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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-K (Mark One) þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003 OR o
    
    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
    
    52-2213841State or other jurisdiction
    
    (IRS Employerincorporation or organization
    
    Identification No.)
 3160 Crow Canyon Road, San Ramon, California 94583   Registrants telephone number, including area code: (925) 242-4002 _________________ 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




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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. Yes x No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes o No x The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of June 30, 2003 was $31,427,076 (based on
the last sale price of $4.25). The number of shares outstanding of the registrants common stock, $0.001 par
value, as of March 10, 2004 was 8,986,923. On August 22, 2001 our stockholders
approved a ten-for-one reverse stock split. All share and per share data is
presented to give effect to the retroactive application of the reverse stock
split. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants Proxy Statement for the Annual Stockholders
Meeting to be held on or about May 4, 2004, 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.




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TABLE OF CONTENTS  PART IIPIX SECURITYIPIX AD TECHNOLOGIESIPIX INFOMEDIAPART IISIGNATURESPOWER OF ATTORNEYREPORT OF INDEPENDENT AUDITORSCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITYCONSOLIDATED STATEMENTS OF CASH FLOWSNOTES TO CONSOLIDATED FINANCIAL STATEMENTSEx-14.1 Code of Ethics for CEO & SFO'sEx-14.2 Code of Business Conduct and EthicsEx-23.1 Consent of PricewaterhouseCoopers LLpEX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32 SECTION 906 CERTIFICATION OF THE CEO & CFO    Table of Contents  
 PART I 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 us, our products and services and industries, derived from
public available reports and other publications referenced in this annual
report. These organizations generally use methodology 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 of completeness of such information. While we believe
this information to be reliable, we have not independently verified such data. OVERVIEW IPIX Corporation, formally Internet Pictures Corporation, is a leading provider
of technology solutions enabling public and private enterprises to use visual
data efficiently. We combine our experience, people, technology, processes and
partnerships to deliver an extensive range of visual data solutions worldwide.
Our services and technologies provide our customers with the opportunity to
increase revenues, improve customer satisfaction and enhance security for the
protection of life and property. Our patented immersive imaging technology is
used to provide an unparalleled view of the world. Government and commercial
enterprises and others around the world are finding new ways to use our
products for video security, situational awareness, visual documentation and
on-line marketing. Our Rimfire technology is used by publishers to
dramatically improve the effectiveness of directional advertising in both
traditional publishing such as yellow pages and newspaper classifieds ads. It
is also used by on-line publishers such as real-estate and automobile resale
aggregators. Substantially all of our recurring revenue has been derived from transaction
fees generated by our Rimfire service. In 2003, we received 87% of our total
revenue from eBay pursuant to a visual content services agreement. We amended
our agreement with eBay in June 2003 and received a one-time license fee of
$8.0 million for our Rimfire technology and other services. We no longer
provide any products or services to eBay as of November 1, 2003, and we will
not receive any further revenue from eBay pursuant to these agreements. In 2003, our organization moved from being technology focused (Immersive Video
Solutions, Transaction Services and Immersive Still Solutions) to being market
focused in order to better serve the needs of our customers. We are now
organized into three business units: IPIX Security, IPIX Ad Technologies and
IPIX InfoMedia, respectively.  
    
    IPIX Securityprovides security and surveillance products and
services for commercial and governmental customers.  
    
    IPIX Ad Technologiesfocuses on the sale of complete solutions to
customers who rely on visual data to create effective directional
advertising such as publishers of newspaper classifieds, yellow page
directories, on-line auctions, real estate and autos classifieds.  
    
    IPIX InfoMediafocuses on the sale of immersive still technology
licenses for the on-line real estate, travel and hospitality and visual
documentation markets. Each of our business units is discussed below in detail. 
 IPIX SECURITY Prior to the terrorist attacks of September 11, 2001, the size of the global
security market was estimated by the J.P. Freeman 2000 Report on Security
Industry to be over $100 billion in sales annually across all segments of the
security industry. Within the security market, the U.S. accounts for
approximately 44% of the global market, of which video surveillance is the
fastest growing market segment.




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We believe IPIX Security is well positioned to address the video surveillance
segment of the security industry. We offer new and innovative digital cameras
that are highly attractive to end-users because our cameras are simple to
operate, reduce the number of conventional cameras that are required to provide
adequate coverage thereby reducing installation labor and material costs. THE SECURITY SOLUTION IPIX Security, using our core immersive technology, brings to market an
innovative development in security and surveillance imaging that provides an
expansive view of live and archival video from a single camera. By using a
single fisheye lens, we are able to capture a Full-360 degree field of view
from a video camera, then de-warp the fisheye video image using patented
technology and compensate for distortion errors that are inherent in fisheye
images and present the image in a manner that looks like a
traditional image and can be easily understood by the
viewer. The resulting image can be viewed in any direction, up-down,
left-right and horizon to horizon. The viewer can easily navigate the image by
moving a cursor inside the image or using our navigation controls. We have developed a new generation and category of high resolution digital
video cameras that use our patented technology for use by security
professionals in commercial and government security applications. Our core immersive technology has been successfully productized into a new
category of digital, high resolution, network camera systems that provide
continuous situational awareness by being able to:  
    
    see in all directions simultaneously with no blind spots;  
    
    provide alarms based on motion detection that is built into the camera;  
    
    allow viewers to roam within live or recorded video using pan-tilt-zoom with no moving parts;  
    
    provide recording and playback capability; and  
    
    scale easily. IPIX Security will launch its new product portfolio of Full-360 digital cameras
on March 31, 2004 at ISC EXPO West in Las Vegas. The new product portfolio
consists of three camera product lines with various configurations within each
product line. The product lines include: CommandView, CommandView360 and
InSight camera systems. The core camera electronics and fisheye lens optics
have been designed to be used across the entire product line to enable
economies of scale to be reached quickly in manufacturing. The camera
systems will be offered in ceiling, wall and pole mount configurations with
several mounting options available for each configuration. IPIX CommandView The CommandView camera consists of a two mega-pixel sensor, a digital signal
processor (DSP) module and a power distribution and communication module.
CommandView utilizes our fisheye lens that has been optimized for the image
sensor in the camera subassembly, and bundles one licensed copy of the
Milestone Security Management System Software with the our viewing software to
provide a high value, highly attractive video surveillance product offering to
the security market. CommandView comes in two configurations: wall-mount or
ceiling-mount. A typical high-speed dome camera relies upon a mechanical pan-tilt-zoom table
to steer it to where it needs to be pointed and to monitor the area of concern.
Control of where such a camera is pointed can be performed either by using
presets that are tied to specific alarm points or manually by an operator who
controls where the camera is pointed. One person could cause a diversion by
tripping an alarm that causes a typical camera to rotate in that direction to
see what is causing the alarm, while a second person commits an actual
crime or incident in the blind spot of the mechanical camera. For the first time, IPIX Security offers the security professional a camera
system that cannot be defeated by co-conspirators that cause a diversion in one
direction while the real threat or incident occurs in the opposite direction.
The uses and applications of CommandView are virtually limitless because unlike
the cameras it replaces, CommandView provides complete and continuous
situational awareness. It cannot be fooled into looking in one 2




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direction and not another. CommandView sees everything at the same time and
monitors everything in its area of concern with no blind spots. IPIX CommandView360 CommandView360 further leverages our investment made into video camera and lens
technologies. It uses the CommandView camera subassembly, our same fisheye
lens and our same patented viewing software. CommandView360 utilizes two
camera subassemblies mounted back-to-back and one fisheye lens on each camera
to provide Full-360 degree coverage of the area of concern. Full-360 means it
is monitoring in both the horizontal and vertical dimensions at the same time.
This innovative camera system allows the user to view live and recorded video
at user definable frame rates and compression settings to conserve bandwidth
requirements. The dual-lens, fixed spherical 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 CommandView360 with the mechanical pan-tilt-zoom camera is simple and
efficient and allows the operator to get on target quicker by using the
Assisted Cue and Zoom feature of the CommandView360. Targets of interest are
seen through the spherical view of the CommandView360 and the operator simply
mouse-clicks on a target of interest in the viewer screen. The CommandView360 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. Without the Assisted Cue and Zoom
feature offered by CommandView360, an operator using just a mechanical
pan-tilt-zoom camera would have a very difficult time finding a target that
could be anywhere in three-dimensional space either above, below, to the right,
to the left or behind the current direction that a typical camera could be
pointing. Designed to provide the highest level of reliable operation for continuous
situational awareness, the CommandView360 is rugged in construction and small
in size making it ideal for fixed, outdoor installations where it is desirable
to protect critical infrastructure and key assets such as ports, harbors,
waterways, dams, power stations, airports and national icons against threats
that could come from any direction on land, sea or air. Early prototype
versions of the CommandView360 were first used in the fourth quarter of 2003 as
part of our Beta Test and Evaluation Program. Participants in this program
include TVA, Oak Ridge National Laboratories, Los Alamos National laboratory,
Cumberland Gap Tunnel, Tennessee State Capitol, Boeing, Digital Force
Technology, Cisco, Electronics Warfare Associates and SAIC. IPIX InSight We also have a family of surveillance cameras that take advantage of the high
resolution and video frame rates in the CommandView platform. InSight is our
entry level digital camera system using the camera subassembly that forms the
foundation of our entire product portfolio. The two mega-pixel InSight camera:  
    
    can be fitted with a standard 1/2 inch CS mount
commercial-off-the-shelf lens that provides a field-of-view in
accordance with the users requirements;  
    
    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;  
    
    can automatically send streaming video over the network in one of
three video streaming protocols; HTTP, RTP and RTSP and  
    
    is offered in two configurations: ceiling-mount and wall-mount. 3




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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 InSight
camera may be mounted in a parapet or rampart enclosure for outdoor use. The
InSight camera fills a void that currently exists in the security video
surveillance market for a fixed, high resolution (1.0+ mega-pixel image),
network camera that is capable of delivering video at full-motion frame rates. IPIX XProtect Security Management Software High-end users of security products need to efficiently manage, store and
retrieve their image streams. To meet this need IPIX Security has entered into
a strategic relationship with Milestone Systems A/S, a security management
software company located in Denmark. Milestone is a leader in network video
recorder software and is an enabling technology for our new digital camera
product line. Milestone has integrated their XProtect Security Management
Software with our products. The Milestone XProtect software provides 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. Users can digitally pan-tilt-zoom
within the scene on both live and recorded video. Milestone software is
easily scalable and can be used with a single camera installed at a single
location, or across an entire enterprise consisting of hundreds or thousands of
cameras spread around a multi-building campus, or a geographical area that is
local, regional, national or global in scope. Milestone has agreed to provide
its market leading software to IPIX Security for our new product line of
network cameras and has agreed not to support any other companies competing in
the same technology space as IPIX Security. SECURITY MARKET In the government security market, we are directing our marketing and sales
channel development efforts on infrastructure protection related to ports,
harbors, waterways, dams, conventional and nuclear power stations, utilities,
airports and mass transit rail systems. In the military, we are concentrating
on developing sales channels with system integrators involved in perimeter
force protection, unmanned vehicles and special operations. In the commercial security market, we are developing a network of resellers who
are experts in providing IT network security solutions to commercial and
government customers. In addition, we are building a network of resellers in
the security system integrator community to help us penetrate the banking,
industrial, institutional, health care, education, cultural and commercial
building markets. We are also licensing our technology to leading digital video
recorder (DVR), network video recorder (NVR) and digital camera original
equipment manufacturers. SECURITY SALES AND MARKETING Our sales and marketing group focuses on indirect sales and direct sales. Our
seven sales professionals are located across the United States, and are focused
on developing new sales channels with business partners and maintaining and
strengthening strategic relationships with existing partners and customers in
our target markets. Our marketing efforts focus on supporting our indirect sales channel partners
with trade shows, advertising, marketing collateral materials, co-marketing
programs, public relations campaigns, sales tools and training and education on
our products and programs. We generate qualified sales leads that shorten the
sales cycle time so new business opportunities close faster. We are committed
to being responsive to our customers, providing high quality products at stable
prices and including our partners and customers feedback directly into our
product planning process. Go-to Market Strategy IPIX Security must market itself and its products directly to end-users,
architects, specifying engineers, consultants and general contractors for the
commercial market and to the proscribers and specifiers within the federal,
state and local government. In addition, IPIX Security will sell its products
through a world-wide network of indirect sales channel partners who are
knowledgeable about local market conditions and requirements, have established
relationships in the local security market and enable us to more quickly
penetrate the market. 4




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We believe this strategy will enable us to achieve meaningful revenues from the
market while controlling our operating and support expenses and develop
multiple sales and marketing channels for IPIX Security products and services
including: Indirect Sales Channel Partners We seek to partner with established security system integrators, prime
government contractors and resellers to help penetrate the commercial and
governmental security and observation markets. We are also developing
distribution agreements with partners in a wide range of countries that
allow us to deploy our technology into regions of the world that would
normally require significant time and effort for marketing and
development. Business Development and Strategic Direct Sales In addition to our indirect sales channels, IPIX Security employs a team
of seven senior sales professionals focused on new business development
opportunities and strategic direct sales across our target markets.
Through our professional services organization, IPIX Security seeks
opportunities to obtain research and development contracts with government
research organizations and prime government contractors to provide our
technology and engineering services to applications involving robotics,
unmanned vehicles for the military and intelligent software for object
classification and tracking. IPIX SECURITY COMPETITION Current manufacturers of camera systems for the security and surveillance
markets are substantially larger than we are and have access to significant
amounts of capital. IPIX Security has several direct competitors, including:
RemoteReality, Egg Systems, Sony and American Dynamics. We believe our patent
protected de-warping software and our use of fisheye lens provides us an
advantage over our competitors. 
 IPIX AD TECHNOLOGIES In June 2003, we amended our existing agreement with eBay for use of our
Rimfire Technology to power eBay Picture Services. Rimfire Technology was a
key driver behind the increased adoption of photo use within eBay listings.
Listings using images at the inception of the eBay agreement were 8% of total
listings, this increased to over 80% of all listings in late 2003, producing
material revenue for both parties. The core value and significant scale of the
service had grown to make it impractical to continue as an outsourced solution,
and the parties agreed to a licensing and transition agreement completed in
November of 2003. We retained all current and future technology rights and
expertise in the Rimfire technology. Leveraging the success of creating visual ads for listings on eBay and other
partners, we expanded the functionality of our core platform to serve the
growing needs of on-line advertising in the broader advertising market of
publishing. IPIX Ad Technologies (Ad Technologies) is focused on the
directional advertising market. Directional advertising directs buyers to
sellers when theyre ready to buy, so there is an established need.Examples
include newspaper classified ads (print and on-line), yellow pages (print and
on-line), paid search engines and other paid directories. THE MARKET The directional advertising market, long held by print publishers (newspapers
and yellow pages), is a market under attack by companies such as Google,
Overture and eBay, which are beginning to take significant advertising revenue
from the print publishers. This fundamental shift in the directional
advertising market is being driven by consumers who are increasingly moving
on-line for purchases. As advertisers follow the consumer they drive the
rapidly growing need for tools that allow them to effectively reach qualified
leads in an increasingly complicated on-line environment. We believe that local advertising of goods and services, which is largely
comprised of small and medium enterprises (SME), is lagging the consumer
movement, creating a gap in the supply and demand of directional advertising. 5




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According to industry analysts such as The Kelsey Group, eMarketer and
BizRate.com, the directional advertising market is estimated to be a very large
market and today most of its advertising dollars are spent with traditional
publishers such as newspaper classifieds and yellow page directories. Local
advertising spending by private parties and small businesses is estimated to be
half of market. There are over 10 million widely distributed SMEs in the U.S.
today and their advertising budgets generally average six thousand dollars a
year. SMEs do the majority of their business within a 50 mile radius of their
location and over 70% of all SMEs do not have, need or maintain a website. To meet the need of SME advertisers, while competing with the downward pricing
pressure from competition, publishers must adopt effective self-service tools
that allow the SME advertiser to compete with national business on-line,
minimizing or eliminating the current barriers. There also is a need to help
bridge the transition from print to web, as both have a place in a local
business advertising strategy. We believe these self-service tools must:  
    
    simplify the creation process;  
    
    make it cost effective, flexible and easily updated;  
    
    improve the relevancy of local search results;  
    
    not be dependent on a web site; and  
    
    make advertisements media rich with photos, maps, coupons contact information and more. THE AD TECHNONOGIES SOLUTION Since 2001 our comprehensive media platform, Rimfire, has allowed both print
and on-line publishers to provide services to advertisers enabling them to
easily and elegantly capture, transform, manage and distribute digital media
with little or no technical expertise. During 2003, we extended the
functionality of our technology to meet the needs of the SMEs for creating
self-service directional advertising on-line and in-print. We market this
product under the trade name of AdMission. AdMission makes professional-quality directional advertising accessible to SMEs
and individuals. AdMission offers simple, intuitive self-serve ad creation
tools to publish visually-enhanced directional ads in real-time, maximizing
ad effectiveness, both on-line and in-print. AdMission, through enhanced
visual content, also helps advertisers communicate their value to consumers
more efficiently and effectively than traditional display or text-only ads,
resulting in higher-qualified leads. Integrated into a publishers advertising
system, the result is an easy to use self-service tool for creating media rich
directional advertisements. The AdMission solution is provided as an ASP service to publishers, allowing
then an accelerated time to market. By outsourcing to us, publishers can
leveraging our proven technology platform, extensive experience and
infrastructure built over the last three years while providing large scale
transaction services to eBay and other partners. The major components of the AdMission solution include: AdMission Acquire AdMission Acquire leverages proprietary technology to allow end users to
easily select or drag-and-drop media content to ad templates which can be
published both off-line and on the Web without the need to process the
image with expensive and complex desktop software ahead of time. AdMission
Acquire accepts a wide and growing variety of file formats and converts
the files to publisher specifications automatically, without user
intervention. AdMissions smart-sizing feature allows the user to supply
files of any size without the worry of upload times for submission, or
viewing times. AdMission automatically prepares the media for transmission
by optimizing its size to the requirements of the site. Unlike traditional
web-based file upload mechanisms, AdMission makes it easy to upload many
files at once and associate those files with their respective data. 6




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AdMission Process Once media is received by AdMission, it is processed to meet customer
specifications. AdMissions plug-in architecture and configurable account
rules enable services such as the transformation of still images into
interactive advertisements, slide shows, images watermarked with text or
graphics or new capabilities created by us or our third party developers.
Challenging and complex imaging tasks such as formatting, color
correction, press calibration, sizing and cropping, are handled
automatically behind the scenes according to the publishers
specifications. Instant previews of the media supplied prevent incorrect
submissions, increase up sells and increase customer satisfaction. AdMission Distribute After media has been processed, it is stored on a highly scalable and
fault tolerant infrastructure designed to handle high volumes of user
submissions and to match our customers rapid pace of growth. AdMission
goes beyond serving up static media, providing multiple viewing and
distribution capabilities. For example, media items can be requested with
dynamic transforms, allowing for optimized output for a variety of
publisher templates, formats and output devices. AdMission provides
pre-built, optimized viewing templates that provide compelling visual ads
with minimal integration work. By integrating our technology, publishers offer new functionality to SMEs and
individuals to create visual ads whether they have a website presence or not.
And, by offering an outsourced solution, we provide our customers with an
alternative to building a costly infrastructure, enabling them to utilize
scarce technical resources in other mission critical capacities. AD TECHNOLOGIES MARKETS We have directed our sales efforts and channel strategies toward the industry
leaders within the following segments of the directional advertising market. Newspaper Classifieds: Newspapers rely on the revenue streams from classified
advertisement. We allow newspapers to offer enhanced visual ads to their
customers to produce compelling ads both on-line and in-print. We have worked
extensively with our newspaper customers and understand the unique needs of the
traditional publisher. The AdMission system is also offered as an integrated
self-service component of the ad order entry system, or through the call center
sales force. Sellers require an easy to use method for uploading media elements
to accompany their item listing and buyers have greater confidence in items
they can view and inspect on-line. In our experience, listings with images
attract more buyers and sell for higher prices. With AdMission, classified
sites can offer enhanced visual ad services that make adding media to ads easy,
as well as affordable and efficient. Yellow Page Directories: Traditional yellow page providers have many of the
same challenges and opportunities as newspaper publishers. They are the
historically dominant vehicle for SME local advertising and have an extensive
feet-on-the-street sales force. We present them with an up-sell opportunity
from the traditional printed yellow page ad to visually rich and dynamic
on-line advertisements that can be additionally enhanced with coupons and other
call-to-action elements that can be updated as frequently as business needs
demand. For Internet yellow page publishers, we offer a cost-effective
self-serve visually enhanced ad opportunity that does not require an SME to
have a website nor technical expertise. Search: The search directory companies have extensive self-serve advertising
vehicles for creating a national reach, but are not as effective in producing
relevant and actionable results for local search. By incorporating the
enhanced visual ad capabilities of AdMission, consumers can find relevant data
at their fingertips. Search platforms can leverage our technology to gain
access to the SME advertiser who needs to differentiate their offering from
large national advertisers, yet cost effectively create compelling media rich
ads that attract qualified consumers. 7




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AD TECHNOLOGIES CHANNELS Indirect Sales Channels Our strategy is to leverage our relationships with business partners and major
market leaders in order to increase our market penetration and revenues while
reducing our sales and marketing expenses. This strategy will develop multiple
sales and marketing channels for our products and services. We are targeting
the top ad order systems providers to integrate our products with theirs making
the AdMission product available and a natural enhancement to existing ad
creation systems. To date IPIX has partnered with market leaders such as: CCI
Europe, Mactive, DTI, PBS and AdStar among the leaders in the industry. Direct Sales Channels To increase adoption and accelerate demand creation we also target direct
relationships with the top directional ad platform providers both on-line and
in-print. We have signed agreements and are in the process of roll outs with:
Tribune Media, Cox Communications, Los Angeles Times, Homestore, Seattle Times,
Los Angeles Newspaper Group, Scripps-Knoxville News, Cars.com, Yell.com,
NewsQuest Digital Media and Haymarket in the UK, as well as others. We also
have a direct sales channel strategy for the Internet yellow page companies and
the on-line search companies. Through these relationships, our customers market and sell visually enhanced ad
products and services, powered by our technology, to their customers. We
believe we benefit from the brand equity and buying recommendations provided by
the customers sales channel to increase sales and market penetration while
maintaining the ability to focus on our technology support and enhancements. We
plan to continue to partner with additional vertical market leaders to serve as
direct and indirect channels for the promotion and sale of our products and
services. AD TECHNOLOGIES COMPETITION When selling our services, we often find that potential customers are
considering internal development of system components. Our solution provides an
end-to-end, integrated solution for acquiring, managing and distributing media
content. The time, complexity, cost and expertise required to build and scale
such a system, while still having to expend the expertise and resources to make
images print-ready, make outsourcing an attractive option. We are continually
enhancing our product features and services to maintain the broadest
accessibility across browsers, operating systems and file formats, which
further increase the advantage of outsourcing to us. Nevertheless, we view
internally-built and operated capabilities as competitive. Where outsourced imaging management capabilities for our target markets are
concerned, we view companies such as AdPixx and PictureAds as competitors. We
believe that our technology and extensive experience handling large volumes of
imaging data serve to differentiate us from these competitors. Several other
companies currently operate as self-serve ad creation technology providers for
SMEs, with a focus on different markets; however, such companies may choose to
expand into the markets currently targeted by AdMission at any time. These
companies include: Celebro and DynAccSys in print display ad creation for
newspapers; AdLizard in print display ad creation for yellow pages; Amazing
Media and PointRoll in on-line banner ad creation. Again, we view our
proprietary technology and extensive expertise in image management as a key
differentiator. 
 IPIX INFOMEDIA Our patented imaging technology enables the creation of panoramic image content
through the use of a wide angle or fisheye lens. Our immersive technology
represents the easiest way possible to capture the entire field-of-view
surrounding a camera. In use, separate 185 degree images are captured and then
stitched together to form an interactive panoramic image. When viewing IPIX
panoramic images, users are able to select a portion of the scene to view by
using their cursor or other pointing device. By moving the cursor in different
directions, the user experiences the location in which the image was taken as
if they were physically there. 8




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We believe the market for interactive, panoramic imaging content is poised for
steady, long-term growth as the panoramic imaging marketplace continues to
expand and mature. Panoramic imaging is becoming a must have in the traditional
on-line marketing applications and is finding broader applications across a
wide variety of commercial markets. The IPIX InfoMedia Solution IPIX InfoMedia (InfoMedia) benefits from marketplace drivers that continue to
reinforce the need for panoramic imaging. The number of Web sites needing
compelling content continues to grow. Acceptance of on-line searching and
purchase transactions for travel and hospitality, real estate, automobiles and
other markets drive continued demand for panoramic virtual tours in on-line
marketing applications. Additionally, ongoing concerns about security, the need
to be better prepared in the case of emergency situations and the need to
better manage physical assets and infrastructure, have all led to the use of
panoramic imaging for visual documentation. The InfoMedia group continues to be a leader in panoramic imaging technology.
Our two-shot photography process creates a light-weight, expansive view image
that is interactively viewable and fast to download over the Internet. Our
traditional markets, which we continue to serve today, leverage the value of
IPIX panoramic imaging as a visual media type that attracts and engages viewers
for on-line marketing applications. Customers include professional
photographers, creative/design agencies, web developers and marketing agencies.
Visual media market customers use IPIX panoramic images for the high-quality
and professional way they showcase places, events and products. New market applications have emerged that benefit from the value of IPIX
panoramic imaging in combination with business critical information. These
visual documentation markets include facility management, police and fire
rescue, government, insurance and corporate enterprise. Unlike the visual media
market, the visual documentation market uses the IPIX panoramic images created
for their informational value, and often incorporate IPIX panoramic images in a
database that links the images to relevant data. InfoMedia Products InfoMedia markets hardware and software products that provide a complete
solution for easily creating panoramic images. The products are based on
patented technology for capturing a Full-360 degree field of view from a
digital camera in a manner that is extremely efficient for the user. The
products and services offered by InfoMedia center on making this production
process simple and efficient. By integrating the end-to-end process, including
production workflow, image editing and output options, our platform enhances
the workflow efficiency for providing high quality results. Image Creator Platform (ICP) Drawing from a decade of experience in panoramic imaging software marketing and
development, the InfoMedia group has developed and launched its new products
built on a core architecture platform. This multi-tiered software platform
forms the basis for our product strategy for the next several years. The platform:  
    
    has an open architecture, multi-function, modular format designed
to be the industry standard solution for immersive imaging across a
broad range of vertical markets;  
    
    is compatible with both Windows and Macintosh platforms;  
    
    is flexible enough to integrate a wide range of traditional media
types such as flat images and panoramas into a single workflow
solution;  
    
    opens up our technology for integration into third party products
aimed at specific vertical markets (such as forensics); and  
    
    enables a new third party after-market based upon creating ICP
plug-ins. Our legacy Key licensing model is replaced with an open solution that makes it
easy for customers to select a license model most appropriate for their
particular use. For those companies that license ICP for integration into their
own products, ICP includes a customizable user interface that allows quick and
easy sub-branding within the user interface. The plug-in architecture also
allows ICP to tailor product configurations to the requirements of target
markets, allowing the unit to achieve consistency in pricing across the wide
range of market opportunity. 9




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Interactive Studio The first product built on the ICP platform is the IPIX® Interactive Studio
(Interactive Studio). It is our solution for driving the standardization of
panoramic photography. The Interactive Studio, which was announced in February
2004 at the Photo Marketing Association International (PMAI) tradeshow,
represents a highly strategic move for the company in that we have replaced our
proprietary key licensing model with a flexible enterprise licensing
approach. In the new business model, customers gain unlimited annual access to
our technology. Our licensing terms offer them a range of pricing models tuned
to their particular needs. The Interactive Studio offers panorama photographers a single integrated
solution that can automate a wide variety of tasks previously requiring
separate tools. The Interactive Studio makes creating multiple Full-360 degree
images as simple a drag-and-drop of fisheye source images into the application,
selecting the output file formats desired and hitting the save button. Doing
so, the Interactive Studio can output a wide range of formats, including our
legacy (.ipx) format, QuickTimes (.mov) format, as well as open file
formats like cubic and equirectangular. The Interactive Studio includes
features including image editors, image format converter tools and high dynamic
range image compositors, not previously available in a single panoramic
photography solution. With the Interactive Studio, a single batch of 10s or
100s of images can be stitched, enhanced and output using a highly automated
workflow, saving the photographer time while increasing the service options
that can be offered to their customers. Because Interactive Studio is based on a plug-in architecture, we are able to
work with strategic partners to offer broader solutions to our target markets.
We have announced our first two strategic partnerships for ICP. Two leading
companies in the panoramic photography marketplace, iSeeMedia and RealViz,
previously in competition with InfoMedia, announced plug-in products for the
Interactive Studio. These partnerships reinforce our strategy of opening up our
technology and growing the panoramic imaging market. Through the Interactive
Studio, we provide customers a single solution they can use for the broadest
range of panoramic imaging needs GPS Mapping System Our GPS Mapping System, developed in partnership with Red Hen, provides
everything needed to integrate panoramic and still images into GIS Maps,
complete with zoomable layers. The GPS Mapping System includes the GeoBuilder
software for batch-building high-resolution panoramic images and Red Hen
Systems MediaMapper®, a full-featured map creation and editing software. The
GPS Mapping System automatically imports and hotlinks immersive images, still
images and other files into multi-layer GIS maps for accurate GPS positioning.
The GPS Mapping System allows the user to create interactive visual maps that
include immersive images built from the GeoBuilder and other links to visual,
audio and textual data. The system works by importing images, matching the time
stamps of the images with the log from a GPS unit and then matching the
coordinates. These coordinates are then plotted on the maps and linked to the
images at the GPS registered locations. IPIX Movies The InfoMedia group also markets to the entertainment industry a full service
to create IPIX Movies. IPIX Movies are made by capturing two back to back
scenes using a fisheye lens on one or more video cameras. The movies are
digitized and edited using standard post-production processes, techniques and
tools. Each IPIX Movie is processed frame-by-frame for editing, stitching and
encoding. Finished movie content can be delivered on DVDs or viewed over the
Internet using either the Real Media format (.rm) from Real Networks or our
proprietary format and viewer. IPIX Movies have been used in various travel and hospitality marketing projects
as well as on several high profile Hollywood DVD movies releases. Within the
travel and hospitality markets examples of the use of the technology include an
internet-based promotional for the Atlantis Resort and a virtual helicopter
fly-through for the Hawaiian Tourist and Convention Center. IPIX Movies has
been used for value-added DVD content for Harry Potter and the Sorcerers Stone
and Harry Potter and the Chamber of Secrets. Additional high profile Hollywood
projects are already in the production stage for release to market in
2004/2005. 10




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InfoMedia Markets InfoMedias customers include a broad range of industry leaders in the Real
Estate, Travel and Hospitality, Automotive, Publishing, eCommerce, Advertising
and Promotion, Education and Entertainment industries. In the Visual Media markets, our customers are content developers whose
expertise in photography and multimedia production command a premium with their
customers. These markets include professional photographers, advertising and
creative media agencies and web development firms. For these markets, InfoMedia
solutions provide a distinct visual media format that is compatible with a wide
range of production tools and that offers our direct customers a way to command
a premium for development services from their customers. In the Visual Documentation markets, our customers include a broad cross
section of public and private sector organizations that use InfoMedia solutions
to document and index places or events. For these customers, our solutions
provide a distinct visual documentation format that can simply and quickly
capture the complete details of an environment. Also, because the visual data
can be combined with descriptive information about the location, these markets
can leverage the visual documentation in ways that support their organizational
goals. InfoMedia Sales and Marketing InfoMedia photography products are sold in the U.S. and Canada through a direct
sales model. We use a telesales team of two people located in Oak Ridge,
Tennessee. We manage an on-line electronic commerce site for execution of sales
transactions. Within the U.S., Homestore is the exclusive sales and
distribution channel for iPIX Full-360 degree panoramic photography products
into the residential real estate market. Our products are marketed primarily through the use of on-line Internet
marketing. We use a variety of mechanisms to generate new customer leads. We
utilize keyword based advertising to generate leads from internet search engine
queries and drive potential customers to our web site and on-line store. We
offer our software for download and in the process capture customer information
for follow on marketing. We manage a database of customers from which we run
permissions based marketing campaigns. Additional marketing efforts focus on creating industry awareness at trade
shows, industry consortium memberships and sponsorships, advertising, marketing
collateral materials, co-marketing programs, public relations campaigns, sales
tools and training and education on our products and programs. Within vertical markets, we co-market with partner companies and lead
customers. Their expertise in the market allows use to leverage our resources
effectively without having to undertake large direct marketing campaigns. In
establishing technology partnerships with companies like RealViz and iSeeMedia,
InfoMedia will be able to jointly market products directly to the partner
customers, and benefit from partner marketing and awareness building. InfoMedia Competition We currently compete with several providers of immersive imaging technology.
We do not believe any of our competitors are dominant in this industry. We
compete with these companies on the basis of ease of use, reliability, end user
experience and price. While competitors may offer only components of the
end-to-end solution of InfoMedia, they may have greater financial, marketing,
distribution and technical resources with which to target our markets. Our
success will be dependent upon our ability to compete on the cost-effectiveness
and quality of our solutions, the success of our indirect channel partners and
the tangible value of our solutions. INTELLECTUAL PROPERTY We rely on a combination of patent, copyright, trade secret and trademark laws
and contractual restrictions to establish and protect proprietary rights in our
products. Our patents are intended to protect and support current and future
development of our technology. We currently have over 20 U.S. patents. In
addition, we hold international counterparts to many of our U.S. patents in
selected countries covering various aspects of our products. We have numerous
patent applications pending in the United States as well as international
counterparts to many of these applications. 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. 11




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Our success and ability to compete are dependent on our ability to develop and
maintain the proprietary aspects of our technology and operate without
infringing on the proprietary rights of others. We seek to limit disclosure of
our intellectual property by requiring employees, suppliers and customers with
access to our proprietary information to execute confidentiality agreements
with us and by restricting access to our source code. Despite our efforts to
protect our proprietary rights, unauthorized parties may attempt to copy
aspects of our services or software or to obtain and use information that we
regard as proprietary. We have experienced wrongful use in the past, and
although we have taken steps to stop that use, we expect to experience more
attempts in the future. The laws of many countries do not protect our
proprietary rights to as great an extent as to the laws of the United States.
Litigation may be necessary in the future to enforce our intellectual property
rights to protect our 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 we currently depend upon will provide sufficient protection to
prevent misappropriation of our technology or deter independent third-party
development of competing technologies. Claims by third parties that our current or future 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. We have been involved in litigation
relating to the protection of our intellectual property rights. Such
litigation, and any future litigation, regardless of outcome, may result in
substantial expense to us and significant diversion of our management and
technical personnel. An adverse determination in any litigation may subject us
to significant liabilities to third parties, require us to license disputed
rights from other parties, if licenses to these rights could be obtained, or
require us to cease using the technology. EMPLOYEES As of March 1, 2004, we employed 63 full-time employees. Our employees are not
represented by any collective bargaining unit. We believe our relations with
our employees are good. 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. Item 2.Properties. We lease approximately 13,000 square feet of space in Oak Ridge, Tennessee for
our corporate office and operations and approximately 19,000 square feet in San
Ramon, California for our co-headquarters. We have exited approximately 6,500
square feet of office space in San Ramon for which approximately half has been
sub-let and 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 12 to our
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K.) Item 3.Legal Proceedings. On November 15, 2002, a First Amended Consolidated Complaint for violation of
federal securities laws was filed against Homestore.com, Inc. (Homestore) by
the California Teachers Retirement System (CalSTRS). The Complaint is a
class action lawsuit filed on behalf of stockholders of Homestore which flows
from alleged misstatements and omissions made by Homestore and the other named
defendants, which include us. The Complaint alleges that during 2001,
Homestore and IPIX entered into fraudulent reciprocal transactions intended to
artificially bolster and maintain Homestores and our respective stock prices.
The Complaint alleges that Homestores public statements with respect to these
transactions are attributable to us and violate Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. We joined with other co-defendants and filed
a joint motion to dismiss, alleging that the 12




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Complaint fails to state a claim upon which relief may be granted, among other
things. On March 7, 2003, the United States District Court for the District
of Central California granted our motion to dismiss, with prejudice. However,
CalSTRS may appeal this dismissal in accordance with the federal rules of
procedure. In June 2003, we filed a lawsuit against Ford Oxaal and Minds-Eye-View, Inc. in
the United States District Court for the Eastern District of Tennessee alleging
patent infringement of certain patents and other causes of action. The
defendants in the lawsuit have filed counterclaims against the Company in their
response to our action. The litigation is in the pre trial motion stage at the
current time. We are not currently a party to any other legal proceedings the adverse outcome
of which, individually or in the aggregate, we believe could have a material
adverse effect on our business, financial condition, results of operations or
cash flows. Item 4.Submission of Matters to Vote of Security Holders No matters where submitted to a vote of the Companys stockholders during the
fourth quarter of fiscal year 2003. Item 4A.Executive Officers of Registrant The following sets forth information with respect to our executive officers as
of March 1, 2004: NAME
    
    AGE
    
    TITLEDonald W. Strickland
    
    
    54
    
    
    President and Chief Executive OfficerPaul A. Farmer
    
    
    45
    
    
    Chief Financial Officer, Executive VicePresident, Secretary and TreasurerSarah F. Pate
    
    
    44
    
    
    Executive Vice President and General Manger
 DONALD W. STRICKLANDhas been the chief executive officer of IPIX since May
2001 and has been president and chief operating officer since October 2000. Mr.
Strickland joined IPIX in April 2000 and served as executive vice president
until his appointment as president and chief operating officer in October 2000.
Prior to joining us, Mr. Strickland was president and chief executive officer
of PictureWorks Technology, Inc. from March 1996 until March 2000. From June
1993 until March 1996, Mr. Strickland held the position of vice president,
Imaging and Publishing at Apple Computer. Prior to joining Apple in June 1993,
Mr. Strickland spent twenty years at Eastman Kodak Company where he held a
succession of positions in engineering, sales, marketing and executive
management. Mr. Strickland holds several degrees including a bachelors degree
in physics from Virginia Tech, a masters degree in physics from the University
of Notre Dame, a masters degree in optics from the University of Rochester, a
masters degree in management from the Stanford Sloan School of Management and
a law degree from George Washington University. PAUL A. FARMERhas been the chief financial officer, executive vice president
and treasurer of IPIX since June 2001. Prior to joining us, Mr. Farmer was the
chief financial officer of Buzzsaw.com from June 2000 to June 2001. Prior to
Buzzsaw, Mr. Farmer was chief financial officer, chief administrative officer
and executive vice president of CCAi Consulting from June 1998 to June 2000.
Prior to CCAi, Mr. Farmer was chief financial officer of TCSI, Inc. from June
1994 to June 1998 and vice president and corporate controller of Technology
Solutions Company from November 1990 to June 1994. Mr. Farmer is a CPA and was
with Price Waterhouse from January 1982 through November 1990. Mr. Farmer
holds a bachelors degree in accounting from the University of Illinois and a
masters in business administration from the University of Chicago. 13




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SARAH F. PATEhas been the executive vice president, general manager of IPIXs
Transactional Services Group since December 2001, and has been with IPIX since
April 2000. Prior to joining us, Ms. Pate was vice president in charge of
operations for PictureWorks Technology, Inc., from August 1995 until March
2000. Ms. Pate has extensive experience in financial services and in managing
large and small organizations. She spent 12 years with Household International
serving as president of Household Bank, director of sales at Household Finance
Corporation and several other high-level management roles. Ms. Pate holds a
bachelors degree in business administration from the University of Washington. 
 PART II Item 5.Market for Registrants Common Equity and Related Stockholder Matters Our common stock is traded on the Nasdaq SmallCap Market (symbol: IPIX). As of
March 1, 2004, there were 1,003 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
    
    LowFISCAL 2003Fourth Quarter
    
    $
    3.22
    
    
    $
    1.76Third Quarter
    
    
    4.99
    
    
    
    2.30Second Quarter
    
    
    5.25
    
    
    
    1.10First Quarter
    
    
    1.37
    
    
    
    0.75FISCAL 2002Fourth Quarter
    
    $
    1.45
    
    
    $
    0.72Third Quarter
    
    
    1.86
    
    
    
    1.00Second Quarter
    
    
    2.84
    
    
    
    1.25First Quarter
    
    
    3.48
    
    
    
    2.00
 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. The table below sets forth information relating to our shareholder approved
compensation plans as of the end of 2003: Number ofsecuritiesremaining availableNumber of
    
    
    
    
    
    for future issuancesecurities to be
    
    
    
    
    
    under equityissued upon
    
    Weighted-average
    
    compensation plansexercises of
    
    exercise price of
    
    (excludingoutstanding
    
    outstanding
    
    securitiesoptions, warrants
    
    options, warrants
    
    reflected in columnPlan Category
    
    and rights
    
    and rights
    
    (a))(a)
    
    (b)
    
    (c)2001 Equity Compensation
    
    
    3,000,545
    
    
    $
    1.63
    
    
    
    3,043,6512000 Equity Compensation
    
    
    232,672
    
    
    $
    22.99
    
    
    
    1998 Employee, Director
and Consultant Stock
Option
    
    
    24,941
    
    
    $
    286.23
    
    
    
    1997 Equity Compensation
    
    
    21,484
    
    
    $
    113.01
    
    
    
    Prior option plans
    
    
    20,374
    
    
    $
    24.52
    
    
    
    Employee Stock Purchase
    
    
    
    
    
    
    
    
    
    
    533,106Total
    
    
    3,300,016
    
    
    $
    6.29
    
    
    
    3,576,757
 14




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Item 6.Selected Financial Data Selected Historical Financial Information The statement of operations data presented below for the years ended December
31, 2001, 2002 and 2003 and the balance sheet data as of December 31, 2002 and
2003 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, 1999 and 2000 and the balance sheet data as of
December 31, 1999, 2000 and 2001 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. Fiscal Years Ended December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003(In thousands, except per share data)Statement of Operations DataRevenues:Products
    
    $
    12,523
    
    
    $
    48,943
    
    
    $
    14,758
    
    
    $
    6,512
    
    
    $
    10,503Services
    
    
    
    
    
    
    4,730
    
    
    
    14,148
    
    
    
    15,901
    
    
    
    18,33612,523
    
    
    
    53,673
    
    
    
    28,906
    
    
    
    22,413
    
    
    
    28,839Cost of revenues:Products
    
    
    7,660
    
    
    
    25,555
    
    
    
    7,270
    
    
    
    2,145
    
    
    
    1,582Services
    
    
    
    
    
    
    2,516
    
    
    
    4,991
    
    
    
    6,583
    
    
    
    6,5387,660
    
    
    
    28,071
    
    
    
    12,261
    
    
    
    8,728
    
    
    
    8,120Gross profit
    
    
    4,863
    
    
    
    25,602
    
    
    
    16,645
    
    
    
    13,685
    
    
    
    20,719Operating expenses:Sales and marketing
    
    
    51,138
    
    
    
    83,064
    
    
    
    21,252
    
    
    
    7,607
    
    
    
    7,605Research and development
    
    
    6,690
    
    
    
    14,582
    
    
    
    7,671
    
    
    
    4,862
    
    
    
    4,553General and administrative
    
    
    19,499
    
    
    
    22,850
    
    
    
    15,816
    
    
    
    2,933
    
    
    
    3,452Impairment and amortization of
intangibles
    
    
    
    
    
    
    234,024
    
    
    
    2,433
    
    
    
    
    
    
    
    3,042Merger expenses
    
    
    
    
    
    
    15,175
    
    
    
    
    
    
    
    
    
    
    
    Loss on disposal of assets
    
    
    
    
    
    
    
    
    
    
    1,655
    
    
    
    
    
    
    
    Restructuring and impairment
    
    
    
    
    
    
    4,161
    
    
    
    11,655
    
    
    
    687
    
    
    
    89Total operating expenses
    
    
    77,327
    
    
    
    373,856
    
    
    
    60,482
    
    
    
    16,089
    
    
    
    18,741Income (loss) from operations
    
    
    (72,464
    )
    
    
    (348,254
    )
    
    
    (43,837
    )
    
    
    (2,404
    )
    
    
    1,978Interest expense
    
    
    (6,684
    )
    
    
    (436
    )
    
    
    (10,667
    )
    
    
    (183
    )
    
    
    (158
    )Interest income
    
    
    2,546
    
    
    
    3,345
    
    
    
    305
    
    
    
    456
    
    
    
    65Patent infringement award
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,000
    
    
    
    Loss on foreign currency
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (491
    )Other expense
    
    
    (1
    )
    
    
    (1,250
    )
    
    
    (380
    )
    
    
    (12
    )
    
    
    (8
    )Net income (loss) before
extraordinary gain
    
    
    (76,603
    )
    
    
    (346,595
    )
    
    
    (54,579
    )
    
    
    (1,143
    )
    
    
    1,386Extraordinary gain
    
    
    
    
    
    
    
    
    
    
    901
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (76,603
    )
    
    
    (346,595
    )
    
    
    (53,678
    )
    
    
    (1,143
    )
    
    
    1,386Dividend relative to beneficial
conversion feature of Series B
convertible preferred stock
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,784
    )
    
    
    (1,778
    )Net loss attributable to common
stockholders
    
    $
    (77,603
    )
    
    $
    (346,595
    )
    
    $
    (53,678
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Net loss per
common share 
basic and diluted
    
    $
    (30.13
    )
    
    $
    (61.55
    )
    
    $
    (8.22
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Weighted
average common shares 
basic and diluted
    
    
    2,576
    
    
    
    5,631
    
    
    
    6,534
    
    
    
    6,794
    
    
    
    7,365
 15




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As of December 31,1999
    
    2000
    
    2001
    
    2002
    
    2003(In thousands)Balance Sheet Data:Cash and cash equivalents, restricted
cash and short-term investments
and securities available for sale
    
    $
    73,366
    
    
    $
    11,035
    
    
    $
    13,401
    
    
    $
    5,992
    
    
    $
    12,303Working capital
    
    
    58,617
    
    
    
    1,174
    
    
    
    3,506
    
    
    
    2,418
    
    
    
    9,216Total assets
    
    
    95,803
    
    
    
    60,614
    
    
    
    23,078
    
    
    
    18,435
    
    
    
    16,284Long-term liabilities
    
    
    387
    
    
    
    957
    
    
    
    2,392
    
    
    
    1,769
    
    
    
    181Total stockholders equity
    
    
    81,041
    
    
    
    28,213
    
    
    
    8,770
    
    
    
    8,392
    
    
    
    11,465
 Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations 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 Over the past few years, we have restructured the Company around our higher
gross margin businesses. In 2003, our organization moved from being technology
focused (Immersive Video Solutions, Transaction Services and Immersive Still
Solutions) to being market focused in order to better serve the needs of our
customers. We are now organized into three business units: IPIX Security, IPIX
Ad Technologies and IPIX InfoMedia, respectively.  
    
    IPIX Securityprovides security and surveillance products and
services for commercial and governmental customers.  
    
    IPIX Ad Technologiesfocuses on the sale of complete solutions to
customers who rely on visual data to create effective directional
advertising such as publishers of newspaper classifieds, yellow page
directories, on-line auctions, real estate and autos classifieds.  
    
    IPIX InfoMediafocuses on the sale of immersive still technology
licenses for the on-line real estate, travel and hospitality and visual
documentation markets. Business Trends and Conditions Substantially all of our recurring revenue is derived from transaction fees
generated by our Ad Technologies business unit. In particular, eBay
represented approximately 87% of total revenue for 2003. Revenues in the
quarter and year ended December 31, 2003 include a one-time $8.0 million
license fee from eBay for our Rimfire technology and other services. As
announced in June 2003, we amended our then current commercial agreement with
eBay, which was subsequently extended by eBay to October 31, 2003 for a final
$0.45 million additional fee. We no longer provide any products or services to
eBay as of November 1, 2003. We continue to diversify and add additional Ad
Technologies customers and are currently targeting image management for
publications, on-line and in-print classified advertising and other business
opportunities. 16




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##### Table of Contents



Our immersive technology used by the InfoMedia business unit primarily
generates revenues in two ways: licenses of software and the sale of camera
equipment. In the past, we utilized keys to license our InfoMedia technology
to capture and save a single immersive image. With the launch of Interactive
Studios, we now offer time-based seat or user licenses which permit an
unlimited number of immersive images to be captured and saved within a specific
time period, usually a year. We sell our immersive products and services
primarily into the real estate, travel and hospitality and visual documentation
markets. The cost of sales for our licenses is low in proportion to the related
revenue. The cost of sales for the sale of camera equipment has generally been
50% to 75% of related revenues. We continue to develop our immersive imaging
business for the security and surveillance market. We also provide professional services to customers that request specific
customizations or integrations of our products and services. Providing
professional services is labor intensive, and our cost of sales for
professional service tends to be 40% to 60% of revenues. iPIX INTERNATIONAL In the third quarter of 2002, we 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. We provide certain hosting services during the term of
the agreements. Under the terms of the agreements, we received a minority equity interest in
iPIX-I, however, we do not have the ability to exercise significant influence
over iPIX-I operations. We account for the investment in iPIX-I on the cost
basis, not as a variable interest entity under FIN 46. We did not make any
capital contributions to iPIX-I and we have no commitments to fund iPIX-I. We
do 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 six months ended December 31, 2002, we recognized $0.6 million of
revenue under these agreements. During the year ended December 31, 2003, we
recognized $0.4 million of revenue under these agreements. On March 21, 2004,
the parties mutually terminated these agreements and we returned our minority
equity interest in iPIX-I. The termination of the agreements did not have a
material impact on our financial condition or expected result of operations. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. 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, 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; 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




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##### Table of Contents



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. We believe the following represent our critical accounting
policies: Revenue Recognition We recognize revenue in accordance with SOP 97-2, Software Revenue
Recognition and SEC Staff Accounting Bulletin No. 104 (SAB 104), Revenue
Recognition in Financial Statements. We derive revenue from product sales and
services we provide to customers. Product revenue includes InfoMedia hardware
and licenses, IPIX Security hardware and licenses, as well as Ad Technology
license revenue. Service revenues are primarily from transactions where a
seller uses our image management products to enhance their on-line offering. Product revenue is recognized upon shipment or delivery 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. Transaction hosting revenue is recognized ratably as transactions are performed
provided there was persuasive evidence of an arrangement, the fee was fixed or
determinable and collection of the resulting receivable was reasonably assured.
Revenue generated from professional services is recognized as the related
services are performed. When such professional services are combined with
on-going transaction services or are deemed to be essential to the
functionality of the delivered software product, revenue from the entire
arrangement is recognized while the transaction services are performed, on a
percentage of completion method or not until the contract is completed in
accordance with SOP 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts, and ARB No. 45, Long-Term
Construction-Type Contracts. Reimbursements received for out-of-pocket
expenses incurred are characterized as revenue in the statement of operations. Where multiple elements exist in an arrangement, the arrangement fee is
allocated to the different elements based upon verifiable objective evidence of
the fair value of the elements, as governed under EITF 00-21, which is codified
in SEC Staff Accounting Bulletin No. 104 SAB 104. Multiple element
arrangements primarily involve an arrangement with professional services and
transaction hosting. Revenue is recognized as each element is earned, namely
upon completion of the services, provided that the fair value of the
undelivered element(s) has been determined, the delivered element has
stand-alone value, there is no right of return on delivered element(s), and we
are in control of delivery of the undelivered element(s). Royalties derived from desktop imaging products were recognized as revenues
upon receipt of the royalty sell-through reports from customers, which are
generally in the quarter following the quarter in which the sale by the
customer took place. Payments received in advance are initially recorded as deferred revenue and
recognized ratably as obligations are fulfilled. Allowances for Doubtful Accounts Significant management judgments and estimates must be made and used in
connection with establishing the doubtful account allowances in any accounting
period. Management specifically analyzes accounts receivable and historical bad
debts, customer concentrations, customer credit-worthiness, current economic
trends and changes in our 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. 18




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##### Table of Contents



Goodwill Under United States generally accepted accounting principles, 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 Ad Technologies 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 Ad Technologies business unit.
As a result, an impairment charge was recorded to expense in the year ended
December 31, 2003. Significant Accruals, including Restructuring Charges and Sales Tax We recorded restructuring charges associated with vacated facilities. 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 our future financial results. RESTRUCTURING ACTIONS We executed several restructuring actions throughout 2001 and 2002. These
actions and the charges relating to them are described below. On March 1, 2001, we had 552 employees, but by the end of the second quarter we
had reduced our workforce by approximately 440 positions. The reductions were
primarily in the full-service virtual real estate business. The first quarter
reductions resulted in a restructuring charge of $3.0 million. In the second quarter of 2001, we reorganized our management personnel, closed
our sales offices throughout the U.S. and made further reductions in our
workforce. As a result of these actions, we recorded a $7.2 million
restructuring charge in the second quarter of 2001. Included in 2001 is a $1.5
million impairment charge related to the write off of the unamortized portion
of our directors and officers insurance policy. We were required to obtain a
new policy due to the change in control related to our 2001 financing. In September 2002, $0.7 million of restructuring charges were recorded related
to expenses associated primarily with a negotiated buy-out of certain lease
obligations for previously vacated offices. We paid approximately $1.3 million
during the fourth quarter of 2002 to end our continuing obligations under those
leases. During October 2003, $0.1 million of restructuring charges were recorded
related to expenses associated with the lease obligations from previously
vacated office space in San Ramon, CA. 19




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##### Table of Contents



The activity in the current and long-term restructuring accruals for the years
ended December 31, were as follows: Balance at
    
    
    
    
    
    Payments/
    
    Balance at
    
    
    
    
    
    Payments/
    
    Balance at
    
    
    
    
    
    Payments/
    
    Balance atDecember
    
    
    
    
    
    Write-offs
    
    December
    
    
    
    
    
    Write-offs
    
    December
    
    
    
    
    
    Write-off
    
    December(In Thousands)
    
    31, 2000
    
    Expense in 2001
    
    in 2001
    
    31, 2001
    
    Expense in 2002
    
    in 2002
    
    31, 2002
    
    Expense in 2003
    
    in 2003
    
    31, 2003Restructuring Provisions:Severance
    
    $
    590
    
    
    $
    4,537
    
    
    $
    (4,027
    )
    
    $
    1,100
    
    
    $
    
    
    
    $
    (600
    )
    
    $
    500
    
    
    $
    
    
    
    $
    (500
    )
    
    $
    Employee debt
forgiveness
    
    
    
    
    
    
    2,163
    
    
    
    (2,163
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Write-offs and
impairments
    
    
    95
    
    
    
    1,959
    
    
    
    (2,054
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Lease obligations
    
    
    1,344
    
    
    
    3,006
    
    
    
    (2,897
    )
    
    
    1,453
    
    
    
    687
    
    
    
    (1,591
    )
    
    
    549
    
    
    
    89
    
    
    
    (267
    )
    
    
    371Other
    
    
    31
    
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    2,060
    
    
    $
    11,665
    
    
    $
    (11,172
    )
    
    $
    2,553
    
    
    $
    687
    
    
    $
    (2,191
    )
    
    $
    1,049
    
    
    $
    89
    
    
    $
    (767
    )
    
    $
    371
 OUTLOOK We have only a limited operating history, and our business model has been
modified over the past three years. In addition, our recurring revenues from
our commercial agreement with eBay ended in 2003 which represented
approximately 87% of our total revenue in 2003. With the loss of revenues from
our largest customer, we are attempting to diversify and add new Ad Technology
customers. Our prospects should be considered in light of the risks,
uncertainties, expenses and difficulties frequently encountered by companies in
their early stages of development, particularly companies in new and rapidly
evolving markets such as the Internet. 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. Although our revenue grew significantly in our early history, during recent
periods, we have been unable to sustain this growth and have had to reduce our
expense structure. Therefore, you should not consider our historical growth
indicative of future revenue levels or operating results. In order to reduce
our operating cost structure to a sustainable level commensurate with our
revenues, we have gone through several restructurings during the last three
years. We began 2004 with three business units all at different stages in their
development. The IPIX Security group has developed products based upon our proven immersive
technology and is focused on a large global market opportunity  security and
surveillance. During the first quarter of 2004, the group successfully
completed beta trial testing of its new products. In March and April 2004,
the group will launch its new products. 20




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##### Table of Contents



The Ad Technologies group has proven technology, strong customer references and
is focused on a large global market opportunity  improving on-line
advertising. In 2004, however, the group must rebuild its revenue base given
the change in its relationship with its largest customer, eBay, which
represented 87% of our revenues in 2003. The InfoMedia group also has proven technology and strong customer references.
In February 2004, the group launched a new product called Interactive Studios.
With this launch, the group also announced that after 2004, they would no
longer be selling one-use keys to their core technology. Instead,
Interactive Studio will be sold as a software platform under primarily annual
licenses allowing for unlimited usage. The group will continue to sell
cameras, lens and other equipment that are used with the Studio by professional
immersive photographers. In addition, we are subject to generally prevailing economic conditions and, as
such, our success in 2004 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 make significant investments in our image management business and
in the development, sale and marketing of new products for the security 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 2004 will be to manage cash requirements and focus our operations on
efficient spending. Fiscal Years Ended December 31,2001
    
    2002
    
    2003(In thousands, except per share data)Statement of Operations Data:Revenues:Products
    
    $
    14,758
    
    
    $
    6,512
    
    
    $
    10,503Services
    
    
    14,148
    
    
    
    15,901
    
    
    
    18,33628,906
    
    
    
    22,413
    
    
    
    28,839Cost of revenues:Products
    
    
    7,270
    
    
    
    2,145
    
    
    
    1,582Services
    
    
    4,991
    
    
    
    6,583
    
    
    
    6,53812,261
    
    
    
    8,728
    
    
    
    8,120Gross profit
    
    
    16,645
    
    
    
    13,685
    
    
    
    20,719Operating expenses:Sales and marketing
    
    
    21,252
    
    
    
    7,607
    
    
    
    7,605Research and development
    
    
    7,671
    
    
    
    4,862
    
    
    
    4,553General and administrative
    
    
    15,816
    
    
    
    2,933
    
    
    
    3,452Impairment and amortization of intangibles
    
    
    2,433
    
    
    
    
    
    
    
    3,042Loss on disposal of assets
    
    
    1,655
    
    
    
    
    
    
    
    Restructuring and impairment
    
    
    11,655
    
    
    
    687
    
    
    
    89Total operating expenses
    
    
    60,482
    
    
    
    16,089
    
    
    
    18,741Income (loss) from operations
    
    
    (43,837
    )
    
    
    (2,404
    )
    
    
    1,978Interest expense
    
    
    (10,667
    )
    
    
    (183
    )
    
    
    (158
    )Interest income
    
    
    305
    
    
    
    456
    
    
    
    65Patent infringement award
    
    
    
    
    
    
    1,000
    
    
    
    Loss on foreign currency
    
    
    
    
    
    
    
    
    
    
    (491
    )Other expense
    
    
    (380
    )
    
    
    (12
    )
    
    
    (8
    )Net income (loss) before extraordinary gain
    
    
    (54,579
    )
    
    
    (1,143
    )
    
    
    1,386Extraordinary gain
    
    
    901
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (53,678
    )
    
    
    (1,143
    )
    
    
    1,386Preferred stock dividends
    
    
    
    
    
    
    (1,784
    )
    
    
    (1,778
    )Net loss available to common stockholders
    
    $
    (53,678
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Net loss per common share  basic and diluted
    
    $
    (8.22
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Weighted average common shares  basic and diluted
    
    
    6,534
    
    
    
    6,794
    
    
    
    7,365
 21




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##### Table of Contents



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 31,2001
    
    2002
    
    2003Revenues:Products
    
    
    51.1
    %
    
    
    29.1
    %
    
    
    36.4
    %Services
    
    
    48.9
    
    
    
    70.9
    
    
    
    63.6100.0
    
    
    
    100.0
    
    
    
    100.0Cost of revenues:Products
    
    
    25.2
    
    
    
    9.5
    
    
    
    5.5Services
    
    
    17.3
    
    
    
    29.4
    
    
    
    22.7Total cost of revenue
    
    
    42.5
    
    
    
    38.9
    
    
    
    28.2Gross profit
    
    
    57.5
    
    
    
    61.1
    
    
    
    71.8Operating expenses:Sales and marketing
    
    
    73.5
    
    
    
    33.9
    
    
    
    26.4Research and development
    
    
    26.6
    
    
    
    21.7
    
    
    
    15.8General and administrative
    
    
    54.7
    
    
    
    13.1
    
    
    
    12.0Impairment and amortization of intangibles
    
    
    8.4
    
    
    
    
    
    
    
    10.5Loss on disposal of assets
    
    
    5.7
    
    
    
    
    
    
    
    Restructuring and impairment
    
    
    40.3
    
    
    
    3.1
    
    
    
    0.3Total operating expenses
    
    
    209.2
    
    
    
    71.8
    
    
    
    65.0Income (loss) from operations
    
    
    (151.7
    )
    
    
    (10.7
    )
    
    
    6.8Interest expense
    
    
    (36.9
    )
    
    
    (0.8
    )
    
    
    (0.5
    )Interest income
    
    
    1.1
    
    
    
    2.0
    
    
    
    0.2Patent infringement award
    
    
    
    
    
    
    4.5
    
    
    
    Loss on foreign currency
    
    
    
    
    
    
    
    
    
    
    (1.7
    )Other expense
    
    
    (1.3
    )
    
    
    (0.1
    )
    
    
    Net income (loss) before extraordinary gain.
    
    
    (188.8
    )
    
    
    (5.1
    )
    
    
    4.8Extraordinary gain
    
    
    3.1
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (185.7
    )%
    
    
    (5.1
    )%
    
    
    4.8
    %
 RESULTS OF OPERATIONS FOR 2003, 2002 AND 2001 Revenues For Years endedDecember 31,Percent
    
    Percent2001
    
    2002
    
    2003
    
    Change in 2002
    
    Change in 2003(Dollars in thousands)REVENUES:Products
    
    $
    14,758
    
    
    $
    6,512
    
    
    $
    10,503
    
    
    
    (56
    )%
    
    
    61
    %Services
    
    
    14,148
    
    
    
    15,901
    
    
    
    18,336
    
    
    
    12
    
    
    
    15Total revenue
    
    
    28,906
    
    
    
    22,413
    
    
    
    28,839
    
    
    
    (22
    )
    
    
    29COST OF REVENUES:Products
    
    
    7,270
    
    
    
    2,145
    
    
    
    1,582
    
    
    
    (70
    )
    
    
    (26
    )Services
    
    
    4,991
    
    
    
    6,583
    
    
    
    6,538
    
    
    
    32
    
    
    
    (1
    )Total cost of revenue
    
    
    12,261
    
    
    
    8,728
    
    
    
    8,120
    
    
    
    (29
    )
    
    
    (7
    )Gross profit
    
    $
    16,645
    
    
    $
    13,685
    
    
    $
    20,719
    
    
    
    (18
    )%
    
    
    51
    %
 22




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##### Table of Contents



Product Revenues. The increase in 2003 was primarily due to a one-time $8.0
million license fee from eBay for our Rimfire technology and other services.
During 2002, we reduced our sales and marketing efforts related to the sale of
lower margin immersive kits and keys. As a result of lower sales and marketing
expenditures we had $3.9 million in lower immersive revenues year-over-year.
As part of the sale of assets to Homestore.com during the first quarter of
2001, we no longer directly sell full service virtual tours or IPIX keys to
customers in the U.S. residential real estate market. Instead, through January
12, 2002, we provided Homstore.com certain processing, hosting and distribution
services and received transaction fees and royalties. Throughout 2002, other
than full service virtual tours, our real estate focused revenues were
generated from three primary sources: image management services; camera kits
and immersive keys; and other services. In 2001, product revenues of $7.5
million related to full service virtual real estate tours. We did not have any
full service virtual real estate tour revenues after 2001. Service Revenues. The increase from 2001 to 2002 and from 2002 and 2003 was
primarily due to increased volumes of images processed by Rimfire, primarily
related to on-line auctions for eBay. Cost of Revenues. Cost of revenues consists of our direct expenses associated
with the processing, hosting and distribution of digital content and the costs
of the digital camera and related components included in InfoMedia hardware.
Cost of revenues, as a percentage of total revenues, decreased to 28% in 2003
from 39% in 2002 primarily as a result of the one-time license fee from eBay.
Cost of revenues as a percentage of total revenues decreased to 39% in 2002
from 42% in 2001. This decrease was primarily the result of a lower volume of
virtual tour deliveries and an increase in higher margin Rimfire based
revenues. Operating Expenses For Years endedDecember 31,PercentChange
    
    Percent2001
    
    2002
    
    2003
    
    in 2002
    
    Change in 2003(Dollars in thousands)Sales and marketing
    
    $
    21,252
    
    
    $
    7,607
    
    
    $
    7,605
    
    
    
    (64
    )%
    
    
    
    %Research and development
    
    
    7,671
    
    
    
    4,862
    
    
    
    4,553
    
    
    
    (37
    )
    
    
    (6
    )General and administrative
    
    
    15,816
    
    
    
    2,933
    
    
    
    3,452
    
    
    
    (81
    )
    
    
    18Impairment and amortization of intangibles
    
    
    2,433
    
    
    
    
    
    
    
    3,042
    
    
    
    (100
    )
    
    
    100Loss on disposal of assets
    
    
    1,655
    
    
    
    
    
    
    
    
    
    
    
    (100
    )
    
    
    Restructuring and impairment
    
    
    11,655
    
    
    
    687
    
    
    
    89
    
    
    
    (94
    )
    
    
    (87
    )Total operating expenses
    
    
    60,482
    
    
    
    16,089
    
    
    
    18,741
    
    
    
    (73
    )
    
    
    16Loss from operations
    
    $
    (43,837
    )
    
    $
    (2,404
    )
    
    $
    1,978
    
    
    
    95
    %
    
    
    (182
    )%
 Sales and Marketing. Sales and marketing expenses consist primarily of
salaries for marketing, sales and business development personnel. Sales and
marketing expenses also include commissions and related benefits for sales
personnel and consultants, traditional advertising and promotional expenses.
Sales and marketing expenses were essentially at the same dollar levels for
2003 as compared with 2002. As a percentage of total revenues, sales and
marketing expenses decreased to 26% for 2003 from 34% for 2002 primarily due to
the growth in transaction revenues as a result of the one-time license fee from
eBay. Sales and marketing expenses decreased $13.6 million in 2002 primarily
due to our decision to sell more of our products and services through third
parties and become less reliant upon a worldwide direct sales force. As a
result, we significantly reduced our sales force and eliminated our field
operations personnel resulting in a decrease of $11.5 million. In addition, we
eliminated costs relating to technology access and sponsorship fees and
decreased advertising and branding expenses, which accounted for $2.1 million
of the decrease. To begin 2004, as a result of the changed relationship with
eBay, we have taken certain actions which should reduce our annualized sales
and marketing expenses by approximately 25% from 2003 spending levels. 23




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Research and Development.Research and development expenses consist primarily
of personnel costs related to building and enhancing our digital media
infrastructure and immersive imaging technology. As part of the restructuring
during 2001 and 2002 and our exit from the full service virtual tour real
estate business, our spending on research and development was reduced and
focused on our core image management and immersive technologies. As a
percentage of revenues, research and development charges decreased to 16% for
2003 from 22% for 2002 as a result of the one-time license fee from eBay. To
begin 2004, as a result of the changed relationship with eBay, we have taken
certain actions which should reduce our annualized research and development
expenses by approximately 15% from 2003 spending levels. General and Administrative. General and administrative expenses consist
primarily of salaries and related benefits for administrative and executive
staff, fees for outside professional services, bad debt expenses and other
costs associated with being a public company. The increase in 2003 was
primarily due to a $0.3 million collection in 2002 of previously reserved
receivables and a decrease in personnel and related costs of $0.1 million.
Professional fees, which include legal fees, accounting fees and public company
expenses, accounted for the remaining $0.2 million of the increase in 2003.
The decrease in 2002 was primarily due to a decrease in personnel and related
costs of $6.2 million. Bad debt expense decreased by $4.7 million in 2002. In
2002, no additional provisions for uncollectible receivables were required;
however, $0.3 million was collected from previously reserved receivables.
Professional fees accounted for $2.0 million of the decrease in 2002. Expected
general and administrative spending in 2004 should be substantially similar to
2003 levels. Stock-based Compensation. Stock-based compensation expense is included in
various expense line items in the statement of operations and consists of the
amortization of deferred compensation related to stock options granted to
employees and others prior to our initial public offering with an exercise
price below the deemed fair market value of our common stock on the date of
grant. In addition, it also includes the amortization of the fair value of
warrants and options issued to non-employees and restricted stock granted to
employees. The related compensation is amortized over the vesting period of the
options or warrants. Expenses related to the warrants are amortized over the
term of the agreements to which they relate. There was no stock-based expense
for 2003 because the related stock options and warrants were fully vested prior
to 2003. In 2002 and 2003, we did not issue any additional warrants or stock
options priced below the deemed fair market value of our common stock on the
date of grant. The decrease in total expense for 2001 and 2002 was because
most of the related stock options and warrants were fully vested prior to the
end of 2001. The following table summarizes amounts expensed in 2001 and 2002
for stock-based compensation: For Years ended December 31,2001
    
    2002(In thousands)Cost of revenues
    
    $
    95
    
    
    $
    Sales and marketing
    
    
    1,605
    
    
    
    171Research and development
    
    
    650
    
    
    
    General and administrative
    
    
    2,149
    
    
    
    $
    4,499
    
    
    $
    171
 Impairment and Amortization of Intangibles.Amortization expense in 2001
consists of goodwill associated with corporate acquisitions during the second
quarter of 2000. We adopted Statement of Financial Accounting Standards 142,
Goodwill and Other Intangible Assets (FAS 142), effective January 1, 2002.
Under FAS 142, goodwill is no longer amortized, but reviewed for impairment
annually or more frequently if certain indicators arise. During the quarter
ended December 31, 2003, we recognized a $3.0 million impairment of the
remaining balance of our goodwill because we were unable to extend our
agreement with eBay. The eBay agreement ended in November 2003 and was the
primary source of cash flows for the technology associated with our goodwill
balance. Loss on Disposal of Assets. We recorded a loss in 2001 as a result of the sale
of assets used to provide residential real estate virtual tours that consisted
of the remaining residential real estate assets that were unrelated to the 2000
pooling of Interactive Pictures Corporation and bamboo.com. 24




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Restructuring and Impairment. Restructuring and Impairment charges are
primarily associated with reductions of our workforce, outstanding obligations
under non-productive leases resulting from the consolidation of certain offices
and write-offs of abandoned computers and office furniture and equipment.
Included in the 2001 impairment expense is $1.5 million related to the write
off of the unamortized portion of our directors and officers insurance
policy. We were required to obtain a new policy due to the change in control
related to our 2001 financing which culminated in the third quarter. The
charges in 2001 included significant workforce reductions, while in 2002 and
2003 the charges related primarily to changed estimates for outstanding lease
obligations. See Note 4 in the accompanying financial statements for a more
detailed explanation. Other Income (Expense) For Years endedDecember 31,Percent
    
    Percent2001
    
    2002
    
    2003
    
    Change in 2002
    
    Change in 2003(Dollars in thousands)Interest expense
    
    
    (10,667
    )
    
    
    (183
    )
    
    
    (158
    )
    
    
    (98
    )%
    
    
    (14
    )%Interest income
    
    
    305
    
    
    
    456
    
    
    
    65
    
    
    
    50
    
    
    
    (85
    )Loss on foreign currency
    
    
    
    
    
    
    
    
    
    
    (491
    )
    
    
    
    
    
    
    100Patent infringement award
    
    
    
    
    
    
    1,000
    
    
    
    
    
    
    
    100
    
    
    
    (100
    )Other expense
    
    
    (380
    )
    
    
    (12
    )
    
    
    (8
    )
    
    
    97
    
    
    
    (33
    )Net loss before extraordinary gain
    
    
    (54,579
    )
    
    
    (1,143
    )
    
    
    1,386
    
    
    
    98
    
    
    
    221Extraordinary gain
    
    
    901
    
    
    
    
    
    
    
    
    
    
    
    (100
    )
    
    
    Net loss
    
    $
    (53,678
    )
    
    $
    (1,143
    )
    
    $
    1,386
    
    
    
    98
    %
    
    
    221
    %
 Interest Expense.Interest expense relates to capital lease obligations and in
2001, we recorded a non-cash interest expense of $10.0 million related to the
accretion of a promissory note issued in the second quarter 2001 to its face
value when the promissory note was converted to Series B preferred stock during
the third quarter of 2001 and $0.3 million of interest expense on the
promissory note. Interest Income.Interest income consists primarily of interest earned on cash
and investments and in 2002 interest earned of $0.3 million on the patent
infringement award. Lower interest income earned in 2003 was the result of
declining investment balances. Loss on Foreign Currency.Loss on foreign currency in 2003 is due to the
recognition of cumulative currency translations from dissolved foreign
subsidiaries. Patent Infringement Award.The patent infringement award in 2002 is due to the
collection of a previously awarded court judgment for which all legal remedies
for appeal have been exhausted and the case was closed. Other Expense.Other expense in 2001 was primarily due to realized losses on
investments sold during the year. Extraordinary Gain. We recorded an extraordinary gain from the cash received
from the sale of assets to Homestore.com in January 2001. The assets were used
to provide virtual tours of residential real estate properties that were
related to the pooling of Interactive Pictures Corporation and bamboo.com,
which occurred less than 12 months prior to the sale. 25




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LIQUIDITY AND CAPITAL RESOURCES The accompanying financial statements have been prepared on a going-concern
basis, which contemplates the realization of assets and satisfaction of
liabilities and other commitments in the normal course of business. The report
of our independent auditors contains an explanatory paragraph stating that
significant matters exist concerning us, including the change in the
relationship with our largest customer, that raises substantial doubt about our
ability to continue as a going concern. The financial statements do not include
any adjustments relating to the recoverability and classification of recorded
asset amounts or the amounts and classification of liabilities that may be
necessary if we are unable to continue as a going concern. Since inception, we have financed our operations through our registered public
offerings, the private placements of capital stock, a convertible debenture, a
convertible promissory note, capital lease obligations and warrant and option
exercises. We finished 2003 with approximately $12.3 million in cash reserves
(cash and cash equivalents of $10.24 million, short-term restricted investments
of $1.10 million, long-term restricted cash of $0.63 million and short-term
investments of $0.33 million). Summary Consolidated Cash Flow Data Years Ended December 31,2002
    
    2003(In thousands)Net cash provided by (used in) operating
activities
    
    $
    (4,691
    )
    
    $
    8,955Net cash used in investing
activities
    
    
    (4,908
    )
    
    
    (940
    )Net cash provided by (used in) financing
activities
    
    
    1,541
    
    
    
    (797
    )Effect of exchange rate changes on
cash
    
    
    (25
    )
    
    
    3Net increase (decrease) in cash and cash
equivalents
    
    
    (8,083
    )
    
    
    7,221Cash and cash equivalents, beginning of
period
    
    
    11,103
    
    
    
    3,020Cash and cash equivalents, end of
period
    
    $
    3,020
    
    
    $
    10,241
 Net cash provided by (used in) operating activities was $9.0 million for year
ended December 31, 2003 and $(4.7) million for the year ended December 31,
2002. Net cash provided by operating activities in 2003 was primarily the
result of net income of $1.4 million, plus $3.2 million of non-cash
depreciation charged during the year and $3.0 million from the non-cash
impairment of goodwill expense. In addition, during 2003, accounts receivables
decreased $3.3 million, primarily as a result of fourth quarter revenues from
2003 which were mostly collected before December 31, 2003. Net income for the
year ended December 31, 2003 includes a non-recurring $8.0 million license fee
from eBay for our Rimfire technology and other services. As announced in June
2003, we amended our then current commercial agreement with eBay. We no longer
provide any products or services to eBay as of November 1, 2003. Net cash used in investment activities was $4.9 million for the year ended
December 31, 2002 and $0.9 million for the year ended December 31, 2003. The
decrease was the result of lower purchases of computer software and hardware
($2.6 million) and lower net investment activity ($1.4 million). Net cash provided by (used in) financing activities was $(0.8) million for the
year ended December 31, 2003 and $1.5 million for the year ended December 31,
2002. The net cash used in financing activities for 2003 was due primarily to
the repayment of capital lease obligations ($2.0 million) and payment of Series
B Preferred Stock Dividends ($0.4 million); offset by cash provided by the
exercise of employee options ($1.6 million). The net cash provided by
financing activities for 2002 was due primarily to the proceeds from
sale-leaseback transactions. 26




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##### Table of Contents



Contractual Obligations The table below shows our contractual obligations as of December 31, 2003: Payments Due by PeriodLess than
    
    2
    
    3
    
    After 3Total
    
    1 year
    
    years
    
    years
    
    Years(In thousands)Capital Leases
    
    $
    623
    
    
    $
    623
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating Leases
    
    
    2,647
    
    
    
    1,044
    
    
    
    768
    
    
    
    771
    
    
    
    64Total
    
    
    3,270
    
    
    
    1,667
    
    
    
    768
    
    
    
    771
    
    
    
    64
 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. Management believes we have sufficient cash
resources to meet our funding needs for 2004. We finished 2003 with
approximately $12.3 million in cash reserves (cash and cash equivalents of
$10.24 million, short-term restricted investments of $1.10 million, long-term
restricted cash of $0.63 million and short-term investments of $0.33 million).
At December 31, 2003, $0.9 million of the above future lease payments have been
prepaid and reflected as current and long-term prepaid expenses. Additionally,
at December 31, 2003, the $0.63 million long-term restricted cash has been
restricted related to the above future lease payments. In 2004, we plan to launch new products in the InfoMedia and Security groups.
In addition, we plan to invest in the Ad Technologies group pursuit of
additional customers and revenue growth from existing customers. Depending
upon the success of each of our three business units, 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. Managements focus in 2004 will be to manage our cash requirements and focus
our operations on efficient spending. Our long-term strategy remains
unchanged. We will continue to make significant investments in sales and
marketing as well as research and development for all segments in order to
fulfill our expectations for the expansion of the on-line auction and
classified services and in the development of new immersive products and
services. RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables (EITF 00-21). EITF 00-21 provides
guidance on how to account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use assets. The
provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. We adopted this standard in the quarter
ended September 30, 2003 and the adoption did not have a material effect on our
financial statements. In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities (VIE), an Interpretation of ARB No. 51 (FIN 46) and in
December 2003, issued a revised interpretation (FIN 46-R). FIN No. 46, as
revised, requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The provisions of
FIN 46-R are effective immediately for all arrangements entered into after
January 31, 2003. For arrangements entered into prior to February 1, 2003, we
are required to adopt the provisions of FIN 46-R in the first quarter of 2004.
The adoption of FIN 46-R is not expected to have a significant effect on our
financial position or results of operations. 27




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In May 2003, the FASB issued FAS No. 150, Accounting For Certain Financial
Instruments with Characteristics of both Liabilities and Equity (FAS 150).
FAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). FAS 150 is to be
implemented by reporting the cumulative effect of a change in an accounting
principle for the financial instrument created before November 2003 and still
existing at the beginning of the interim period of adoption. Restatement is
not permitted. We do not believe that the adoption of this statement will have
a material impact on our financial position, results of operations or cash
flows. On December 17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No.
104 (SAB 104), Revenue Recognition, which superceded SAB 101, Revenue
Recognition in Financial Statements. SAB 104s primary purpose is to rescind
account guidance contained in SAB 101 related to multiple element revenue
arrangements, superceded as a result of the issuance of EITF 00-21, Accounting
for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104
rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked
Questions and Answers(the FAQ) issued with SAB 101 that had been codified in
SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been
incorporated into SAB 104. While the wording of SAB 104 has changed to reflect
the issuance of EITF 00-21, the revenue recognition principles of SAB 101
remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104
did not materially affect our revenue recognition policies, or our results of
operations, financial position or cash flows. 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, 2003, we had $12.3 million of cash reserves. 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 PricewaterhouseCoopers, LLP,
independent accountants, are set forth on the pages indicated in item 15 (a)
below 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. 28




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##### Table of Contents



RISK FACTORS Our limited operating history and recent changes in our customer base makes it
difficult to evaluate our business During late 2003, our relationship with our largest customer changed and in
early 2004, we launched new products in our IPIX Security and IPIX InfoMedia
business units. As a result, we have a limited operating history of the
Company as it will operate in 2004 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:  
    
    increase our customer base for Rimfire services;  
    
    maintain and enhance our brand and expand our immersive product and service 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. Additional capital or strategic alternatives may be required for us to continue
our operations and as a result, the independent auditors report includes an
explanatory paragraph that states that significant matters exist, including the
change in the relationship with our largest customer, that raise substantial
doubt about our ability to continue as a going concern As of December 31, 2003, we had an accumulated deficit of $504 million. In June
2003, we amended our commercial agreement with eBay, Inc., and we no longer
provide any products or services to eBay. eBay represented approximately 87%
of our total revenue for 2003. As a result of the loss of revenues from our
largest customer, the lack of any sales history for our new security products,
our past recurring losses from operations and our accumulated deficit, the
independent auditors report includes an explanatory paragraph stating that
significant matters exist that raise substantial doubt about our ability to
continue as a going concern. We believe our $12.3 million of cash reserves (cash and cash equivalents of
$10.24 million, short-term restricted investments of $1.10 million, long-term
restricted cash of $0.63 million and short-term investments of $0.33 million)
at December 31, 2003, may be sufficient to fund operations for 2004, assuming
we are successful in the sale of new products and increasing our revenues and
continue to see improvement in our overall cost structure. If we are not
successful in increasing our revenues or cutting costs, we may be required to
reduce operations further or seek additional private 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 2003. 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. 29




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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 internal 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. Our operating results are highly dependent on generating recurring revenue from
our Rimfire service, and we must be successful in adding new Rimfire service
customers and generating revenue from new and existing markets Substantially all of our recurring revenue has been derived from transaction
fees generated by our Rimfire service. In particular, eBay was our largest
Rimfire customer. eBay represented approximately 87% of total revenue and 96%
of total Rimfire service revenue for 2003. As announced in June 2003, we
amended our then current commercial agreement with eBay and we no longer
provide any products or services to eBay as of November 1, 2003. We continue
to diversify and add additional Ad Technologies customers and are currently
targeting image management for publications, on-line and off line classified
advertising and other business opportunities. If we fail to add significant
customers and increase revenues in this segment of our business, our results of
operations and cash flows could be adversely affected. In addition, we must
continue to improve and enhance our Rimfire service. If we fail to do so in a
timely manner, or if we suffer a decrease in demand for our products and
services, our revenue will decrease. 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 response to the Q4 2003 loss of revenues from our largest customer and
challenging market conditions, we initiated certain cost-reduction programs.
In late 2003, we reduced the number of employees in the business unit which
previously supported our largest customer. We have completed the required
personnel actions and completed the outsourcing of certain of our network
management operations. Also, we are streamlining our external spending on
marketing and administration. As a result, we hope to lower our future
break-even revenue level. In order to be successful, however, we must replace
this lost revenue. 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; our manufacturing capabilities; and the performance of other
parties under outsourcing arrangements. An important cost-reduction action is to outsource most of our network
operations. While we have business and risk management plans in place in case
delivery, quality or capacity is significantly reduced or eliminated by a
co-location facility, our current size does not allow us to have numerous
alternative vendors; and, accordingly, our operations 30




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could be disrupted for extended periods of time. As a result, we could have
difficulties performing our services and our revenues and operating result
could be negatively impacted. 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. We rely on third party systems to provide our Rimfire service We rely on certain third-party computer systems and third-party service
providers, including a third party Internet service provider, to host and
maintain our production services for all of our Rimfire customers. The
performance and availability of our Internet systems is critical to our
business and reputation. Any system failure, including network, software or
hardware failure that interrupts the delivery of Rimfire services or decreases
our responsiveness to our customers could be disruptive to our business. Our
Internet service provider does not guarantee that its Internet access will be
uninterrupted, error free or secure. From time to time it is necessary to
change the providers of these services. During the period we are moving our
services from one provider to another, interruptions in our offerings could
occur. Because our revenue from our Rimfire service is transaction based, any
interruption in Internet access will result in a loss of revenue for the period
that Internet access is unavailable. 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. 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 not 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. 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 involved in litigation relating to the protection of intellectual
property rights and could be involved in future litigation as third parties
develop products that 31




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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. 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. 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. In addition,
widespread changes in Internet, networking or telecommunications technologies
or other technological alterations could require substantial expenditures to
modify our products, services or infrastructure. Failure to adapt to new
technology in any of these areas could have a material adverse effect on our
business, results of operations and financial condition. 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 the
Internet, digital imaging or other required technologies;  
    
    unexpected changes in regulatory requirements, especially regarding the Internet;  
    
    slower payment and collection of accounts receivable than in our domestic market; and  
    
    political and economic instability. We cannot assure you that we will be able to successfully market our products
in foreign markets. We are susceptible to breaches of on-line commerce security A party able to circumvent our security measures could misappropriate
proprietary database information or cause interruptions in operations. As a
result, we may need to expend significant capital and other resources to
protect against security breaches or to alleviate problems caused by security
breaches. This additional expense could harm our business, financial condition
and results of operation. 32




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Concentrated control over our voting stock could adversely affect stockholders The holders of our Series B preferred stock beneficially owned over 60% of our
outstanding voting stock. As a result, these stockholders are able to exercise
control over certain matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. Such
control could discourage others from initiating potential merger, takeover or
other change of control transactions. As a result, the market price of our
common stock could be adversely affected. 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. Because many of our product and service offerings are intended to enhance
Internet commercial transactions, the success of our business will be dependent
upon continued growth of Internet commerce Many of our products and services are intended to enhance and facilitate
commercial transactions over the Internet. Our future revenues are
substantially dependent upon the widespread acceptance and use of the Internet
and other on-line services as a medium for commerce by consumers and sellers.
If continued acceptance and growth of Internet use does not occur, it could
have a material adverse effect on our business. The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and in the amount of traffic.
Continued development and maintenance of the Internets infrastructure to
handle this increased traffic must continue. In addition, timely development
of complimentary products, such as high-speed modems, providing reliable
Internet access and services will also be required. The Internet has experienced a variety of outages and other delays as a result
of computer viruses and other damages to portions of its infrastructure.
Outages and delays and infections by computer viruses are likely to continue
and affect the level of Internet usage generally. Such outages and delays will
affect processing of transactions on Rimfire integrated Websites. We will
experience a reduction in revenues and increased expenses as a result of such
outages and delays. We will be required to continually make capital
investments to enhance our infrastructure and protect our services from
computer viruses and other outages and delays on the Internet. The cost of such
improvements could have a material adverse effect on our business. 33




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Our market is highly competitive, and our business may suffer if we are unable
to compete successfully The market for our immersive products and our Rimfire products and services are
new and rapidly evolving. Competition for Rimfire primarily comes in the form
of a buy vs. build analysis. The market for immersive products and services is
intensely competitive. We compete with other providers of immersive imaging
technology, such as BeHere Corporation, Remote Reality and EasyPano. Each of
these companies develops and markets 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 the delay or cancellation of customer orders, 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 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 Rule13a-14(c)) as of the end of the period covered by this annual
report. Based on that evaluation, the chief executive officer and chief
financial officer have concluded that the Companys disclosure controls and
procedures are effective to ensure that material information relating to the
Company and the Companys consolidated subsidiaries is made known to such
officers by others within these entities, particularly during the period this
annual report was prepared, in order to allow timely decisions regarding
required disclosure. (b) Changes in Internal Controls. There have not been any changes in the
Companys internal control over financial reporting during the Companys fourth
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting. 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 May 4, 2004, to be filed with the SEC pursuant to Regulations 14A under
the Securities Exchange Act of 1934, as amended. 34




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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 May 4, 2004, 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 May 4, 2004, 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 May 4, 2004, to be filed with the SEC pursuant to Regulation 14A under
the Securities Exchange Act of 1934, as amended. PART IV 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 May 4, 2004, to be filed with the SEC pursuant to Regulation 14A under
the Securities Exchange Act of 1934, as amended. 35




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##### Table of Contents



Item 15.Exhibits, Financial Statement Schedules and Reports on form 8-K. (a) (1) The following documents are filed as part of this Annual Report on Form 10-K: PageReport of Independent Auditors
    
    
    F-1IPIX Corporation Consolidated Financial StatementsConsolidated Balance Sheets at December 31, 2002 and 2003
    
    
    F-2Consolidated Statements of Operations for the years ended December 31, 2001, 2002
and 2003
    
    
    F-3Consolidated Statements of Changes in Stockholders Equity
for the years ended December 31, 2001, 2002 and 2003
    
    
    F-4Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2002 and 2003
    
    
    F-6Notes to Consolidated Financial Statements
    
    
    F-7
 (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. Report Of Independent Auditors On
Financial Statement Schedule To the Board of Directors and Stockholders of
IPIX Corporation: Our audits of the consolidated financial statements referred to in our report
dated March 24, 2004 appearing in this Annual Report on Form 10-K also included
an audit of the accompanying financial statement schedule. 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/ PricewaterhouseCoopers LLP San Jose, California
March 24, 2004 36




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VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FISCAL YEARS 2001, 2002 AND 2003 ADDITIONSBALANCE BEGINNING
    
    (DEDUCTIONS)
    
    WRITE-OFFS AND
    
    BALANCE AT END OFDESCRIPTION
    
    OF PERIOD
    
    CHARGED TO EXPENSE
    
    DEDUCTIONS
    
    PERIOD2001Allowance for doubtful
accounts
    
    $
    4,617
    
    
    $
    4,421
    
    
    $
    (6,867
    )
    
    $
    2,171Valuation allowance
on deferred tax assets
    
    
    (95,851
    )
    
    
    
    
    
    
    82,180
    
    
    
    (13,671
    )Provision for
excess and obsolete
inventory
    
    
    203
    
    
    
    276
    
    
    
    14
    
    
    
    4932002Allowance for doubtful
accounts
    
    $
    2,171
    
    
    $
    (279
    )
    
    $
    (1,684
    )
    
    $
    208Valuation allowance
on deferred tax assets
    
    
    (13,671
    )
    
    
    
    
    
    
    (7,051
    )
    
    
    (20,722
    )Provision for excess and
obsolete inventory
    
    
    493
    
    
    
    
    
    
    
    (333
    )
    
    
    1602003Allowance 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
    )
    
    
    
    
    
    
    148
 (b) Reports on Form 8-K. A Form 8-K was filed on November 6, 2003, under Item 12, furnishing the
Companys press release for the Companys third quarter 2003 financial
results. (c) Exhibits. The following exhibits are filed herewith or incorporated by reference: ExhibitNumber
    
    Description3.1
    
    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).
 37




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##### Table of Contents



4.2
    
    Rights Agreement dated October 31, 2000 between IPIX Corporation and
EquiServe (incorporated herein by reference to Form 8-A as filed with
the 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).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))
 38




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##### Table of Contents



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
    
    Acquisition Agreement dated January 12, 2001 between IPIX Corporation
and Homestore Virtual Tours, Inc. (incorporated herein by reference to
Form 8-K as filed with the Commission on January 29, 2001).10.15**
    
    License Agreement dated January 12, 2001 between IPIX Corporation and
Homestore Virtual Tours, Inc. (incorporated herein by reference to Form
10-K as filed with the Commission on April 2, 2001).10.16**
    
    Visual Content Service Agreement, as amended, between IPIX Corporation
and eBay Inc. (incorporated herein by reference to Form 10-Q filed with
the Commission on October 31, 2001) as amended by Amendment #3 dated
June 27, 2003 (incorporated herein by reference to Form 8-K filed with
the Commission on June 30, 2003).10.17
    
    Purchase Agreement between IPIX Corporation and eBay Inc. dated
September 26, 2001 (incorporated herein by reference to Form 10-Q filed
with the Commission on October 31, 2001).10.18
    
    Master Lease Agreement between IPIX Corporation and eBay Inc. dated
September 26, 2001 (incorporated herein by reference to Form 10-Q filed
with the Commission on October 31, 2001).10.19
    
    Purchase Agreement between IPIX Corporation and eBay Inc. dated
December 1, 2001(incorporated herein by reference to Form 10-K filed
with the Commission on March 29, 2002).10.20
    
    Purchase Agreement No. 3 between the Company and eBay Inc. dated May
31, 2002 (incorporated herein by reference to Form 10-Q filed with the
Commission on August 13, 2002).14.1#
    
    Code of Ethics for Chief Executive Officer and Senior Financial Officers14.2#
    
    Code of Business Conduct and Ethics21.1
    
    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 LLP24.1
    
    Power of Attorney (included on page 28)31.1#
    
    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
 39




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##### Table of Contents



*
    
    Executive Compensation Plan or Agreement**
    
    Portions of the exhibit have been omitted pursuant to a request for confidential treatment.#
    
    Filed Herewith 40




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##### Table of Contents



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 CORPORATIONBy:
    /s/ Donald W. StricklandDonald W. StricklandDate: March 29, 2004
    
    President and Chief Executive Officer 41




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POWER OF ATTORNEY Each person whose signature appears below hereby appoints Donald W.
Strickland, Paul A. Farmer 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/ Donald W. Strickland
Donald W. Strickland
    
    President, Chief Executive
Officer and Director
    
    March 29, 2004/s/ Paul A. Farmer
Paul A. Farmer
    
    Chief Financial Officer (Chief
Accounting Officer)
    
    March 29, 2004/s/ David M. Wilds
David M. Wilds
    
    Chairman of the Board of Directors
    
    March 29, 2004/s/ Michael D. Easterly
Michael D. Easterly
    
    Director
    
    March 29, 2004/s/ Laban P. Jackson, Jr.
Laban P. Jackson, Jr.
    
    Director
    
    March 29, 2004/s/ Andrew P. Seamons
Andrew P. Seamons
    
    Director
    
    March 29, 2004
 42




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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of
IPIX Corporation: In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of changes in
stockholders equity and of cash flows present fairly, in all material
respects, the financial position of IPIX Corporation and its
subsidiaries (the Company) at December 31, 2002 and 2003 and the
results of their operations and their cash flows for each of the three
years in the period 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 audits. We conducted our audits
of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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 audits provide a reasonable basis for our opinion. As discussed in Note 5 to the consolidated financial statements,
effective January 1, 2002, the Company changed its method of accounting
for goodwill in accordance with Statement of Financial Accounting
Standards No. 142, Goodwill and other Intangible Assets. The accompanying 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 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 F-1




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IPIX CORPORATION






|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |              |        |  |       | 
|------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | -------- | ----------------- | ------ | --------------------------- | -------- | ------------ | ------ |  | ----- | 
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        | December 31,                |          | December 31,
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        | 2002                        |          | 2003        
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        | (In thousands, except share
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        | and per share data)        
|ASSETS                                                                                     |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|CURRENT ASSETS:                                                                            |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|Cash and cash equivalents                                                                  |                                                                                                                                                                                  | $                                          | 3,020    |                   |        | $                           | 10,241   |             
|Restricted cash and short term investments                                                 |                                                                                                                                                                                  |                                            | 2,972    |                   |        |                             | 1,100    |             
|Short term investments                                                                     |                                                                                                                                                                                  |                                            |         |                   |        |                             | 331      |             
|Accounts receivable, net of allowance for doubtful accounts of
$208 in 2002 and $0 in 2003 |                                                                                                                                                                                  |                                            | 3,535    |                   |        |                             | 261      |             
|Inventory, net of reserve for obsolescence of $160 in 2002 and $148 in 2003                |                                                                                                                                                                                  |                                            | 181      |                   |        |                             | 398      |             
|Prepaid expenses and other current assets                                                  |                                                                                                                                                                                  |                                            | 984      |                   |        |                             | 1,523    |             
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  | Total current assets                       |          |                   | 10,692 |                             |          |              | 13,854 | 
|Computer hardware, software and other, net                                                 |                                                                                                                                                                                  |                                            | 4,631    |                   |        |                             | 1,578    |             
|Restricted cash and other long term assets                                                 |                                                                                                                                                                                  |                                            | 70       |                   |        |                             | 852      |             
|Goodwill                                                                                   |                                                                                                                                                                                  |                                            | 3,042    |                   |        |                             |         |             
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  | Total assets                               |          | $                 | 18,435 |                             |          | $            | 16,284 | 
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                       |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|CURRENT LIABILITIES:                                                                       |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|Accounts payable                                                                           |                                                                                                                                                                                  | $                                          | 360      |                   |        | $                           | 612      |             
|Accrued liabilities                                                                        |                                                                                                                                                                                  |                                            | 5,426    |                   |        |                             | 3,342    |             
|Deferred revenue                                                                           |                                                                                                                                                                                  |                                            | 85       |                   |        |                             | 76       |             
|Current portion of obligations under capital leases                                        |                                                                                                                                                                                  |                                            | 2,403    |                   |        |                             | 608      |             
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  | Total current liabilities                  |          |                   | 8,274  |                             |          |              | 4,638  | 
|Obligations under capital leases, net of current portion                                   |                                                                                                                                                                                  |                                            | 1,459    |                   |        |                             |         |             
|Other long term liabilities                                                                |                                                                                                                                                                                  |                                            | 310      |                   |        |                             | 181      |             
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  |                                            |          | Total liabilities |        |                             | 10,043   |              |        |  | 4,819 | 
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|Commitments and Contingencies (Note 12)                                                    |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                          
|STOCKHOLDERS EQUITY:                                                                      |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|Preferred stock, $0.001 par value:                                                         |                                                                                                                                                                                  |                                            | 1        |                   |        |                             | 1        |             
|                                                                                           | Authorized:
5,001,100 shares in 2002 and 2003
Issued and outstanding: 1,115,080 in 2002 and 1,003,830 in 2003
(Aggregate liquidation value: $24,560 in 2002 and $23,716 in 2003) |                                            |          |                   |        |                             |          |              |       
|Common stock, $0.001 par value:                                                            |                                                                                                                                                                                  |                                            | 7        |                   |        |                             | 9        |             
|                                                                                           | Authorized:
50,000,000 in 2002 and 2003
Issued and outstanding: 6,795,007 in 2002 and 8,678,729 in 2003                                                                          |                                            |          |                   |        |                             |          |              |       
|Class B common stock, $0.0001 par value:                                                   |                                                                                                                                                                                  |                                            |         |                   |        |                             |         |             
|                                                                                           | Authorized:
7,421,536 shares in 2002 and 2003
Issued and outstanding: 17,948 shares in 2002 and 14,000 shares in
2003                                                           
|Additional paid-in capital                                                                 |                                                                                                                                                                                  |                                            | 513,995  |                   |        |                             | 515,186  |             
|Accumulated other comprehensive loss                                                       |                                                                                                                                                                                  |                                            | (494     | )                 |        |                             |         |             
|Accumulated deficit                                                                        |                                                                                                                                                                                  |                                            | (505,117 | )                 |        |                             | (503,731 | )           
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  | Total stockholders equity                 |          |                   | 8,392  |                             |          |              | 11,465 | 
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             
|                                                                                           |                                                                                                                                                                                  | Total liabilities and stockholders equity |          | $                 | 18,435 |                             |          | $            | 16,284 | 
|                                                                                           |                                                                                                                                                                                  |                                            |          |                   |        |                             |          |             

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

F-2



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##### Table of Contents



IPIX CORPORATION 
  FOR YEARS ENDED DECEMBER 31,2001
    
    2002
    
    2003(In thousands, except per share data)REVENUES:Products
    
    $
    14,758
    
    
    $
    6,512
    
    
    $
    10,503Services
    
    
    14,148
    
    
    
    15,901
    
    
    
    18,336Total revenue
    
    
    28,906
    
    
    
    22,413
    
    
    
    28,839COST OF REVENUES:Products
    
    
    7,270
    
    
    
    2,145
    
    
    
    1,582Services
    
    
    4,991
    
    
    
    6,583
    
    
    
    6,538Total cost of revenue
    
    
    12,261
    
    
    
    8,728
    
    
    
    8,120Gross profit
    
    
    16,645
    
    
    
    13,685
    
    
    
    20,719OPERATING EXPENSES:Sales and marketing
    
    
    21,252
    
    
    
    7,607
    
    
    
    7,605Research and development
    
    
    7,671
    
    
    
    4,862
    
    
    
    4,553General and administrative
    
    
    15,816
    
    
    
    2,933
    
    
    
    3,452Amortization of intangibles
    
    
    2,433
    
    
    
    
    
    
    
    Impairment of intangibles
    
    
    
    
    
    
    
    
    
    
    3,042Loss on disposal of assets
    
    
    1,655
    
    
    
    
    
    
    
    Restructuring and impairment
    
    
    11,655
    
    
    
    687
    
    
    
    89Total operating expenses
    
    
    60,482
    
    
    
    16,089
    
    
    
    18,741Income (loss) from operations
    
    
    (43,837
    )
    
    
    (2,404
    )
    
    
    1,978OTHER INCOME (EXPENSE):Interest expense
    
    
    (10,667
    )
    
    
    (183
    )
    
    
    (158
    )Interest income
    
    
    305
    
    
    
    456
    
    
    
    65Patent infringement award
    
    
    
    
    
    
    1,000
    
    
    
    Loss on foreign currency
    
    
    
    
    
    
    
    
    
    
    (491
    )Other expense
    
    
    (380
    )
    
    
    (12
    )
    
    
    (8
    )Net income (loss) before extraordinary item
    
    
    (54,579
    )
    
    
    (1,143
    )
    
    
    1,386Extraordinary item
    
    
    901
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (53,678
    )
    
    
    (1,143
    )
    
    
    1,386Preferred stock dividends
    
    
    
    
    
    
    (1,784
    )
    
    
    (1,778
    )Net loss available to common stockholders
    
    $
    (53,678
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Net loss per common share:Basic
    
    $
    (8.22
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Diluted
    
    $
    (8.22
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Weighted
average common shares  Basic and diluted
    
    
    6,534
    
    
    
    6,794
    
    
    
    7,365
 The accompanying notes are an integral part of these consolidated financial statements. F-3




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##### Table of Contents



IPIX CORPORATION 
  
 Class B Common Stock
    
    Series B Preferred Stock
    
    Common StockNumber
    
    Amount
    
    Number
    
    Amount
    
    Number
    
    AmountBalance, December 31, 2000
    
    
    404,173
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    5,946,402
    
    
    $
    6Stock issued on exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,977
    
    
    
    Stock issued from employee stock purchase plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,581
    
    
    
    Stock issued from option exchange program
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    137,684
    
    
    
    Notes receivable from stockholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Sale of convertible debt and preferred stock
    
    
    
    
    
    
    
    
    
    
    1,115,080
    
    
    
    1
    
    
    
    
    
    
    
    Amortization of unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dividend to stockholder
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    190,000
    
    
    
    Conversion of Class B common stock
    
    
    (386,225
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    386,225
    
    
    
    1Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balances, December 31, 2001
    
    
    17,948
    
    
    $
    
    
    
    
    1,115,080
    
    
    $
    1
    
    
    
    6,729,869
    
    
    $
    7
 Notes
    
    
    
    
    
    AccumulatedAdditional
    
    Receivable
    
    Unearned Stock-
    
    otherPaid-in
    
    from
    
    Based
    
    Comprehensive
    
    AccumulatedCapital
    
    Stockholder
    
    Compensation
    
    Income (Loss)
    
    Deficit
    
    TotalBalance, December 31, 2000
    
    $
    484,151
    
    
    $
    (2,349
    )
    
    $
    (3,361
    )
    
    $
    62
    
    
    $
    (450,296
    )
    
    $
    28,213Stock issued on exercise of stock options
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28Stock issued from employee stock purchase plan
    
    
    86
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    86Stock issued from option exchange program
    
    
    969
    
    
    
    
    
    
    
    (970
    )
    
    
    
    
    
    
    
    
    
    
    Notes receivable from stockholders
    
    
    
    
    
    
    2,170
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,170Unearned stock-based compensation
    
    
    310
    
    
    
    
    
    
    
    (310
    )
    
    
    
    
    
    
    
    
    
    
    Sale of convertible debt and preferred stock
    
    
    30,962
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,962Amortization of unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    4,499
    
    
    
    
    
    
    
    
    
    
    
    4,499Dividend to stockholder
    
    
    (2,979
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,979
    )Conversion of Class B common stock
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (53,678
    )
    
    
    (53,678
    )Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (531
    )
    
    
    
    
    
    
    (531
    )Balances, December 31, 2001
    
    $
    513,526
    
    
    $
    (179
    )
    
    $
    (142
    )
    
    $
    (469
    )
    
    $
    (503,974
    )
    
    $
    8,770
 Class B Common Stock
    
    Series B Preferred Stock
    
    Common StockNumber
    
    Amount
    
    Number
    
    Amount
    
    Number
    
    AmountBalance, December 31, 2001
    
    
    17,948
    
    
    $
    
    
    
    
    1,115,080
    
    
    $
    1
    
    
    
    6,729,869
    
    
    $
    7Stock issued on exercise of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,500
    
    
    
    Stock issued from employee stock purchase plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,638
    
    
    
    Notes receivable from stockholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Reversal of accrued stock issuance costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balances, December 31, 2002
    
    
    17,948
    
    
    $
    
    
    
    
    1,115,080
    
    
    $
    1
    
    
    
    6,795,007
    
    
    $
    7
 Notes
    
    
    
    
    
    AccumulatedAdditional
    
    Receivable
    
    Unearned Stock-
    
    otherPaid-in
    
    from
    
    Based
    
    Comprehensive
    
    AccumulatedCapital
    
    Stockholder
    
    Compensation
    
    Income (Loss)
    
    Deficit
    
    TotalBalance, December 31, 2001
    
    $
    513,526
    
    
    $
    (179
    )
    
    $
    (142
    )
    
    $
    (469
    )
    
    $
    (503,974
    )
    
    $
    8,770Stock issued on exercise of stock options
    
    
    84
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84Stock issued from employee stock purchase plan
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47Notes receivable from stockholders
    
    
    
    
    
    
    179
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Unearned stock-based compensation
    
    
    29
    
    
    
    
    
    
    
    (29
    )
    
    
    
    
    
    
    
    
    
    
    Reversal of accrued stock issuance costs
    
    
    309
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    309Amortization of unearned stock-based compensation
    
    
    
    
    
    
    
    
    
    
    171
    
    
    
    
    
    
    
    
    
    
    
    171Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,143
    )
    
    
    (1,143
    )Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (25
    )
    
    
    
    
    
    
    (25
    )Balances, December 31, 2002
    
    $
    513,995
    
    
    $
    
    
    
    $
    
    
    
    $
    (494
    )
    
    $
    (505,117
    )
    
    $
    8,392
 F-4




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##### Table of Contents



Class B Common Stock
    
    Series B Preferred Stock
    
    Common StockNumber
    
    Amount
    
    Number
    
    Amount
    
    Number
    
    AmountBalance, 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


Additional
    
    Accumulated otherPaid-in
    
    Comprehensive
    
    AccumulatedCapital
    
    Income (Loss)
    
    Deficit
    
    TotalBalance, 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


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

F-5



---



##### Table of Contents



IPIX CORPORATION 
  For Years Ended December 31,2001
    
    2002
    
    2003(In thousands)Cash flows from operating activities:Net income (loss)
    
    $
    (53,678
    )
    
    $
    (1,143
    )
    
    $
    1,386Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:Depreciation
    
    
    3,477
    
    
    
    3,400
    
    
    
    3,164Impairment and amortization of intangibles
    
    
    2,434
    
    
    
    
    
    
    
    3,042Provision for doubtful accounts receivable
    
    
    4,421
    
    
    
    (279
    )
    
    
    8Provision for inventory obsolescence
    
    
    276
    
    
    
    
    
    
    
    (12
    )Loss on foreign exchange
    
    
    
    
    
    
    
    
    
    
    491Interest charge for amortization of discount on convertible debt
    
    
    10,000
    
    
    
    
    
    
    
    Non-cash compensation expense
    
    
    4,449
    
    
    
    171
    
    
    
    Forgiveness of debt
    
    
    2,193
    
    
    
    
    
    
    
    Impairment loss
    
    
    1,122
    
    
    
    
    
    
    
    Loss (gain) on disposal of assets
    
    
    1,655
    
    
    
    
    
    
    
    (177
    )Extraordinary gain
    
    
    (901
    )
    
    
    
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    1,546
    
    
    
    (2,335
    )
    
    
    3,266Inventory
    
    
    566
    
    
    
    38
    
    
    
    (205
    )Prepaid expenses and other assets
    
    
    904
    
    
    
    (103
    )
    
    
    (632
    )Other long term assets
    
    
    1,199
    
    
    
    (70
    )
    
    
    (782
    )Accounts payable
    
    
    (2,697
    )
    
    
    (1,140
    )
    
    
    252Accrued expenses
    
    
    (3,825
    )
    
    
    (1,723
    )
    
    
    (837
    )Deferred revenue
    
    
    158
    
    
    
    (1,507
    )
    
    
    (9
    )Net cash provided by (used in) operating activities
    
    
    (26,651
    )
    
    
    (4,691
    )
    
    
    8,955Cash flow from investing activities:Purchases of computer hardware, software and other
    
    
    (1,440
    )
    
    
    (3,508
    )
    
    
    (909
    )Purchase of short term investments
    
    
    
    
    
    
    (1,400
    )
    
    
    (1,431
    )Proceeds from sale of assets
    
    
    8,666
    
    
    
    
    
    
    
    Maturities of short term investments
    
    
    6,000
    
    
    
    
    
    
    
    1,400Net cash provided by (used in) investing activities
    
    
    13,226
    
    
    
    (4,908
    )
    
    
    (940
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    114
    
    
    
    131
    
    
    
    1,557Net proceeds from issuance of convertible debt and exercise of warrants for preferred stock
    
    
    20,666
    
    
    
    
    
    
    
    Dividend attributable to Series B preferred stock conversion
    
    
    
    
    
    
    
    
    
    
    (364
    )Proceeds from sale/leaseback
    
    
    2,840
    
    
    
    3,870
    
    
    
    Repayments of capital lease obligations and notes payable
    
    
    (2,762
    )
    
    
    (2,460
    )
    
    
    (1,990
    )Distribution to stockholders
    
    
    (839
    )
    
    
    
    
    
    
    Net cash provided by (used in) financing activities
    
    
    20,019
    
    
    
    1,541
    
    
    
    (797
    )Effect of exchange rate changes on cash
    
    
    (813
    )
    
    
    (25
    )
    
    
    3Net increase (decrease) in cash and cash equivalents
    
    
    5,781
    
    
    
    (8,083
    )
    
    
    7,221Cash and cash equivalents, beginning of period
    
    
    5,322
    
    
    
    11,103
    
    
    
    3,020Cash and cash equivalents, end of period
    
    $
    11,103
    
    
    $
    3,020
    
    
    $
    10,241
 SUPPLEMENTAL DATA For the years ended December 31,2001
    
    2002
    
    2003Unearned stock-based compensation related to stock options and warrants
    
    $
    1,280
    
    
    $
    29
    
    
    $
    Interest paid
    
    
    667
    
    
    
    183
    
    
    
    158Conversion of accrued interest into Series B preferred stock
    
    
    227
    
    
    
    
    
    
    
    
 The accompanying notes are an integral part of these consolidated financial statements. F-6




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IPIX CORPORATION 
   1. NATURE OF OPERATIONS IPIX Corporation (IPIX or Company), formally 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-degree by 360-degree
immersive images and video. In 2003, the Companys business units moved from
being technology focused (Immersive Video Solutions, Transaction Services and
Immersive Still Solutions) to being market focused in order to better serve the
needs of its customers. The Company is now organized into three business units:
IPIX Security, IPIX Ad Technologies and IPIX InfoMedia, respectively. IPIX
Security provides security and surveillance products and services for
commercial and governmental customers. IPIX Ad Technologies focuses on the
sale of complete solutions to customers who rely on visual data to create
effective directional advertising such as publishers of newspaper classifieds,
yellow page directories, on-line auctions, real estate and autos classifieds.
IPIX InfoMedia focuses on the sale of immersive still technology licenses for
the on-line real estate, travel and hospitality and visual documentation
markets. IPIXs extensive intellectual property covers patents for immersive 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 has ceased operations in its Canadian and
United Kingdom subsidiaries and the Company is in the process of liquidating
such subsidiaries; accordingly, the balance in the accumulated other
comprehensive loss account has been 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, 2002 and 2003, the Company had a certificate of deposit of
$1,400 and $1,431, respectively, with a remaining maturity of six months and an
interest rate of 2.25% and 0.95%, respectively. The certificates of deposit
are classified as short-term investments. At December 31, 2002 and 2003,
$1,400 and $1,100, respectively, of those investments have been provided as
collateral for a letter of credit related to certain capital lease obligations
and, accordingly, classified as restricted. At December 31, 2003, the Company had $630 of its cash deposits restricted as
collateral on a letter of credit for certain co-location facility leases
expiring in 2005 and, accordingly, classified as long-term restricted cash.
The remaining balance of restricted cash at December 31, 2002 relates primarily
to certain customer deposits. Interest income includes interest, amortization of purchase premiums and
discounts and realized gains and losses on sales of securities. A realized loss
of $282 was recognized in 2001 primarily because of the write down of various
investments. 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. The following table summarizes the revenue from customers in excess of 10% of
total revenues: Years ended December 31,2001
    
    2002
    
    2003(unaudited)Homestore
    
    
    23
    %
    
    
    16
    %
    
    
    3
    %eBay
    
    
    21
    %
    
    
    60
    %
    
    
    87
    %
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At December 31, 2003, Homestore and eBay represented 22% and 0% of accounts
receivable, respectively. All amounts due from Homestore as of December 31,
2003, were collected in full during February 2004. At December 31, 2002,
Homestore and eBay represented 0% and 83% of accounts receivable, respectively.
Net income for the year ended December 31, 2003 includes 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. INVENTORY. Inventory, which consists primarily of digital cameras and related
hardware, is stated at the lower of cost or market, with costs determined using
standard costs (which approximate actual first-in, first-out costs). The
Company records a provision for obsolete inventory whenever impairment has been
identified. PREPAID EXPENSES. Prepaid expenses consist primarily of pre-payments of a
co-location facility, insurance, maintenance and rent, which will be reflected
as an expense during the periods benefited. At December 31, 2003, $785
remained from the pre-payment to the co-location facility. COMPUTER HARDWARE, SOFTWARE AND OTHER. Computer hardware and software are
recorded at cost and are depreciated primarily using the straight-line method
over estimated useful lives, which range from two to three years. Furniture and
fixtures are depreciated over the estimated useful life, which range from two
to five years. Leasehold improvements are amortized 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. 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. 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 and is in the
process of liquidating 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. 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. The Company recognizes revenue in accordance with SOP
97-2, Software Revenue Recognition and SEC Staff Accounting Bulletin No. 104,
Revenue Recognition in Financial Statements. The Company derives its revenue
from product revenue and services it provides to its customers. Product
revenue includes InfoMedia hardware and licenses, IPIX Security hardware and
licenses, as well as Ad Technology license revenue. Service revenues are
primarily from transactions where a seller uses IPIX image management products
to enhance their on-line offering. Product revenue is recognized upon shipment or delivery 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. Transaction hosting revenues are recognized ratably as transactions are
performed provided there was persuasive evidence of an arrangement, the fee was
fixed or determinable and collection of the resulting receivable was reasonably
assured. Revenues generated from professional services are recognized as the
related services are performed. When such professional services are combined
with on-going transaction services or are deemed to be essential to the
functionality of the delivered software product, revenue from the entire
arrangement is recognized while the transaction services are performed, on a
percentage of completion method or not until the contract is completed in
accordance with SOP 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts, and ARB No. 45, Long-Term
Construction-Type Contracts. Reimbursements received for out-of-pocket
expenses incurred are characterized as revenue in the statement of operations. F-8




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Where multiple elements exist in an arrangement, the arrangement fee is
allocated to the different elements based upon verifiable objective evidence of
the fair value of the elements, as governed under EITF 00-21, which is codified
in SEC Staff Accounting Bulletin No. 104 SAB 104. Multiple element
arrangements primarily involve an arrangement with professional services and
transaction hosting. Revenue is recognized as each element is earned, namely
upon completion of the services, provided that the fair value of the
undelivered element(s) has been determined, the delivered element has
stand-alone value, there is no right of return on delivered element(s), and the
Company is in control of delivery of the undelivered element(s). Royalties derived from desktop imaging products were recognized as revenues
upon receipt of the royalty sell-through reports from customers, which are
generally in the quarter following the quarter in which the sale by the
customer took place. Payments received in advance are initially recorded as deferred revenue and
recognized ratably as obligations are fulfilled. FAIR VALUE OF FINANCIAL INSTRUMENTS. Carrying amounts of the Companys
financial instruments including short-term investments, accounts receivable,
accounts payable, accrued liabilities 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. RESEARCH AND DEVELOPMENT COSTS. Research and development expenditures are
expensed as incurred. ADVERTISING EXPENSES. All advertising expenditures are expensed as incurred.
Advertising expenses for 2001, 2002 and 2003, were $4,130, $2,017 and $1,526,
respectively. STOCK-BASED COMPENSATION. The Company has adopted the disclosure provisions of
Financial Accounting Standards Board 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 income (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 31,2001
    
    2002
    
    2003(In thousands, except per share)Net loss available to common stockholders before extraordinary gain
    
    $
    (54,579
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Extraordinary gain
    
    
    901
    
    
    
    
    
    
    
    Net loss available to common stockholders
    
    
    (53,678
    )
    
    
    (2,927
    )
    
    
    (392
    )Add employee stock compensation expense included in reported net loss
    
    
    3,213
    
    
    
    171
    
    
    
    Less total stock-based employee compensation expense determined under
fair value based methods for all awards
    
    
    (11,503
    )
    
    
    (5,742
    )
    
    
    (1,472
    )Adjusted net loss available to common stockholders
    
    $
    (61,968
    )
    
    $
    (8,498
    )
    
    $
    (1,864
    )Basic net loss per common share:Net loss available to common stockholders before extraordinary gain
    
    $
    (8.36
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Extraordinary gain
    
    
    0.14
    
    
    
    
    
    
    
    Net loss available to common stockholders
before pro-forma charges
    
    
    (8.22
    )
    
    
    (0.43
    )
    
    
    (0.05
    )Net effect of pro-forma charges
    
    
    (1.27
    )
    
    
    (0.82
    )
    
    
    (0.20
    )Adjusted basic net loss per common share
available to common stockholders
    
    $
    (9.49
    )
    
    $
    (1.25
    )
    
    $
    (0.25
    )
 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 2001, 2002 and 2003; risk free interest rate of 4.7% to 5.4% in 2001,
4.0% to 4.5% in 2002 and 3.5% to 4.0% in 2003; expected dividends of zero in
2001, 2002 and 2003; and volatility of 271% in 2001, 92% in 2002 and 114% in
2003. F-9




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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 generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. 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, restructuring changes, sales taxes and
the carrying value of goodwill. SEGMENT REPORTING. The Company uses a management approach, which designates
the internal organization that is used by management for making operating
decisions and assessing performance as the source of the Companys reportable
segments. Segment reporting includes disclosures about products and services,
geographic areas and major customers for years ending December 31, 2001, 2002
and 2003. In addition, for fiscal years 2001, 2002 and 2003, segment reporting
includes the Companys primary business units: Ad Technologies, 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 and convertible debenture. The following table sets forth potential common shares that are not included in
the diluted net loss per share calculation above because to do so would be
antidilutive for the periods indicated: FOR YEARS ENDED DECEMBER 31,2001
    
    2002
    
    2003WEIGHTED AVERAGE EFFECT OF POTENTIAL COMMON SHARES:Series B preferred stock
    
    
    2,700,387
    
    
    
    10,267,096
    
    
    
    10,924,287Employee stock options
    
    
    539,983
    
    
    
    195,866
    
    
    
    960,851Warrants to purchase Series B preferred stock
    
    
    2,051,902
    
    
    
    
    
    
    
    218,446Convertible debentures
    
    
    1,702,756
    
    
    
    
    
    
    
    6,995,028
    
    
    
    10,462,962
    
    
    
    12,103,584
 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 is $12.15 and the
average strike price of employee stock options is $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. In 2002, the Companys common stock had an average share price of $1.77. The
average strike price of the warrants to purchase common stock is $3.04 and the
average strike price of employee stock options is $9.86. Not included in the
table above are (i) 1,935,852 shares issuable upon exercise of options and (ii)
2,438,824 shares issuable upon exercise of warrants, all of which have a strike
price above the average share price during 2002. 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 available-for-sale securities
and 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 31,2001
    
    2002
    
    2003Net income (loss)
    
    $
    (53,678
    )
    
    $
    (1,143
    )
    
    $
    1,386Foreign currency translation adjustment
    
    
    (813
    )
    
    
    (25
    )
    
    
    (3
    )Fair market value adjustment of investments
    
    
    282
    
    
    
    
    
    
    
    Comprehensive income (loss)
    
    $
    (54,209
    )
    
    $
    (1,168
    )
    
    $
    1,383
 F-10




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RECENT ACCOUNTING PRONOUNCEMENTS In November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables (EITF 00-21). EITF 00-21 provides
guidance on how to account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use assets. The
provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The Company adopted this standard in the
quarter ended September 30, 2003 and the adoption did not have a material
effect on the Companys financial statements. In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities (VIE), an Interpretation of ARB No. 51 (FIN 46) and in
December 2003, issued a revised interpretation (FIN 46-R). FIN No. 46, as
revised, requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The provisions of
FIN 46-R are effective immediately for all arrangements entered into after
January 31, 2003. For arrangements entered into prior to February 1, 2003, the
Company is required to adopt the provisions of FIN 46-R in the first quarter of
2004. The adoption of FIN 46-R is not expected to have a significant effect on
the Companys financial position or results of operations. In May 2003, the FASB issued FAS No. 150, Accounting For Certain Financial
Instruments with Characteristics of both Liabilities and Equity (FAS 150).
FAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances). FAS 150 is to be
implemented by reporting the cumulative effect of a change in an accounting
principle for the financial instrument created before November 2003 and still
existing at the beginning of the interim period of adoption. Restatement is
not permitted. The Company does not believe that the adoption of this
statement will have a material impact on its financial position, results of
operations or cash flows. On December 17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No.
104 (SAB 104), Revenue Recognition, which superceded SAB 101, Revenue
Recognition in Financial Statements. SAB 104s primary purpose is to rescind
account guidance contained in SAB 101 related to multiple element revenue
arrangements, superceded as a result of the issuance of EITF 00-21, Accounting
for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104
rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked
Questions and Answers(the FAQ) issued with SAB 101 that had been codified in
SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been
incorporated into SAB 104. While the wording of SAB 104 has changed to reflect
the issuance of EITF 00-21, the revenue recognition principles of SAB 101
remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104
did not materially affect the Companys revenue recognition policies, or its
results of operations, financial position or cash flows. RECLASSIFICATIONS Certain amounts reported in the previous period have been reclassified to
conform to the current period presentation. The reclassifications did not
affect the previously reported total revenue, operating loss, net loss, total
current assets, total assets or stockholders equity. 3. GOING CONCERN CONSIDERATIONS The accompanying financial statements have been presented in accordance with
generally accepted accounting principles, which assume the continuity of the
Company as a going concern. During the year ended December 31, 2003 and in the
prior fiscal years, the Company has experienced, and continues to experience,
certain issues related to cash flow and profitability. Additionally, the
Companys relationship with its largest customer changed in 2003 as noted
below. These factors raise substantial doubt about the Companys ability to
continue as a going concern. The Company believes that it can generate
sufficient cash flow to fund its operations through the launch and sale of new
products in early 2004 in two of the Companys three business units. In
addition, 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. Management will focus on operating costs
in relation to revenue generated. During 2003, the Company changed its relationship with its largest customer,
eBay, which represented 87% of revenue for the year ended December 31, 2003.
eBay licensed technology from the Company that had previously been used by the
Company to provide eBay with recurring services. After November 2003, the
Company no longer provides any services to eBay. As a result, the Company has
a limited operating history as it will operate in 2004 and upon which an
evaluation of its business and prospects in 2004 may be made. In addition, the
Company is subject to generally prevailing economic conditions and, as such,
the Companys operating results in 2004 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, however, that the Company has sufficient cash resources to
meet its funding needs for 2004. The Company finished 2003 with approximately
$12.3 million in cash reserves (cash and cash equivalents of $10.24 million,
short-term restricted investments of $1.10 million, long-term restricted cash
of $0.63 million and short-term investments of $0.33 million). The Company
began 2004 with three business units all at different stages in their
development. Management expects to continue to make significant investments in
the image management business and in the development, sale and marketing of new
products for the security market, which may consume available cash reserves. Depending upon the Companys ability to sell its new products, the timeliness
of collection of accounts receivable and other potential working capital needs,
as well as the timing and rate of revenue growth and managements ability to
control costs, the Company 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 the Company. If
the Company is not able to raise additional funds, it may be required to
significantly curtail its operations and thus would have an adverse effect on
its financial position, results of operations and cash flow. F-11




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4. RESTRUCTURING AND OTHER During 2001, 2002 and 2003, the Company recorded as a separate line item in its
statements of operations 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. On March 1, 2001, the Company had 552 employees, but by the end of the second
quarter of 2001 the Company had reduced its workforce by approximately 440
positions. The reductions were primarily in the full-service virtual real
estate business. Included in the 2001 charges is a $1,462 impairment charge
related to the write off of the unamortized portion of the Companys directors
and officers insurance policy. The Company was required to obtain a new
policy due to the change in control related to the 2001 financing. During the third quarter of 2002, the Company recorded a restructuring charge
of $687 consisting of expenses associated primarily with a negotiated buy-out
of certain lease obligations for previously vacated offices. In November 2002,
the Company paid approximately $1,250 related to the buy-out. As of December
31, 2002, $1,049 remained in these restructuring accruals, primarily associated
with abandoned re-negotiated lease obligations and long term severance
agreements. During October 2003, $89 of restructuring charges was recorded related to
expenses associated with the lease obligations from previously vacated office
space in San Ramon. The activity in the current and long-term restructuring accruals for the years
ended December 31, are as follows: Balance at
    
    
    
    
    
    Payments/
    
    Balance at
    
    
    
    
    
    Payments/
    
    Balance at
    
    
    
    
    
    Payments/
    
    Balance atDecember
    
    Expense in
    
    Write-offs
    
    December
    
    Expense
    
    Write-offs
    
    December
    
    Expense in
    
    Write-offs
    
    December31, 2000
    
    2001
    
    in 2001
    
    31, 2001
    
    in 2002
    
    in 2002
    
    31, 2002
    
    2003
    
    in 2003
    
    31, 2003Restructuring Provisions:Severance
    
    $
    590
    
    
    $
    4,537
    
    
    $
    (4,027
    )
    
    $
    1,100
    
    
    $
    
    
    
    $
    (600
    )
    
    $
    500
    
    
    $
    
    
    
    $
    (500
    )
    
    $
    Employee debt
forgiveness
    
    
    
    
    
    
    2,163
    
    
    
    (2,163
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Write-offs and
impairments
    
    
    95
    
    
    
    1,959
    
    
    
    (2,054
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Lease obligations
    
    
    1,344
    
    
    
    3,006
    
    
    
    (2,897
    )
    
    
    1,453
    
    
    
    687
    
    
    
    (1,591
    )
    
    
    549
    
    
    
    89
    
    
    
    (267
    )
    
    
    371Other
    
    
    31
    
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    2,060
    
    
    $
    11,665
    
    
    $
    (11,172
    )
    
    $
    2,553
    
    
    $
    687
    
    
    $
    (2,191
    )
    
    $
    1,049
    
    
    $
    89
    
    
    $
    (767
    )
    
    $
    371
 LOSS ON DISPOSAL OF ASSETS A subsidiary of Homestore purchased certain assets from the Company pursuant to
the terms of an acquisition agreement dated January 12, 2001. Under the terms
of the acquisition agreement, the subsidiary of Homestore purchased certain
computers, furniture, fixtures and equipment and certain sales contracts with
residential real estate brokers and agents. The Company used these assets in
its operations providing virtual tours of residential real estate properties.
As part of the acquisition, Homestores subsidiary hired certain sales force
and customer service personnel. The purchase price for these assets was
$12,000 in cash, of which $155 was paid directly to a lessor for certain
capital lease obligations, $7,454 was deposited into control accounts for
deferred revenue obligations and the remainder, $4,391, was paid to the
Company. The Company also granted Homestores subsidiary an exclusive domestic
license of certain of its virtual tour technology for the residential real
estate market. In the first quarter of 2001, the Company recorded an
extraordinary gain of $901 from the cash received from the 2001 agreement,
resulting in the disposal of assets used to provide tours of residential real
estate properties that were related to the 2000 pooling of Interactive Pictures
Corporation and bamboo.com. The $1,655 loss on the 2001 sale of the remaining residential real estate
related assets that were unrelated to the pooling of Interactive Pictures
Corporation and bamboo.com was included in loss on the disposal of assets in
the accompanying statement of operations. 5. BALANCE SHEET ACCOUNTS COMPUTER HARDWARE, SOFTWARE AND OTHER: The components of computer hardware, software and other as of December 31 are
as follows: 2002
    
    2003Computer hardware and software
    
    $
    9,729
    
    
    $
    5,480Fixtures and leasehold improvements
    
    
    317
    
    
    
    24010,046
    
    
    
    5,720Accumulated depreciation and amortization
    
    
    (5,415
    )
    
    
    (4,142
    )Computer hardware, software and other, net
    
    $
    4,631
    
    
    $
    1,578
 F-12




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##### Table of Contents



Computer hardware, software and other includes $6,220 and $1,564 of assets held
under capital leases and related accumulated amortization of $2,337 and $1,154
at December 31, 2002 and 2003, respectively. During 2003, the Company disposed
of $225 of fully depreciated assets and sold certain assets to a related party
which resulted in a net gain of $177 (See Note 14). 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 Ad
Technologies 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 Ad Technologies reporting unit. As a result, an
impairment charge of $3,042 was recorded to expense in the year ended December
31, 2003. A reconciliation of reported net loss and net loss per common share as if FAS
142 had been in effect for 2001 is presented as follows: For Years Ended December 31,2001
    
    2002
    
    2003(In thousands, except per share)Net loss before extraordinary gain available to common stockholders
    
    $
    (54,579
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Extraordinary gain
    
    
    901
    
    
    
    
    
    
    
    Net loss available to common stockholders
    
    
    (53,678
    )
    
    
    (2,927
    )
    
    
    (392
    )Goodwill amortization
    
    
    2,433
    
    
    
    
    
    
    
    Adjusted net loss available to common stockholders
    
    $
    (51,245
    )
    
    $
    (2,927
    )
    
    $
    (392
    )Basic net loss per common share:Net loss before extraordinary gain available to common stockholders
    
    $
    (8.36
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )Extraordinary gain
    
    
    0.14
    
    
    
    
    
    
    
    Net loss available to common stockholders
    
    
    (8.22
    )
    
    
    (0.43
    )
    
    
    (0.05
    )Goodwill amortization
    
    
    0.38
    
    
    
    
    
    
    
    Adjusted basic net loss per common share
available to common stockholders
    
    $
    (7.84
    )
    
    $
    (0.43
    )
    
    $
    (0.05
    )
 ACCRUED LIABILITIES: The following table summarizes current and long term accrued liabilities as of
December 31: 2002
    
    2003Current:Accrued sales, franchise and other taxes
    
    $
    1,250
    
    
    $
    1,203Accrued
liabilities  trade
    
    
    495
    
    
    
    529Accrued salaries and benefits
    
    
    210
    
    
    
    98Accrued legal fees
    
    
    31
    
    
    
    100Accrued vacation
    
    
    356
    
    
    
    327Accrued restructuring
    
    
    739
    
    
    
    190Customer deposits
    
    
    1,372
    
    
    
    7Other
    
    
    973
    
    
    
    888Total current liabilities
    
    
    5,426
    
    
    
    3,342Long-term restructuring
    
    
    310
    
    
    
    181Total accrued liabilities
    
    $
    5,736
    
    
    $
    3,523
 F-13




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6. INCOME TAXES The components of the Companys net deferred tax assets (liabilities) as of
December 31 are as follows: 2002
    
    2003DEFERRED TAX ASSETS (LIABILITIES) CURRENT:Financial reserves
    
    $
    141
    
    
    $
    63Accrued expenses and deferred revenues
    
    
    1,590
    
    
    
    967Other
    
    
    36
    
    
    
    391,767
    
    
    
    1,069Valuation allowance
    
    
    (1,767
    )
    
    
    (1,069
    )Net current deferred tax assets
    
    $
    
    
    
    $
    DEFERRED TAX ASSETS (LIABILITIES) LONG-TERM:Net operating loss carryforwards
    
    $
    11,733
    
    
    $
    19,132Capitalized research and development
    
    
    6,908
    
    
    
    7,679Depreciation
    
    
    210
    
    
    
    342Other
    
    
    104
    
    
    
    14018,955
    
    
    
    27,293Valuation allowance
    
    
    (18,955
    )
    
    
    (27,293
    )Net long-term deferred tax assets (liabilities)
    
    $
    
    
    
    $
    
 At December 31, 2003, the Company has approximately $52,000 and $26,000 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,
2003, the Company also has approximately $600 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, 2002 and 2003,
the change in the valuation allowance was $7,051 and $7,640, respectively. The Companys 2001, 2002 and 2003 income tax provision differs from that
obtained by using the U.S. statutory rate of 34% due to the following: FOR YEARS ENDED DECEMBER 31,2001
    
    2002
    
    2003Computed expected tax (benefit)
provision
    
    $
    (18,251
    )
    
    $
    (389
    )
    
    $
    471State income taxes, net of U.S.
federal benefits
    
    
    (2,267
    )
    
    
    (48
    )
    
    
    77Investment in foreign
subsidiaries
    
    
    
    
    
    
    
    
    
    
    (8,587
    )Valuation allowance changes
affecting the provision for
income taxes
    
    
    17,857
    
    
    
    359
    
    
    
    6,906Warrant expense
    
    
    1,706
    
    
    
    66
    
    
    
    Permanent differences
    
    
    955
    
    
    
    12
    
    
    
    1,133$
    
    
    
    $
    
    
    
    $
    
 7. CONVERTIBLE DEBT 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 $10,000 convertible senior secured note and
received Tranche A and Tranche B warrants to purchase up to $20,000 of the
Companys Series B preferred stock. The warrants were issued in conjunction
with the convertible promissory note, and accordingly, based on APB 14,
Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants
and EITF 98-5, Accounting for Convertible Securities with Beneficial
Conversion Features, the entire proceeds from the convertible promissory note,
$10,000, were allocated to the warrants and the beneficial conversion feature
based on a calculation using the Black-Scholes model. During the third quarter
of 2001, the $10,000 note and the Tranche B warrants were converted to
preferred stock and accordingly, in 2001, the Company recorded $10,000 as
interest expense related to the accretion of the convertible promissory note to
its face value. F-14




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##### Table of Contents



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
FIN 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 six months
ended December 31, 2002, the Company recognized $0.6 million of revenue under
these 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 1,115,080 and 1,003,830 shares of Series B preferred
stock outstanding at December 31, 2002 and 2003, respectively. There were no
shares of Series C preferred stock outstanding at December 31, 2002 or 2003. 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. During the year ended December
31, 2003, an investor converted 3,948 shares of Class B common stock to 3,948
shares of Class A common stock. Common Stock During 2003, the Company issued 771,056 shares of common stock upon exercise of
stock options and 79,969 shares under the employee stock purchase program. The
total proceeds from the option exercises and employee stock purchases were
$1,557. In June and July 2003, certain investors converted 11,250 shares of
Series B preferred stock into 103,583 shares of common stock in accordance with
the conversion terms of the Series B preferred stock. In conjunction with the
conversion, the Company paid them $14 of cash and 4,416 shares of common stock
(with a value of $18) in dividends accrued through the date of conversion as
required under the conversion terms of the Series B preferred stock. In
December 2003, a certain investor converted 100,000 shares of Series B
preferred stock into 920,750 shares of common stock in accordance with the
conversion terms of the Series B preferred stock. In conjunction with the
conversion, the Company paid them $350 of cash in dividends accrued through the
date of conversion as required under the conversion terms of the Series B
preferred stock. The Company does not receive any proceeds upon the conversion
of Series B preferred stock. 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 $10,000 convertible senior secured note and
received Tranche A and Tranche B warrants to purchase up to $20,000 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 $22,302, represented by the
conversion of the $10,000 note, the conversion of $277 of interest on the Note
and $12,025 in cash through the exercise of Tranche B warrants. The remainder
of the Tranche B warrants expired. The Company recorded a charge of $1,636 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 are two Tranche A warrants (Warrant 1 and
Warrant 2), issued to Paradigm Capital Partners and Memphis Angels, LLC,
which are outstanding. Warrant 1 entitles the holder to purchase 150,000
shares of Series B preferred stock at $20 per share and is exercisable at F-15




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##### Table of Contents



any time before the expiration date of May 14, 2006. Warrant 2 entitles the
holder 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 (See
Note 13). 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 by 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. 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 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 6,044,196 shares of common stock. As of December 31,
2003, 3,000,545 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. 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, 2003, 232,672 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, 2003, 24,941 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 $100 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. The Company reserved
a sufficient number of shares of common stock for issuance pursuant to the
authorized options. As of December 31, 2003, 21,484 options are outstanding
under the 1997 Plan. In addition, the Company granted certain options to
purchase shares of common stock to employees not under the 1997 Plan; these
options were primarily granted prior to the authorization of 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 F-16




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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,
2003, 20,374 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. A summary of the Companys stock option activity under all plans is as follows: WEIGHTED AVERAGEWEIGHTED AVERAGE OF
    
    GRANT DATE FAIR
    
    STOCK OPTIONS
    
    WEIGHTED AVERAGESHARES
    
    EXERCISE PRICES
    
    VALUE
    
    EXERCISABLE
    
    EXERCISE PRICEUnder option at December 31, 2000
    
    
    774,609
    
    
    
    
    
    
    
    
    
    
    
    287,520
    
    
    
    68.40Options granted
    
    
    4,227,100
    
    
    $
    2.43
    
    
    
    1.90Options exercised
    
    
    (37,977
    )
    
    
    1.77Options forfeited or expired
    
    
    (589,425
    )
    
    
    42.30Options cancelled
    
    
    (273,961
    )
    
    
    147.74Under option at December 31, 2001
    
    
    4,100,346
    
    
    
    
    
    
    
    
    
    
    
    969,056
    
    
    
    11.22Options granted
    
    
    260,000
    
    
    
    1.86
    
    
    
    2.06Options exercised
    
    
    (32,500
    )
    
    
    2.60Options forfeited or expired
    
    
    (1,107,967
    )
    
    
    13.22Under 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
    
    
    
    10.10
 The following table summarizes information about stock options at December 31,
2003: OPTIONS OUTSTANDING
    
    OPTIONS EXERCISABLEWEIGHTED-AVERAGERANGE OF
    
    NUMBER
    
    REMAINING
    
    WEIGHTED AVERAGE
    
    NUMBER
    
    WEIGHTED-AVERAGEEXERCISE PRICE
    
    OUTSTANDING
    
    CONTRACTUAL LIFE
    
    EXERCISE PRICE
    
    EXERCISABLE
    
    EXERCISE PRICE$1.10-1.50
    
    
    1,614,672
    
    
    
    8.65
    
    
    $
    1.19
    
    
    
    409,755
    
    
    $
    1.49$1.51-3.00
    
    
    1,270,420
    
    
    
    7.90
    
    
    $
    2.37
    
    
    
    1,136,827
    
    
    $
    2.37$3.01-10.00
    
    
    317,350
    
    
    
    4.36
    
    
    $
    6.56
    
    
    
    216,191
    
    
    $
    8.13$10.01-300.00
    
    
    97,574
    
    
    
    5.57
    
    
    $
    140.95
    
    
    
    96,859
    
    
    $
    141.59TOTAL
    
    
    3,300,016
    
    
    
    7.86
    
    
    $
    6.29
    
    
    
    1,859,632
    
    
    $
    10.10
 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, 2003, 725,000 shares were reserved under the
Purchase Plan. As of December 31, 2003, 191,894 shares had been issued and
533,106 shares were available for issuance under the Purchase Plan.
Stock-Based Compensation Stock based compensation charges are made up of the following: FOR YEARS ENDED DECEMBER 31,2001
    
    2002
    
    2003Stock options
    
    $
    2,385
    
    
    $
    
    
    
    $
    Stock and restricted stock
    
    
    828
    
    
    
    
    
    
    
    Warrants
    
    
    1,286
    
    
    
    171
    
    
    
    $
    4,499
    
    
    $
    171
    
    
    $
    
 In the years ended December 31, 1999 and 2000, in connection with certain stock
options granted to consultants or to employees (with below market price
exercise prices), the Company recorded unearned stock-based compensation, which
was amortized over the vesting periods of the related options, generally two to
three years. In the years ended December 1999 and 2000, in connection with
certain restricted stock awards to employees, the Company recorded unearned
stock-based compensation for the value of the restricted awards, which was
amortized over the vesting periods of the awards, generally less than a year.
The Company has from time to time issued to customers warrants to purchase
equity securities. The value of these warrants F-17




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##### Table of Contents



was estimated using the Black-Scholes option-pricing model and recorded as
stock-based compensation over the vesting period of the warrants, generally two
to three years (See Note 13). 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. During 2001 the Company matched sixty-five cents per dollar up to 6.15%
of the employees annual salary. The Company made contributions, net of
forfeitures, of $117, $0 and $0 in 2001, 2002 and 2003, respectively. 11. SEGMENT INFORMATION The Company has three reportable segments. The accounting policies of the
segments are the same as those of the Company. Management evaluates the
performance of the segments and allocates resources to them based on
evaluations of the segments gross profit. There are no inter-segment revenues.
The Company does not make allocations of corporate costs to the individual
segments and does not identify separate assets of the segments in making
decisions regarding performance or allocation of resources to them. Over the past few years, the Company has been restructured around its higher
gross margin businesses. The Company is organized into three business units:
Ad Technologies, Security and InfoMedia. The Ad Technologies business unit
focuses on the sale of complete solutions to customers who rely on visual data
to create effective directional advertising such as publishers of newspaper
classifieds, yellow page directories, on-line auctions, real estate and autos
classifieds. The Security unit provides security and surveillance products and
services for commercial and governmental customers. The InfoMedia unit focuses
on the sale of immersive still technology licenses for the on-line real estate,
travel and hospitality and visual documentation markets. As part of the sale of assets to Homestore.com during the first quarter of
2001, the Company no longer directly sells full service virtual real estate
tours or IPIX keys to customers in the U.S. residential real estate market.
During 2001, the Company generated $7,550 of revenue, with a gross profit of
$3,948, related to full service virtual real estate tours. The Company has not
generated full service virtual tour revenues since the quarter ended September
30, 2001. Of the $28,906 of revenues for 2001, $21,356 was not related to full service
virtual tours. Of the $16,645 of gross profit for 2001, $12,697 was not related
to full service virtual tours. Information about the new 2001 reported segments
is as follows: AD TECHNOLOGIES
    
    INFOMEDIA
    
    SECURITY
    
    TOTALYEARS ENDED DECEMBER 31:2003Revenues
    
    $
    26,245
    
    
    $
    2,321
    
    
    $
    273
    
    
    $
    28,839Gross profit
    
    
    19,705
    
    
    
    919
    
    
    
    95
    
    
    
    20,7192002Revenues
    
    $
    16,242
    
    
    $
    6,171
    
    
    $
    
    
    
    $
    22,413Gross profit
    
    
    9,414
    
    
    
    4,271
    
    
    
    
    
    
    
    13,6852001Revenues
    
    $
    13,320
    
    
    $
    8,036
    
    
    $
    
    
    
    $
    21,356Gross profit
    
    
    7,436
    
    
    
    5,261
    
    
    
    
    
    
    
    12,697
 Information about prior reported segments is as follows: PRODUCTS
    
    SERVICES
    
    TOTALYEARS ENDED DECEMBER 31:2003Revenues
    
    $
    10,503
    
    
    $
    18,336
    
    
    $
    28,839Gross profit
    
    
    8,921
    
    
    
    11,798
    
    
    
    20,7192002Revenues
    
    $
    6,512
    
    
    $
    15,901
    
    
    $
    22,413Gross profit
    
    
    4,367
    
    
    
    9,318
    
    
    
    13,6852001Revenues
    
    $
    7,208
    
    
    $
    14,148
    
    
    $
    21,356Gross profit
    
    
    3,540
    
    
    
    9,157
    
    
    
    12,697
 F-18




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##### Table of Contents



Revenues by geographic area are as follows: FOR YEARS ENDED DECEMBER 31,2001
    
    2002
    
    2003REVENUES:United States
    
    $
    24,683
    
    
    $
    19,962
    
    
    $
    28,257Canada
    
    
    369
    
    
    
    
    
    
    
    Japan
    
    
    
    
    
    
    577
    
    
    
    29Europe
    
    
    2,802
    
    
    
    904
    
    
    
    122Other foreign countries
    
    
    1,052
    
    
    
    970
    
    
    
    431$
    28,906
    
    
    $
    22,413
    
    
    $
    28,839
 Long-lived asset information by geographic area is as follows: AS OF DECEMBER 31,2001
    
    2002
    
    2003LONG-LIVED ASSETS:Foreign
    
    $
    83
    
    
    $
    
    
    
    $
    United States
    
    
    4,531
    
    
    
    4,631
    
    
    
    1,578$
    4,614
    
    
    $
    4,631
    
    
    $
    1,578
 Foreign revenues include all sales made to customers outside the United States,
including those generated by United Kingdom and Canadian subsidiaries. 12. COMMITMENTS AND CONTINGENCIES 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 $16,000 over a two-year period. As of September 26, 2001, the
Company had paid $9,500 of the $16,000 commitment and agreed to extend the
additional $6,500 of payments through September 2003 (See Note 14). There are
no amounts due under this agreement as of December 31, 2003. In 2001 and 2002, the Company sold certain assets totaling $2,840 and $2,494,
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 $906, associated with these
lease obligations and eBay forgave the remaining balances due of $1,083. The
resulting gain of $177 was 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 $1,564 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. At December 31,
2003, the remaining balance due under this lease, $608, is due in 2004, plus
interest of $15. During the quarter ending September 30, 2002, the Company received
approximately $1,400 in cash from a previously disclosed favorable jury verdict
against Infinite Pictures that found the defendants liable for infringement of
our patents under the doctrine of equivalents and awarding us $1,000 in
damages, plus approximately $400 in interest and court costs. The defendants
filed for a writ of certiorari with the United States Supreme Court in an
effort to reverse the lower courts findings in our favor. The Supreme Court
refused to grant the writ, which exhausted the legal remedies for disputing the
award. Accordingly, the Company recorded the $1,000 in damages as patent
infringement award, along with the $400 in interest and court costs, in the
quarter ended September 30, 2002. 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: 2004
    
    $
    1,0442005
    
    
    7682006
    
    
    7712007
    
    
    64
 Rental expense for operating leases was $2,921, $2,638 and $2,727 for 2001,
2002 and 2003, respectively. At December 31, 2003, $918 of the above future
lease payments have been prepaid and reflected as current and long-term prepaid
expenses. Additionally, at December 31, 2003, $630 of cash has been restricted
related to the above future lease payments. F-19




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CONTINGENCIES On November 15, 2002, a First Amended Consolidated Complaint for violation of
federal securities laws was filed against Homestore.com, Inc. (Homestore) by
the California Teachers Retirement System (CalSTRS). The Complaint is a
class action lawsuit filed on behalf of stockholders of Homestore.com which
flows from alleged misstatements and omissions made by Homestore and the other
named defendants, which include the Company. The Complaint alleges that during
2001, Homestore and IPIX entered into fraudulent reciprocal transactions
intended to artificially bolster and maintain Homestores and the Companys
respective stock prices. The Complaint alleges that Homestores public
statements with respect to these transactions are attributable to the Company
and violate Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
The Company joined with other co-defendants and filed a joint motion to
dismiss, alleging that the Complaint fails to state a claim upon which relief
may be granted, among other things. On March 7, 2003, the United States
District Court for the District of Central California granted the Companys
motion to dismiss, with prejudice. However, CalSTRS may appeal this dismissal
in accordance with the federal rules of procedure. The Company is not currently a party to any other legal proceedings the adverse
outcome of which, individually or in the aggregate, the Company believes could
have a material adverse effect on the Companys business, financial condition,
results of operations or cash flows. INDEMNIFICATION PROVISIONS During the ordinary course of business, in certain limited circumstances, the
Company has included 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. To date, the Company has not incurred any costs in connection
with such indemnification clauses. 13. WARRANTS The Company has from time to time issued warrants to purchase equity
securities. As of December 31, 2003, all outstanding warrants are exercisable.
The following tables summarize warrants outstanding at December 31, 2003: Common
Stock Grant
    
    Expiration
    
    
    
    
    
    ExerciseDate
    
    Date
    
    Shares
    
    Price4/19/2000
    
    
    
    4/19/2010
    
    
    
    60,000
    
    
    $
    203.805/26/2000
    
    
    
    2/25/2005
    
    
    
    20,000
    
    
    $
    120.605/26/2000
    
    
    
    2/25/2005
    
    
    
    20,000
    
    
    $
    120.601/6/2000
    
    
    
    1/5/2009
    
    
    
    20,000
    
    
    $
    154.702000
    
    
    Various
    
    
    16,949
    
    
    $
    40.00 to $176.60136,949
 Date
    
    Expiration
    
    
    
    
    
    ExerciseSeries B Preferred Stock
    
    of Grant
    
    Date
    
    Shares
    
    PriceWarrant 1
    
    
    5/14/2001
    
    
    
    5/14/2006
    
    
    
    150,000
    
    
    $
    20.00Warrant 2
    
    
    5/14/2001
    
    
    
    5/14/2006
    
    
    
    100,000
    
    
    $
    40.00Equivalent to common shares
    
    
    9.21Warrant 1
    
    
    
    
    
    
    
    
    
    
    1,381,125
    
    
    $
    2.17Warrant 2
    
    
    
    
    
    
    
    
    
    
    920,750
    
    
    $
    4.34Total
    
    
    
    
    
    
    
    
    
    
    2,301,875
 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. 14. RELATED PARTY TRANSACTIONS During 2000, the Companys CEO at that time obtained a $2,000 loan under a line
of credit made available through his employment agreement dated February 22,
2000. Interest accrued at a rate of 9.5% during 2000 and 5.0% during 2001. The
loan was collateralized by the Company stock owned by the F-20




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##### Table of Contents



CEO and the stock options granted pursuant to his employment agreement. In May
2001, as part of a separation agreement, the loan was forgiven, along with
accrued interest of $163. Compensation expense related to this forgiveness is
included in restructuring expense for the year ended December 31, 2001. In September 1996, PictureWorks President, currently the Companys CEO,
exercised his right under his employment agreement to purchase 39,339 shares of
IPIX common stock in exchange for a full recourse promissory note issued to the
Company in the amount of $126. Interest accrued semiannually at a 6.74% annual
rate. The note and accrued interest were forgiven. Compensation expense
totaling $178 was recorded in 2002 for the forgiveness of the principal and
accrued interest. Transactions with eBay, Inc. Pursuant to an agreement dated April 19, 2000, as amended, the Company provided
to eBay, Inc., which beneficially owns 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 expires
on April 19, 2010. Under this agreement, as amended, the Company generated
revenue of $6,048, $13,368 and $25,087 for the years ended December 31, 2001,
2002 and 2003, respectively. 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. 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 is required to pay marketing
fees to eBay of $16,000 over a two-year period. As of September 26, 2001, the
Company had paid $9,500 of the $16,000 commitment and agreed to extend the
additional $6,500 of payments through September 2003. In accordance with EITF
01-09, $1,000 and $1,500 of these fees was offset against revenue which amount
represented the excess over the fair value of the benefit received during the
years ended December 31, 2002 and 2003, respectively. 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 $5,334. The transactions resulted in no gain or loss to the
Company. In 2001, 2002 and 2003, the Company paid eBay $194, $2,373 and
$1,994, respectively, pursuant to these lease schedules. In 2003, the Company
returned the underlying equipment, with a net carrying amount of $906,
associated with these lease obligations and eBay forgave the remaining balances
due of $1,083. The resulting gain of $177 was recognized in cost of revenues
in the statement of operations because the underlying equipment was used to
generate eBay service revenues. QUARTERLY INFORMATION (unaudited) FOR QUARTER ENDEDTOTAL
    
    MARCH 31
    
    JUNE 30
    
    SEPT 30
    
    DEC 31FISCAL YEAR 2003:Revenue
    
    $
    28,839
    
    
    $
    6,391
    
    
    $
    6,552
    
    
    $
    6,623
    
    
    $
    9,273Gross profit
    
    
    20,719
    
    
    
    4,267
    
    
    
    4,415
    
    
    
    4,272
    
    
    
    7,765Net income
(loss) available for common stockholders(1)
    
    
    (392
    )
    
    
    (72
    )
    
    
    (118
    )
    
    
    (300
    )
    
    
    96Net income (loss) per common share(1):Basic
    
    
    (0.05
    )
    
    
    (0.01
    )
    
    
    (0.02
    )
    
    
    (0.04
    )
    
    
    0.01Diluted
    
    
    (0.05
    )
    
    
    (0.01
    )
    
    
    (0.02
    )
    
    
    (0.04
    )
    
    
    0.01FISCAL YEAR 2002:Revenue
    
    $
    22,413
    
    
    $
    4,794
    
    
    $
    5,761
    
    
    $
    5,995
    
    
    $
    5,863Gross profit
    
    
    13,685
    
    
    
    2,670
    
    
    
    3,575
    
    
    
    3,696
    
    
    
    3,744Net income
(loss) available for common stockholders(1)
    
    
    (2,927
    )
    
    
    (1,953
    )
    
    
    (1,136
    )
    
    
    126
    
    
    
    36Net income (loss) per common share(1):Basic
    
    
    (0.43
    )
    
    
    (0.29
    )
    
    
    (0.17
    )
    
    
    0.01
    
    
    
    0.00Diluted
    
    
    (0.43
    )
    
    
    (0.29
    )
    
    
    (0.17
    )
    
    
    0.01
    
    
    
    0.00FISCAL YEAR 2001:Revenue
    
    $
    28,906
    
    
    $
    9,523
    
    
    $
    7,963
    
    
    $
    6,576
    
    
    $
    4,844Gross profit
    
    
    16,645
    
    
    
    4,689
    
    
    
    4,526
    
    
    
    4,185
    
    
    
    3,245Extraordinary gain
    
    
    901
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    901Net loss
available for common stockholders(1)
    
    
    (53,678
    )
    
    
    (17,108
    )
    
    
    (19,615
    )
    
    
    (14,546
    )
    
    
    (2,409
    )Net loss per common share(1):Basic
    
    
    (8.22
    )
    
    
    (2.69
    )
    
    
    (3.00
    )
    
    
    (2.19
    )
    
    
    (0.36
    )Diluted
    
    
    (8.22
    )
    
    
    (2.69
    )
    
    
    (3.00
    )
    
    
    (2.19
    )
    
    
    (0.36
    )
  (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-21