of our hardware, sales of licenses and keys for our software
      and professional services we provide to customers. Professional service revenues
      include effort performed under government contracts. Formerly professional
      services consisted of transaction hosting revenue where a reseller uses image
      management products to enhance their on-line offering. Transaction hosting
      revenue was primarily performed by the AdMission business unit which was
      discontinued in 2004 and sold in the first quarter of 2005.





Transaction
      hosting revenue (which is included in discontinued operations) was recognized
      ratably as transactions were performed provided there was persuasive evidence
      of
      an arrangement, the fee was fixed or determinable and collection of the
      resulting receivable was reasonably assured.





Hardware
      and software revenue is recognized upon shipment, if the contract shipping
      term
      is FOB shipping point, and upon delivery, if the contract shipping term is
      FOB
      destination, provided there are no uncertainties surrounding product acceptance,
      persuasive evidence of an arrangement exists, there are no significant vendor
      obligations, the fees are fixed or determinable and collection is reasonably
      assured. Initial license fees are recognized when a contract exists, the fee
      is
      fixed or determinable, software delivery has occurred and collection of the
      receivable is reasonably assured. If there are continuing obligations, then
      license fees are recognized ratably over the life of the contract. Revenue
      from
      hardware and software sales to distributors is recognized upon shipment
      (“sell-in”) if the distributor relationship does not create substantial
      uncertainty regarding fixed or determinable fees and collectibility. If at
      the
      beginning of an arrangement we determine the arrangement fee is not, or is
      presumed to not be, fixed or determinable, or there is uncertainty over
      collectibility, revenue is deferred and subsequently recognized as amounts
      become due or collected.





The
        Company recognizes revenue in accordance with Statement of Position (“SOP”)
        No. 97-2, “Software Revenue Recognition” and SOP No. 98-9,
“Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
        Transactions.” If a contract requires significant production, modification or
        customization of the software, the arrangement is accounted for as a long-term
        service contract. If it does not, software revenue is realizable when the
        following criteria are met: persuasive evidence of an arrangement exists,
        delivery has occurred or services have been rendered, the seller’s price to the
        buyer is fixed or determinable and collectibility is reasonably assured.





Other
      criteria that must be met include the determination of whether the revenue
      in
      multiple-element arrangements can be recognized separately for each element
      as
      performance occurs and the determination of the fee based on vendor-specific
      objective evidence (“VSOE”) of fair value for each element. The Company
      determines VSOE of fair value of each element by the price charged when the
      same
      element is sold separately or based on Management’s established prices for
      elements such as professional rates on comparable service contracts or the
      price
      of software with the same functionality available in the industry. If Management
      is unable to determine the VSOE of a delivered element, the revenue is
      recognized by the residual method. As performance occurs, the fee for the
      delivered item is determined by the total fee of the arrangement less the total
      fair value of the undelivered elements. The total fair value of the undelivered
      elements is deferred and subsequently recognized as performance occurs. If
      Management is unable to determine the VSOE of an undelivered element, all
      revenue from the contract is deferred until the VSOE is established or all
      performance has occurred. If the only undelivered element without VSOE of fair
      value is services that can be accounted for separately, the entire fee is
      recognized over the service period.





Our
      professional service revenue under government contracts consist primarily of
      services provided by our employees, consultants and the pass through of costs
      for equipment or other third party services. Cost of services consists primarily
      of compensation expenses for program personnel, the fringe benefits associated
      with this compensation, consulting labor and other direct expenses incurred
      to
      complete programs, including cost of equipment. The current government contract
      is a cost-plus-fixed-fee contract. Revenues for cost-reimbursement contracts
      are
      recorded as reimbursable costs are incurred, including a pro-rata share of
      the
      contractual fees.





The
      Company recognizes other professional service revenue from long-term service
      contracts in accordance with Accounting Research Bulletin (“ARB”) No. 45,
“Long-Term Construction Type Contracts,” using the relevant guidance in SOP
      81-1, “Accounting for Performance of Construction-Type and Certain
      Production-Type Contracts,” as determined by the terms and conditions of the
      Company’s contracts with its customers. Revenue is typically recognized ratably
      over the contractual periods or as services are performed. In addition, when
      professional service contracts involve software that is essential to the
      functionality of the delivered software product, revenue from the entire
      arrangement is recognized as services are performed on a percentage of
      completion method or not until the contract is completed. In fixed price
      contracts, revenue is recognized based on the percentage of completion method,
      income is recognized at a consistent profit margin over the period of
      performance based on estimated profit margins at completion of the contract.
      This method of accounting requires estimating the total revenues and total
      contract cost at completion of the contract. Estimated losses on contracts
      at
      completion are recognized when identified.







18


**Allowances
      for Doubtful Accounts**





Significant
      Management judgments and estimates must be made and used in connection with
      establishing the allowance for doubtful accounts in any accounting period.
      Management specifically analyzes accounts receivable and historical bad debts,
      customer concentrations, customer credit-worthiness, current economic trends
      and
      changes in the customer payment terms when evaluating the adequacy of the
      allowance for doubtful accounts. Material differences could result in the amount
      and timing of expense recorded if Management had different judgment or utilized
      different estimates as the latter related to different reporting periods.





**Reserve
      for Inventory Obsolescence**





Significant
      Management estimates must be made and used in conjunction with establishing
      the
      inventory obsolescence reserve in any accounting period. This may occur as
      a
      result of technological advances, out of production sub-assemblies, radical
      changes in market demand or change of suppliers. Management periodically reviews
      the inventory aging, turnover, sales forecast as well as input from vendors
      in
      determining the appropriate amount of the reserve.




**Goodwill**




We
      evaluated goodwill for impairment on an annual basis and on an interim basis
      if
      events or changes in circumstances between annual impairment tests indicate
      that
      the asset might be impaired. In assessing the recoverability of our goodwill,
      we
      made assumptions regarding estimated future cash flows and other factors to
      determine the fair value of the goodwill. These estimates included forecasted
      revenues and operating expenses, which are inherently difficult to predict.
      We
      believe that the accounting estimate related to goodwill is a “critical
      accounting estimate” because it requires Company management to make assumptions
      about fair values. During the fourth quarter of 2003, certain events, including
      the end of the agreement with eBay, led the Company to perform an impairment
      review of goodwill. The eBay agreement ended in November 2003 and was the
      primary source of cash flows for the technology associated with goodwill in
      the
      AdMission business unit. This review indicated that goodwill was being carried
      at amounts in excess of the fair value based on estimated discounted future
      cash
      flows of the AdMission business unit. As a result, an impairment charge was
      recorded to expense in the year ended December 31, 2003.




**Significant
        Accruals, including Restructuring Charges, Discontinued Operations and Sales
        Tax**





We
      recorded restructuring charges associated with vacated facilities and reductions
      in personnel staffing levels. The key assumptions associated with these charges
      include the timing and amount of sub-lease income. In addition, in establishing
      and providing for sales tax accruals, we make judgments based on the actual
      tax
      laws and guidance. While Management believes that its judgments and
      interpretations regarding tax liabilities are appropriate, significant
      differences in actual experience may materially affect the Company’s future
      financial results.





**RESTRUCTURING
      ACTIONS AND DISCONTINUED OPERATIONS**





We
      executed several reorganizing actions throughout 2003, 2004 and 2005 including
      discontinuing operations in San Ramon, CA and restructuring operations in Oak
      Ridge, TN. These actions and the charges relating to them are described below.





During
      the fourth quarter in 2003 and 2004, $0.1 million and $0.2 million,
      respectively, of restructuring charges were recorded related to expenses
      associated with the lease obligations from previously vacated office space
      in
      San Ramon, CA.





In
      2004
      and 2005, we reflected losses from discontinued operations of approximately
      $6.285 million in connection with the AdMission business unit, which was
      sold in the first quarter of 2005. Approximately $4.925 million was incurred
      in
      2004 and approximately $1.360 million was incurred in the first quarter of
      2005.





We
      anticipate incurring approximately $3 million dollars in total restructuring
      costs related to restructuring of the Company’s operations in California and
      Tennessee, costs consisting primarily of future lease payments, severance
      payments, impairment of fixed assets, and re-configuration of IT infrastructure.
      $2.799 million of these anticipated costs were incurred in 2005 per the table
      below.




**San
                Ramon**
            
            **Oak
                Ridge**
            
            **Total**Lease
            
            $
            1,061
            
            $
            304
            
            $
            1,365Severance
            
            
            362
            
            
            3
            
            
            365Information
                Systems Relocation
            
            
            
            
            
            36
            
            
            36Fixed
                Asset Buyout
            
            
            747
            
            
            
            
            
            747Fixed
                Asset Write-down
            
            
            
            
            
            221
            
            
            221Other
            
            
            59
            
            
            6
            
            
            65**TOTALS**
            
            **$**
            **2,229**
            
            **$**
            **570**
            
            **$**
            **2,799**







19


The
      activity in the current and long-term restructuring and discontinued operations
      accruals for the years ended December 31, were as follows:





**Balance
                Dec.31,**
            
            **Expense
                in**
            
            **Payments/
                Write-offs**
            
            **Balance
                Dec. 31,**
            
            **Expense
                in**
            
            **Payments/**
            
            **Balance
                Dec. 31,**
            
            **Expense
                in**
            
            **Payments/
                Write-offs**
            
            **Balance
                Dec. 31,****2002**
            
            **2003**
            
            **in
                2003**
            
            **2003**
            
            **2004**
            
            **in
                2004**
            
            **2004**
            
            **2005**
            
            **in
                2005**
            
            **2005**(In
                thousands)Severance
            
            $
            500
            
            $
            —
            
            $
            (500
            )
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            365
            
            $
            (354
            )
            $
            3Other
            
            
            549
            
            
            89
            
            
            (267
            )
            
            371
            
            
            170
            
            
            (284
            )
            
            257
            
            
            2,434
            
            
            (1,685
            )
            
            1,014Total
            
            $
            1,049
            
            $
            89
            
            $
            (767
            )
            $
            371
            
            $
            170
            
            $
            (284
            )
            $
            257
            
            $
            2,799
            
            $
            (2,039
            )
            $
            1,017





**OUTLOOK**





Our
      business model has been modified substantially over the past three years, and
      we
      have only a limited operating history in marketing security and surveillance
      systems. Our prospects should be considered in light of the risks,
      uncertainties, expenses and difficulties frequently encountered by companies
      in
      new and rapidly evolving markets. To address these risks, we must, among other
      things, be able to continue to:




·
            deliver
                high quality products and services;


·
            respond
                to highly competitive developments;


·
            attract,
                retain and motivate qualified
                personnel;


·
            implement
                and successfully execute our marketing
                plans;


·
            continue
                to upgrade our technologies;


·
            develop
                new distribution channels; and


·
            improve
                our operational and financial
                systems.





Our
      product mix and business units have changed over the past few years. In early
      2005, we sold our AdMission business unit to AdMission Corporation. In order
      to
      reduce our operating costs to a sustainable level given current revenues, we
      have gone through several restructurings during the past four years. Beginning
      in 2005, our core business is immersive still and video imaging product lines.





In
      addition, we are subject to generally prevailing economic conditions and, as
      such, our success in 2006 will be dependent upon our ability to provide quality
      products and services, the success of our customers and the appropriations
      processes of various commercial and governmental entities. We expect to continue
      to invest in the development, sale and marketing of new products for the
      immersive imaging market which may consume our cash reserves.





We
      are
      monitoring our cash position carefully and evaluating our future operating
      cash
      requirements in the context of our strategy, business objectives and expected
      business performance. Our focus in 2006 will be to manage cash requirements
      and
      focus our operations on efficient spending. We finished 2005 with approximately
      $6.34 million in cash reserves (cash and cash equivalents of
      $4.86 million, and short-term investments of $1.48 million).





In
      2006,
      we plan to continue to develop and market our immersive video and still product
      lines. Depending upon the success of each of our these products, the timeliness
      of collection of our accounts receivable and other potential working capital
      needs, as well as the timing and rate of revenue growth and our ability to
      control costs, we may require additional equity or debt financing to meet future
      working capital or capital expenditure needs. There can be no assurance that
      such additional financing will be available or if available, that such financing
      can be obtained on terms satisfactory to us. If we are not able to raise
      additional funds, we may be required to significantly curtail some of our
      operations and this would have an adverse effect on our financial position,
      results of operations and cash flow.





20


Management’s
      focus in 2006 will be to manage cash requirements and focus our operations
      on
      efficient spending. Our long-term strategy remains unchanged. We will continue
      to make investments in sales and marketing as well as research and development
      in order to fulfill our expectations in the development of new immersive
      products and services.







Fiscal
                  Years Ended December 31,2003*
              
              2004
              
              2005(In
                  thousands except per share data)Revenue:Hardware
              
              $
              1,159
              
              $
              2,476
              
              $
              2,523Services
              
              
              357
              
              
              189
              
              
              1,728License
                  & other
              
              
              1,078
              
              
              1,199
              
              
              1,148Total
                  revenue:
              
              
              2,594
              
              
              3,864
              
              
              5,399Cost
                  of revenue:Hardware
              
              
              1,320
              
              
              2,320
              
              
              2,172Services
              
              
              159
              
              
              108
              
              
              1,382Licenses
                  & other
              
              
              101
              
              
              98
              
              
              31Total
                  cost of revenue
              
              
              1,580
              
              
              2,526
              
              
              3,585Gross
                  profit
              
              
              1,014
              
              
              1,338
              
              
              1,814Operating
                  expenses:Sales
                  and marketing
              
              
              3,621
              
              
              4,305
              
              
              7,125Research
                  and development
              
              
              1,694
              
              
              2,065
              
              
              2,493General
                  and administrative
              
              
              3,452
              
              
              4,490
              
              
              10,125Restructuring
                  and impairment
              
              
              89
              
              
              170
              
              
              3,053Total
                  operating expenses
              
              
              8,856
              
              
              11,030
              
              
              22,796Loss
                  from operations
              
              
              (7,842
              )
              
              (9,692
              )
              
              (20,982
              )Interest
                  expense
              
              
              (158
              )
              
              (235
              )
              
              (58
              )Interest
                  income
              
              
              65
              
              
              115
              
              
              240Loss
                  on foreign currency
              
              
              (491
              )
              
              —
              
              
              —Other
                  income (expense)
              
              
              (8
              )
              
              2
              
              
              140Loss
                  from continuing operations before income taxes
              
              
              (8,434
              )
              
              (9,810
              )
              
              (20,660
              )Income
                  tax benefit
              
              
              3,764
              
              
              —
              
              
              —Loss
                  from continuing operations after income taxes
              
              
              (4,670
              )
              
              (9,810
              )
              
              (20,660
              )Income
                  (loss) from discontinued operations, net of tax
              
              
              6,056
              
              
              (4,925
              )
              
              (1,360
              )Net
                  income (loss)
              
              
              1,386
              
              
              (14,735
              )
              
              (22,020
              )Preferred
                  stock dividends
              
              
              (1,778
              )
              
              (874
              )
              
              (439
              )Net
                  loss available to common stockholders
              
              $
              (392
              )
              $
              (15,609
              )
              $
              (22,459
              )Basic
                  and diluted net loss per share available to common stockholders:Continuing
                  operations
              
              $
              (0.87
              )
              $
              (0.65
              )
              $
              (0.85
              )Discontinued
                  operations
              
              
              0.82
              
              
              (0.30
              )
              
              (0.06
              )Basic
                  and diluted net loss per common share available to common stockholders
              
              $
              (0.05
              )
              $
              (0.95
              )
              $
              (0.91
              )Weighted
                  average common shares - basic and diluted
              
              
              7,365
              
              
              16,470
              
              
              24,799





*
                As a*As
                adjusted for discontinued operations (See Note 4 to our consolidated
                financial statements)





21


The
      following table presents for the periods indicated, the percent relationship
      to
      total revenues of select items of our statement of operations:





**Fiscal
                Years Ended December 31,****2003***
            
            **2004**
            
            **2005**Revenue:Hardware
            
            
            44.7
            %
            
            64.1
            %
            
            46.7
            %Services
            
            
            13.7
            %
            
            4.9
            %
            
            32.0
            %License
                & other
            
            
            41.6
            %
            
            31.0
            %
            
            21.3
            %Total
                revenue:
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Cost
                of revenue:Hardware
            
            
            50.9
            %
            
            60.0
            %
            
            40.2
            %Services
            
            
            6.1
            %
            
            2.8
            %
            
            25.6
            %Licenses
                & other
            
            
            3.9
            %
            
            2.6
            %
            
            0.6
            %Total
                cost of revenue
            
            
            60.9
            %
            
            65.4
            %
            
            66.4
            %Gross
                profit
            
            
            39.1
            %
            
            34.6
            %
            
            33.6
            %Operating
                expenses:Sales
                and marketing
            
            
            139.6
            %
            
            111.4
            %
            
            132.0
            %Research
                and development
            
            
            65.3
            %
            
            53.4
            %
            
            46.2
            %General
                and administrative
            
            
            133.1
            %
            
            116.2
            %
            
            187.5
            %Restructuring
                and impairment
            
            
            3.4
            %
            
            4.4
            %
            
            56.5
            %Total
                operating expenses
            
            
            341.4
            %
            
            285.4
            %
            
            422.2
            %Loss
                from operations
            
            
            (302.3
            )%
            
            (250.8
            )%
            
            (388.6
            )%Interest
                expense
            
            
            (6.1
            )%
            
            (6.1
            )%
            
            (1.1
            )%Interest
                income
            
            
            2.5
            %
            
            3.0
            %
            
            4.4
            %Loss
                on foreign currency
            
            
            (18.9
            )%
            
            —
            
            
            —Other
                income (expense)
            
            
            (0.3
            )%
            
            0.1
            %
            
            2.6
            %Loss
                from continuing operations before income taxes
            
            
            (325.1
            )%
            
            (253.8
            )%
            
            (382.7
            )%Income
                tax benefit
            
            
            145.1
            %
            
            0.0
            %
            
            0.0
            %Loss
                from continuing operations after income taxes
            
            
            (180.0
            )%
            
            (253.8
            )%
            
            (382.7
            )%Income
                (loss) from discontinued operations, net of tax
            
            
            233.5
            %
            
            (127.5
            )%
            
            (25.2
            )%Net
                income (loss)
            
            
            53.5
            %
            
            (381.3
            )%
            
            (407.9
            )%





*
                As a*As
                adjusted for discontinued operations(See
                Note 4 to our consolidated financial statements)




**RESULTS
      OF OPERATIONS FOR 2005, 2004 AND 2003**





**Revenue**


**Fiscal
                Years Ended December 31,**
            
            **Percent
                Change in****2003***
            
            **2004**
            
            **2005**
            
            **2004**
            
            **2005****(In
                thousands)**Revenue:Hardware
            
            
            
            
            $
            1,159
            
            $
            2,476
            
            $
            2,523
            
            
            113.6
            %
            
            1.9
            %Services
            
            
            
            
            
            357
            
            
            189
            
            
            1,728
            
            
            (47.1
            )%
            
            814.3
            %License
                & other
            
            
            
            
            
            1,078
            
            
            1,199
            
            
            1,148
            
            
            11.2
            %
            
            (4.3
            )%Total
                revenue:
            
            
            
            
            
            2,594
            
            
            3,864
            
            
            5,399
            
            
            49.0
            %
            
            39.7
            %Cost
                of revenue:Hardware
            
            
            
            
            
            1,320
            
            
            2,320
            
            
            2,172
            
            
            75.8
            %
            
            (6.4
            )%Services
            
            
            
            
            
            159
            
            
            108
            
            
            1,382
            
            
            (32.1
            )%
            
            1179.6
            %Licenses
                & other
            
            
            
            
            
            101
            
            
            98
            
            
            31
            
            
            (3.0
            )%
            
            (68.4
            )%Total
                cost of revenue
            
            
            
            
            
            1,580
            
            
            2,526
            
            
            3,585
            
            
            59.9
            %
            
            41.9
            %Gross
                profit
            
            
            
            
            $
            1,014
            
            $
            1,338
            
            $
            1,814
            
            
            32.0
            %
            
            35.6
            %





*
      As
      adjusted for discontinued operations (See Note 4 to our consolidated financial
      statements)





The
      Company derives its revenue from its 360° technology through licenses of
      software and from hardware sales of camera equipment, and from professional
      services. Total revenue for the year ended December 31, 2005 was
      $5,399,000, an increase of $1,535,000, or 40% as compared to the twelve months
      ended December 31, 2004. For the year 2004, revenue of $3,864,000 increased
      by $1,270,000 or 49% as compared to the same period the prior year.





22


For
      the
      twelve months ended December 31, 2005, total hardware sales increased to
      $2,523,000 or 2%, as compared to the prior year. However, for the twelve months
      ended December 31, 2005, hardware sales of the immersive video products
      increased to $2,042,000 or 30%, as compared to the prior year. It should be
      noted that these 2005 hardware sales reflect lower shipments, by $716,000 versus
      2004, to the Company’s UK distributor (NMI), whose exclusive distribution
      agreement was terminated during the third quarter of 2005. NMI continues to
      operate under a non-exclusive distribution agreement in the UK. For the year
      ended December 31, 2005 hardware sales of the immersive stills products
      decreased to $481,000, or 47% as compared to the same periods in 2004. The
      Company has deemphasized sales of commercially available cameras which have
      low
      margin opportunities. Hardware for the immersive stills product line consists
      of
      brand name cameras which can be obtained from the brand’s major distributors at
      competitive prices. For the year 2004, hardware sales increased to $2,476,000
      or
      113% as compared to 2003. This increase reflects the rollout of the video
      product in 2004 as compared to minimal shipments, primarily for demo units,
      in
      2003.





Professional
      services revenue for the twelve months of 2005 of $1,728,000 represents an
      increase of $1,539,000 over the same period the prior year. $1,391,000 of this
      increase is due to the efforts expended on the first phase of the
      $2.4 million research contract from the Defense Advanced Research Projects
      Agency (DARPA) to research and build the world’s highest resolution video
      camera. Other professional services arising from video products’ clients totaled
      $217,000 for which there was no comparable prior year revenue. Professional
      services related to the immersive stills product line decreased $69,000 in
      the
      current period as compared to the prior year reflecting lower training revenue.
      For the year 2004, professional services declined to $189,000 or a decrease
      of
      47% as compared to 2003. This reflected lower services and training related
      to
      the stills products.





License
      and other revenue, primarily related to the immersive stills product line,
      decreased to $1,148,000, a decrease of 4% for the twelve months ended
      December 31, 2005 as compared to the same period the prior year. This was
      primarily due to a general decline in stills business. For the year 2004,
      license and other revenue increased to $1,199,000 or 11% over the same period
      of
      2003. This was primarily due to the shift away from keys to licensing of the
      stills software.




**Cost
      of Revenue**





The
      Company’s cost of revenue consists of cost of components and assembled units for
      video and immersive stills cameras, internally developed software, licensed
      software, fulfillment and shipping costs, customer and technical support,
      internet hosting fees, professional service expenses and direct labor. Total
      cost of revenue for the year ended December 31, 2005 was $3,585,000, an increase
      of $1,059,000, or 42% as compared to the year ended December 31, 2004. For
      the year 2004, cost of revenue of $2,526,000 increased by $946,000 or 60% as
      compared to the same period the prior year.





Hardware
      cost of revenue decreased 6% as compared to a 2% increase in hardware revenue,
      resulting in a hardware gross margin for the twelve months ended
      December 31, 2005 of 14% as compared to 6% for the same period in 2004. The
      increase in hardware gross margin is due to improved margins for both video
      and
      stills products in 2005 as compared to the same period the prior year. For
      the
      year 2004, hardware cost of sales increased to $2,320,000 or 76% as compared
      to
      2003. This increase reflects the rollout of the video product in 2004 as
      compared to minimal shipments, primarily for demo units, in 2003.





Professional
      service costs increased significantly in 2005 over 2004, primarily as a result
      of performance under the cost-plus-fixed-fee DARPA contract that has low gross
      margin relative to revenue. The cost for professional services for the DARPA
      contract is due primarily to direct labor and other direct purchased costs.
      The
      DARPA contract gross margin is 9%. For the year 2004, professional services
      cost
      declined to $108,000 or a decrease of 32% as compared to 2003. This reflected
      lower services and training related to the stills products.





Cost
      of
      license and other revenue for the year ended December 31, 2005 decreased 68%
      from the same period 2004 which is greater than the 4% decrease in license
      and
      other revenue. This was the result of improving revenue derived from our on-line
      store that has minimal variable cost associated with this type of sale. For
      the
      year 2004, cost of license and other revenue decreased to $98,000 or a decrease
      of 3% versus the same period of 2003. This was primarily due to the shift away
      from keys to licensing of the stills software.





23


**Operating
      Expenses**


**Fiscal
                Years Ended December 31,**
            
            **Percent
                Change in****2003***
            
            **2004**
            
            **2005**
            
            **2004**
            
            **2005**(In
                thousands)Operating
                expenses:Sales
                and marketing
            
            $
            3,621
            
            $
            4,305
            
            $
            7,125
            
            
            18.9
            %
            
            65.5
            %Research
                and development
            
            
            1,694
            
            
            2,065
            
            
            2,493
            
            
            21.9
            %
            
            20.7
            %General
                and administrative
            
            
            3,452
            
            
            4,490
            
            
            10,125
            
            
            30.1
            %
            
            125.5
            %Restructuring
                and impairment
            
            
            89
            
            
            170
            
            
            3,053
            
            
            91.0
            %
            
            1695.9
            %Total
                operating expenses
            
            $
            8,856
            
            $
            11,030
            
            $
            22,796
            
            
            24.5
            %
            
            106.7
            %*
                As adjusted for discontinued operations (See Note 4 to our consolidated
                financial statements)





*Sales
      and Marketing.* Sales
      and
      marketing expenses for the year ended December 31, 2005 of $7,125,000 increased
      by $2,820,000, or 66% as compared to the same period 2004. This increase is
      primarily due to additional sales personnel and expenditures focused on building
      strong product awareness for the immersive video product line. The increase
      primarily consisted of employee salary, benefits, commissions and recruitment
      expenses related to the increase in our sales force of $1,233,000; an increase
      in marketing, travel and trade show activities of $1,222,000; as well as
      facility and related expenses of $316,000. For the year 2004, sales and
      marketing expenses increased to $4,305,000 or 19% as compared to the prior
      year,
      as the company began to build its sales and marketing activities to support
      the
      immersive video products.





*Research
      and Development* .
      Research and development expenses consist primarily of personnel costs and
      consulting labor related to building and enhancing our digital media
      infrastructure and immersive imaging technology.





Research
      and development expense for the twelve month period ended December 31, 2005
      was $2,493,000 These expenses increased by $428,000 in 2005 as compared to
      the
      same period 2004. The increase in expenses is due to increased head count of
      research and engineering personnel focused on the integration of the IPIX IP
      camera into a variety of digital video recording (DVR) devices utilized in
      the surveillance market that IPIX addresses and development of a three megapixel
      version of the camera introduced in January 2006, as well as the cost of filing
      and maintaining the company’s patent portfolio. For the year 2004, research and
      development expenses increased to $2,065,000 or 22% as compared to the same
      period the prior year as the company focused on the new family of Full-360
      degree security cameras.





*General
      and Administrative.* General
      and administrative expenses consist primarily of salaries and related benefits
      for administrative and executive staff, fees for outside professional services,
      legal fees, insurance and other costs associated with being a public company.





General
      and administrative expenses of $10,125,000 increased by $5,635,000 for the
      year
      ended December 31, 2005 as compared to the same period of 2004. For the
      twelve months ended December 31, 2005, the increase over the prior year was
      primarily a result of: increase in headcount of executive, administrative,
      and
      consulting professionals resulting in an increase in salaries, benefits, fees,
      bonuses and related costs of $250,000; an increase in recruiting costs of
      $69,000; an increase in expenses of $917,000 incurred in association with
      compliance with public company regulations, including Sarbanes-Oxley compliance;
      an increase in professional fees to lawyers primarily due to patent litigation
      of $2,729,000 and SEC filing, and other shareholder activities of $236,000;
      and
      an increase of $502,000 in director and officer’s insurance premiums due to
      increased coverage and rates. In addition, facilities expenses increased
      $889,000 due to an increase in rent of the new facilities in Tennessee and
      Virginia and also an increase in depreciation from acquisitions of furniture
      and
      computer equipment. For the year 2004, general and administrative expenses
      increased to $4,490,000 as compared to the year 2003, primarily due to an
      increase in expenses incurred in association with compliance with public company
      regulations, including Sarbanes-Oxley compliance and corporate system
      enhancements, and an increase in director and officer’s insurance premiums due
      to increased coverage.





*Restructuring
      and Impairment Charges* .
      In the
      first quarter of 2005, the Company entered into a plan to move the executive
      office from California to Virginia upon the sale of the AdMission business
      unit
      which comprised the following actions: termination of certain employees,
      termination of a lease for equipment, abandon certain fixed assets and abandon
      an additional operating lease. As a result, in 2005, the Company paid
      approximately $362,000 in severance expenses, paid a buy out fee of $747,000,
      which included penalties and a forfeited deposit, to terminate the lease for
      the
      computer equipment and wrote off $11,000 of fixed assets. In addition, a charge
      of $1,061,000 representing the net present value of the abandoned leased office
      space was recorded as restructuring charges. In the fourth quarter of 2005,
      the
      company closed its Oak Ridge, Tennessee facility. As a result of this closing,
      a
      charge of $304,000 representing the net present value of the abandoned leased
      office space was recorded as restructuring charges; other costs of $36,000
      for
      the relocation the Information Technology and engineering development systems
      to
      Virginia were accrued as were $221,000 in write-downs of fixed assets and
      miscellaneous expenses.





24


Loss
      on
      impairment of AdMission preferred stock for the twelve months ended
      December 31, 2005 was $253,000. This amount was due to a write down to zero
      in the first quarter of 2005 the net book value of the investment which was
      acquired as a result of the sale of the AdMission business unit (see Note 4).
      Restructuring and impairment charges in 2004 and 2003 relate primarily to
      changed estimates for outstanding lease obligations. See Note 5 in the
      accompanying financial statements.





**Other
      Income (Expense)**


**Fiscal
                Years Ended December 31,**
            
            **Percent
                Change in****2003***
            
            **2004**
            
            **2005**
            
            **2004**
            
            **2005**(In
                thousands except percentages)Interest
                expense
            
            $
            (158
            )
            $
            (235
            )
            $
            (58
            )
            
            48.7
            %
            
            (75.3
            )%Interest
                income
            
            
            65
            
            
            115
            
            
            240
            
            
            76.9
            %
            
            108.7
            %Loss
                on foreign currency
            
            
            (491
            )
            
            -
            
            
            -
            
            
            N/A
            
            
            N/AOther
                income (expense)
            
            
            (8
            )
            
            2
            
            
            140
            
            
            125
            %
            
            6900
            %Total
                other income (expense), net
            
            $
            (592
            )
            $
            (118
            )
            $
            322
            
            
            80.1
            %
            
            372.9
            %





*
      As
      adjusted for discontinued operations (See Note 4 to our consolidated financial
      statements)





*Other
      Income (Expense), Net* .
      Other
      income (expense) for the twelve months ended December 31, 2005 was $322,000
      as compared to an expense of $118,000 for the same period in 2004. This increase
      is primarily due to the sale of one of the Company’s discontinued web domain
      names during the first quarter of 2005 for which there is no such amount in
      2004. In addition, increased interest rates and higher balances for the period
      in cash and short-term investments also caused an increase. For the years 2004
      and 2003, the interest expense relates to capital lease obligations and interest
      income reflects earnings in increased investment balances. The loss on foreign
      currency in 2003 was due to the recognition of cumulative currency translations
      from dissolved foreign subsidiaries.





*Loss
      from Discontinued Operations* .
      Loss
      from discontinued operations net of tax was $1,360,000 for the twelve months
      ended December 31, 2005, compared to $4,925,000 for the same period in
      2004. This was due to the discontinued operations of the Company’s AdMission
      business unit which was classified as discontinued operations in the fourth
      quarter of 2004 and sold in the first quarter of 2005. The prior period results
      were reclassified to properly classify the business unit as discontinued
      operations.





*Net
      Loss* .
      As a
      result of the factors described above, the net loss for the twelve months ended
      December 31, 2005 was $22,020,000. This was an increase of $7,285,000 as
      compared to the same periods in 2004. Net loss for 2004 was $14,735,000 versus
      a
      net profit of $1,386,000 in 2003.





**LIQUIDITY
      AND CAPITAL RESOURCES**





Since
      inception, the Company has financed its operations through registered public
      offerings, the private placements of capital stock, a convertible debenture,
      a
      convertible promissory note and warrant and option exercises. At
      December 31, 2005, the Company had $6.34 million of cash reserves, which
      consisted of cash, cash equivalents of $4.86 and a short-term investment of
      $1.48 million.





**Common
      Stock**





During
      2005, IPIX issued 1,165,445 shares of common stock upon exercise of stock
      options. Total proceeds from the option exercises were $2.38 million. Also,
      in 2005, IPIX sold 90,418 shares of common stock to employees under the IPIX
      Employee Stock Purchase Plan (“ESPP”). Proceeds from these ESPP purchases were
      $.173 million. As of December 31, 2005, we have collected $22,000 for our
      employees’ second quarter 2006 ESPP purchases.





On
      June
      21, 2005 IPIX completed a private placement of 4,149,376 shares of common stock,
      which generated net proceeds of $9.8 million. As part of the private placement,
      IPIX entered into a Securities Purchase Agreement (the "Purchase Agreement"),
      dated June 21, 2005, with Iroquois Master Fund Ltd and certain other purchasers
      (collectively, the "Purchasers"). Pursuant to the Purchase Agreement, IPIX
      sold
      $10,000,000 of its $0.001 par value common stock (the "Common Stock"),
      additional investment rights (the "AIR") and warrants (the "Warrants"). With
      each share of common stock purchased at $2.41, each Purchaser is entitled under
      the Purchase Agreement to receive an AIR to purchase 0.06 of a share of common
      stock and a Warrant to purchase 0.44 of a share of common stock. The exercise
      price for each AIR is $2.41 per share, and the exercise price of each warrant
      is
      $3.11 per share. AIRs were exercisable immediately, and Warrants could not
      be
      exercised until six months after issuance. The AIR rights were exercisable
      until
      December 22, 2005 by which time purchasers had acquired 87,596 shares of common
      stock with proceeds of $200,000 to the Company. Warrants expire four years
      after
      date of issuance. The common stock sold in the transaction and from the AIRs
      has
      been registered under the Securities Act of 1933, as amended, and may be offered
      or sold in the United States.




25


In
      connection with the initial sale and the exercise of the AIR rights, IPIX paid
      Olympus Securities, LLC (the "Olympus") a placement fee of $236,805. IPIX also
      issued to Olympus warrants to purchase 211,849 shares of common stock at an
      exercise price of $3.11 per share.




During
      2004, IPIX issued 2,190,632 shares of common stock upon exercise of stock
      options. Total proceeds from the option exercises were $5.3 million. Also,
      in 2004, IPIX sold 293,219 shares of common stock to employees under the IPIX
      Employee Stock Purchase Plan (“ESPP”). Proceeds from these ESPP purchases were
      $400,000.





On
      April 5, 2004, IPIX completed the sale of 909,090 shares of our common
      stock, resulting in net proceeds received of approximately $4.9 million,
      and additional investment rights (“AIR”) to purchase another 888,180 shares of
      our unregistered common stock in a private offering to accredited institutional
      investors (“PIPE”). The shares of common stock were sold at $5.50 per share and
      the shares of common stock underlying the AIR are purchasable at $6.05 per
      share. The AIR was exercisable until September 28, 2004, at which time all
      AIRs had been exercised resulting in net proceeds of $5.4 million. The
      common stock sold in the PIPE and from the AIRs has been registered under the
      Securities Act of 1933, as amended, and may be offered or sold in the United
      States.





**Preferred
      Stock**





At
      December 31, 2003, there were two Tranche A warrants (“Warrant 1” and
“Warrant 2”) outstanding. During 2004, Warrant 1, which entitled the holders to
      purchase 150,000 shares of Series B Preferred Stock at $20 per share, was
      exercised in full. IPIX received $3.0 million in cash from the exercise of
      Warrant 1 and the conversion of the underlying Series B Preferred Stock.
      Warrant 2 entitles the holders to purchase 100,000 shares of Series B
      Preferred Stock at $40 per share and is exercisable at any time before the
      expiration date of May 14, 2006. During 2004, 400 shares of Warrant 2 were
      converted into 2,914 shares of common stock. We did not receive any proceeds
      from this exercise. During 2004, 862,833 shares of Series B preferred
      shares were converted into 8,557,923 common shares. During the third quarter
      of
      2005, 41,380 shares of Warrant 1 were converted into 381,007 shares of common
      stock. We did not receive any proceeds from the third quarter Warrant 1
      exercise. During the fourth quarter of 2005, 2,100 shares of Warrant 1 were
      converted into 19,336 shares of common stock. The Company did not receive any
      proceeds from the fourth quarter Warrant 1 exercise. In conjunction with the
      Warrant 1 exercise the Company issued 22,847 shares of common stock as a result
      of the conversion of accumulated and unpaid dividends on the related Warrant
      1
      preferred shares.





**Other
      Liquidity and Capital Resources**





**Summary
                Consolidated Cash Flow Data****Twelve
                months ended December 31,****2004**
            
            **2005**(In
                thousands)Net
                cash used in operating activities
            
            $
            (15,218
            )
            $
            (17,904
            )Net
                cash used in investing activities
            
            
            (394
            )
            
            (2,064
            )Net
                cash provided by financing activities
            
            
            18,155
            
            
            12,044Net
                increase (decrease) in cash and cash equivalents
            
            
            2,543
            
            
            (7,924
            )Cash
                and cash equivalents, beginning of period
            
            
            10,241
            
            
            12,784Cash
                and cash equivalents, end of period
            
            $
            12,784
            
            $
            4,860





Cash
      flows from operating activities for the twelve months ending December 31,
      2005, reflect a net loss of $22,020,000 as compared to a net loss of $14,735,000
      for the same period 2004. The increase in net loss is primarily due to an
      increase in sales and marketing expenses of $2.8 million for an expanded
      focus on building direct and channel sales, an increase in general and
      administrative expenses of $5.6 million due to relocation of company
      headquarters, litigation expense, and increased public company expenses to
      comply with new legislation requiring additional documentation of internal
      controls, and fees associated with the sale of the AdMission business unit.
      Also
      impacting the change in operating activities is an increase in accounts
      receivable of $953,000, offset by a decrease in inventory purchases as compared
      to the prior year of $321,000, a decrease of prepaid expenses and other assets
      of $1,699,000 due to the reclassification of collateral held for a letter of
      credit to short term investment and the release of assets held for sale relating
      to the discontinued operations and sale of the AdMission business unit and
      an
      increase in accounts payable and accruals of $1,452,000.





26


The
      Company incurred non-cash compensation expenses of: $819,000 associated with
      the
      acceleration of stock options for terminated employees, $740,000 in
      depreciation, and $221,000 write-down of fixed assets. Deferred revenue
      decreased by $84,000, since there was no deferred revenue at December 31,
      2005.





Net
      cash
      used in investing activities for the twelve months ending December 31, 2005
      was $2,064,000 compared with $394,000 for the same period in 2004. The change
      was primarily related to the acquisition of computer software and hardware
      to
      build-out of a new computer and communication center in Oak Ridge, Tennessee
      and
      Reston, Virginia.





Net
      cash
      provided by financing activities for the twelve months ending December 31,
      2005 was primarily related to $9,759,000 of net proceeds from the private
      placement of common stock in June 2005 compared to $4,920,000 of net proceeds
      from a private placement of common stock in April 2004. Offsetting the increased
      cash from private placement financings, the Company had a $3,157,000 decrease
      in
      net proceeds from the exercise of stock options and employee stock purchase
      plan
      proceeds for the twelve months ended December 31, 2005 compared with the
      same period in 2004. As compared to the twelve month period 2004, the Company
      did not have similar exercise in the current year of warrants and Additional
      Investment Rights resulting in lower cash proceeds of $8,161,000. The Company
      paid, during 2005, $185,000 in dividends to Series B preferred shareholders
      upon
      exercise of conversion rights of the preferred for common shares as compared
      to
      $452,000 paid in 2004.





During
      the twelve months ended December 31, 2005 and in the prior fiscal years,
      the Company experienced, and continues to experience, certain issues related
      to
      cash flow and profitability. These factors raise substantial doubt about the
      Company’s ability to continue as a going concern. The Company completed a
      $10 million private placement of common stock, including additional
      investment rights and warrants to a group of existing and new institutional
      investors on June 21, 2005. Management will monitor the Company’s cash
      position carefully and evaluate its future operating cash requirements with
      respect to its strategy, business objectives and performance. In order to reduce
      its cash burn, the Company may implement further measures to reduce operating
      costs, including a reduction in sales and marketing expenses, support and other
      general and administrative expenses. The Company finished the year 2005 with
      $6.34 million in cash reserves (cash and cash equivalents of $4.86 million
      and
      short-term investments of $1.48 million).





**Contractual
      Obligations**





The
      table
      below shows our contractual obligations as of December 31, 2005:





**Payments
                due by Period****Total**
            
            **Less
                than 1****Year**
            
            **1-3
                Years**
            
            **3-5
                Years**
            
            **>
                5 Years**(In
                thousands)Operating
                leases
            
            $
            2,840
            
            $
            1,402
            
            $
            986
            
            $
            449
            
            $
            3**Total**
            
            **$**
            **2,840**
            
            **$**
            **1,402**
            
            **$**
            **986**
            
            **$**
            **449**
            
            **$**
            **3**





On
      April
      18, 2005 IPIX Corporation (the "Company") entered into a sublease agreement
      (the
      "Sublease") with Thomas Group, Inc. (the "Sublessor") with respect to the
      Company's a new corporate headquarters in Reston, Virginia for our sales,
      marketing, engineering and corporate offices. The Sublease is for a period
      of 31
      months beginning April 15, 2005. The base rent is approximately $297,668 per
      year and will increase by approximately three (3%) percent each year beginning
      April 1, 2006. In addition to the base rent, the Company is responsible for
      any
      increases in operating expenses and property taxes billed to the landlord and
      paid by the Sublessor. The Company is also responsible for the costs of tenant
      improvement. All terms and conditions of the master lease between the Sublessor
      and REC Partners, L.P. dated February 15, 2000 are incorporated into and made
      part of the Sublease.





On
      February 3, 2005, we entered into a lease agreement with Oak Ridge
      Technical Center Partners - One, L.P. The Lease is for a period of five years
      beginning May 1, 2005. The base rent is approximately $0.313 million
      per year and will increase by approximately $0.005 million each year
      beginning in 2006. In addition to the base rent, we are required to pay certain
      taxes and a pro rata share of operating expenses. We are also responsible for
      the costs of certain tenant improvements associated with the new facility,
      but
      will be entitled to reimbursement for certain costs from the Landlord. The
      Lease
      also provides for three 36 month renewal options at 95% of the then
      prevailing fair market rents.





On
      March
      13, 2006, the Company completed negotiations to terminate immediately the lease
      agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
      Partners - One, L.P. The terms of the agreement to terminate included IPIX
      agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
      lump-sum payment in the amount of $198,500, due and payable immediately; (2)
      prorated rent through March 8, 2006 - $5,606; and , prorated Tenant Improvement
      expense though March 8, 2006 - $596. Oak Ridge Technical Center Partners -
      One
      L.P. has agreed to: (1) act as intermediary in the sale of IPIX’s furniture to a
      third party for $40,000; and (2) deduct that amount from the above payments
      due
      from IPIX. This should reduce the cash-flow related to the lease commitments
      enumerated above by approximately $1.187 million.





27


Mr.
      Crew
      has resigned as CFO of the Company effective April 1, 2006. On
      February 27, 2006, the Company entered into a separation agreement with Mr.
      Crew. The Company and Mr. Crew have agreed to terminate the employment agreement
      between the Company and Mr. Crew dated April 1, 2005 (the "Employment
      Agreement") effective April, 1, 2006. Under the Separation Agreement, the
      Company will pay any portion of Mr. Crew's base salary, vacation time, travel
      and business expense incurred or accrued through April 1, 2006. The Company
      will
      also pay total bonus compensation to Mr. Crew of $20,000 for the fourth quarter
      of 2005 and first quarter of 2006 as provided in Mr. Crew's employment
      agreement. In addition, the Company will pay Mr. Crew a severance payment of
      $200,000. Stock options to purchase up to 200,000 shares of Company common
      stock
      granted to Mr. Crew on April 1, 2005 will become fully vested on April 1, 2006,
      and such options must be exercised on or before June 30, 2006, at which time
      they will expire. For a period of six months after April 1, 2006, the Company
      will reimburse Mr. Crew for the amount of any premium payments for group health
      coverage made by Mr. Crew pursuant to the Consolidated Omnibus Budget
      Reconciliation Act of 1985.





**Off
      Balance Sheet Arrangements**





At
      December 31, 2005, the Company had the potential obligation to pay holders
      of
      the Company’s Series B Preferred Stock $1,685,000 in cash dividends had
      they elected to convert their Series B Preferred Stock and take accrued
      dividends in cash. These dividends will continue to accrue until such time
      as
      the holders of the Series B Preferred Stock elect to convert at which time
      they have the option to take the dividends in additional shares of common stock
      or in cash. See **LIQUIDITY
      AND CAPITAL RESOURCES -** the **Preferred
      Stock** above
      and
      Note 9 STOCKHOLDERS’ EQUITY to our Financial Statements presented elsewhere in
      the Annual Report on Form 10-K.





**RECENT
      ACCOUNTING PRONOUNCEMENTS**





In
      December 2004, the FASB issued FAS No. 123 (R), “Share-Based Payment”
to replace FAS No. 123, “Accounting for Stock-Based Compensation” and APB
      Opinion No. 25, “Accounting for Stock Issued to Employees.” FAS
      No. 123 (R) requires, among other things, that all share-based
      payments to employees, including grants of stock options, be measured based
      on
      their grant-date fair value and recognized as expense in the financial
      statements effective for interim or annual periods beginning after June 15,
      2005. Unless observable market prices exist, the grant-date fair value is
      estimated using an appropriate option-pricing model as determined by Management.
      Management must also make certain assumptions about employee exercise habits,
      forfeiture rates and select an appropriate amortization methodology for
      recognizing compensation expense. The Statement requires a modified prospective
      method of adoption. Companies may also elect to restate their previously issued
      financial statements to provide consistency across all periods presented under
      a
      modified retrospective method. Management believes the adoption of FAS
      No. 123(R) will have a material impact on the Company’s consolidated
      results of operations and earnings per share but has not yet determined the
      method of adoption that will be applied or whether adoption will result in
      expense amounts materially different from those currently provided under the
      pro
      forma disclosures.





In
      April 2005, the Securities and Exchange Commission announced the adoption
      of a new rule that amends the effective date of FAS No. 123(R). The
      effective date of the new standard under these new rules for our consolidated
      financial statements is January 1, 2006. Adoption of this statement will
      have a significant impact on the consolidated results of operations and earnings
      per share as the Company will be required to expense the fair value of stock
      option grants and stock purchases under the employee stock purchase plan rather
      than disclose the impact on the Company’s consolidated net loss within the
      footnotes, as is the Company’s current practice.





In
      November 2005, the FASB issued FSP FAS123(R)-3, *Transition
      Election to Accounting for the Tax Effects of Share-Based Payment Awards.* This
      FSP
      requires an entity to follow either the transition guidance for the
      additional-paid-in-capital pool as prescribed in SFAS No. 123(R), *Share-Based
      Payment* ,
      or the
      alternative transition method as described in the FSP. An entity that adopts
      SFAS No. 123(R) using the modified prospective application may make a
      one-time election to adopt the transition method described in this FSP. An
      entity may take up to one year from the later of its initial adoption of SFAS
      No. 123(R) or the effective date of this FSP to evaluate its available
      transition alternatives and make its one-time election. This FSP became
      effective in November 2005. We continue to evaluate the impact that the adoption
      of this FSP could have on our financial statements.





In
      June 2005, the FASB issued FAS No. 154, Accounting Changes and Error
      Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and
      FASB No. 3, Reporting Accounting Changes in Interim Financial Statements.
      The Statement applies to all voluntary changes in accounting principle, and
      changes the requirements for accounting for and reporting of a change in
      accounting principle. FAS 154 requires retrospective application to prior
      periods’ financial statements of a voluntary change in accounting principle
      unless it is impracticable. It is effective for accounting changes and
      corrections of errors made in fiscal years beginning after December 15,
      2005. Earlier application is permitted for accounting changes and corrections
      of
      errors made occurring in fiscal years beginning after June 1, 2005. The
      Company does not expect the effect of FAS 154 will have material impact on
      its
      financial statements.





28


In
      November 2005, the FASB issued Staff Position (“FSP”) FAS115-1/124-1, *The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments* ,
      which
      addresses the determination as to when an investment is considered impaired,
      whether that impairment is other than temporary, and the measurement of an
      impairment loss. This FSP also includes accounting considerations
      subsequent to the recognition of an other-than-temporary impairment and requires
      certain disclosures about unrealized losses that have not been recognized as
      other-than-temporary impairments. The guidance in this FSP amends FASB
      Statements No. 115, *Accounting
      for Certain Investments in Debt and Equity Securities* ,
      and
      No. 124, *Accounting
      for Certain Investments Held by Not-for-Profit Organizations* ,
      and APB
      Opinion No. 18, *The
      Equity Method of Accounting for Investments in Common Stock* . This
      FSP is effective for reporting periods beginning after December 15,
      2005. We do not believe the adoption of this FSP will have a material
      impact on our financial statements.





**INFLATION**





Inflation
      has not had a significant impact on our operations to date.





**Item 7A.*****Quantitative
      and Qualitative Disclosures about Market Risk.***





As
      of
      December 31, 2005, we had $4.9 million of cash reserves and cash
      equivalents. Our interest income is sensitive to changes in the general level
      of
      United States interest rates, particularly since the majority of our investments
      are in short-term instruments. Due to the nature of our short-term investments,
      we concluded that we do not have material market risk exposure.




**Item 8.** ***Financial
      Statements and Supplementary Data.***





The
      consolidated financial statements and financial statement schedule of the
      Company, together with the reports thereon of Armanino McKenna LLP and
      PricewaterhouseCoopers LLP, independent registered public accounting firms,
      are
      set forth on the pages indicated in Item 15 (a) of this Annual Report
      on Form 10-K.





*This
      Form 10-K contains certain forward-looking statements regarding, among other
      things, the anticipated financial and operating results of the Company.
      Investors are cautioned not to place undue reliance on these forward-looking
      statements, which speak only as of the date hereof. We do not undertake any
      obligation to publicly release any modifications or revisions to these
      forward-looking statements to reflect events or circumstances occurring after
      the date hereof or to reflect the occurrence of unanticipated events. In
      connection with the “safe harbor” provisions of the Private Securities
      Litigation Reform Act of 1995, we caution investors that future financial and
      operating results may differ materially from those projected in forward-looking
      statements made by, or on behalf of, us. Such forward-looking statements involve
      known and unknown risks, uncertainties and other factors that may cause our
      actual results, performance or achievements to be materially different form
      any
      future results, performance or achievements expressed or implied by such
      forward-looking statements.*




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





None.





**Item
      9A. Controls and Procedures**





(a)
      Evaluation of Disclosure Controls and Procedures. The Company's management,
      with
      the participation of the Company's chief executive officer and chief financial
      officer, have evaluated the effectiveness of the design and operation of the
      Company's disclosure controls and procedures (as defined in Exchange Act Rule
      13a-15(e)) as of the end of the period covered by this annual report on Form
      10-K. Based on that evaluation, the chief executive officer and chief financial
      officer have concluded that the Company's disclosure controls and procedures
      were effective.





(b)
      Management's Annual Report on Internal Control over Financial Reporting.
      Management, including the Company's CEO and CFO, has the responsibility for
      establishing and maintaining adequate internal control over financial reporting,
      as defined in Exchange Act Rule 13a-15(f). Internal control over financial
      reporting is a process designed by, or under the supervision of, the Company's
      principal executive and principal financial officers, or persons performing
      similar functions and effected by the Company's Board of Directors, management
      and other personnel, to provide reasonable assurance regarding the reliability
      of financial reporting and the preparation of financial statements for external
      purposes in accordance with accounting principles generally accepted in the
      United States of America ("GAAP"). Because of its inherent limitations, internal
      control over financial reporting may not prevent or detect misstatements. In
      addition, projections of any evaluation of effectiveness to future periods
      are
      subject to the risk that controls may become inadequate or insufficient because
      of changes in operating conditions, or that the degree of compliance with the
      policies or procedures may deteriorate.





29


A
      control
      deficiency exists when the design or operation of a control does not allow
      management or employees, in the ordinary course of performing their assigned
      functions, to prevent or detect misstatements on a timely basis. A significant
      deficiency is a control deficiency, or combination of control deficiencies,
      that
      adversely affects the Company's ability to initiate, authorize, record, process,
      or report external financial data reliably in accordance with GAAP, such that
      there is a more than remote likelihood that a misstatement of the Company's
      annual or interim financial statements that is more than inconsequential will
      not be prevented or detected. A material weakness is a control deficiency,
      or
      combination of control deficiencies, that results in more than a remote
      likelihood that a material misstatement of the annual or interim financial
      statements will not be prevented or detected.





We
      have
      completed our evaluation and testing of internal control over financial
      reporting in accordance with the Internal Control - Integrated Framework issued
      by the Committee of Sponsoring Organizations of the Treadway Commission. Based
      on this evaluation, management concluded that the Company maintained effective
      internal control over financial reporting as of December 31, 2005.





Armanino
      McKenna LLP, the Company’s independent registered public accounting firm that
      audited the financial statements for 2005 in this Form 10-K, has issued an
      audit
      report on management’s assessment of the Company’s internal control over
      financial reporting and
      independently assessed the effectiveness of internal control over financial
      reporting as
      of
      December 31, 2005. This audit report is included on page F-2 of this Form 10-K.





(c)
      Changes in Internal Control over Financial Reporting. During 2005 the Company
      implemented a significant program to improve internal control over its financial
      reporting and information technology systems. The actions taken by management
      included hiring a new CFO and accounting staff, contracting with a firm with
      expertise in Sarbanes-Oxley implementation and compliance, and training of
      all
      individuals in the performance of their activities in compliance with company
      policies and procedures. Significant effort was made to assure that
      transactions, approvals and changes were evidenced by the respective control
      manager. Comprehensive management testing of controls was performed, remediation
      of deficiencies was addressed and internal controls were modified and updated
      as
      appropriate to assure compliance and auditability.





**Item 9B.
      Other Information**





None.




**PART
      III**




**Item 10.** ***Directors
      and Executive Officers of the Registrant.***





The
      information called for by this item is incorporated herein by reference to
      IPIX’s Proxy Statement for its Annual Meeting of Stockholders to be held on or
      about June 23, 2006, to be filed with the SEC pursuant to Regulations 14A under
      the Securities Exchange Act of 1934, as amended.




**Item 11.** ***Executive
      Compensation***





The
      information called for by this item is incorporated herein by reference to
      IPIX’s Proxy Statement for its Annual Meeting of Stockholders to be held on or
      about June 23, 2006, to be filed with the SEC pursuant to Regulation 14A
      under the Securities Exchange Act of 1934, as amended.




**Item 12.** ***Security
      Ownership of Certain Beneficial Owners and Management.***





The
      information called for by this item is incorporated herein by reference to
      IPIX’s Proxy Statement for its Annual Meeting of Stockholders to be held on or
      about June 23, 2006, to be filed with the SEC pursuant to Regulation 14A
      under the Securities Exchange Act of 1934, as amended.




**Item 13.** ***Certain
      Relationships and Related Transactions.***





The
      information called for by this item is incorporated herein by reference to
      IPIX’s Proxy Statement for its Annual Meeting of Stockholders to be held on or
      about June 23, 2006, to be filed with the SEC pursuant to Regulation 14A
      under the Securities Exchange Act of 1934, as amended.




30


**Item 14.** ***Principal
      Accountant Fees and Services***





The
      information called for by this item is incorporated herein by reference to
      IPIX’s Proxy Statement for its Annual Meeting of Stockholders to be held on or
      about June 23, 2006, to be filed with the SEC pursuant to Regulation 14A
      under the Securities Exchange Act of 1934, as amended.





**PART
      IV**




**Item 15.*****Exhibits
      and Financial Statement Schedules.***





(a)





(1) The
      following documents are filed as part of this Annual Report on Form 10-K:





PageReports
                of Independent Registered Public Accounting Firms
            
            F-1IPIX
                Corporation Consolidated Financial StatementsConsolidated
                Balance Sheets at December 31, 2004 and 2005
            
            F-4Consolidated
                Statements of Operations for the years ended December 31, 2003, 2004
                and 2005
            
            F-5Consolidated
                Statements of Changes in Stockholders’ Equity for the years ended
                December 31, 2003, 2004 and 2005
            
            F-6Consolidated
                Statements of Cash Flows for the years ended December 31, 2003, 2004
                and 2005
            
            F-8Notes
                to Consolidated Financial Statements
            
            F-9





(2) Except
      as provided below, all schedules have been omitted because they are not required
      or because the required information is contained in the financial statements
      or
      notes thereto.





31


**Report
      of Independent Registered Public Accounting Firm**


**On
      Financial Statement Schedule**





To
      the
      Board of Directors and Stockholders of


IPIX
      Corporation:





Our
      audit
      of the consolidated financial statements referred to in our report dated
      March 24, 2004, except as to Note 4, which is as of March 30, 2005,
      appearing in this Annual Report on Form 10-K also included an audit of the
      accompanying financial statement schedule, for the year ended December 31,
      2003. In our opinion, this financial statement schedule, for the year ended
      December 31, 2003, presents fairly, in all material respects, the
      information set forth therein when read in conjunction with the related
      consolidated financial statements.





/s/
      PricewaterhouseCoopers LLP





San
      Jose,
      California


March 24,
      2004, except as to Note 4,


which
      is
      as of March 30, 2005








32


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**


**ON
      FINANCIAL STATEMENT SCHEDULE**











To
      the
      Board of Directors and Stockholders of


IPIX
      Corporation


Reston,
      Virginia





Our
      audits of the consolidated financial statements referred to in our report dated
      March 21, 2006 appearing in this Annual Report on Form 10-K also included an
      audit of the accompanying financial statement schedule for the years ended
      December 31, 2005 and 2004. In our opinion, this financial statement schedule
      presents fairly, in all material respects, the information set forth therein
      when read in conjunction with the related consolidated financial
      statements.











/s/
      ARMANINO McKENNA LLP


San
      Ramon, California


March
      21,
      2006





33








VALUATION
      AND QUALIFYING ACCOUNTS AND RESERVES


FISCAL
      YEARS 2003, 2004 AND 2005





**Additions****Balance**
            
            **(Deductions)**
            
            
            
            
            
            
            
            
            
            **Balance****Beginning**
            
            **Charged
                to**
            
            
            
            **Write-offs
                and**
            
            
            
            **At
                End of**DESCRIPTION
            
            
            
            **of
                Period**
            
            **Expense**
            
            
            
            **Deductions**
            
            
            
            **Period****(In
                thousands)**2003Allowance
                for doubtful accounts
            
            
            
            
            
            
            
            $
            208
            
            
            
            
            $
            8
            
            
            
            
            
            
            
            $
            (216
            )
            
            
            
            
            
            
            $
            —Valuation
                allowance on deferred tax assets
            
            
            
            
            
            
            
            
            (20,722
            )
            
            
            
            
            —
            
            
            
            
            
            
            
            
            (7,640
            )
            
            
            
            
            
            
            
            (28,362
            )Provision
                for excess and obsolete inventory
            
            
            
            
            
            
            
            
            160
            
            
            
            
            
            (12
            )
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            
            1482004Allowance
                for doubtful accounts
            
            
            
            
            
            
            
            $
            —
            
            
            
            
            $
            3
            
            
            
            
            
            
            
            $
            (3
            )
            
            
            
            
            
            
            $
            —Valuation
                allowance on deferred tax assets
            
            
            
            
            
            
            
            
            (28,362
            )
            
            
            
            
            —
            
            
            
            
            
            
            
            
            (11,387
            )
            
            
            
            
            
            
            
            (39,749
            )Provision
                for excess and obsolete inventory
            
            
            
            
            
            
            
            
            148
            
            
            
            
            
            198
            
            
            
            
            
            
            
            
            —
            
            
            
            
            
            
            
            
            3462005Allowance
                for doubtful accounts
            
            
            
            
            
            
            
            $
            —
            
            
            
            
            $
            19
            
            
            
            
            
            
            
            $
            (19
            )
            
            
            
            
            
            
            $
            —Valuation
                allowance on deferred tax assets
            
            
            
            
            
            
            
            
            (39,749
            )
            
            
            
            
            —
            
            
            
            
            
            
            
            
            (7,879
            )
            
            
            
            
            
            
            
            (47,628
            )Provision
                for excess and obsolete inventory
            
            
            
            
            
            
            
            
            346
            
            
            
            
            
            (136
            )
            
            4
            
            
            
            
            
            4
            
            
            
            
            
            
            
            
            214

















34


(c) Exhibits.





The
      following exhibits are filed herewith or incorporated by reference:




**Exhibit****Number**
              
              **Description**3.1
              
              Amended
                  and Restated Certificate of Incorporation of the Registrant (incorporated
                  herein by reference to Form S-1 as declared effective on
                  August 25, 1999 (File No. 333-80639)).3.1(a)
              
              Amendment
                  to the Amended and Restated Certificate of Incorporation of the
                  Registrant
                  (incorporated herein by reference to Form S-1 as filed with the
                  Commission on March 17, 2000).3.2
              
              Amended
                  and Restated Bylaws of the Registrant (incorporated herein by reference
                  to
                  Form 10-Q as filed with the Commission on November 14, 2000).3.3
              
              Certificate
                  of Designations of Series A Junior Participating Preferred Stock
                  (incorporated herein by reference to Form 8-A as filed with the
                  Commission on November 2, 2000).3.3
              
              Amended
                  Certificate of Designations of Series B Preferred Stock (incorporated
                  herein by reference to Form 8-K as filed with the Commission on
                  October 3, 2001).4.1
              
              Form
                  of certificate representing the common stock, $.001 par value per
                  share of
                  IPIX Corporation (incorporated herein by reference to Form 10-K
                  as filed
                  with the Commission on March 29, 2000).Commission
                  on November 2, 2000).4.3
              
              Registration
                  Rights Agreement dated May 14, 2001 between IPIX Corporation and
                  Image Investors Portfolio, a separate series of Memphis Angels,
                  LLC
                  (incorporated herein by reference to Form 8-K as filed with the
                  Commission on May 29, 2001).4.4
              
              Registration
                  Rights Agreement dated April 4, 2004 between IPIX Corporation and
                  institutional investors named therein (incorporated by reference
                  to
                  Form 8-K as filed with the Commission on April 7, 2004).10.1*
              
              Employment
                  Agreement dated July 1, 2001, between IPIX Corporation and Donald W.
                  Strickland (incorporated herein by reference to Form 10-Q as filed
                  with the Commission on August 14, 2001).10.2*
              
              Employment
                  Agreement dated July 1, 2001, between IPIX Corporation and Paul A.
                  Farmer (incorporated herein by reference to Form 10-Q as filed with
                  the Commission on August 14, 2001).10.3*
              
              Employment
                  Agreement dated July 1, 2001 between IPIX Corporation and Sarah Pate
                  (incorporated herein by reference to Form 10-K as filed with the
                  Commission on March 31, 2003).10.4
              
              Reserved10.5*
              
              Amended
                  and Restated IPIX Corporation 2001 Equity Incentive Plan (incorporated
                  herein by reference to Form S-8 as filed with the Commission on
                  January 16, 2002).10.6*
              
              Amended
                  and Restated 1997 Equity Compensation Plan (incorporated herein
                  by
                  reference to Form S-4 as declared effective on December 16, 1999
                  (File No. 91139).10.7*
              
              Amended
                  and Restated 1998 Employee, Director and Consultant Stock Plan
                  (incorporated herein by reference to Form S-4 as declared effective
                  on December 16, 1999 (File No. 91139)).10.8*
              
              1999
                  Employee Stock Purchase Plan (incorporated herein by reference
                  to
                  Form S-4 as declared effective on December 16, 1999 (File
                  No. 91139)10.9*
              
              2000
                  Equity Incentive Plan (incorporated herein by reference to Form
                  S-8 as
                  declared effective on June 27, 2000 (File No. 333-40160).10.10*
              
              PictureWorks
                  Technology, Inc. 1994 Stock Option Plan (incorporated herein by
                  reference
                  to Form S-8 as declared effective on May 2, 2000 (File
                  No. 333-36068))10.11*
              
              PictureWorks
                  Technology, Inc. 1996 Stock Option Plan (incorporated herein by
                  reference
                  to Form S-8 as declared effective on May 2, 2000 (File
                  No. 333-36068))10.12*
              
              PictureWorks
                  Technology, Inc. 1997 Stock Option Plan (incorporated herein by
                  reference
                  to Form S-8 as declared effective on May 2, 2000 (File
                  No. 333-36068))10.13
              
              Form
                  of Indemnification Agreement between the Registrant and each of
                  its
                  directors and officers (incorporated herein by reference to Form
                  S-1 as
                  declared effective on August 25, 1999 (File
                  No. 333-80639)).10.14*
              
              Separation
                  Agreement dated September 16, 2004, between IPIX Corporation and
                  Donald W. Strickland (incorporated by reference to Form 8-K as filed
                  with the Commission on September 21, 2004).10.15
                  *
              
              Employment
                  Agreement dated September 16, 2004 between IPIX Corporation and Clara
                  M. Conti (incorporated herein by reference to Form 10-Q as filed with
                  the Commission on November 15, 2004).10.16*
              
              Separation
                  Agreement dated January 25, 2005, between IPIX Corporation and Paul
                  A. Farmer (incorporated herein by reference to Form 8-K as filed with
                  the Commission on January 31, 2005).10.17
              
              Lease
                  dated February 3, 2005, between IPIX Corporation and Oak Ridge
                  Technical Center Partners — One, LP10.18
              
              Patent
                  Purchase, License and Repurchase Agreement dated February 11, 2005,
                  between IPIX Corporation and AdMission Corporation (incorporated
                  by
                  reference to Form 8-K filed with the Commission on February 17,
                  2005).
  35
 10.19
              
              Trademark/Service
                  Mark License Agreement dated February 11, 2005, between IPIX
                  Corporation and AdMission Corporation (incorporated by reference
                  to
                  Form 8-K filed with the Commission on February 17, 2005).10.20
              
              Letter
                  Agreement dated October 25, 2004, between IPIX Corporation and Kara
                  Brand (incorporated by reference to Form 8-K filed with the
                  Commission on April 4, 2005).10.21
              
              Letter
                  Agreement dated March 29, 2005, between IPIX Corporation and Kara
                  Brand (incorporated by reference to Form 8-K filed with the
                  Commission on April 4, 2005).10.22
              
              Employment
                  Agreement effective April 1, 2005, between IPIX Corporation and
                  Charles A.
                  Crew (incorporated by reference to Form 8-K filed with the Commission
                  on April 4, 2005).10.23
              
              Lease
                  Agreement dated February 15, 2000, by and between R.E.C. Partners,
                  L.P. and Thomas Group, Inc. (incorporated by reference to Form 10-Q
                  filed with the Commission on May 10, 2005).10.24
              
              Sublease
                  Agreement dated April 18, 2005, between Thomas Group, Inc. and IPIX
                  Corporation (incorporated by reference to Form 10-Q filed with the
                  Commission on May 10, 2005).10.25
              
              Securities
                  Purchase Agreement dated June 21, 2005, among IPIX Corporation
                  and each of
                  the purchasers (incorporated by reference to Form 8-K filed with the
                  Commission on June 23, 2005).10.26
              
              Separation
                  Agreement dated February 27, 2006, between IPIX Corporation and
                  Charles A.
                  Crew (incorporated by reference to Form 8-K filed with the Commission
                  on March 3, 2006).10.27
              
              Amendment
                  A Termination of Lease dated March 13, 2006, by and between IPIX
                  Corporation and Oak Ridge Technical Center Partners - One, L.P.
                  (incorporated by reference to Form 8-K filed with the Commission
                  on March
                  16, 2006).14.1
              
              Code
                  of Ethics for Chief Executive Officer and Senior Financial Officers
                  (incorporated by reference to Form 10-K filed with the Commission on
                  March 30, 2004)14.2
              
              Code
                  of Business Conduct and Ethics (incorporated by reference to Form
                  10-K
                  filed with the Commission on March 30, 2004)16.1
              
              Letter
                  dated June 15, 2004 regarding change in certifying accountant
                  (incorporated by reference to Form 8-K filed with the Commission on
                  June 18, 2004).21.1
              
              Subsidiaries
                  of the Registrant (incorporated herein by reference to Form 10-K
                  filed with the Commission on March 31, 2003).23.1#
              
              Consent
                  of PricewaterhouseCoopers LLP23.2#
              
              Consent
                  of Armanino McKenna LLP24.1
              
              Power
                  of Attorney (included on page #3131.1#
              
              Certification
                  of Chief Executive Officer pursuant to Rule 13a-14(a) under the
                  Securities Exchange Act of 1934.31.2#
              
              Certification
                  of Chief Financial Officer pursuant to Rule 13a-14(a) under the
                  Securities Exchange Act of 1934.32#
              
              Certification
                  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                  Section 906 of the Sarbanes-Oxley Act of 2002





*
                Executive Compensation Plan or Agreement#
                Filed Herewith





36


**SIGNATURES**





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








IPIX
        CORPORATION
 By:
        /s/ Clara M. Conti
 Clara
        M.
        Conti
 President
        and Chief Executive Officer
 Date:
        March 21, 2006













37


**POWER
      OF ATTORNEY**





Each
      person whose signature appears below hereby appoints Clara M. Conti, Charles
      Crew and Matthew S. Heiter, or any of them, as such person’s true and lawful
      attorney-in-fact, with full power of substitution or resubstitution for such
      person and in such person’s name, place and stead, in any and all capacities, to
      sign on such person’s behalf, individually and in each capacity stated below,
      any and all amendments to this Report on Form 10-K, with all exhibits thereto,
      and other documents in connection therewith, with the Securities and Exchange
      Commission, granting unto said attorneys-in-fact, full power and authority
      to do
      and perform each and every act and thing requisite or necessary to be done
      in
      and about the premises, as fully to all intents and purposes as such person
      might or could do in person, hereby ratifying and confirming all that said
      attorneys-in-fact, or their substitute or substitutes, may lawfully do or cause
      to be done by virtue hereof.





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





**Signature**
            **Title**
            **Date**/s/
                Clara M. Conti
            President,
                Chief Executive Officer and
            March
                21, 2006Clara
                M. Conti
            Director/s/
                Charles Crew
            Chief
                Financial Officer
            March
                21, 2006Charles
                Crew/s/
                David M. Wilds
            Chairman
                of the Board of Directors
            March
                21, 2006David
                M. Wilds/s/
                Michael D. Easterly
            Director
            March
                21, 2006Michael
                D. Easterly/s/
                James H. Hunt
            Director
            March
                21, 2006James
                H. Hunt/s/
                Laban P. Jackson, Jr.
            Director
            March
                21, 2006Laban
                P. Jackson, Jr./s/
                Andrew P. Seamons
            Director
            March
                21, 2006Andrew
                P. Seamons











38





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders of


IPIX
      Corporation





In
      our
      opinion, the consolidated statements of operations, of changes in stockholders’
equity and of cash flows present fairly, in all material respects, the results
      of operations and cash flows of IPIX Corporation and its subsidiaries (the
      “Company”) for the year ended December 31, 2003, in conformity with
      accounting principles generally accepted in the United States of America. These
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audit. We conducted our audit of these statements in accordance with the
      standards of the Public Company Accounting Oversight Board (United States).
      Those standards require that we plan and perform the audit to obtain reasonable
      assurance about whether the financial statements are free of material
      misstatement. An audit includes examining, on a test basis, evidence supporting
      the amounts and disclosures in the financial statements, assessing the
      accounting principles used and significant estimates made by management, and
      evaluating the overall financial statement presentation. We believe that our
      audit provides a reasonable basis for our opinion.





The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 3 to the
      consolidated financial statements for the year ended December 31, 2003,
      there are significant matters concerning the Company, including the change
      in
      relationship with its largest customer, that raise substantial doubt about
      its
      ability to continue as a going concern. Management’s plans in regard to these
      matters are also described in Note 3. The consolidated financial statements
      do
      not include any adjustments that might result from the outcome of this
      uncertainty.





/s/
      PricewaterhouseCoopers LLP





San
      Jose,
      California


March 24,
      2004, except as to


Note
      4,
      which is as of March 30, 2005


F
          -
          1













**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








To
      the
      Board of Directors and Stockholders of


IPIX
      Corporation


Reston,
      Virginia





We
      have
      audited the accompanying consolidated balance sheets of IPIX Corporation as
      of
      December 31, 2005 and 2004, and the related consolidated statements of
      operations, changes in stockholders’ equity, and cash flows for each of the two
      years in the period ended December 31, 2005. These financial statements are
      the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. An audit includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements. An audit also includes assessing the accounting
      principles used and significant estimates made by management, as well as
      evaluating the overall financial statement presentation. We believe that our
      audits provide a reasonable basis for our opinion.





In
      our
      opinion, the 2005 and 2004 consolidated financial statements referred to above
      present fairly, in all material respects, the consolidated financial position
      of
      IPIX Corporation at December 31, 2005 and 2004, and the consolidated results
      of
      its operations and its cash flows for each of the two years in the period ended
      December 31, 2005, in conformity with accounting principles generally accepted
      in the United States of America.





The
      accompanying consolidated financial statements have been prepared assuming
      that
      the Company will continue as a going concern. As discussed in Note 3 to the
      consolidated financial statements, there are significant matters concerning
      the
      Company, including recurring losses and negative cash flow from operations,
      that
      raise substantial doubt about its ability to continue as a going concern.
      Management’s plans regarding those matters are also described in Note 3. The
      consolidated financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.





We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of IPIX Corporation’s
      internal control over financial reporting as of December 31, 2005, based on
      criteria established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
      and our report dated March 21, 2006 expressed an unqualified opinion on
      management’s assessment of internal control over financial reporting and an
      unqualified opinion on the effectiveness of internal control over financial
      reporting.











/s/
      ARMANINO McKENNA LLP


San
      Ramon, California


March
      21,
      2006


F
          -
          2





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








To
      the
      Board of Directors and Stockholders of


IPIX
      Corporation


Reston,
      Virginia





We
      have
      audited management’s assessment, included in the accompanying Management Report
      on Internal Control Over Financial Reporting, appearing under Item 9A, that
      IPIX
      Corporation maintained effective internal control over financial reporting
      as of
      December 31, 2005, based on criteria established in *Internal
      Control—Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (“COSO”). IPIX Corporation’s management is responsible for maintaining effective
      internal control over financial reporting and for its assessment of the
      effectiveness of internal control over financial reporting. Our responsibility
      is to express an opinion on management’s assessment and an opinion on the
      effectiveness of the Company’s internal control over financial reporting based
      on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with accounting principles generally accepted in the United States of America.
      A
      company’s internal control over financial reporting includes those policies and
      procedures that (1) pertain to the maintenance of records that, in
      reasonable detail, accurately and fairly reflect the transactions and
      dispositions of the assets of the company; (2) provide reasonable assurance
      that transactions are recorded as necessary to permit preparation of financial
      statements in accordance with accounting principles generally accepted in the
      United States of America, and that receipts and expenditures of the company
      are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or
      timely detection of unauthorized acquisition, use, or disposition of the
      company’s assets that could have a material effect on the financial statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, management’s assessment that IPIX Corporation maintained effective
      internal control over financial reporting as of December 31, 2005, is fairly
      stated, in all material respects, based on the COSO criteria. Also, in our
      opinion, IPIX Corporation maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2005, based on
      the
      COSO criteria.





We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the 2005 consolidated financial statements
      of
      IPIX Corporation and our report dated March 21, 2006 expressed an unqualified
      opinion thereon. Our audit report included an explanatory paragraph concerning
      the Company’s ability to continue as a going concern.











/s/
      ARMANINO McKENNA LLP


San
      Ramon, California


March
      21,
      2006








F
            -
            3





**IPIX
      CORPORATION**


**CONSOLIDATED
      BALANCE SHEETS**





**December
                31,**
            
            **December
                31,****2004**
            
            **2005**(In
                thousands)ASSETSCURRENT
                ASSETS:Cash
                and cash equivalents
            
            $
            12,784
            
            $
            4,860Restricted
                cash and short term investments
            
            
            550Short
                term investments
            
            
            895
            
            
            1,481Accounts
                receivable, net of allowance for doubtful accounts of $0 in 2004
                and 2005
            
            
            414
            
            
            1,348Inventory,
                net of reserve for obsolescence of $346 in 2004 and $214 in 2005
            
            
            2,334
            
            
            2,145Prepaid
                expenses and other current assets
            
            
            1,512
            
            
            1,158Assets
                held for sale
            
            
            321
            
            
            28Total
                current assets
            
            
            18,810
            
            
            11,020Computer
                hardware, software and other, net
            
            
            716
            
            
            1,191Restricted
                cash and other long term assets
            
            
            718
            
            
            80Total
                assets
            
            $
            20,244
            
            $
            12,291LIABILITIES
                AND STOCKHOLDERS’ EQUITYCURRENT
                LIABILITIES:Accounts
                payable
            
            $
            1,043
            
            $
            2,543Accrued
                liabilities
            
            
            3,376
            
            
            3,350Deferred
                revenue
            
            
            84
            
            
            —Liabilities
                held for sale for discontinued operations
            
            
            164
            
            
            —Current
                portion of obligations under capital leases
            
            
            220
            
            
            —Total
                current liabilities
            
            
            4,887
            
            
            5,893Other
                long term liabilities
            
            
            142
            
            
            53Total
                liabilities
            
            
            5,029
            
            
            5,946Commitments
                and Contingencies (Note 11)STOCKHOLDERS’
                EQUITY:Preferred
                stock, $0.001 par value:
            
            
            —
            
            
            —Authorized:
                5,001,100 shares in 2004 and 2005 Issued and outstanding: 290,347
                in 2004
                and 246,867 in 2005. (Aggregate liquidation value: $7,325 in 2004
                and
                $6,623 in 2005)Common
                stock, $0.001 par value:
            
            
            22
            
            
            27Authorized:
                50,000,000 in 2004 and 2005 Issued and outstanding: 21,539,058 in
                2004 and
                27,455,083 in 2005.Class B
                common stock, $0.0001 par value:
            
            
            —
            
            
            —Authorized:
                7,421,536 shares in 2004 and 2005 Issued and outstanding: 0 shares
                in 2004
                and 0 shares in 2005Additional
                paid-in capital
            
            
            533,659
            
            
            546,804Accumulated
                deficit
            
            
            (518,466
            )
            
            (540,486
            )Total
                stockholders’ equity
            
            
            15,215
            
            
            6,345Total
                liabilities and stockholders’ equity
            
            $
            20,244
            
            $
            12,291





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


F
          -
          4





IPIX
      CORPORATION


CONSOLIDATED
      STATEMENTS OF OPERATIONS








**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands, except per share data)Revenue:Hardware
            
            
            
            
            $
            1,159
            
            $
            2,476
            
            $
            2,523Services
            
            
            
            
            
            357
            
            
            189
            
            
            1,728License
                and other
            
            
            
            
            
            1,078
            
            
            1,199
            
            
            1,148Total
                revenue
            
            
            
            
            
            2,594
            
            
            3,864
            
            
            5,399Cost
                of revenue:Hardware
            
            
            
            
            
            1,320
            
            
            2,320
            
            
            2,172Services
            
            
            
            
            
            159
            
            
            108
            
            
            1,382License
                and other
            
            
            
            
            
            101
            
            
            98
            
            
            31Total
                cost of revenue
            
            
            
            
            
            1,580
            
            
            2,526
            
            
            3,585Gross
                profit
            
            
            
            
            
            1,014
            
            
            1,338
            
            
            1,814Operating
                expenses:Sales
                and marketing
            
            
            
            
            
            3,621
            
            
            4,305
            
            
            7,125Research
                and development
            
            
            
            
            
            1,694
            
            
            2,065
            
            
            2,493General
                and administrative
            
            
            
            
            
            3,452
            
            
            4,490
            
            
            10,125Restructuring
                and impairment
            
            
            
            
            
            89
            
            
            170
            
            
            3,053Total
                operating expenses
            
            
            
            
            
            8,856
            
            
            11,030
            
            
            22,796Loss
                from operations
            
            
            
            
            
            (7,842
            )
            
            (9,692
            )
            
            (20,982
            )Other
                income (expense) :Interest
                expense
            
            
            
            
            
            (158
            )
            
            (235
            )
            
            (58
            )Interest
                income
            
            
            
            
            
            65
            
            
            115
            
            
            240Loss
                on foreign currency
            
            
            
            
            
            (491
            )
            
            —
            
            
            —Other
                income (expense)
            
            
            
            
            
            (8
            )
            
            2
            
            
            140Loss
                from continuing operations before income taxes
            
            
            
            
            
            (8,434
            )
            
            (9,810
            )
            
            (20,660
            )Income
                tax benefit
            
            
            
            
            
            3,764
            
            
            —
            
            
            —Loss
                from continuing operations after taxes
            
            
            
            
            
            (4,670
            )
            
            (9,810
            )
            
            (20,660
            )Income
                (loss) from discontinued operations, net of taxes
            
            
            
            
            
            6,056
            
            
            (4,925
            )
            
            (1,360
            )Net
                income (loss)
            
            
            
            
            
            1,386
            
            
            (14,735
            )
            
            (22,020
            )Preferred
                stock dividends
            
            
            
            
            
            (1,778
            )
            
            (874
            )
            
            (439
            )Net
                loss available to common stockholders
            
            
            
            
            $
            (392
            )
            $
            (15,609
            )
            $
            (22,459
            )Basic
                and diluted loss per share:Continuing
                operations
            
            
            
            
            $
            (0.87
            )
            $
            (0.65
            )
            $
            (0.85
            )Discontinued
                operations
            
            
            
            
            
            0.82
            
            
            (0.30
            )
            
            (0.06
            )Net
                loss per common share to common stockholders (basic and diluted)
            
            
            
            
            $
            (0.05
            )
            $
            (0.95
            )
            $
            (0.91
            )Weighted
                average common shares - Basic and diluted
            
            
            
            
            
            7,365
            
            
            16,470
            
            
            24,799





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


F
          -
          5


IPIX
      CORPORATION


CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


FOR
      THE
      PERIODS ENDED DECEMBER 31, 2003, 2004, AND 2005


(In
      thousands, except share amounts)





**Class
                B Common Stock**
            
            **Series
                B Preferred Stock**
            
            **Common
                Stock****Number**
            
            **Amount**
            
            **Number**
            
            **Amount**
            
            **Number**
            
            **Amount**Balance,
                December 31, 2002
            
            
            
            
            
            17,948
            
            
            
            
            $
            —
            
            
            
            
            
            1,115,080
            
            
            
            
            $
            1
            
            
            
            
            
            6,795,007
            
            
            
            
            $
            7Stock
                issued on exercise of stock options
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            771,056
            
            
            
            
            
            1Stock
                issued from employee stock purchase plan
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            79,969
            
            
            
            
            
            —Shares
                issued from Series B dividend
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            4,416
            
            
            
            
            
            —Foreign
                translation loss
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Dividend
                attributable to Series B conversion
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Conversion
                of Class B common stock
            
            
            
            
            
            (3,948
            )
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            3,948
            
            
            
            
            
            —Conversion
                of Series B Preferred Stock
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            (111,250
            )
            
            
            
            
            —
            
            
            
            
            
            1,024,333
            
            
            
            
            
            1Net
                income
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Other
                comprehensive loss
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Balances,
                December 31, 2003
            
            
            
            
            
            14,000
            
            
            
            
            $
            —
            
            
            
            
            
            1,003,830
            
            
            
            
            $
            1
            
            
            
            
            
            8,678,729
            
            
            
            
            $
            9





**Accumulated
                other****Additional
                Paid-in**
            
            **Comprehensive**
            
            **Accumulated****Capital**
            
            **Income
                (Loss)**
            
            **Deficit**
            
            **Total**Balance,
                December 31, 2002
            
            
            
            
            $
            513,995
            
            
            
            
            $
            (494
            )
            $
            (505,117
            )
            
            
            
            $
            8,392Stock
                issued on exercise of stock options
            
            
            
            
            
            1,468
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            1,469Stock
                issued from employee stock purchase plan
            
            
            
            
            
            88
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            88Shares
                issued from Series B dividend
            
            
            
            
            
            18
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            18Foreign
                translation loss
            
            
            
            
            
            —
            
            
            
            
            
            491
            
            
            —
            
            
            
            
            
            491Dividend
                attributable to Series B conversion
            
            
            
            
            
            (382
            )
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            (382
            )Conversion
                of Class B common stock
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            —Conversion
                of Series B Preferred Stock
            
            
            
            
            
            (1
            )
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            —Net
                income
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            1,386
            
            
            
            
            
            1,386Other
                comprehensive loss
            
            
            
            
            
            —
            
            
            
            
            
            3
            
            
            —
            
            
            
            
            
            3Balances,
                December 31, 2003
            
            
            
            
            $
            515,186
            
            
            
            
            $
            —
            
            $
            (503,731
            )
            
            
            
            $
            11,465





**Class
                B Common Stock**
            
            **Series
                B Preferred Stock**
            
            **Common
                Stock****Number**
            
            **Amount**
            
            **Number**
            
            **Amount**
            
            **Number**
            
            **Amount**Balance,
                December 31, 2003
            
            
            
            
            
            14,000
            
            
            
            
            $
            —
            
            
            
            
            
            1,003,830
            
            $
            1
            
            
            
            
            
            8,678,729
            
            
            
            
            $
            9Stock
                issued on exercise of stock options
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            2,190,632
            
            
            
            
            
            2Stock
                issued from employee stock purchase plan
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            293,219
            
            
            
            
            
            —PIPE
                Investment
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            909,090
            
            
            
            
            
            1Conversion
                of AIR
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            888,179
            
            
            
            
            
            1Dividend
                attributable to Series B conversion
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Conversion
                of warrant
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            7,286
            
            
            
            
            
            —Conversion
                of Class B common stock
            
            
            
            
            
            (14,000
            )
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            14,000
            
            
            
            
            
            —Conversion
                of Series B Preferred Stock
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            (862,883
            )
            
            (1
            )
            
            
            
            
            8,557,923
            
            
            
            
            
            9Conversion
                of Series B Warrant
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            149,400
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Net
                loss
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Balances,
                Dec. 31, 2004
            
            
            
            
            
            —
            
            
            
            
            $
            —
            
            
            
            
            
            290,347
            
            $
            —
            
            
            
            
            
            21,539,058
            
            
            
            
            $
            22






F
          - 6





**Additional
                  Paid-in****Capital**
              
              
              **Accumulated
                  Deficit**
              
              
              **Total**Balance,
                  December 31, 2003
              
              $
              515,186
              
              
              $
              (503,731)
              
              
              $
              11,465Stock
                  issued on exercise of stock options
              
              
              5,270
              
              
              
              —
              
              
              
              5,272Stock
                  issued from employee stock purchase plan
              
              
              384
              
              
              
              —
              
              
              
              384PIPE
                  Investment
              
              
              4,918
              
              
              
              —
              
              
              
              4,919Conversion
                  of AIR
              
              
              5,373
              
              
              
              —
              
              
              
              5,374Dividend
                  attributable to Series B conversion
              
              
              (452
              )
              
              
              —
              
              
              
              (452)Conversion
                  of warrant
              
              
              —
              
              
              
              —
              
              
              
              —Conversion
                  of Class B common stock
              
              
              —
              
              
              
              —
              
              
              
              —Conversion
                  of Series B Preferred Stock
              
              
              (8
              )
              
              
              —
              
              
              
              —Conversion
                  of Series B Warrant
              
              
              2,988
              
              
              
              —
              
              
              
              2,988Net
                  loss
              
              
              —
              
              
              
              (14,735)
              
              
              
              (14,735)Balances,
                  December 31, 2004
              
              $
              533,659
              
              
              $
              (518,466)
              
              
              $
              15,215
  **Class
                    B Common Stock Number**
                **Amount**
                **Series
                    B Preferred Stock Number**
                ****
                ****
                **Amount**
                ****
                **Common
                    Stock Number**
                ****
                ****
                **Amount**Balance,
                    December 31, 2004
                
                
                —
                
                
                $
                —
                
                
                
                290,347
                
                
                $
                —
                
                
                
                21,539,058
                
                
                $
                22
                
                1Stock
                    issued on exercise of stock options
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                1,165,445
                
                
                
                1Stock
                    issued from employee stock purchase plan
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                90,418PIPE
                    Investment
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                4,149,376
                
                
                
                4Conversion
                    of AIR
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                87,596Dividend
                    attributable to Series B conversion
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                22,847Conversion
                    of Series B Preferred Stock
                
                
                
                
                
                
                
                
                
                
                (43,480)
                
                
                
                —
                
                
                
                400,343Net
                    loss
                
                
                
                
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                —Balances,
                    December 31, 2005
                
                
                —
                
                
                
                
                
                
                
                246,867
                
                
                
                —
                
                
                
                27,455,083
                
                
                
                27
  ****
                  **Class
                      B Common Stock Number**
                  ****
                  **Amount**
                  ****
                  **Series
                      B Preferred Stock Number**
                  ****
                  **Amount**
                  ****
                  **Common
                      Stock Number**
                  ****
                  **Amount**Balance,
                      December 31, 2004
                  
                  
                  —
                  
                  
                  
                  
                  $
                  —
                  
                  
                  290,347
                  
                  
                  
                  
                  $
                  —
                  
                  
                  21,539,058
                  
                  
                  
                  
                  $
                  22Stock
                      issued on exercise of stock options
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  1,165,445
                  
                  
                  
                  
                  
                  1Stock
                      issued from employee stock purchase plan
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  90,418PIPE
                      Investment
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  4,149,376
                  
                  
                  
                  
                  
                  4Conversion
                      of AIR
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  87,596Dividend
                      attributable to Series B conversion
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  22,847Conversion
                      of Series B Preferred Stock
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (43,480
                  )
                  
                  
                  
                  
                  —
                  
                  
                  400,343Net
                      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  —
                  
                  
                  
                  
                  
                  —
                  
                  
                  —Balances,
                      December 31, 2005
                  
                  
                  —
                  
                  
                  
                  
                  
                  
                  
                  
                  246,867
                  
                  
                  
                  
                  
                  —
                  
                  
                  27,455,083
                  
                  
                  
                  
                  
                  27


**Additional**
              **Paid-in
                Capital****Accumulated
                Deficit**
            
            
            
            **Total**Balances,
                December 31, 2004
            
            
            
            
            $
            533,659
            
            $
            (518,466
            )
            
            
            
            
            
            
            $
            15,215Stock
                issued on exercise of stock options
            
            
            
            
            
            2,383
            
            
            —
            
            
            
            
            
            
            
            
            2,384Stock
                issued from employee stock purchase plan
            
            
            
            
            
            173
            
            
            —
            
            
            
            
            
            
            
            
            173PIPE
                Investment
            
            
            
            
            
            9,755
            
            
            —
            
            
            
            
            
            
            
            
            9,759Conversion
                of AIR
            
            
            
            
            
            200
            
            
            —
            
            
            
            
            
            
            
            
            200Dividend
                attributable to Series B conversion
            
            
            
            
            
            (185
            )
            
            —
            
            
            
            
            
            
            
            
            (185
            )Unearned
                stock-based compensation
            
            
            
            
            
            819
            
            
            —
            
            
            
            
            
            
            
            
            819Net
                loss
            
            
            
            
            
            —
            
            
            (22,020
            )
            
            
            
            
            
            
            
            (22,020
            )Balances,
                December 31, 2005
            
            
            
            
            $
            546,804
            
            $
            (540,486
            )
            
            
            
            
            
            
            $
            6,345





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


F
          -
          7


IPIX
      CORPORATION


CONSOLIDATED
      STATEMENTS OF CASH FLOWS





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**Cash
                flows from operating activities:
            
            (In
                thousands)Net
                income (loss)
            
            
            
            
            $
            1,386
            
            $
            (14,735
            )
            $
            (22,020
            )Adjustments
                to reconcile net income (loss) to net cash provided by (used in)
                operating activities:Depreciation
            
            
            
            
            
            3,164
            
            
            989
            
            
            740Impairment
                and amortization of intangibles
            
            
            
            
            
            3,042
            
            
            —
            
            
            —Write
                down of computer hardware, software
            
            
            
            
            
            —
            
            
            —
            
            
            221Bad
                debt expense (recovery)
            
            
            
            
            
            8
            
            
            3
            
            
            19Provision
                for inventory obsolescence
            
            
            
            
            
            (12
            )
            
            198
            
            
            (132
            )Loss
                on foreign exchange
            
            
            
            
            
            491
            
            
            —
            
            
            —Gain (loss)
                on disposal of assets
            
            
            
            
            
            (177
            )
            
            —
            
            
            14Stock-based
                compensation expense
            
            
            
            
            
            —
            
            
            —
            
            
            819Accounts
                receivable
            
            
            
            
            
            3,266
            
            
            (156
            )
            
            (953
            )Inventory
            
            
            
            
            
            (205
            )
            
            (2,134
            )
            
            321Prepaid
                expenses and other current assets
            
            
            
            
            
            (632
            )
            
            (57
            )
            
            354Long-term
                restricted cash and other assets
            
            
            
            
            
            (782
            )
            
            134
            
            
            1,345Accounts
                payable
            
            
            
            
            
            252
            
            
            431
            
            
            1,500Accrued
                liabilities
            
            
            
            
            
            (837
            )
            
            23
            
            
            (48
            )Deferred
                revenue
            
            
            
            
            
            (9
            )
            
            86
            
            
            (84
            )Net
                cash provided by (used in) operating activities8,955
            
            
            (15,218
            )
            
            (17,904
            )Cash
                flows from investing activities:Purchases
                of computer hardware, software and other
            
            
            
            
            
            (909
            )
            
            (380
            )
            
            (1,478
            )Purchase
                of short term investments
            
            
            
            
            
            (1,431
            )
            
            (1,445
            )
            
            (2,031
            )Maturities
                of short term investments
            
            
            
            
            
            1,400
            
            
            1,431
            
            
            1,445Net
                cash used in investing activities
            
            
            
            
            
            (940
            )
            
            (394
            )
            
            (2,064
            )Cash
                flows from financing activities:Proceeds
                from issuance of common stock
            
            
            
            
            
            1,557
            
            
            5,736
            
            
            2,579PIPE
                Investment
            
            
            
            
            
            —
            
            
            4,920
            
            
            9,759Conversion
                of AIR
            
            
            
            
            
            —
            
            
            5,373
            
            
            200Conversion
                of Series B Preferred Warrant
            
            
            
            
            
            —
            
            
            2,988
            
            
            —Dividend
                attributable to Series B preferred stock conversion
            
            
            
            
            
            (364
            )
            
            (452
            )
            
            (185
            )Repayments
                of lease obligations
            
            
            
            
            
            (1,990
            )
            
            (410
            )
            
            (309
            )Net
                cash provided by (used in) financing activities
            
            
            
            
            
            (797
            )
            
            18,155
            
            
            12,044Effect
                of exchange rate changes on cash
            
            
            
            
            
            3
            
            
            —
            
            
            —Net
                increase (decrease) in cash and cash equivalents
            
            
            
            
            
            7,221
            
            
            2,543
            
            
            (7,924
            )Cash
                and cash equivalents, beginning of period
            
            
            
            
            
            3,020
            
            
            10,241
            
            
            12,784Cash
                and cash equivalents, end of period
            
            
            
            
            $
            10,241
            
            $
            12,784
            
            $
            4,860


SUPPLEMENTAL
      DATA





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)Interest
                paid
            
            
            
            
            $
            158
            
            $
            235
            
            $
            58








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


F
          -
          8


IPIX
      CORPORATION


NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS





1.
      THE
      COMPANY





IPIX
      Corporation (“IPIX” or “Company”), formerly Internet Pictures Corporation,
      provides mission-critical imaging solutions for commerce, communication and
      security applications. The Company’s solutions create, process and manage a rich
      variety of media including still images, 360° by 360° immersive images and
      video. During 2004, the Company focused on realigning its core competencies
      with
      its strategic business goals. The InfoMedia business unit, formerly responsible
      for the development, marketing and sales of immersive photography products,
      was
      integrated with the security business unit. The still photography product teams
      now work closely with the video product teams leveraging mature development
      processes and expertise, and the sales and marketing of each product line is
      conducted as a coordinated effort. In markets where customers benefit from
      combined products (video and stills) in a single offering, this new structure
      allows IPIX to do so seamlessly. In addition, in February 2005 we sold the
      AdMission business unit, which developed and sold products to the on-line
      advertising market. In accordance with Financial Accounting Standards Board
      (“FASB”) Statement of Financial Accounting Standard (“FAS”) No.144, “Accounting
      for the Impairment or Disposal of Long-Lived Assets"(“FAS 144”), the assets and
      liabilities related to the AdMission business unit were classified as held
      for
      sale at December 31, 2004, and the operations of this business unit were
      considered discontinued operations (see Note 4).





The
      Company’s extensive intellectual property covers patents for 360° imaging, video
      and surveillance applications.





2.
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





PRINCIPLES
      OF CONSOLIDATION. The consolidated financial statements include the accounts
      of
      IPIX Corporation and its wholly-owned subsidiaries, Interactive Pictures
      Corporation, Interactive Pictures UK Limited, Internet Pictures (Canada) and
      PW
      Technology, Inc. The consolidation of these entities will collectively be
      referred to as the Company. All significant intercompany balances and
      transactions have been eliminated.





FOREIGN
      CURRENCY TRANSLATION. The functional currency of the Company’s Canadian and
      United Kingdom subsidiaries is the U.S. dollar. Monetary assets and liabilities
      denominated in foreign currencies are translated into the Company’s functional
      currency, U.S. dollars, at the exchange rate prevailing at the balance sheet
      date. Non-monetary assets and liabilities and transactions are translated at
      exchange rates prevailing at the respective transaction dates. Revenue and
      expenses are translated at the average rates of exchange during the year.
      Translation gains and losses are recorded in accumulated other comprehensive
      income. Transaction exchange gains and losses are included in the statement
      of
      operations and have not been material for any periods presented. As of
      December 31, 2003, the Company ceased operations in its Canadian and United
      Kingdom subsidiaries. Such subsidiaries have been liquidated. Accordingly,
      the
      balance in the accumulated other comprehensive loss account was recognized
      in
      the statement of operations for the year ended December 31, 2003.





CASH,
      CASH EQUIVALENTS, RESTRICTED CASH AND SHORT-TERM INVESTMENTS. The Company
      considers all highly liquid debt instruments with an original maturity or
      remaining maturity at date of purchase of three months or less to be cash
      equivalents. All other liquid investments are classified as either short-term
      or
      long-term investments.





Management
      determines the appropriate classification of investment securities at the time
      of purchase and re-evaluates such designation as of each balance sheet date.





At
      December 31, 2004 and 2005, the Company had a certificate of deposit of
      $1.45 million and $1.48 million, respectively, each with a remaining
      maturity of six months and an interest rate of 1.64% and 1.64%, respectively.
      The certificates of deposit are classified as short-term investments. At
      December 31, 2004, $0.55 million of those investments had been
      provided as collateral for a letter of credit related to certain capital lease
      obligations and, accordingly, classified as restricted. In the third quarter
      of
      2005, the Company bought out the capital lease and the restricted cash was
      released.





Interest
      income includes interest earned on our cash reserves.





CERTAIN
      RISKS AND CONCENTRATIONS. Financial instruments that potentially subject the
      Company to a concentration of credit risk consist of cash and cash equivalents,
      restricted cash and short-term investments and accounts receivable. Cash, cash
      equivalents and restricted cash and short-term investments are deposited with
      high quality financial institutions. Accounts receivable are derived from
      revenue earned from customers located in the U.S. and abroad. The Company
      performs ongoing credit evaluations of customers’ financial condition and the
      Company does not require collateral from customers.





F
          -
          9


The
      following table and paragraph summarize the revenue and accounts receivable
      due
      from customers who provide IPIX more than 10% of total revenues or who owed
      IPIX
      more than 10% of outstanding accounts receivable at December 31:





**Revenues
                for Years ended December 31,****2003**
            
            **2004**
            
            **2005**U.S.
                Government
            
            
            —
            
            
            —
            
            
            26
            %British
                Distributor
            
            
            —
            
            
            41
            %
            
            14
            %Sentry
                360 Security Inc.
            
            
            —
            
            
            —
            
            
            3
            %Homestore
            
            
            3
            %
            
            8
            %
            
            —





At
      December 31, 2005, the U.S. Government and Sentry 360 Security represented
      43.5%
      and 9.8% of accounts receivable, respectively. At December 31, 2004,
      Homestore and our UK Distributor represented 21% and 11% of accounts receivable,
      respectively. At December 31, 2003, Homestore and eBay represented 22% and
      0% of accounts receivable, respectively. The discontinued operations for 2003
      include a one-time $8.0 million license fee from eBay for the Company’s Rimfire
      technology and other services. As announced in June 2003, the Company
      amended its then current commercial agreement with eBay. The Company no longer
      provides any products or services to eBay as of November 1, 2003.





The
      Company relies on a few main vendors from which we receive high quality material
      in a reasonable time to manufacture our products.





On
      October 1, 2004, the license agreement dated January 12, 2001 (the
“License Agreement”) between us and Homestore Virtual Tours, Inc. (“Homestore”)
      was terminated. Under the License Agreement, Homestore had the exclusive right
      to sell our virtual tour technology to the U.S. residential real estate market
      and was required to pay us a royalty for each virtual tour sold. A copy of
      the
      license agreement was filed as Exhibit 10.16 to our quarterly report on
      Form 10-Q filed with the Securities and Exchange Commission on
      April 2, 2001. As a result of the termination, Homestore no longer has the
      exclusive right to sell our virtual tour technology to the U.S. residential
      real
      estate market, and we may sell, or license another third party to sell, our
      virtual tour technology into this market. We mutually released each other from
      any further obligations under the License Agreement.





INVENTORY.
      Inventory, which consists primarily of digital cameras and related hardware,
      is
      stated at the lower of cost or market, with costs determined using first-in,
      first out method (FIFO). The Company conducts a physical inventory quarterly
      and
      routinely reviews material for any impairment either because of technical
      obsolescence or because the inventory exceeds by a material amount the forecasts
      for Company sales. The Company records a provision for obsolete or excess
      inventory whenever impairment has been identified.





PREPAID
      EXPENSES. Prepaid expenses consist primarily of pre-payments of insurance,
      rent,
      maintenance and trade deposits which will be reflected as an expense during
      the
      periods benefited.





COMPUTER
      HARDWARE, SOFTWARE AND OTHER. Computer hardware and software are recorded at
      cost and are depreciated using the straight-line method over estimated useful
      lives, which range from two to three years. Furniture and fixtures are
      depreciated using the straight-line method over the estimated useful life,
      which
      range from two to five years. Leasehold improvements are amortized using the
      straight-line method over the term of the lease or estimated useful life, which
      ranges from one to five years. Routine maintenance and repair costs are expensed
      as incurred. The costs of major additions, replacements and improvements are
      capitalized. Gains and losses from disposals are included in operations as
      incurred.





ACCOUNTING
      FOR LONG-LIVED ASSETS. The carrying value of intangible assets, computer
      hardware and software and other long-lived assets is reviewed on a regular
      basis
      for the existence of facts, both internally and externally, that may suggest
      impairment. The Company recognizes impairment losses whenever events or
      circumstances result in the carrying amount of the assets exceeding the sum
      of
      the expected future cash flows associated with such assets. The measurement
      of
      the impairment losses to be recognized is based on the difference between the
      discounted cash flows from such assets and the carrying amounts of the assets.
      In December of 2005, the Company identified certain fixed assets that we plan
      to
      sell. These assets were identified and an appropriate valuation allowance was
      determined. The assets will not be depreciated further. These assets are
      presented on the consolidated balance sheet as assets held for sale net of
      the
      appropriate valuation allowance.





GOODWILL
      AND OTHER INTANGIBLES. Under Financial Accounting Standards Board Statement
      of
      Financial Accounting Standards 142,“Goodwill and Other Intangibles” (FAS 142),
      the Company no longer amortizes goodwill but rather evaluates goodwill for
      impairment on an annual basis and on an interim basis if events or changes
      in
      circumstances between annual impairment tests indicate that the asset might
      be
      impaired. The Company periodically reviews the net realizable value of its
      intangible assets, including goodwill, through an assessment of the estimated
      future cash flows related to such assets. The reviews determine whether future
      cash flows over the remaining estimated useful lives of the assets provide
      for
      recovery of the assets. In assessing the recoverability of goodwill, the Company
      must make assumptions regarding estimated future cash flows and other factors
      to
      determine the fair value of the goodwill. These estimates include forecasted
      revenues and operating expenses, which are inherently difficult to predict.
      The
      Company’s assumptions about fair values require significant judgment because
      broad economic factors, industry factors and technology considerations can
      result in variable and volatile fair values.





F
          -
          10


INCOME
      TAXES. The Company uses the asset and liability method of accounting for income
      taxes, which requires the recognition of deferred tax liabilities and assets
      for
      expected future tax consequences of temporary differences between the carrying
      amounts and the tax basis of assets and liabilities. A valuation allowance
      against deferred tax assets is recorded if, based upon available evidence,
      it is
      more likely than not that some or all of the deferred tax assets will not be
      realized. Tax credits are accounted for as a reduction of tax expense in the
      year in which the credits reduce taxes payable.





The
      Company did not recognize deferred income taxes for temporary differences
      associated with its investment in the foreign subsidiaries because the
      differences are essentially permanent in duration.





As
      of
      December 31, 2003, the Company has ceased operations in its Canadian and
      United Kingdom subsidiaries; accordingly, the balance in the intercompany
      accounts with these subsidiaries has been recognized for tax purposes only
      in
      the results of operations for the year ended December 31, 2003. In
      addition, the Company has liquidated its Canadian and United Kingdom
      subsidiaries. Prior to 2003, Interactive Pictures UK Limited was not included
      in
      the tax filing of its parent, IPIX Corporation. As a result, Interactive
      Pictures UK Limited filed a separate return with the United Kingdom tax
      authorities. Prior to 2003, Internet Pictures (Canada), Inc. was not included
      in
      the tax filing of its parent, IPIX Corporation. As a result, Internet Pictures
      (Canada), Inc. filed a separate return with Canadian tax authorities.





REVENUE
      RECOGNITION. We recognize revenue when persuasive evidence of an arrangement
      exists, delivery has occurred or services have been rendered, the contract
      price
      is fixed or determinable, and collectibility is reasonably assured.





We
      derive
      revenue from sales of our hardware, sales of licenses and keys for our software
      and professional services we provide to customers. Professional service revenues
      include effort performed under government contracts. Formerly professional
      services consisted of transaction hosting revenue where a reseller uses image
      management products to enhance their on-line offering. Transaction hosting
      revenue was primarily performed by the AdMission business unit which was
      discontinued in 2004 and sold in the first quarter of 2005.





Transaction
      hosting revenue (which is included in discontinued operations) was recognized
      ratably as transactions were performed provided there was persuasive evidence
      of
      an arrangement, the fee was fixed or determinable and collection of the
      resulting receivable was reasonably assured.





Hardware
      and software revenue is recognized upon shipment, if the contract shipping
      term
      is FOB shipping point, and upon delivery, if the contract shipping term is
      FOB
      destination, provided there are no uncertainties surrounding product acceptance,
      persuasive evidence of an arrangement exists, there are no significant vendor
      obligations, the fees are fixed or determinable and collection is reasonably
      assured. Initial license fees are recognized when a contract exists, the fee
      is
      fixed or determinable, software delivery has occurred and collection of the
      receivable is reasonably assured. If there are continuing obligations, then
      license fees are recognized ratably over the life of the contract. Revenue
      from
      hardware and software sales to distributors is recognized upon shipment
      (“sell-in”) if the distributor relationship does not create substantial
      uncertainty regarding fixed or determinable fees and collectibility. If at
      the
      beginning of an arrangement we determine the arrangement fee is not, or is
      presumed to not be, fixed or determinable, or there is uncertainty over
      collectibility, revenue is deferred and subsequently recognized as amounts
      become due or collected.





The
      Company recognizes revenue in accordance with Statement of Position (“SOP”)
      No. 97-2, “Software Revenue Recognition” and SOP No. 98-9,
“Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
      Transactions.” If a contract requires significant production, modification or
      customization of the software, the arrangement is accounted for as a long-term
      service contract. If it does not, software revenue is realizable when the
      following criteria are met: persuasive evidence of an arrangement exists,
      delivery has occurred or services have been rendered, the seller’s price to the
      buyer is fixed or determinable and collectibility is reasonably assured.





Other
      criteria that must be met include the determination of whether the revenue
      in
      multiple-element arrangements can be recognized separately for each element
      as
      performance occurs and the determination of the fee based on vendor-specific
      objective evidence (“VSOE”) of fair value for each element. The Company
      determines VSOE of fair value of each element by the price charged when the
      same
      element is sold separately or based on Management’s established prices for
      elements such as professional rates on comparable service contracts or the
      price
      of software with the same functionality available in the industry. If management
      is unable to determine the VSOE of a delivered element, the revenue is
      recognized by the residual method. As performance occurs, the fee for the
      delivered item is determined by the total fee of the arrangement less the total
      fair value of the undelivered elements. The total fair value of the undelivered
      elements is deferred and subsequently recognized as performance occurs. If
      management is unable to determine the VSOE of an undelivered element, all
      revenue from the contract is deferred until the VSOE is established or all
      performance has occurred. If the only undelivered element without VSOE of fair
      value is services that can be accounted for separately, the entire fee is
      recognized over the service period.





F
          -
          11


Our
      professional service revenue under government contracts consist primarily of
      services provided by our employees, consultants and the pass through of costs
      for equipment or other third party services. Cost of services consists primarily
      of compensation expenses for program personnel, the fringe benefits associated
      with this compensation, consulting labor and other direct expenses incurred
      to
      complete programs, including cost of equipment. The current government contract
      is a cost-plus-fixed-fee contract. Revenues for cost-reimbursement contracts
      are
      recorded as reimbursable costs are incurred, including a pro-rata share of
      the
      contractual fees.





The
      Company recognizes other professional service revenue from long-term service
      contracts in accordance with Accounting Research Bulletin (“ARB”) No. 45,
“Long-Term Construction Type Contracts,” using the relevant guidance in SOP
      81-1, “Accounting for Performance of Construction-Type and Certain
      Production-Type Contracts,” as determined by the terms and conditions of the
      Company’s contracts with its customers. Revenue is typically recognized ratably
      over the contractual periods or as services are performed. In addition, when
      professional service contracts involve software that is essential to the
      functionality of the delivered software product, revenue from the entire
      arrangement is recognized as services are performed on a percentage of
      completion method or not until the contract is completed. In fixed price
      contracts, revenue is recognized based on the percentage of completion method,
      income is recognized at a consistent profit margin over the period of
      performance based on estimated profit margins at completion of the contract.
      This method of accounting requires estimating the total revenues and total
      contract cost at completion of the contract. Estimated losses on contracts
      at
      completion are recognized when identified.





FAIR
      VALUE OF FINANCIAL INSTRUMENTS. Carrying amounts of the Company’s financial
      instruments including short-term investments, accounts receivable, and accounts
      payable approximate fair value due to their short maturities. Obligations under
      capital leases are recorded at discounted value of the future lease payments
      and
      approximate fair value.





SHIPPING
      AND HANDLING COSTS. Costs incurred for shipping and handling are included in
      cost of revenues at the time the related revenue is recognized. Amounts billed
      to a customer for shipping and handling are reported as revenue.





RESEARCH
      AND DEVELOPMENT COSTS. Research and development expenditures are expensed as
      incurred. Research and development costs associated with the contract work
      on
      behalf of the U.S. Government are booked to cost of goods sold.





ADVERTISING
      EXPENSES. All advertising expenditures are expensed as incurred. Advertising
      expenses for 2003, 2004 and 2005, were $1.5 million, $0.2 million and
      $0.3 million, respectively.





STOCK-BASED
      COMPENSATION. The Company has adopted the disclosure provisions of Statement
      of
      Financial Accounting Standards No. 123, “Accounting for Stock-based
      Compensation"(“FAS 123”) as amended by FAS No. 148, “Accounting for
      Stock-based Compensation.” The Company has elected to continue accounting for
      stock-based compensation issued to employees using Accounting Principles Board
      Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”).
      Under APB 25, compensation expense is based on the difference, if any, on the
      date of grant, between the fair value of the Company’s stock and exercise price
      of the option. Stock and other equity instruments issued to non-employees have
      been accounted for in accordance with FAS 123 and Emerging Issues Task Force
      Issue No. 96-18, “Accounting for Equity Instruments Issued to Other Than
      Employees for Acquiring, or in Conjunction with Selling, Goods, or Services,”
and valued using the Black-Scholes model.





The
      following table illustrates the effect on net loss available to common
      stockholders and earnings per share if the Company had adopted the fair value
      recognition provisions of FAS 123 to stock-based employee compensation:





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands, except per share data)Net
                loss available to common stockholders
            
            
            
            
            $
            (392
            )
            $
            (15,609
            )
            $
            (22,459
            )Add
                employee stock compensation expense included in reported net loss
            
            
            
            
            
            —
            
            
            —
            
            
            819Less
                total stock-based employee compensation expense determined under
                fair
                value based methods for all awards
            
            
            
            
            
            (1,472
            )
            
            (2,701
            )
            
            (3,135
            )Adjusted
                net loss available to common stockholders
            
            
            
            
            $
            (1,864
            )
            $
            (18,310
            )
            $
            (24,775
            )Basic
                net loss per common share:Net
                loss available to common stockholders before pro-forma charge
            
            
            
            
            $
            (0.05
            )
            $
            (0.95
            )
            $
            (0.91
            )Net
                effect of pro-forma charges
            
            
            
            
            
            (0.20
            )
            
            (0.16
            )
            
            (0.09
            )Adjusted
                basic net loss per common share available to common stockholders
            
            
            
            
            $
            (0.25
            )
            $
            (1.11
            )
            $
            (1.00
            )







F
          -
          12


Under
      FAS
      123, grants under the Employee Stock Purchase Plan (“ESPP”) have a look-back
      feature and a 15% discount and accordingly would have had compensation expense
      calculated as a result. The fair value disclosure associated with the ESPP
      grants is included in the fair value pro-forma information above.





The
      minimum fair value of each option grant is estimated on the date of grant using
      the Black-Scholes option-pricing model with the following weighted-average
      assumptions used for grants: expected lives of three to four years in 2003,
      2004
      and 2005; risk free interest rate of 3.5% to 4.0% in 2003, 4.0% to 5.0% in
      2004
      and 3.625% to 5.0% in 2005; expected dividends of zero in 2003, 2004 and 2005;
      and volatility of 114% in 2003, 175% in 2004 and 121% in 2005.





In
      connection with certain employee and non-employee stock option and restricted
      stock grants, the Company amortizes unearned stock-based compensation over
      the
      vesting period of the related grant using the method prescribed in FASB
      Interpretation No. 28. Under this method, each vested tranche of options is
      accounted for as a separate grant awarded for past services. Accordingly, the
      compensation expense is recognized over the period in which the services have
      been provided. This method results in higher compensation expense in the earlier
      vesting periods of the related grants.





ESTIMATES.
      The preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the dates
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting periods. Actual results could differ from those estimates.
      Examples of items affected by certain significant estimates made by management
      are adequacy of the allowance for doubtful accounts, inventory obsolescence
      reserve, restructuring charges, sales taxes and the carrying value of goodwill.





SEGMENT
                INFORMATION




SFAS
      No. 131, “Disclosures about Segments of an Enterprise and Related
      Information,” requires disclosures of certain information regarding operating
      segments, products and services, geographic areas of operation and major
      customers. SFAS No. 131 reporting is based upon the “management approach”:
      how management organizes the company’s operating segments for which separate
      financial information is (i) available and (ii) evaluated regularly by
      the chief operating decision maker in deciding how to allocate resources and
      in
      assessing performance. Our chief operating decision maker is its President
      and
      Chief Executive Officer, or CEO.





During
      2004, we realigned our previous business divisions into one operating segment.
      Therefore, segment information is no longer relevant for 2005 as our CEO is
      provided information and evaluates performance for the entire company as a
      whole
      rather than in previous operating segments. For 2003 and 2004, we reported
      segment information for our previous primary business units: Security and
      InfoMedia.





NET
      LOSS
      PER SHARE. The Company computes net loss per common share in accordance with
      FAS
      No. 128, “Earnings Per Share”. Basic income (loss) per share is
      computed by dividing net income (loss) available to common stockholders for
      the
      period by the weighted average number of shares of common stock outstanding.
      Net
      income (loss) available to common stockholders is calculated as the net
      income (loss) less cumulative preferred stock dividends for the period. If
      dilutive, the participation right of the preferred stock is reflected in the
      calculation of basic income (loss) per share using the “if-converted” method or
      the two class method if more dilutive. Diluted income (loss) per common
      share is computed by dividing net income (loss) for the period by the
      weighted average number of shares of common stock outstanding plus, if dilutive,
      potential common stock outstanding during the period. Potential common shares
      are composed of incremental shares of common stock issuable upon the exercise
      of
      potentially dilutive stock options and warrants and upon conversion of the
      Company’s preferred stock.





The
      following table sets forth potential common shares that are not included in
      the
      diluted net loss per share calculation because to do so would be antidilutive
      for the periods indicated:


**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**WEIGHTED
                AVERAGE EFFECT OF POTENTIAL COMMON SHARES:Series B
                preferred stock
            
            
            10,924,287
            
            
            2,871,843
            
            
            2,821,837Employee
                stock options
            
            
            960,851
            
            
            2,260,097
            
            
            257,176Warrants
                to purchase Series B preferred stock
            
            
            218,446
            
            
            338,536
            
            
            —TOTAL
            
            
            12,103,584
            
            
            5,470,476
            
            
            3,079,013





In
      2005,
      the Company’s common stock had an average share price of $3.07. The average
      strike price of the warrants to purchase common stock is $4.51 and the average
      strike price of employee stock options is $4.45. Not included in the table
      above
      are 928,899 shares issuable upon exercise of exercisable options at December
      31,
      2005 and 2,974,641 shares issuable upon exercise of warrants, all of which
      have
      a strike price above the average share price during 2005





F
          -
          13


In
      2004,
      the Company’s common stock had an average share price of $7.04. The average
      strike price of the warrants to purchase common stock was $14.48 and the average
      strike price of employee stock options was $7.6 3.
      Not
      included in the table above are 766,437 shares issuable upon exercise of options
      and 76,949 shares issuable upon exercise of warrants, all of which have a strike
      price above the average share price during 2004.





In
      2003,
      the Company’s common stock had an average share price of $2.39. The average
      strike price of the warrants to purchase common stock was $12.15 and the average
      strike price of employee stock options was $6.29. Not included in the table
      above are 989,762 shares issuable upon exercise of options and 1,057,699 shares
      issuable upon exercise of warrants, all of which have a strike price above
      the
      average share price during 2003.





COMPREHENSIVE
      INCOME (LOSS). The Company follows FAS No. 130, “Reporting Comprehensive
      Income” (“FAS 130”), which establishes requirements for reporting and displaying
      comprehensive income (loss) and its components. FAS 130 requires net
      unrealized gains or losses on the Company’s foreign currency translation
      adjustments to be reported as accumulated other comprehensive income (loss).





The
      components of comprehensive income (loss) are as follows:





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)Net
                income (loss)
            
            
            
            
            $
            1,386
            
            $
            (14,735
            )
            $
            (22,020
            )Foreign
                currency translation adjustment
            
            
            
            
            
            (3
            )
            
            —
            
            
            —Comprehensive
                income (loss)
            
            
            
            
            $
            1,383
            
            $
            (14,735
            )
            $
            (22,020
            )





RECENT
      ACCOUNTING PRONOUNCEMENTS.





In
      December 2004, the FASB issued FAS No. 123 (R), “Share-Based Payment”
to replace FAS No. 123, “Accounting for Stock-Based Compensation” and APB
      Opinion No. 25, “Accounting for Stock Issued to Employees.” FAS
      No. 123 (R) requires, among other things, that all share-based
      payments to employees, including grants of stock options, be measured based
      on
      their grant-date fair value and recognized as expense in the financial
      statements effective for interim or annual periods beginning after June 15,
      2005. Unless observable market prices exist, the grant-date fair value is
      estimated using an appropriate option-pricing model as determined by Management.
      Management must also make certain assumptions about employee exercise habits,
      forfeiture rates and select an appropriate amortization methodology for
      recognizing compensation expense. The Statement requires a modified prospective
      method of adoption. Companies may also elect to restate their previously issued
      financial statements to provide consistency across all periods presented under
      a
      modified retrospective method. Management believes the adoption of FAS
      No. 123(R) will have a material impact on the Company’s consolidated
      results of operations and earnings per share but has not yet determined the
      method of adoption that will be applied or whether adoption will result in
      expense amounts materially different from those currently provided under the
      pro
      forma disclosures.





In
      April 2005, the Securities and Exchange Commission announced the adoption
      of a new rule that amends the effective date of FAS No. 123(R). The
      effective date of the new standard under these new rules for our consolidated
      financial statements is January 1, 2006. Adoption of this statement will
      have a significant impact on the consolidated results of operations and earnings
      per share as the Company will be required to expense the fair value of stock
      option grants and stock purchases under the employee stock purchase plan rather
      than disclose the impact on the Company’s consolidated net loss within the
      footnotes, as is the Company’s current practice.





In
      November 2005, the FASB issued FSP FAS123(R)-3, *Transition
      Election to Accounting for the Tax Effects of Share-Based Payment Awards.* This
      FSP
      requires an entity to follow either the transition guidance for the
      additional-paid-in-capital pool as prescribed in SFAS No. 123(R), *Share-Based
      Payment* ,
      or the
      alternative transition method as described in the FSP. An entity that adopts
      SFAS No. 123(R) using the modified prospective application may make a
      one-time election to adopt the transition method described in this FSP. An
      entity may take up to one year from the later of its initial adoption of SFAS
      No. 123(R) or the effective date of this FSP to evaluate its available
      transition alternatives and make its one-time election. This FSP became
      effective in November 2005. We continue to evaluate the impact that the adoption
      of this FSP could have on our financial statements.





F
          -
          14


In
      June 2005, the FASB issued FAS No. 154, Accounting Changes and Error
      Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and
      FASB No. 3, Reporting Accounting Changes in Interim Financial Statements.
      The Statement applies to all voluntary changes in accounting principle, and
      changes the requirements for accounting for and reporting of a change in
      accounting principle. FAS 154 requires retrospective application to prior
      periods’ financial statements of a voluntary change in accounting principle
      unless it is impracticable. It is effective for accounting changes and
      corrections of errors made in fiscal years beginning after December 15,
      2005. Earlier application is permitted for accounting changes and corrections
      of
      errors made occurring in fiscal years beginning after June 1, 2005. The
      Company does not expect the effect of FAS 154 will have material impact on
      its
      financial statements.





In
      November 2005, the FASB issued Staff Position (“FSP”) FAS115-1/124-1, *The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments* ,
      which
      addresses the determination as to when an investment is considered impaired,
      whether that impairment is other than temporary, and the measurement of an
      impairment loss. This FSP also includes accounting considerations
      subsequent to the recognition of an other-than-temporary impairment and requires
      certain disclosures about unrealized losses that have not been recognized as
      other-than-temporary impairments. The guidance in this FSP amends FASB
      Statements No. 115, *Accounting
      for Certain Investments in Debt and Equity Securities* ,
      and
      No. 124, *Accounting
      for Certain Investments Held by Not-for-Profit Organizations* ,
      and APB
      Opinion No. 18, *The
      Equity Method of Accounting for Investments in Common Stock* . This
      FSP is effective for reporting periods beginning after December 15,
      2005. We do not believe the adoption of this FSP will have a material
      impact on our financial statements.





RECLASSIFICATIONS.
      Certain amounts reported in the previous periods have been reclassified to
      conform to the current period presentation. As previously discussed, AdMission
      business unit has been sold and its operations have been reclassed to
      discontinued operations in all years presented. The Company also no longer
      reports on multiple segments having consolidated its operations into a single
      segment. Prior periods have been restated for comparability.





3.
      GOING
      CONCERN CONSIDERATIONS





The
      accompanying consolidated financial statements have been presented in accordance
      with U.S. GAAP, which assume the continuity of the Company as a going concern.
      During the year ended December 31, 2005 and in the prior fiscal years, the
      Company has experienced, and continues to experience, certain issues related
      to
      cash flow and profitability. These factors raise substantial doubt about the
      Company’s ability to continue as a going concern. The Company completed a
      $10 million private placement of common stock, including additional
      investment rights and warrants to a group of existing and new institutional
      investors on June 21, 2005. Management monitors the Company’s cash position
      carefully and evaluates its future operating cash requirements with respect
      to
      its strategy, business objectives and performance. The Company completed the
      sale of the AdMission business unit to AdMission Corporation in the first
      quarter of 2005. During the first two quarters of 2005, we incurred certain
      costs for accountant and lawyer fees, buyout of an equipment lease and
      abandonment of an operating lease as a result of the sale of the AdMission
      business unit. (See Note 4)





On
      November 18, 2005, the Company issued a press release announcing action taken
      to
      further streamline the Company's structure and reduce cost. The action taken
      was
      intended to reduce personnel costs, facility costs and expenses. As a result
      of
      these actions, the Company reduced its total headcount by 15 staff positions.
      A
      restructuring charge, of approximately $612,000 was recorded in the fourth
      quarter of 2005 which included $570,000 for activities associated with the
      Company’s operations at Oak Ridge, Tennessee as well as $42,000 associated with
      the previously discussed closure of the Company’s operations in California.




The
      Company has a limited operating history as it will operate in 2006 and upon
      which an evaluation of its business and prospects in 2006 may be made. In
      addition, the Company is subject to generally prevailing economic conditions
      and, as such, the Company’s operating results in 2006 will be dependent upon its
      ability to provide quality products and services, the success of its customers
      and the appropriations processes of various commercial and governmental
      entities. Management believes the Company will have to acquire additional
      working capital through financing to supplement working capital from operations
      to meet its funding needs for 2006. There can be no assurance that such
      additional financing will be available or if available, that such financing
      can
      be obtained on terms satisfactory to the Company. If the Company is not able
      to
      raise additional funds, it may be required to significantly curtail its
      operations which would have an adverse effect on its financial position, results
      of operations and cash flow. The financial statements do not include any
      adjustments that might result from the outcome of this uncertainty. The Company
      finished 2005 with approximately $6.34 million in cash reserves (cash and
      cash equivalents of $4.86 million and short-term investments of $1.48
      million). Management expects to continue to make investments in the sale and
      marketing of new products for the security market, which may consume available
      cash reserves.





F
          -
          15


4.
      DISCONTINUED OPERATIONS





On
      February 11, 2005, the Company and AdMission Corporation, a privately held
      Delaware corporation (“AdMission”), closed the transactions under the asset
      purchase agreement dated January 11, 2005 between the parties (the “Asset
      Purchase Agreement”). Pursuant to the terms of the Asset Purchase Agreement,
      IPIX sold to AdMission certain of its assets (including certain patent rights
      and other intellectual property) and contracts relating to its IPIX AdMission
      business unit (the “AdMission Business”). In consideration for the sale, IPIX
      received 1,035,000 shares of the Series A Convertible Preferred Stock of
      AdMission and a warrant to purchase 200,000 shares of the Common Stock of
      AdMission. Additionally, AdMission assumed certain liabilities associated with
      the AdMission business unit. In accordance with FAS 144, the assets and
      liabilities related to the AdMission business were classified as held for sale
      at December 31, 2004, and the operations of this business unit were
      considered discontinued operations for each quarter and for each full year
      presented. The preferred stock and warrant were recorded as an asset investment
      in AdMission and subsequently written-down to zero. This write-down was based
      on
      Management’s assessment of the fair market value of the investment related to
      the carrying value of the asset which was based upon AdMission’s first quarter
      loss until the sale date and the marketability of the private company’s stock.
      The sale of assets and liabilities to AdMission consists of fixed assets of
      $253,000, prepaid items of $62,000 and deferred revenue of $62,000. The
      operating results of AdMission for 2005 were also reclassified to discontinued
      operations. During the first quarter of 2005, the Company incurred non-cash
      compensation expenses of $794 thousand associated with the acceleration of
      stock
      options related to the sale of the AdMission business unit. In connection with
      the Asset Purchase Agreement, IPIX and AdMission entered into a Patent Purchase,
      License and Repurchase Agreement dated as of February 11, 2005 which
      provides for the transfer to AdMission of certain patents relating to the
      AdMission Business, the license of those patents back to IPIX for use by IPIX
      in
      the conduct of its security sector business and certain other limited uses,
      and
      repurchase right by IPIX in the event of certain triggering events by AdMission.
      The patent agreement remains in effect until all of the patents transferred
      by
      the agreement expire. Patent No. 6,732,162 issued March 4, 2004
“Method of Providing Preprocessed Images for a Plurality of Internet Web Sites”
expires November 15, 2019. An acquired application 09/357,836 was
      subsequently issued on March 17, 2005 as patent No. 6,895,557
“Web-based Media Submission Tool” expires July 21, 2019. The agreement does
      not provide for any payment for the license of the patents. The Company has
      no
      expectation of exercising its repurchase right of these patents as there is
      no
      present indication that the triggering event will occur. IPIX and AdMission
      also
      entered into an IPIX Trademark/Service Mark License Agreement which provides
      AdMission with an eighteen (18) month royalty-free, nonexclusive license to
      use certain IPIX marks and certain other trademarks and business brands in
      connection with the conduct of the AdMission Business.





On
      February 11, 2005, the Company entered into an AdMission Service Agreement
      (the
      Agreement) with AdMission Corporation (AdMission) under which, AdMission will
      provide hosting services to the Company for certain computer-based applications.
      The Agreement has variable pricing depending on usage with a minimum financial
      commitment of $10,000 per month. The Company has not in the past exceeded the
      usage threshold which would result in payment of fees greater than the minimum
      and the Company does not foresee paying more than the minimum at any point
      in
      the future.





Other
      than the obligation to provide AdMission with a license of certain IPIX marks
      and certain other trademarks and business brands pursuant to the IPIX
      Trademark/Service Mark License Agreement and the requirements of the foregoing
      Agreement, the Company has no continuing obligations to AdMission.





Net
      operating revenues, operating expenses and income (loss) reported in
      discontinued operations for the years ended December 31, 2003, 2004 and
      2005 are as follows:





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)Revenues
            
            
            
            
            $
            26,245
            
            $
            1,116
            
            $
            159Cost
                of Revenues
            
            
            
            
            
            6,540
            
            
            2,304
            
            
            220Gross
                profit
            
            
            
            
            
            19,705
            
            
            (1,188
            )
            
            (61
            )Operating
                expenses:Sales
                and marketing
            
            
            
            
            
            3,985
            
            
            1,968
            
            
            908Research
                and development
            
            
            
            
            
            2,858
            
            
            1,769
            
            
            391Impairment
                and amortization of intangibles
            
            
            
            
            
            3,042
            
            
            —
            
            
            —Total
                operating expenses
            
            
            
            
            
            9,885
            
            
            3,737
            
            
            1,299Income
                (loss) from discontinued operations before income tax
            
            
            
            
            
            9,820
            
            
            (4,925
            )
            
            (1,360
            )Income
                tax provision
            
            
            
            
            
            (3,764
            )
            
            —
            
            
            —Income
                (loss) from discontinued operations, net of tax
            
            
            
            
            $
            6,056
            
            $
            (4,925
            )
            $
            (1,360
            )





5.
      RESTRUCTURING AND OTHER





During
      2003, 2004 and 2005, the Company recorded as a separate line item in its
      statements of operations for restructuring charges which consist primarily
      of
      expenses associated with reductions in workforce, the consolidation of certain
      offices, principally lease obligations for vacated offices, as well as a write
      down of abandoned office equipment and leasehold improvements to net realizable
      values.





F
          -
          16


The
      Company anticipates total costs of approximately $3 million for restructuring
      during the entire course of its restructuring activities. In 2005, the Company
      incurred $2.799 million in restructuring expense are delineated in the following
      table.





**San
                Ramon**
            
            **Oak
                Ridge**
            
            **Total**Lease
            
            $
            1,061
            
            $
            304
            
            $
            1,365Severance
            
            
            362
            
            
            3
            
            
            365Information
                Systems Relocation
            
            
            
            
            
            36
            
            
            36Fixed
                Asset Buyout
            
            
            747
            
            
            
            
            
            747Fixed
                Asset Write-down
            
            
            
            
            
            221
            
            
            221Other
            
            
            59
            
            
            6
            
            
            65**TOTALS**
            
            **$**
            **2,229**
            
            **$**
            **570**
            
            **$**
            **2,799**





The
      activity in the current and long-term restructuring accruals for the years
      ended
      December 31, are as follows:





**Balance
                Dec.31,**
            
            **Expense
                in**
            
            **Payments/
                Write-offs**
            
            **Balance
                Dec. 31,**
            
            **Expense
                in**
            
            **Payments/**
            
            **Balance
                Dec. 31,**
            
            **Expense
                in**
            
            **Payments/
                Write-offs**
            
            **Balance
                Dec. 31,****2002**
            
            **2003**
            
            **in
                2003**
            
            **2003**
            
            **2004**
            
            **in
                2004**
            
            **2004**
            
            **2005**
            
            **in
                2005**
            
            **2005**(In
                thousands)Severance
            
            $
            500
            
            $
            —
            
            $
            (500
            )
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            365
            
            $
            (354
            )
            $
            3Other
            
            
            549
            
            
            89
            
            
            (267
            )
            
            371
            
            
            170
            
            
            (284
            )
            
            257
            
            
            2,434
            
            
            (1,685
            )
            
            1,014Total
            
            $
            1,049
            
            $
            89
            
            $
            (767
            )
            $
            371
            
            $
            170
            
            $
            (284
            )
            $
            257
            
            $
            2,799
            
            $
            (2,039
            )
            $
            1,017








Of
      the
      $3.053 million on the 2005 Statement of Operations attributed to restructuring
      and impairment, $2.799 million is attributable to restructuring and the balance
      to the impairment of AdMission preferred stock.





6.
      BALANCE SHEET ACCOUNTS





INVENTORY





The
      Company’s inventory consists primarily of finished camera products and camera
      components. The inventory is valued at the lower of cost, or market, using
      the
      FIFO method. The table below shows the Company’s inventory mix as of December
      31, 2004 and December 31, 2005:





December
                31, 2004
            
            December
                31, 2005Components
            
            $
            1,437
            
            $
            1,218Finished
                goods
            
            $
            1,243
            
            $
            1,141Total
                Inventory
            
            $
            2,680
            
            $
            2,359Inventory
                Reserve
            
            $
            (346
            )
            $
            (214
            )Total
                Inventory, net
            
            $
            2,334
            
            $
            2,145





COMPUTER
      HARDWARE, SOFTWARE AND OTHER:





The
      components of computer hardware, software and other as of December 31 are
      as follows:


**2004**
            
            **2005**(In
                thousands)Computer
                hardware and software
            
            $
            1,766
            
            $
            2,355Fixtures
                and leasehold improvements
            
            
            218
            
            
            2601,984
            
            
            2,615Accumulated
                depreciation and amortization
            
            
            (1,268
            )
            
            (1,424
            )Computer
                hardware, software and other, net
            
            $
            716
            
            $
            1,191







F
          -
          17


Computer
      hardware, software and other includes no assets held under capital leases at
      December 31, 2004 or 2005.





GOODWILL
      AND OTHER INTANGIBLES:





Under
      FAS
      142,“Goodwill and Other Intangibles”, the Company no longer amortizes goodwill
      but rather evaluates goodwill for impairment on an annual basis and on an
      interim basis if events or changes in circumstances between annual impairment
      tests indicate that the asset might be impaired. The Company periodically
      reviews the net realizable value of its intangible assets, including goodwill,
      through an assessment of the estimated future cash flows related to such assets.
      The reviews determine whether future cash flows over the remaining estimated
      useful lives of the assets provide for recovery of the assets. In assessing
      the
      recoverability of goodwill, the Company must make assumptions regarding
      estimated future cash flows and other factors to determine the fair value of
      the
      goodwill. These estimates include forecasted revenues and operating expenses,
      which are inherently difficult to predict. The Company’s assumptions about fair
      values require significant judgment because broad economic factors, industry
      factors and technology considerations can result in variable and volatile fair
      values.




During
      the fourth quarter of 2003, certain events, including the end of the agreement
      with eBay, led the Company to perform an impairment review of goodwill. The
      eBay
      agreement ended in November 2003 and was the primary source of cash flows for
      the technology associated with goodwill in the AdMission reporting unit. This
      review indicated that goodwill was being carried at amounts in excess of the
      fair value based on estimated discounted future cash flows of the AdMission
      reporting unit. As a result, an impairment charge of $3.042 million was recorded
      to expense in the year ended December 31, 2003.




During
      2004, the operations of the AdMission business unit were reclassified to
      discontinued operations
      (See Note 4).





ACCRUED
      LIABILITIES:





The
      following table summarizes current and long term accrued liabilities as of
      December 31:





**2004**
            
            **2005**(In
                thousands)CURRENTAccrued
                sales, franchise and other taxes
            
            $
            1,202
            
            $
            1,050Accrued
                liabilities - trade
            
            
            1,482
            
            
            1,038Accrued
                salaries and benefits
            
            
            224
            
            
            92Accrued
                legal fees
            
            
            133
            
            
            104Accrued
                vacation
            
            
            213
            
            
            80Accrued
                restructuring
            
            
            115
            
            
            964Customer
                deposits
            
            
            7
            
            
            22Total
                current liabilities
            
            
            3,376
            
            
            3,350Long-term
                restructuring
            
            
            142
            
            
            53Total
                accrued liabilities
            
            $
            3,518
            
            $
            3,403




7.
      INCOME
      TAXES





The
      components of the Company’s net deferred tax assets (liabilities) as of
      December 31 are as follows:





**2004**
            
            **2005**(In
                thousands)DEFERRED
                TAX ASSETS (LIABILITIES) CURRENT:Financial
                reserves
            
            $
            137
            
            $
            83Accrued
                expenses and deferred revenues
            
            
            1,132
            
            
            1,201Other
            
            
            4
            
            
            81,273
            
            
            1,292Valuation
                allowance
            
            
            (1,273
            )
            
            (1,292
            )Net
                current deferred tax assets
            
            $
            —
            
            $
            —





**2004**
            
            
            
            **2005**(In
                thousands)DEFERRED
                TAX ASSETS (LIABILITIES) LONG-TERM:Net
                operating loss carryforwards
            
            $
                28,628
            $
                38,375Capitalized
                research and development
            
            9,407
            7,808Depreciation
            
            327
            55Other
            
            114
            9838,476
            46,336Valuation
                allowance
            
            (38,476)
            (46,336)Net
                long-term deferred tax assets (liabilities).
            
            $
                —
            $
                —







F
          -
          18


At
      December 31, 2005, the Company has approximately $86 million and $71
      million of federal and state, respectively, net operating loss carryforwards,
      which it may use to offset future taxable income as described below. The net
      operating loss carryforwards, if not utilized, will begin to expire in 2009.
      At
      December 31, 2005, the Company also has approximately $13.7 million of
      deferred deductions related to stock option exercises. To the extent that
      carryforwards, when realized, relate to stock option deductions, the resulting
      benefits will be credited to stockholders’ equity.





Internal
      Revenue Code Section 382 stipulates an annual limitation on the amount of
      Federal net operating losses incurred prior to a change in ownership, which
      can
      be utilized to offset the Company’s future taxable income. An ownership change
      occurred as a result of the conversion of debt and exercise of warrants into
      preferred stock on September 26, 2001. The Section 382 limitation has
      significantly limited the amount of net operating losses the Company can use
      in
      future years. Accordingly, the Company has included in its deferred tax assets
      only the amount of net operating losses that are available under the
      Section 382 limit.





The
      Company has recorded a full valuation allowance against its deferred tax assets
      because it believes it is more likely than not that sufficient taxable income
      will not be realized during the carryforward period to utilize the deferred
      tax
      asset. Realization of the future tax benefits related to the deferred tax assets
      is dependent upon many factors, including the Company’s ability to generate
      taxable income in the respective tax jurisdiction within the loss carryforward
      periods. For the year ended December 31, 2004 and 2005, the change in the
      valuation allowance was $11.387 million and $7.879 million respectively.





The
      Company’s 2003, 2004 and 2005 income tax provision differs from that obtained by
      using the U.S. statutory rate of 34% due to the following:





**For
                Years Ended December 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)Computed
                “expected” tax (benefit) provision
            
            
            
            
            
            
            
            $
            471
            
            
            
            
            $
            (5,010
            )
            
            
            
            $
            (7,487
            )State
                income taxes, net of U.S. federal benefits
            
            
            
            
            
            
            
            
            77
            
            
            
            
            
            (805
            )
            
            
            
            
            (1,016
            )Investment
                in foreign subsidiaries
            
            
            
            
            
            
            
            
            (8,587
            )
            
            
            
            
            —
            
            
            
            
            
            —Valuation
                allowance changes affecting the provision for income taxes
            
            6,906
            
            
            
            
            
            6,099
            
            
            
            
            
            7,785Warrant
                expense
            
            
            
            
            
            
            
            
            —
            
            
            
            
            
            —
            
            
            
            
            
            —Permanent
                differences
            
            
            
            
            
            
            
            
            1,133
            
            
            
            
            
            14
            
            
            
            
            
            15State
                tax rate change
            
            
            
            
            
            
            
            
            —
            
            
            
            
            
            55
            
            
            
            
            
            703True
                up of prior year permanent items
            
            
            
            
            
            
            
            
            —
            
            
            
            
            
            (353
            )
            
            
            
            
            —$
            —
            
            
            
            
            $
            —
            
            
            
            
            $
            —





8.
      IPIX
      INTERNATIONAL





In
      the
      third quarter of 2002, the Company entered into license, distribution and
      trademark agreements with Soroof International, a Saudi Arabia-based corporation
      (“Soroof”). Under the agreements, Soroof became the exclusive distributor for
      IPIX InfoMedia products outside of North America and Asia through Soroof’s newly
      established entity, iPIX International (“iPIX-I”). The agreement, effective
      July 1, 2002, expires December 31, 2007, unless renewed. iPIX-I has an
      exclusive license to develop integrated solutions for markets including real
      estate, travel and tourism and other markets in which on-line marketing is
      critical. The Company provides certain hosting services during the term of
      the
      agreements.





Under
      the
      terms of the agreements, the Company received a minority equity interest in
      iPIX-I, however, the Company does not have the ability to exercise significant
      influence over iPIX-I operations. The Company accounts for the investment in
      iPIX-I on the cost basis, not as a variable interest entity under Financial
      Interpretation No. 46. The Company did not make any capital contributions
      to iPIX-I and the Company has no commitments to fund iPIX-I. The Company does
      have the right, however, but not the obligation, to purchase iPIX-I from Soroof
      after December 31, 2005 for consideration as defined in the agreements.
      During the year ended December 31, 2003, the Company recognized
      $0.4 million of revenue under these agreements. On March 21, 2004, the
      parties mutually terminated these agreements and the Company returned its
      minority equity interest in iPIX-I. The termination of the agreements did not
      have a material impact on the Company’s financial condition or expected result
      of operations.





9.
      STOCKHOLDERS’ EQUITY





GENERAL





On
      May 28, 2002 at the annual stockholders meeting, the authorized number of
      shares of common stock was reduced to 50,000,000 from 150,000,000. The Company’s
      amended and restated certificate of incorporation authorizes the issuance of
      up
      to 50,000,000 shares of common stock, par value $0.001 per share, 7,421,536
      shares of Class B common stock, par value $0.0001 per share and 5,001,100
      shares of preferred stock, par value $0.001 per share. The board of directors
      is
      authorized, without stockholder approval, to issue up to an aggregate of
      5,001,100 shares of preferred stock, $0.001 par value per share, in one or
      more
      series. Included in this amount are designated 1,100 shares of Series C
      redeemable preferred stock and designated 3,000,000 shares of Series B
      preferred stock. Each series of preferred stock may have the rights and
      preferences, including voting rights, dividend rights, conversion rights,
      redemption privileges and liquidation preferences that the board of directors
      determines. There were 290,347 and 246,867 shares of Series B preferred
      stock outstanding at December 31, 2004 and 2005, respectively. There were
      no shares of Series C preferred stock outstanding at December 31, 2004
      or 2005.





F
          -
          19


Each
      holder of common stock is entitled to one vote for each share on all matters
      to
      be voted upon by the stockholders, and there are no cumulative voting rights.
      Holders of common stock may receive dividends after all dividends that are
      owed
      have been paid to holders of preferred stock. Each holder of Class B common
      stock is entitled to one vote for each share on all matters to be voted upon
      by
      the stockholders and, except as required by law, shall have voting rights and
      powers equal to the voting rights and powers of the common stock. There are
      no
      cumulative voting rights. Holders of Class B common stock may at any time
      convert Class B shares into Class A common stock, are not entitled to
      dividends and are not entitled to receive any assets of the corporation upon
      dissolution or liquidation. At December 31, 2004, no shares of Class B
      common stock were outstanding.





COMMON
      STOCK





On
      April 5, 2004, IPIX completed the sale of 909,090 shares of our common
      stock, resulting in net proceeds received of approximately $4.9 million,
      and additional investment rights (“AIR”) to purchase another 888,180 shares of
      our unregistered common stock in a private offering to accredited institutional
      investors (“PIPE”). The shares of common stock were sold at $5.50 per share and
      the shares of common stock underlying the AIR are purchasable at $6.05 per
      share. The AIR was exercisable until September 28, 2004, at which time all
      AIRs had been exercised resulting in net proceeds of $5.4 million. The
      common stock sold in the PIPE and from the AIRs has been registered under the
      Securities Act of 1933, as amended, and may be offered or sold in the United
      States.





During
      2004, IPIX issued 2,190,632 shares of common stock upon exercise of stock
      options. Total proceeds from the option exercises were $5.3 million. Also,
      in 2004, IPIX sold 293,219 shares of common stock to employees under the IPIX
      Employee Stock Purchase Plan (“ESPP”). Proceeds from these ESPP purchases were
      $0.4 million. As of December 31, 2004, we had collected
      $0.1 million for our employees’ second quarter 2005 ESPP
      purchases.





During
      2005, IPIX issued 1,165,445 shares of common stock upon exercise of stock
      options. Total proceeds from the option exercises were $2.38 million. Also,
      in 2005, IPIX sold 90,418 shares of common stock to employees under the IPIX
      Employee Stock Purchase Plan (“ESPP”). Proceeds from these ESPP purchases were
      $.17 million. As of December 31, 2005, we have collected $21,999 for our
      employees’ second quarter 2006 ESPP purchases.





On
      June
      21, 2005 IPIX completed a private placement of 4,149,376 shares of common stock,
      which generated net proceeds of $9.8 million. As part of the private placement,
      IPIX entered into a Securities Purchase Agreement (the "Purchase Agreement"),
      dated June 21, 2005, with Iroquois Master Fund Ltd and certain other purchasers
      (collectively, the "Purchasers"). Pursuant to the Purchase Agreement, IPIX
      sold
      $10,000,000 of its $0.001 par value common stock (the "Common Stock"),
      additional investment rights (the "AIR") and warrants (the "Warrants"). With
      each share of common stock purchased at $2.41, each Purchaser is entitled under
      the Purchase Agreement to receive an AIR to purchase 0.06 of a share of common
      stock and a Warrant to purchase 0.44 of a share of common stock. The exercise
      price for each AIR is $2.41 per share, and the exercise price of each warrant
      is
      $3.11 per share. AIRs are exercisable immediately, and Warrants may not be
      exercised until six months after issuance. Warrants expire four years after
      date
      of issuance. The common stock sold in the transaction and from the AIRs has
      been
      registered under the Securities Act of 1933, as amended, and may be offered
      or
      sold in the United States.





In
      connection with the sale and the exercise of the AIR rights, IPIX paid Olympus
      Securities, LLC (the "Olympus") a placement fee of $236,805. IPIX also issued
      to
      Olympus warrants to purchase 211,849 shares of common stock at an exercise
      price
      of $3.11 per share. AIRs were exercisable immediately, and Warrants could not
      be
      exercised until six months after issuance. The AIR rights were exercisable
      until
      December 22, 2005 by which time purchasers had acquired 87,596 shares of common
      stock with proceeds of $.2 million to the Company.





The
      Common Stock, AIRs and Warrants described herein were offered and sold to the
      Purchasers in a private placement transaction made in reliance upon exemptions
      from registration pursuant to Section 4(2) under the Securities Act of 1933
      and
      Rule 506 promulgated thereunder. Each of the Purchasers is an accredited
      investor as defined in Rule 501 of Regulation D promulgated under the Securities
      Act of 1933.





F
          -
          20


PREFERRED
      STOCK





On
      May 14, 2001, the Company entered into a definitive agreement with Image
      Investor Portfolio, a separate series of Memphis Angels, LLC (“Image”) for an
      investment by Image in the Company. Pursuant to the terms of a securities
      purchase agreement between the Company and Image dated as of May 14, 2001,
      Image purchased the Company’s $10.0 million convertible senior secured note
      and received Tranche A and Tranche B warrants to purchase up to
      $20.0 million of the Company’s Series B preferred stock. On
      September 26, 2001, the Company, Image and strategic investors completed
      the Tranche B stage of the investment. At this time, the Company issued
      1,115,080 shares of the Company’s Series B preferred stock for total
      consideration of $22.3 million, represented by the conversion of the
      $10.0 million note, the conversion of $0.3 million of interest on the
      Note and $12.0 million in cash through the exercise of Tranche B warrants.
      The remainder of the Tranche B warrants expired. The Company recorded a charge
      of $1.6 million to additional paid in capital for costs incurred related to
      the Tranche A and Tranche B financings. These costs consisted primarily of
      costs
      of attorneys, accountants and other directly related external costs.





At
      December 31, 2003, there were two Tranche A warrants (“Warrant 1” and
“Warrant 2”) outstanding. During 2004, Warrant 1, which entitled the holders to
      purchase 150,000 shares of Series B Preferred Stock at $20 per share, was
      exercised in full. IPIX received $3.0 million in cash from the exercise of
      Warrant 1 and the conversion of the underlying Series B Preferred Stock.
      Warrant 2 entitles the holders to purchase 100,000 shares of Series B
      Preferred Stock at $40 per share and is exercisable at any time before the
      expiration date of May 14, 2006. During 2004, 400 shares of Warrant 2 were
      converted into 2,914 shares of common stock. We did not receive any proceeds
      from this exercise. During 2004, 862,833 shares of Series B preferred
      shares were converted into 8,557,923 common shares. During the third quarter
      of
      2005, 41,380 shares of Warrant 1 were converted into 381,007 shares of common
      stock. We did not receive any proceeds from the third quarter Warrant 1
      exercise. During the fourth quarter of 2005, 2,100 shares of Warrant 1 were
      converted into 19,336 shares of common stock. The Company did not receive any
      proceeds from the fourth quarter Warrant 1 exercise. In conjunction with the
      Warrant 1 exercise the Company issued 22,847 shares of common stock as a result
      of the conversion of accumulated and unpaid dividends on the related Warrant
      1
      preferred shares.





Each
      share of the Series B preferred stock is convertible into approximately 9.2
      shares of the Company’s common stock and is entitled to vote on matters
      submitted to holders of common stock on an as-converted basis. However, at
      any
      time that the holders of the Series B preferred stock hold more than 50% of
      the voting stock of the Company, a voluntary liquidation, dissolution or winding
      up of the Company must be approved by at least five of the seven members of
      the
      Company’s board of directors. Holders of Series B preferred, in preference
      to holders of any other series of preferred stock and in preference to the
      holders of Common Stock (collectively, “Junior Securities”), shall be entitled
      to receive, when and if declared by the Board, but only out of funds that are
      legally available, cash dividends at the rate of eight percent (8%) of $20
      (or
      $40 for Warrant 2 shares) per annum on each outstanding share of Series B
      preferred stock (“Series B Dividends”). The Series B Dividends are
      cumulative, accrue daily and shall be payable, when and if declared by the
      Board, upon conversion or as an accretion to the Liquidation Preference, as
      defined below. Accrued Series B Dividends may be paid in cash or common stock,
      at the election of the Series B Preferred stockholder. Holders of
      Series B preferred stock participate on an as-if converted basis in any
      common stock dividends.





At
      December 31, 2005, the Company had the potential obligation to pay holders
      of
      the Company’s Series B Preferred Stock $1,685,000 in cash dividends had
      they elected to convert their Series B Preferred Stock and take accrued
      dividends in cash. These dividends will continue to accrue until such time
      as
      the holders of the Series B Preferred Stock elect to convert at which time
      they have the option to take the dividends in additional shares of common stock
      or in cash. See the Note 9 STOCKHOLDERS’ EQUITY.




Upon
      any
      liquidation event, before any distribution or payment shall be made to the
      holders of any junior securities, the holders of Series B preferred shall
      be entitled to be paid out of the assets of the Company legally available for
      distribution, or the consideration received in such transaction, an amount
      per
      share of Series B preferred equal to the $20 (or $40 for Warrant 2 shares)
      plus all accrued and unpaid Series B Dividends for each share of
      Series B preferred held by them (the “Liquidation Preference”). If, upon
      any such Liquidation Event, the assets of the Company (or the consideration
      received in such transaction) shall be insufficient to make payment in full
      to
      all holders of Series B preferred of the Liquidation Preference, then such
      assets (or consideration) shall be distributed among the holders of
      Series B preferred at the time outstanding, ratably in proportion to the
      full amounts to which they would otherwise be respectively
      entitled.





10.
      EMPLOYEE STOCK AND BENEFIT PLANS





*2005
      Stock Incentive Plan*





In
      2005,
      the Company authorized the 2005 Stock Incentive Plan (the “2005 Plan”). The 2005
      Plan authorizes the granting of options and restricted stock awards to acquire
      up to 5,000,000 shares of common stock. As of December 31, 2005, the
      Company had not filed Form S-8 to register the shares underlying the 2005 Plan
      and no options are outstanding under the 2005 Plan.





F
          -
          21


*2001
      Equity Compensation Plan*





In
      2001,
      the Company authorized the 2001 Equity Compensation Plan (the “2001 Plan”). The
      2001 Plan authorizes the granting of options and restricted stock awards to
      acquire up to 4,056,293 shares of common stock. As of December 31, 2005,
      2,000,635 options are outstanding under the 2001 Plan. The exercise price of
      all
      options granted is the fair value of the Company’s common stock at the date of
      grant. The options generally vest over a one to three-year period and expire
      ten
      years from the grant date. No further options will be granted under the 2001
      Plan. The remaining options not granted under the 2001 Plan were transferred
      to
      the 2005 Plan.





*2000
      Equity Compensation Plan*





In
      January 2000, the Company authorized the 2000 Equity Compensation Plan (the
“2000 Plan”). The 2000 Plan authorizes the granting of options and restricted
      stock awards to acquire up to 350,000 shares of common stock. As of
      December 31, 2005, 2,195 options are outstanding under the 2000 Plan. The
      exercise price of all options granted is the fair value of the Company’s common
      stock at the date of grant. The options generally vest over a two-year period
      and expire ten years from the grant date. No further options will be granted
      under the 2000 Plan. The remaining options not granted under the 2000 Plan
      were
      transferred to the 2001 Plan.





*1998
      Employee, Director and Consultant Stock Option Plan*





During
      1998, the Company authorized an Employee, Director and Consultant Stock Option
      Plan for a total of 238,000 common shares. The 1998 Plan became effective on
      January 1, 1999 once the Company was reorganized. During 1999 and 2000, an
      additional 579,939 and 112,403, respectively, common shares were authorized
      under the 1998 Plan. As of December 31, 2005, 172 options are outstanding
      under the 1998 Plan. Each option under the 1998 Plan allows for the purchase
      of
      common stock and expires not later than five or ten years from the date of
      grant, depending on the ownership of the option participants. The vesting terms
      of the stock options will be determined on each grant date and are generally
      two
      or three years; however, the amount of options that can be exercised per
      participant in any calendar year will be restricted to an aggregate fair market
      value of $0.1 million of the underlying common stock. No further options will
      be
      granted under the 1998 Plan. The remaining options not granted under the 1998
      Plan were transferred to the 2000 Plan.





*1997
      Equity Compensation Plan*





The
      Company authorized the 1997 Equity Compensation Plan, under which 410,503 shares
      of common stock are authorized and reserved for issuance to selected employees,
      officers, directors, consultants and advisors. As of December 31, 2005,
      5,238 options are outstanding under the 1997 Plan. The exercise price of all
      options granted is the fair value of the Company’s common stock at the date of
      grant as estimated by common stock and convertible preferred stock transactions
      with third parties at or near grant dates. The options generally vest over
      one
      to three-year periods and expire five years after the respective vesting dates.
      No further options will be granted under the 1997 Plan. The remaining options
      not granted under the 1997 Plan were transferred to the 2000 Plan.





*Other
      Stock Option Plans*





The
      1994
      Stock Option Plan (the “1994 Plan”), the 1996 Stock Option Plan (the “1996
      Plan”) and the 1997 Stock Option Plan (the “1997 Options Plan”) were originally
      adopted by PictureWorks, Inc., a wholly-owned subsidiary of IPIX, in
      November 1994, May 1996 and November 1996, respectively. Under
      the 1994 Plan, eligible employees, directors and consultants could receive
      options to purchase shares of the Company’s common stock at a price not less
      than 100% and 50% of the fair value on the date of the grant for incentive
      stock
      options and nonqualified stock options, respectively. Under the 1996 Plan and
      1997 Options Plans, eligible employees, directors and consultants who owned
      less
      than 10% of all voting classes of stock could receive options to purchase shares
      of common stock at a price not less than 110% and 85% of fair value on the
      date
      of grant of incentive stock options and nonqualified stock options,
      respectively.





Employees
      owning greater than 10% of all voting classes of stock could receive options
      to
      purchase shares at a price not less than 110% of the fair market value for
      both
      incentive and nonqualified stock options. As of December 31, 2005, 425,100
      options are outstanding under these plans. The options granted under these
      plans
      are exercisable over a maximum term of ten years from the date of grant and
      generally vest in various installments over a five-year period under the 1994
      Plan and a four-year period under the 1996 Plan and 1997 Options Plan. No
      further options or restricted stock awards will be granted under the 1994,
      1996,
      and 1997 Options Plans.





F
          -
          22


A
      summary
      of the Company’s stock option activity under all plans is as follows:





**Shares**
            
            **Weighted
                Average of Exercise Prices**
            
            **Weighted
                Average Grant Date Fair Value**
            
            **Stock
                Options Exercisable**
            
            **Weighted
                Average Exercise Price**Under
                option at December 31, 2002
            
            
            3,219,879
            
            
            
            
            
            
            
            
            2,461,247
            
            $
            12.05Options
                granted
            
            
            1,445,500
            
            $
            1.28
            
            $
            1.78Options
                exercised
            
            
            (771,057
            )
            $
            3.75Options
                forfeited or expired
            
            
            (594,306
            )
            $
            19.12Under
                option at December 31, 2003
            
            
            3,300,016
            
            
            
            
            
            
            
            
            1,859,632
            
            $
            10.10Options
                granted
            
            
            2,531,500
            
            $
            4.34
            
            $
            1.51Options
                exercised
            
            
            (2,190,632
            )
            $
            8.84Options
                forfeited or expired
            
            
            (393,264
            )
            $
            5.01Under
                option at December 31, 2004
            
            
            3,247,620
            
            
            
            
            
            
            
            
            750,643
            
            $
            18.29Options
                granted
            
            
            2,010,000
            
            $
            2.97
            
            $
            2.09Options
                exercised
            
            
            (1,165,445
            )
            $
            2.05Options
                forfeited or expired
            
            
            (1,658,835
            )
            $
            10.57Under
                option at December 31, 2005
            
            
            2,433,340
            
            
            
            
            
            
            
            
            621,137
            
            $
            6.02





The
      following table summarizes information about stock options at December 31,
      2005:




****
              ****
              ****
              **Options
                  Outstanding**
              ****
              **Options
                  Exercisable******
              ****
              ****
              ****
              **Number
                  Outstanding**
              ****
              **Weighted-average
                  Remaining Contractual Life, Years**
              ****
              **Weighted-average
                  Exercise Price**
              ****
              **Number
                  Exercisable**
              ****
              **Weighted-average
                  Exercise Price****Range
                  of Exercise Price**
              ****
              ****
              ****
              ****
              ****$
                  1.07
              
              $
                  2.80
              
              972,441
              
              8.99
              
              $
                  2.28
              
              276,483
              
              $
                  2.03$2.93
              
              $4.56
              
              893,292
              
              9.31
              
              3.33
              
              121,975
              
              3.04$5.63
              
              $12.24
              
              560,002
              
              8.71
              
              8.18
              
              215,074
              
              8.17$43.38
              
              $82.50
              
              3,476
              
              3.43
              
              61.74
              
              3,476
              
              61.74$123.13
              
              $300.00
              
              4,129
              
              4.08
              
              202.75
              
              4,129
              
              202.75**Total**
              ****
              **2,433,340**
              ****
              **9.03**
              ****
              **$4.45**
              ****
              **621,137**
              ****
              **$6.02**






*Employee
      Stock Purchase Plan*





The
      Company has an Employee Stock Purchase Plan (the “Purchase Plan”). Under the
      Purchase Plan, employees meeting certain specific employment qualifications
      are
      eligible to participate and can purchase shares of common stock semi-annually
      through payroll deductions at the lower of 85% of the fair market value of
      the
      stock on the enrollment date or the fair market value of the stock at the end
      of
      the offering period. The Purchase Plan permits eligible employees to purchase
      common stock through payroll deductions for up to 15% of qualified compensation.
      As of December 31, 2005, 865,000 shares were authorized under the Plan,
      575,531shares had been issued
      and 289,469 shares were available for issuance under the Purchase Plan.





Stock-Based
      Compensation





The
      following stock-based compensation charges are related to the acceleration
      of
      employee stock options for terminated personnel.







**For
                Years Ended December 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)Accelerated
                option expense
            
            
            
            
            
            
            
            $
            
            
            
            
            
            $
            
            
            
            
            
            $
            819$
            —
            
            
            
            
            $
            —
            
            
            
            
            $
            819





*401(k)
      Plan*





The
      Company has a 401(k) profit sharing plan, which is available to all full-time
      employees after six months of service and those part-time employees who have
      completed one thousand hours of employment during twelve consecutive months.
      The
      Company made no contributions to the plan in 2003, 2004 and 2005, respectively.





F
          -
          23


11.
      COMMITMENTS, CONTINGENCIES AND OFF BALANCE SHEET ARRANGEMENTS





COMMITMENTS





During
      April 2000, the Company entered into an agreement to provide visual content
      services under which the Company is required to pay marketing fees to a related
      party of $16.0 million over a two-year period. As of September 26,
      2001, the Company had paid $9.5 million of the $16.0 million
      commitment and agreed to extend the additional $6.5 million of payments
      through September 2003 (See Note 14). There were no amounts due under this
      agreement as of December 31, 2003.





In
      2001
      and 2002, the Company sold certain assets totaling $2.84 million and
      $2.5 million, respectively, to a stockholder and agreed to leaseback those
      assets over a three-year period. In order to sell the assets to the stockholder
      during the third quarter 2001, the Company paid off the remaining payments
      under
      an existing capital lease of the assets from a third party. In 2003, the Company
      returned the underlying equipment, with a value of $0.9 million, associated
      with these lease obligations and eBay forgave the remaining balances due of
      $1.08 million. The resulting gain of $0.2 million was originally
      recognized in cost of revenues in the statement of operations because the
      underlying equipment was used to generate eBay service revenues.





During
      the quarter ended September 30, 2002, the Company sold certain assets
      totaling $1.6 million to an unaffiliated leasing company and agreed to
      leaseback those assets. The net book value and the fair value of the assets
      sold
      in these sale/leaseback transactions equaled the sale price, resulting in no
      gain or loss on the sale of the assets. The leases are accounted for as capital
      leases in accordance with SFAS 13, “Accounting for Leases.” The Company bought
      out the lease in the second quarter of 2005.





The
      Company leases certain office space, co-location space and equipment under
      noncancelable operating leases. Future minimum lease payments under these and
      other operating leases are as follows:





2006
            
            $
            1,4022007
            
            
            6542008
            
            
            3322009
            
            
            3352010
            
            
            114Thereafter
            
            
            3TOTAL
            
            $
            2,840





Rental
      expense for operating leases was $2.7 million, $1.7 million and
      $0.9 million for 2003, 2004 and 2005, respectively.


On
      March
      13, 2006, the Company agreed to terminate, effective March 8, 2006, the lease
      agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
      Partners - One, L.P. The terms of the agreement to terminate included IPIX's
      agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
      lump-sum payment in the amount of $198,500, due and payable immediately; (2)
      prorated rent through March 8, 2006 - $5,606, and (3) prorated Tenant
      Improvement expense though March 8, 2006 - $596.




Oak
      Ridge
      Technical Center Partners - One, L.P. has agreed to: (1) act as intermediary
      in
      the sale of IPIX’s furniture to a third party for $40,000; and (2) deduct that
      amount from the above payments due from IPIX.




On
      February 11, 2005, the Company entered into an AdMission Service Agreement
      (the
      Agreement) with AdMission Corporation (AdMission) under which, AdMission will
      provide hosting services to the Company for certain computer-based applications.
      The Agreement has variable pricing depending on usage with a minimum financial
      commitment of $10,000 per month. The Company has not in the past exceeded the
      usage threshold which would result in payment of fees greater than the minimum
      and the Company does not foresee paying more than the minimum at any point
      in
      the future.





Mr.
      Crew
      has resigned as CFO of the Company effective April 1, 2006. On
      February 27, 2006, the Company entered into a separation agreement with Mr.
      Crew. The Company and Mr. Crew have agreed to terminate the employment agreement
      between the Company and Mr. Crew dated April 1, 2005 (the "Employment
      Agreement") effective April, 1, 2006. Under the Separation Agreement, the
      Company will pay any portion of Mr. Crew's base salary, vacation time, travel
      and business expense incurred or accrued through April 1, 2006. The Company
      will
      also pay total bonus compensation to Mr. Crew of $20,000 for the fourth quarter
      of 2005 and first quarter of 2006 as provided in Mr. Crew's employment
      agreement. In addition, the Company will pay Mr. Crew a severance payment of
      $200,000. Stock options to purchase up to 200,000 shares of Company common
      stock
      granted to Mr. Crew on April 1, 2005 will become fully vested on April 1, 2006,
      and such options must be exercised on or before June 30, 2006, at which time
      they will expire. For a period of six months after April 1, 2006, the Company
      will reimburse Mr. Crew for the amount of any premium payments for group health
      coverage made by Mr. Crew pursuant to the Consolidated Omnibus Budget
      Reconciliation Act of 1985.





F
          -
          24


CONTINGENCIES





On
      June 15, 2003, the Company filed an action against Mr. Ford Oxaal and
      his company, Minds-Eye-View, (together, “Oxaal”) in the United States District
      Court for the Eastern District of Tennessee. In the complaint, the Company
      asserted claims for patent infringement, false designation of origin, false
      description or representation, unfair or deceptive acts and tortious
      interference in connection with Oxaal’s competing software product marketed
      under the name “Click Away.” On August 8, 2003, Oxaal filed its answer
      asserting counterclaims for non-infringement, invalidity, unenforceability,
      breach of contract, patent misuse, Lanham Act violations and tortious
      interference. The Company denied all of Oxaal’s allegations. The case was stayed
      pending settlement negotiations, which have since terminated. On March 15,
      2005, a motion was filed by the Company to vacate the stay so that the lawsuit
      can proceed in due course. In September, 2005, the court decided to continue
      the
      stay until the *Grandeye* litigation is completed.





On
      March
      14, 2005, Grandeye, Ltd. filed suit against IPIX in the U.S. District Court
      for
      the Eastern District of Virginia, Norfolk Division, seeking a declaratory
      judgment that (1) its Halocam products do not infringe any valid claim of U.S.
      Patents No. 5,359,363 (“the ‘363 patent”), 6,603,502 B2 (“the ‘502 patent”), and
      Re 36,207 (“the ‘207 patent”), all three of which are owned by IPIX; (2) these
      three patents are invalid; and (3) these three patents are unenforceable as
      a
      result of inequitable conduct committed during prosecution of the patent
      applications leading to the patents. Grandeye also asserted various state law
      claims alleging damage to its business relationships as a result of alleged
      statements and conduct of IPIX. Grandeye also included in its Complaint a claim
      for antitrust violations but has since dismissed that antitrust claim with
      prejudice. IPIX has asserted substantial defenses to Grandeye’s claims and filed
      a counter-suit against Grandeye for infringement of the ‘363 patent, ‘502
      patent, and ‘207 patent. IPIX has vigorously defended, and continues to defend,
      its positions. IPIX has filed a motion seeking summary judgment as to Grandeye’s
      state law claims, and Grandeye has filed a motion seeking a summary judgment
      that its Halocam SP products do not infringe any claims of the ‘363 patent, ‘502
      patent, or ‘207 patent. The parties have opposed each other’s motions and the
      parties’ arguments regarding both summary judgment motions were heard by the
      Court on January 18, 2006. The Court held a hearing during the period November
      7-10, 2005, at which the parties presented their positions regarding the proper
      construction of the terms in the patents’ claims. The
      Court has vacated the trial date in the case, and stayed all proceedings for
      90
      days, so that it can review and decide the parties’ cross motions for summary
      judgment. The Court indicated that it should have a written decision on these
      motions at the end of the 90 day stay period.





The
      Company intends to vigorously defend each of the above referenced lawsuits.
      Because of the inherent uncertainties related to this type of litigation, the
      Company is unable to predict the ultimate outcome of these cases, or the
      likelihood or amount of our potential liability, if any, of these cases.
      However, if the Company is not successful in defending or settling these
      matters, these cases could have a material adverse effect on the business,
      financial condition, results of operations or cash flows of the Company. The
      Company will incur substantial costs in defending these lawsuits.





Like
      many
      companies whose success is dependent on emerging technologies and intellectual
      property, the Company is subject to potential technology related claims such
      as
      product state-of-the-art technology and associated marketability. The Company
      may be subject to claims from distributors and others regarding their purchases
      from the Company related to subsequent technological advances and the associated
      market price considerations. The Company is not currently a party to any other
      legal proceedings, the adverse outcome of which, individually or in the
      aggregate, is believed could have a material adverse effect on the business,
      financial condition, results of operations or cash flows of the Company.





INDEMNIFICATION
      PROVISIONS





During
      the ordinary course of business, in certain limited circumstances, the Company
      includes indemnification provisions within certain of its contracts. Pursuant
      to
      these agreements, the Company will indemnify, hold harmless and agree to
      reimburse the indemnified party for losses suffered or incurred by the
      indemnified party, generally parties with which the Company has commercial
      relations, in connection with certain intellectual property infringement claims
      by any third party with respect to the Company’s products and services. The
      Company discloses indemnification liabilities according to FASB Staff Position
      FIN45-1, “Accounting for Intellectual Property Infringement Indemnifications
      under FAS Interpretation No. 45.” To determine the amount of
      indemnification liability to accrue, a probability analysis of potential
      outcomes based on past claims and cost incurred is performed. To date, there
      have not been any costs incurred in connection with such indemnification
      clauses; therefore, there is no accrual of such amounts at December 31, 2005.
      Our insurance policies do not cover the cost of patent infringement claim
      defense so if a claim was filed against the Company or any party we indemnify,
      we would incur legal costs to vigorously defend our patents. Under FAS
      No. 5, “Loss Contingencies,” a claim would be accrued when a loss is
      probable and the amount can be reasonably estimated. At December 31, 2005,
      no
      such amounts are accrued.





F
          -
          25


OFF
      BALANCE SHEET ARRANGEMENTS





At
      December 31, 2005, the Company had the potential obligation to pay holders
      of
      the Company’s Series B Preferred Stock $1,685,000 in cash dividends had
      they elected to convert their Series B Preferred Stock and take accrued
      dividends in cash. These dividends will continue to accrue until such time
      as
      the holders of the Series B Preferred Stock elect to convert at which time
      they have the option to take the dividends in additional shares of common stock
      or in cash. See the Note 9 STOCKHOLDERS’ EQUITY.





12.
      WARRANTS





The
      Company has from time to time issued warrants to purchase equity securities.
      As
      of December 31, 2005, all outstanding warrants are exercisable. The following
      tables summarize warrants outstanding
      at December 31, 2005:





Date
            
            Expiration
            
            
            
            Exerciseof
                Grant
            
            Date
            
            Shares
            
            PriceCommon
                stock
            
            
            1/6/2000
            
            
            1/5/2009
            
            
            20,000
            
            
            154.70Series
                B Preferred StockWarrant
                2
            
            
            5/14/2001
            
            
            5/14/2006
            
            
            99,600
            
            $
            40.00Equivalent
                to common shares
            
            
            9.21Total
                common shares
            
            
            
            
            
            
            
            
            917,067
            
            $
            4.34PIPE
                WarrantsFirst
                two tranches
            
            
            6/21/2005
            
            
            6/21/2009
            
            
            2,033,194
            
            $
            3.11Second
                tranche
            
            
            12/21/2005
            
            
            6/21/2009
            
            
            4,380
            
            $
            3.11Total
                Common Shares
            
            
            
            
            
            
            
            
            2,037,574
            
            $
            3.11





The
      Company has filed, and maintains effective, a registration statement on
      Form S-3 for the number of shares of Common Stock issuable upon exercise of
      the Series B Preferred Stock warrants and warrants issued in connection
      with the 2004 and 2005 PIPE.





13. REVENUES
      BY GEOGRAPHIC AREA





After
      reclassification of the AdMission business unit to discontinued operations
      in
      2004, the Company had two reportable segments. The accounting policies of the
      segments were the same as those of the Company. In 2005, management determined
      that segment reporting was no longer appropriate given the restructuring of
      the
      business, the elimination of foreign subsidiaries, etc.





Revenues
      by geographic area are as follows:





**FOR
                YEARS ENDED DECEMBER 31,****2003**
            
            **2004**
            
            **2005**REVENUES:
            
            
            
            (In
                thousands)United
                States
            
            
            
            
            $
            2,012
            
            
            
            
            $
            2,241
            
            
            
            
            $
            4,025Japan/Pacific
                Rim
            
            
            
            
            
            29
            
            
            
            
            
            —
            
            
            
            
            
            163Europe
            
            
            
            
            
            122
            
            
            
            
            
            1,603
            
            
            
            
            
            1,001Other
                foreign countries
            
            
            
            
            
            431
            
            
            
            
            
            20
            
            
            
            
            
            210TOTAL
            
            
            
            
            $
            2,594
            
            
            
            
            $
            3,864
            
            
            
            
            $
            5,399





F
          -
          26


Long-lived
      asset information by geographic area is as follows:


**AS
                OF DECEMBER 31,****2003**
            
            **2004**
            
            **2005**(In
                thousands)LONG-LIVED
                ASSETS:Foreign
            
            
            
            
            $
            —
            
            
            
            
            $
            —
            
            
            
            
            $
            —United
                States
            
            
            
            
            
            1,578
            
            
            
            
            
            716
            
            
            
            
            
            1,191$
            1,578
            
            
            
            
            $
            716
            
            
            
            
            $
            1,191





Foreign
      revenues include sales made to customers outside the United States including
      foreign domiciled, unaffiliated distributors.





14.
      RELATED PARTY TRANSACTIONS





TRANSACTIONS
      WITH EBAY, INC.





Pursuant
      to an agreement dated April 19, 2000, as amended, the Company provided to
      eBay, Inc., which beneficially owned more than 10% of the Company’s common
      stock, image management services to eBay’s on-line auction Web sites. Pursuant
      to that agreement, the Company issued eBay a warrant to purchase 60,000 shares
      of common stock at an exercise price of $203.80 per share. The warrant expired
      on October 14, 2004. Under this agreement, as amended, the Company
      generated revenue of $25.1 million for the year ended December 31,
      2003. As announced in June 2003, the Company amended the then current
      commercial agreement with eBay to include a one-time $8.0 million license
      fee from eBay for IPIX Rimfire technology and other services. Subsequent to
      2003, the Company no longer provides any products or services to eBay.





During
      April 2000, the Company entered into an agreement to provide visual content
      services to eBay under which the Company was to pay marketing fees to eBay
      of
      $16.0 million over a two-year period. As of September 26, 2001, the
      Company had paid $9.5 million of the $16.0 million commitment and
      agreed to extend the additional $6.5 million of payments through
      September 2003. In accordance with EITF 01-09, $1.5 million of these
      fees was offset against revenue which amount represented the excess over the
      fair value of the benefit received during the year ended December 31, 2003.





In
      2001
      and 2002, the Company sold to eBay, and eBay leased back to the Company, certain
      computer equipment utilized to provide image management services to eBay and
      other customers. The purchase price for the equipment was approximately
      $5.3 million. The transactions resulted in no gain or loss to the Company.
      In 2003, the Company paid eBay $2.0 million, pursuant to these lease
      schedules. In 2003, the Company returned the underlying equipment, with a net
      carrying amount of $0.9 million, associated with these lease obligations
      and eBay forgave the remaining balances due of $1.1 million. The resulting
      gain of $0.2 million was recognized in cost of revenues in the statement of
      operations because the underlying equipment was used
      to
      generate eBay service revenues.





15.
      SUBSEQUENT EVENTS





PERSONNEL





Mr.
      Crew
      has resigned as CFO of the Company effective April 1, 2006. On
      February 27, 2006, the Company entered into a separation agreement with Mr.
      Crew. The Company and Mr. Crew have agreed to terminate the employment agreement
      between the Company and Mr. Crew dated April 1, 2005 (the "Employment
      Agreement") effective April, 1, 2006. Under the Separation Agreement, the
      Company will pay any portion of Mr. Crew's base salary, vacation time, travel
      and business expense incurred or accrued through April 1, 2006. The Company
      will
      also pay total bonus compensation to Mr. Crew of $20,000 for the fourth quarter
      of 2005 and first quarter of 2006 as provided in Mr. Crew's employment
      agreement. In addition, the Company will pay Mr. Crew a severance payment of
      $200,000. Stock options to purchase up to 200,000 shares of Company common
      stock
      granted to Mr. Crew on April 1, 2005 will become fully vested on April 1, 2006,
      and such options must be exercised on or before June 30, 2006, at which time
      they will expire. For a period of six months after April 1, 2006, the Company
      will reimburse Mr. Crew for the amount of any premium payments for group health
      coverage made by Mr. Crew pursuant to the Consolidated Omnibus Budget
      Reconciliation Act of 1985.





The
      Company has commenced a search for a replacement for Mr. Crew and intends to
      appoint a successor as soon as practicable.





FACILITIES





On
      March
      13, 2006, the Company agreed to terminate, effective March 8, 2006, the lease
      agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
      Partners - One, L.P. The terms of the agreement to terminate included IPIX's
      agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
      lump-sum payment in the amount of $198,500, due and payable immediately; (2)
      prorated rent through March 8, 2006 - $5,606, and (3) prorated Tenant
      Improvement expense though March 8, 2006 - $596.




F
          -
          27


Oak
      Ridge
      Technical Center Partners - One, L.P. has agreed to: (1) act as intermediary
      in
      the sale of IPIX’s furniture to a third party for $40,000; and (2) deduct that
      amount from the above payments due from IPIX.




QUARTERLY
      INFORMATION (unaudited)





**For
                the quarters ended****Total**
            
            **March
                31**
            
            **June
                30**
            
            **September
                30**
            
            **December
                31**(In
                thousands, except per share data)**FISCAL
                YEAR 2005:**Revenue
            
            $
            5,399
            
            $
            668
            
            $
            1,433
            
            $
            1,498
            
            $
            1,800Gross
                profit
            
            
            1,814
            
            
            302
            
            
            677
            
            
            385
            
            
            450Loss
                from continuing operations after income taxes(1)
            
            
            (20,660
            )
            
            (4,521
            )
            
            (5,989
            )
            
            (5,187
            )
            
            (4,963
            )Net
                loss available for common stockholders(1)
            
            $
            (22,459
            )
            $
            (5,996
            )
            $
            (6,105
            )
            $
            (5,287
            )
            $
            (5,071
            )Loss
                from continuing operations per common share(1):Basic
            
            
            (0.85
            )
            
            (0.21
            )
            
            (0.26
            )
            
            (0.20
            )
            
            (0.18
            )Diluted
            
            
            (0.85
            )
            
            (0.21
            )
            
            (0.26
            )
            
            (0.20
            )
            
            (0.18
            )Net
                loss per common share(1):Basic
            
            
            (0.91
            )
            
            (0.27
            )
            
            (0.27
            )
            
            (0.20
            )
            
            (0.18
            )Diluted
            
            $
            (0.91
            )
            $
            (0.27
            )
            $
            (0.27
            )
            $
            (0.20
            )
            $
            (0.18
            )**FISCAL
                YEAR 2004:**Revenue
            
            $
            3,864
            
            $
            476
            
            $
            1,013
            
            $
            1,466
            
            $
            909Gross
                profit
            
            
            1,338
            
            
            179
            
            
            428
            
            
            638
            
            
            93Loss
                from continuing operations after income taxes(1)
            
            
            (9,810
            )
            
            (1,804
            )
            
            (2,064
            )
            
            (2,264
            )
            
            (3,678
            )Net
                loss available for common stockholders(1)
            
            $
            (15,609
            )
            $
            (3,610
            )
            $
            (3,627
            )
            $
            (3,554
            )
            $
            (4,818
            )Loss
                from continuing operations per common share(1):Basic
            
            
            (0.65
            )
            
            (0.25
            )
            
            (0.14
            )
            
            (0.12
            )
            
            (0.18
            )Diluted
            
            
            (0.65
            )
            
            (0.25
            )
            
            (0.14
            )
            
            (0.12
            )
            
            (0.18
            )Net
                loss per common share(1):Basic
            
            
            (0.95
            )
            
            (0.41
            )
            
            (0.23
            )
            
            (0.18
            )
            
            (0.22
            )Diluted
            
            $
            (0.95
            )
            $
            (0.41
            )
            $
            (0.23
            )
            $
            (0.18
            )
            $
            (0.22
            )




(1)      The
                sum of the quarterly income (loss) and income (loss) per common
                share amounts may differ from annual loss and annual loss per common
                share
                because of the differences in the weighted average number of common
                shares
                and dilutive potential shares used in the quarterly and annual
                computations and rounding.


















F
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      28