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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the Quarterly Period Ended June 30, 2006

OR



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

For the transition period from  to.

Commission File Number 000-31081



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TRIPATH TECHNOLOGY INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0407364                          
|(State or other jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

2560 Orchard Parkway

San Jose, California 95131

(Address of Principal Executive Office including
(Zip Code)

(408) 750-3000

(Registrants telephone number, including area code)



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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 (Exchange Act) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days. Yes  x    No ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated
filer ̈Accelerated
filer  x                Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell Company (as
defined in Rule 12b-2 of the Exchange Act). Yes ̈No  x

64,860,203, shares of the Registrants common stock were outstanding as of June 30, 2006.



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##### Table of Contents

TABLE OF CONTENTS



|         |  |                                                                                                                               |  |   
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------- |  | --
|PART I.  |  | Financial Information                                                                                                         |  | 3 
|         |  |                                                                                                                              
|         |  | Item 1.
Financial Statements                                                                                                  |  | 3 
|         |  |                                                                                                                              
|         |  | Condensed Consolidated Balance Sheets as of June 30, 2006 (unaudited) and September 30, 2005 (audited)                        |  | 3 
|         |  |                                                                                                                              
|         |  | Condensed Consolidated Statements of Operations for the three months and Nine Months Ended June 30, 2006 and 2005 (unaudited) |  | 4 
|         |  |                                                                                                                              
|         |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2006 and 2005 (unaudited)                  |  | 5 
|         |  |                                                                                                                              
|         |  | Notes to Condensed Interim Consolidated Financial Statements                                                                  |  | 6 
|         |  |                                                                                                                              
|         |  | Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 26
|         |  |                                                                                                                              
|         |  | Risk Factors                                                                                                                  |  | 39
|         |  |                                                                                                                              
|         |  | Item 3.
Quantitative and Qualitative Disclosures about Market Risk                                                            |  | 52
|         |  |                                                                                                                              
|         |  | Item 4.
Controls and Procedures                                                                                               |  | 52
|         |  |                                                                                                                              
|PART II. |  | Other Information                                                                                                             |  | 54
|         |  |                                                                                                                              
|         |  | Item 1.
Legal Proceedings                                                                                                     |  | 54
|         |  |                                                                                                                              
|         |  | Item 6.
Exhibits                                                                                                              |  | 56
|         |  |                                                                                                                              
|         |  | Signatures                                                                                                                    |  | 57
|         |  |                                                                                                                              
|         |  | Exhibit Index                                                                                                                 |  | 57



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##### Table of Contents

PART I. Financial Information



|Item 1. | Financial Statements
|------- | --------------------

TRIPATH TECHNOLOGY INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | -------- | - | --------------------------- | - | -------- | -
|                                                                                                                                                                                                  |  | June 30, 2006(Unaudited) |          |   | September 30, 2005(Audited) |  
|ASSETS                                                                                                                                                                                            |  |                          |          |   |                             |   |          |  
|Current assets:                                                                                                                                                                                   |  |                          |          |   |                             |   |          |  
|Cash and cash equivalents                                                                                                                                                                         |  | $                        | 745      |   |                             | $ | 716      |  
|Restricted Cash                                                                                                                                                                                   |  |                          | 162      |   |                             |   | 162      |  
|Accounts receivable                                                                                                                                                                               |  |                          | 570      |   |                             |   | 1,010    |  
|Inventories, net                                                                                                                                                                                  |  |                          | 4,864    |   |                             |   | 5,457    |  
|Prepaid expenses and other current assets                                                                                                                                                         |  |                          | 650      |   |                             |   | 1,512    |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total current assets                                                                                                                                                                              |  |                          | 6,991    |   |                             |   | 8,857    |  
|Property and equipment, net                                                                                                                                                                       |  |                          | 715      |   |                             |   | 875      |  
|Other assets                                                                                                                                                                                      |  |                          | 118      |   |                             |   | 122      |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total assets                                                                                                                                                                                      |  | $                        | 7,824    |   |                             | $ | 9,854    |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                                                                    |  |                          |          |   |                             |   |          |  
|Current liabilities:                                                                                                                                                                              |  |                          |          |   |                             |   |          |  
|Accounts payable                                                                                                                                                                                  |  | $                        | 2,195    |   |                             | $ | 3,488    |  
|Current portion of capital lease obligations                                                                                                                                                      |  |                          | 103      |   |                             |   | 215      |  
|Current portion of deferred rent                                                                                                                                                                  |  |                          | 250      |   |                             |   | 305      |  
|Current portion of note payable                                                                                                                                                                   |  |                          | 3,000    |   |                             |   |         |  
|Current portion of note payable discount                                                                                                                                                          |  |                          | (2,500   | ) |                             |   |         |  
|Accrued expenses                                                                                                                                                                                  |  |                          | 2,491    |   |                             |   | 2,899    |  
|Deferred distributor revenue                                                                                                                                                                      |  |                          | 915      |   |                             |   | 1,202    |  
|Warrant liability                                                                                                                                                                                 |  |                          | 3,262    |   |                             |   | 396      |  
|Conversion feature of convertible debt                                                                                                                                                            |  |                          | 2,527    |   |                             |   |         |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total current liabilities                                                                                                                                                                         |  |                          | 12,243   |   |                             |   | 8,505    |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Long term liabilities:                                                                                                                                                                            |  |                          |          |   |                             |   |          |  
|Long term portion of capital lease obligations                                                                                                                                                    |  |                          | 65       |   |                             |   | 21       |  
|Long term portion of deferred rent                                                                                                                                                                |  |                          |         |   |                             |   | 167      |  
|Long term portion of note payable                                                                                                                                                                 |  |                          | 1,250    |   |                             |   |         |  
|Long term portion of note payable discount                                                                                                                                                        |  |                          | (897     | ) |                             |   |         |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total long term liabilities                                                                                                                                                                       |  |                          | 418      |   |                             |   | 188      |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Commitments and contingencies (see Note 11)                                                                                                                                                       |  |                          |          |   |                             |   |          |  
|Stockholders equity (deficit):                                                                                                                                                                   |  |                          |          |   |                             |   |          |  
|Common stock, $0.001 par value, 100,000,000 shares authorized; 64,860,203 and 55,410,722 shares issued and outstanding at June 30, 2006
(unaudited) and September 30, 2005 (audited) respectively |  |                          | 64       |   |                             |   | 55       |  
|Additional paid-in capital                                                                                                                                                                        |  |                          | 206,857  |   |                             |   | 202,310  |  
|Other comprehensive expense                                                                                                                                                                       |  |                          | (4       | ) |                             |   | (3       | )
|Accumulated deficit                                                                                                                                                                               |  |                          | (211,754 | ) |                             |   | (201,201 | )
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total stockholders equity (deficit)                                                                                                                                                              |  |                          | (4,837   | ) |                             |   | 1,161    |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  
|Total liabilities and stockholders equity (deficit)                                                                                                                                              |  | $                        | 7,824    |   |                             | $ | 9,854    |  
|                                                                                                                                                                                                  |  |                          |          |   |                             |   |          |  

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



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##### Table of Contents

TRIPATH TECHNOLOGY INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

Unaudited



|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|----------------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | -------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                                                |  | Three Months Ended June 30, |        |   | Nine Months Ended June 30, |  
|                                                                                                |  | 2006                        |        |   | 2005                       |   |        | 2006 |  |   | 2005    |  
|Revenue                                                                                         |  | $                           | 2,382  |   |                            | $ | 2,886  |      |  | $ | 9,304   |   |  | $ | 7,287  |  
|Cost of revenue                                                                                 |  |                             | 2,327  |   |                            |   | 1,314  |      |  |   | 7,289   |   |  |   | 3,531  |  
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Gross profit                                                                                    |  |                             | 55     |   |                            |   | 1,572  |      |  |   | 2,015   |   |  |   | 3,756  |  
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Operating expenses:                                                                             |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Research and development                                                                        |  |                             | 1,806  |   |                            |   | 1,742  |      |  |   | 5,603   |   |  |   | 5,605  |  
|Selling, general and administrative                                                             |  |                             | 1,358  |   |                            |   | 3,866  |      |  |   | 4,906   |   |  |   | 7,084  |  
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Total operating expenses                                                                        |  |                             | 3,164  |   |                            |   | 5,608  |      |  |   | 10,509  |   |  |   | 12,689 |  
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Loss from operations                                                                            |  |                             | (3,109 | ) |                            |   | (4,036 | )    |  |   | (8,494  | ) |  |   | (8,933 | )
|Change in fair value on revaluation of warrant liability                                        |  |                             | 2,711  |   |                            |   | 213    |      |  |   | 5,054   |   |  |   | 465    |  
|Interest and other expense, net                                                                 |  |                             | (899   | ) |                            |   | (6     | )    |  |   | (7,111  | ) |  |   | (17    | )
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Net loss                                                                                        |  | $                           | (1,297 | ) |                            | $ | (3,829 | )    |  | $ | (10,551 | ) |  | $ | (8,485 | )
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Basic and diluted net loss per share                                                            |  | $                           | (0.02  | ) |                            | $ | (0.07  | )    |  | $ | (0.18   | ) |  | $ | (0.16  | )
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  
|Weighted average number of common shares used in computing basic and diluted net loss per share |  |                             | 60,549 |   |                            |   | 55,351 |      |  |   | 59,756  |   |  |   | 53,646 |  
|                                                                                                |  |                             |        |   |                            |   |        |      |  |   |         |   |  |   |        |  

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



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##### Table of Contents

TRIPATH TECHNOLOGY INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

Unaudited



|                                                                               |  |                            |         |   |      |   |        |  
|------------------------------------------------------------------------------ |  | -------------------------- | ------- | - | ---- | - | ------ | -
|                                                                               |  | Nine Months Ended June 30, |        
|                                                                               |  | 2006                       |         |   | 2005 |  
|Cash flows from operating activities:                                          |  |                            |         |   |      |   |        |  
|Net loss                                                                       |  | $                          | (10,551 | ) |      | $ | (8,485 | )
|Adjustments to reconcile net loss to net cash used in operating activities:    |  |                            |         |   |      |   |        |  
|Revaluation of warrant and conversion feature liabilities                      |  |                            | (5,054  | ) |      |   | (465   | )
|Depreciation and amortization                                                  |  |                            | 327     |   |      |   | 669    |  
|Deferred rent                                                                  |  |                            | (222    | ) |      |   | (192   | )
|Allowance for doubtful accounts                                                |  |                            |        |   |      |   | (50    | )
|Provision for slow moving, excess and obsolete inventory                       |  |                            | 1,001   |   |      |   |       |  
|Stock-based compensation                                                       |  |                            | 1,404   |   |      |   | 95     |  
|Excess value from conversion feature and warrants                              |  |                            | 5,037   |   |      |   |       |  
|Accretion of debt discount                                                     |  |                            | 1,603   |   |      |   |       |  
|Change in value of unissued ESPP shares                                        |  |                            | 11      |   |      |   |       |  
|Changes in assets and liabilities:                                             |  |                            |         |   |      |   |        |  
|Accounts receivable                                                            |  |                            | 440     |   |      |   | 97     |  
|Inventories, net                                                               |  |                            | (407    | ) |      |   | 267    |  
|Prepaid expenses and other assets                                              |  |                            | 1,064   |   |      |   | (2,067 | )
|Accounts payable                                                               |  |                            | (1,293  | ) |      |   | (912   | )
|Accrued expenses                                                               |  |                            | (409    | ) |      |   | 2,137  |  
|Deferred distributor revenue                                                   |  |                            | (287    | ) |      |   | 260    |  
|                                                                               |  |                            |         |   |      |   |        |  
|Net cash used in operating activities                                          |  |                            | (7,336  | ) |      |   | (8,646 | )
|                                                                               |  |                            |         |   |      |   |        |  
|Cash flows from investing activity:                                            |  |                            |         |   |      |   |        |  
|Purchase of property and equipment                                             |  |                            | (168    | ) |      |   | (48    | )
|                                                                               |  |                            |         |   |      |   |        |  
|Net cash used in investing activities                                          |  |                            | (168    | ) |      |   | (48    | )
|                                                                               |  |                            |         |   |      |   |        |  
|Cash flows from financing activity:                                            |  |                            |         |   |      |   |        |  
|Offering costs                                                                 |  |                            | (91     | ) |      |   |       |  
|Proceeds from issuance of common stock upon exercise of warrants               |  |                            | 2,763   |   |      |   | 4,092  |  
|Proceeds from issuance of common stock under ESPP and upon exercise of options |  |                            | 28      |   |      |   |        |  
|Acquisition of capital lease                                                   |  |                            | 123     |   |      |   |       |  
|Principal payments on capital lease obligations                                |  |                            | (191    | ) |      |   | (513   | )
|Proceeds from issuance of 6% convertible debentures and warrants               |  |                            | 5,000   |   |      |   |       |  
|Debt issuance cost for Finders Fees                                           |  |                            | (98     | ) |      |   |       |  
|                                                                               |  |                            |         |   |      |   |        |  
|Net cash provided by financing activities                                      |  |                            | 7,534   |   |      |   | 3,579  |  
|                                                                               |  |                            |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                           |  |                            | 30      |   |      |   | (5,115 | )
|Effect of exchange rate changes on cash and cash equivalents                   |  |                            | (1      | ) |      |   |       |  
|Cash, and cash equivalents, beginning of period                                |  |                            | 716     |   |      |   | 7,339  |  
|                                                                               |  |                            |         |   |      |   |        |  
|Cash, and cash equivalents, end of period                                      |  | $                          | 745     |   |      | $ | 2,224  |  
|                                                                               |  |                            |         |   |      |   |        |  

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



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##### Table of Contents

Tripath Technology Inc.

Notes to Condensed Interim Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

The unaudited condensed interim consolidated financial statements included herein have been prepared by Tripath Technology Inc. (the
Company) in accordance with accounting principles generally accepted in the United States of America and reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary to state
fairly the Companys financial position, results of operations and cash flows for the periods presented. These interim financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included
in the Companys Annual Report on Form 10-K and on Form 10-K/A for the fiscal year ended September 30, 2005. The results of operations for the three months ended June 30, 2006 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire year.

On November 14, 2004, Tripaths Board of Directors approved a change
in the Companys fiscal year end from December 31 to September 30, effective as of September 30, 2004.

The preparation
of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such differences could affect the results of
operations reported in future periods and such differences could be material.

The unaudited condensed interim consolidated financial
statements include the accounts of the Company and its wholly-owned Japanese subsidiary, which was incorporated in January 2001. All significant intercompany balances and transactions have been eliminated in consolidation. The U.S. dollar is the
functional currency for the Companys Japanese wholly-owned subsidiary. Assets and liabilities that are not denominated in the functional currency are remeasured into U.S. dollars and the resulting gains or losses are included in Interest
and other income, net. Such gains or losses have not been material for any period presented.

The Companys consolidated
financial statements have been prepared on the basis of a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred substantial losses and has
experienced negative cash flow since inception and has an accumulated deficit of $212.1 million at June 30, 2006. These factors raise substantial doubt about the Companys ability to continue as a going concern.

Beginning in August 2001, the Company instituted programs to reduce expenses including reducing headcount from 144 employees at the end of July 2001 to
56 employees at the end of December 2003 and reducing employees salaries by 10 percent. In September 2002 the Company relocated its headquarters, which reduced rent expense and canceled its D&O policy which reduced insurance expense. These
actions resulted in significant cost savings in 2003. The Company reduced its cash used in operating activities from approximately $13 million in 2002 to approximately $4 million in 2003. However, for the nine months ended September 30, 2004,
cash used in operating activities increased to $9.1 million and for the year ended September 30, 2005 the Company used $9.8 million in cash. For the three months ended June 30, 2006, the Company had 51 employees and the cash used by the
Company in operating activities was $1.1 million.

During 2004, warrants were exercised which resulted in the Company receiving proceeds
totaling approximately $2.3 million. In addition, in August 2004 the Company raised $5 million through a financing in which the Company sold 2,500,000 shares of common stock at a price of $2.00 per share. In March 2005, the Company completed a
private placement which resulted in gross proceeds of $4.4 million. In connection with this private placement the Company sold 4,833,335 shares of common stock at a price of $0.90 per share and issued warrants to purchase up to 966,667 shares
of common stock with an exercise price of $1.25 per share.

In October 2005, the Company proposed amending the warrants issued as part of
the March 2005 private placement to lower the exercise price to $0.50 per share, eliminate the cashless net exercise provision of the warrant, and advance the warrant termination date to October 14, 2005. On October 14, 2005, the holders
of warrants who exercised 533,333 shares of the Companys common stock agreed to the amendment and, as a result, the Company issued 533,333 shares of common stock upon the exercise of such amended warrants on October 14, 2005 for aggregate
proceeds of $0.3 million. The remaining warrants to purchase 433,334 shares of common stock at an exercise price of $1.25 per share issued pursuant to the March 3, 2005 private placement are exercisable through September 4, 2008.



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##### Table of Contents

On November 8, 2005, the Company completed a private placement which resulted in gross proceeds of
$5.0 million. In connection with this private placement the Company sold $5.0 million in principal amount of 6% Senior Secured Convertible Debentures, convertible into common stock at a price of $0.37 per share (subject to certain adjustments), and
issued Series A Warrants to purchase up to 6,756,755 shares of common stock at an exercise price of $0.37 per share and Series B Warrants and Finders Fee Warrants to purchase up to 10,368,854 shares of common stock at an exercise price of
$0.43 per share. The Series A Warrants are exercisable immediately upon issuance and were exercised on February 14, 2006. The Series B Warrants are exercisable from May 8, 2006 until May 8, 2011.

In February 2006, the Company proposed to the holders of the Series A Warrants that upon the exercise of the Series A Warrants, the Company would issue
new warrants in exchange for the exercise of the Series A Warrants. On February 14, 2006, the holders of the Series A Warrants exercised their Series A Warrants and the Company issued 6,756,755 shares of common stock for aggregate proceeds of
$2.5 million and the Company issued new warrants at a strike price of $0.315 per share on 6,081,079 shares of the Companys common stock; such new warrants terminate on July 1, 2007.

At June 30, 2006, the Company had negative working capital of $5.25 million, including unrestricted cash of $0.7 million.

The Company will continue to require more cash during 2006 to fund its operations. Specifically, the Company does not currently have sufficient funds to
finance its operations through the end of the month of August 2006 and accordingly the Companys future depends on its ability to secure additional sources of financing during the month of August 2006. Management believes that such additional
cash requirements might be met by first obtaining additional financing. However, to date, the Company has no commitment from potential financing sources for such additional financing, and the Company can provide no assurances that such financing
will be obtained. However, the Company may not be able to obtain additional funds on terms that would be favorable to its stockholders and the Company, or at all. The Companys prospects in both the short term and in the long term are dependent
upon obtaining sufficient financing as needed to fund current working capital needs and future growth. In the long term, the Companys prospects also are deptendent upon ultimately achieving profitability.

2. Revenue recognition

The Company recognizes
revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, or SAB 104, Revenue Recognition in Financial Statements. The Company recognizes revenue when all of the following criteria are
met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured. The following policies apply to the
Companys major categories of revenue transactions:

Sales to OEM Customers: Under the Companys standard terms and
conditions of sale, title and risk of loss transfer to the customer at the time product is delivered to the customer, FOB shipping point, and revenue is recognized accordingly. The Company accrues the estimated cost of post-sale obligations,
including product warranties or returns, based on historical experience. The Company has experienced minimal warranty or other returns to date.

Sales to Distributors:Sales to distributors are made under arrangements allowing limited rights of return, generally under product warranty provisions, stock rotation rights and price protection on products unsold by the
distributor. In addition, the distributor may request special pricing and allowances which may be granted subject to the Companys approval. As a result of these return rights and potential pricing adjustments, the Company generally defers
recognition of revenue until such time that the distributor sells product to its customer based upon receipt of point-of-sale reports from the distributor.

Allowance for Doubtful Accounts:The Company provides an allowance for doubtful accounts to ensure trade receivables are not overstated due to un-collectibility. The collectibility of the Companys
receivables is evaluated based on a variety of factors, including the length of time receivables are past due, indication of the customers willingness to pay, significant one-time events and historical experience. An additional reserve for
individual accounts is recorded when the Company becomes aware of a customers inability to meet its financial obligations, such as in the case of bankruptcy filings or substantial deterioration in the customers operating results or
financial position. If circumstances related to the Companys customers change, estimates of the recoverability of receivables would be further adjusted.

3. Net loss per share

Basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common stock outstanding during the period. Diluted net loss per share is computed based on the
weighted average number of common stock and dilutive potential common stock outstanding. The calculation of diluted



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net loss per share excludes potential common stock if the effect is anti-dilutive. Potential common stock consists of incremental common stock issuable upon
the exercise of stock options, shares issuable upon conversion of convertible preferred stock, common stock issuable upon the exercise of common stock warrants and common stock issuable upon the conversion of convertible debentures.

The following table sets forth the computation of basic and diluted net loss per share for the periods presented (in thousands, except per share
amounts):



|                              |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|----------------------------- |  | -------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                              |  | Three months ended June 30 |        |   | Nine months ended June 30 |  
|                              |  | 2006                       |        |   | 2005                      |   |        | 2006 |  |   | 2005    |  
|Numerator:                    |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Net loss                      |  | $                          | (1,297 | ) |                           | $ | (3,829 | )    |  | $ | (10,551 | ) |  | $ | (8,485 | )
|                              |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Denominator:                  |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Weighted average common stock |  |                            | 60,549 |   |                           |   | 55,351 |      |  |   | 59,756  |   |  |   | 53,646 |  
|                              |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Net loss per share:           |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Basic and diluted             |  | $                          | (0.02  | ) |                           | $ | (0.07  | )    |  | $ | (0.18   | ) |  | $ | (0.16  | )
|                              |  |                            |        |   |                           |   |        |      |  |   |         |   |  |   |        |  

4. Cash, cash equivalents and restricted cash

The Company considers all highly liquid investments with a maturity of three months or less from the date of purchase to be cash equivalents. Cash and
cash equivalents consist of cash on deposit with banks, money market funds and commercial paper, bonds and notes, the fair value of which approximates cost.

At June 30, 2006 and September 30, 2005, the Company had $0.2 million and $0.2 million in restricted cash, respectively. The restricted cash represents monies held in a separate money market account as
collateral for a standby letter of credit as called for in the Companys facility lease.

5. Concentration of credit risk and significant customers

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and
short-term investments. Substantially all of the Companys cash and cash equivalents are invested in highly-liquid money market funds with major financial institutions. The Company sells its products through distributors and directly to
original equipment manufacturers. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses, as considered necessary by management. Credit losses to date have been consistent with
managements estimates. During the quarters ended June 30, 2006 and 2005, the Company had minimal bad debts write-offs.



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##### Table of Contents

The following table summarizes sales to end-customers comprising 10 percent or more of the Companys
total revenue for the periods indicated:



|           |  |                                                  |   |  |                                                 |   |  |      |   |  |      |  
|---------- |  | ------------------------------------------------ | - |  | ----------------------------------------------- | - |  | ---- | - |  | ---- | -
|           |  | % of Revenue for the Three Months Ended June 30, |   |  | % of Revenue for the Nine Months Ended June 30, |  
|           |  | 2006                                             |   |  | 2005                                            |   |  | 2006 |   |  | 2005 |  
|Customer A |  | 22                                               | % |  | 21                                              | % |  | 17   | % |  | 18   | %
|Customer B |  | 14                                               | % |  |                                                |   |  | 12   | % |  |     |  

The Companys accounts receivable were concentrated with two customers at June 30, 2006
representing 44 percent and 11 percent of aggregate gross receivables and with three customers at September 30, 2005 representing 40 percent, 16 percent, and 12 percent of aggregate gross receivables.

6. Inventories

Inventories are stated at the lower
of cost or market. This policy requires the Company to make estimates regarding the market value of the Companys inventory, including an assessment of excess or obsolete inventory. The Company determines excess and obsolete inventory based on
an estimate of the future demand and estimated selling prices for the Companys products within a specified time horizon, generally 12 months. The estimates the Company uses for expected demand are also used for near-term capacity planning and
inventory purchasing and are consistent with the Companys revenue forecasts. Actual demand and market conditions may be different from those projected by the Companys management. If the Companys unit demand forecast is less than
the Companys current inventory levels and purchase commitments, during the specified time horizon, or if the estimated selling price is less than the Companys inventory value, the Company will be required to take additional excess
inventory charges or write-downs to net realizable value which will decrease the Companys gross margin and net operating results in the future. During the quarter ended March 31, 2002, the Company recorded a provision for excess inventory
of approximately $5.0 million primarily related to excess inventory for the Companys TA2022 product as a result of a decrease in forecasted sales for this product. In 2004, the Company increased the inventory reserves by an additional $4.3
million from $4.9 million to $9.2 million to account for slow moving, excess, and obsolete inventory. The additional inventory charge related to slow-moving and excess inventory for the Companys TA1101B, TA3020, TA2041, TA2022 and leaded
TA2024 products, the TK2350, TK2051, TK2150, TK2050 and TK2052 chipsets, and Kauai 2BB and U461 die based on a decline in forecasted sales for these parts. These components and finished goods did not have a market or sales forecast based on customer
demand that could support the number of units in inventory at that time. During the year ended September 30, 2005, the Company sold inventory for which the net amount of approximately $4.0 million of inventory reserves were previously provided
for. During the quarters ended June 30, 2006, March 31, 2006 and December 31, 2005, the Company sold inventory for which the net amount of approximately $0.1 million $0.2 million and $0.7 million of inventory reserves were previously provided
for, respectively. These were due to the Companys end-customers experiencing significant growth which resulted in sales of previously written down inventory. In addition during calendar 2005, certain of the Companys customers
products had experienced growth beyond previously estimated levels.

Inventories, net, are comprised of the following (in thousands):



|                               |  |                           |       |                    |   |      
|------------------------------ |  | ------------------------- | ----- | ------------------ | - | -----
|                               |  | June 30, 2006 (Unaudited) |       | September 30, 2005
|Raw materials                  |  | $                         | 1,893 |                    | $ | 946  
|Work-in-process                |  |                           | 1,154 |                    |   | 943  
|Finished goods                 |  |                           | 1,075 |                    |   | 2,643
|Inventory held by distributors |  |                           | 742   |                    |   | 925  
|                               |  |                           |       |                    |   |      
|Total                          |  | $                         | 4,864 |                    | $ | 5,457
|                               |  |                           |       |                    |   |      



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7. Segment and geographic information

The Company has determined that it has one reportable business segment: the design, license and marketing of integrated circuits. The following is a
breakdown of the Companys sales (in thousands) for the following periods in the following markets:



|                       |  |                             |       |                            |   |       |  |      |       |  |   |      
|---------------------- |  | --------------------------- | ----- | -------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                       |  | Three Months Ended June 30, |       | Nine Months Ended June 30,
|                       |  | 2006                        |       | 2005                       |   | 2006  |  | 2005
|Flat Panel TV          |  | $                           | 1,840 |                            | $ | 1991  |  | $    | 6,506 |  | $ | 4,464
|Communications         |  |                             | 6     |                            |   |      |  |      | 1,050 |  |   | 228  
|Consumer & Convergence |  |                             | 317   |                            |   | 175   |  |      | 825   |  |   | 667  
|Automotive             |  |                             | 53    |                            |   | 175   |  |      | 222   |  |   | 333  
|Gaming                 |  |                             | 18    |                            |   | 147   |  |      | 275   |  |   | 572  
|Home Theatre           |  |                             | 148   |                            |   | 398   |  |      | 426   |  |   | 1,023
|                       |  |                             |       |                            |   |       |  |      |       |  |   |      
|                       |  | $                           | 2,382 |                            | $ | 2,886 |  | $    | 9,304 |  | $ | 7,287
|                       |  |                             |       |                            |   |       |  |      |       |  |   |      

The following is a geographic breakdown of the Companys sales by shipping destination for
the following periods (in thousands):



|              |  |                             |       |                            |   |       |  |      |       |  |   |      
|------------- |  | --------------------------- | ----- | -------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|              |  | Three Months Ended June 30, |       | Nine Months Ended June 30,
|              |  | 2006                        |       | 2005                       |   | 2006  |  | 2005
|United States |  | $                           | 186   |                            | $ | 47    |  | $    | 323   |  | $ | 366  
|Japan         |  |                             | 1,546 |                            |   | 1,402 |  |      | 4,516 |  |   | 3,727
|Taiwan        |  |                             | 210   |                            |   | 458   |  |      | 719   |  |   | 617  
|China         |  |                             | 183   |                            |   | 270   |  |      | 2,114 |  |   | 694  
|Europe        |  |                             | 169   |                            |   | 366   |  |      | 983   |  |   | 1,124
|Korea         |  |                             | 87    |                            |   |      |  |      | 590   |  |   | 275  
|Rest of World |  |                             | 1     |                            |   | 343   |  |      | 59    |  |   | 484  
|              |  |                             |       |                            |   |       |  |      |       |  |   |      
|              |  | $                           | 2,382 |                            | $ | 2,886 |  | $    | 9,304 |  | $ | 7,287
|              |  |                             |       |                            |   |       |  |      |       |  |   |      

Approximately 98 percent and 98 percent of the Companys total revenue for the three months
ended June 30, 2006 and June 30, 2005, respectively, was derived from sales to end-customers based outside the United States.

Net property and equipment by country was as follows:



|              |  |              |     |                   |   |    
|------------- |  | ------------ | --- | ----------------- | - | ---
|              |  | June 30,2006 |     | September 30,2005
|United States |  | $            | 273 |                   | $ | 324
|Korea         |  |              | 216 |                   |   | 264
|Malaysia      |  |              | 224 |                   |   | 282
|Japan         |  |              | 2   |                   |   | 5  
|              |  |              |     |                   |   |    
|              |  | $            | 715 |                   | $ | 875
|              |  |              |     |                   |   |    

8. Employee Stock Benefit Plans

Share Option Plan

In April 2000, the Company adopted the 2000 Stock Option Plan (the 2000
Plan) which is an incentive plan for employees, directors and consultants and merged the 1995 Stock Option Plan with the 2000 Plan. Upon adoption of the 2000 Plan, shares reserved for issuance under the 1995 Stock Option Plan relating to
un-granted options were cancelled, and outstanding options under the 1995 Plan became subject to the 2000 Plan. The 2000 Plan is administered by the Board of Directors, which is authorized to grant incentive stock options (ISOs) and
non-statutory stock options (NSOs) to employees, directors and consultants for up to 19,300,000 shares of common stock. ISOs may be granted only to employees of the Company (including officers and directors who are also employees). NSOs
may be granted to employees, non-employee directors and consultants of the Company. No person will be eligible to receive more than 500,000 shares in any



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fiscal year pursuant to awards under the 2000 Plan other than a new employee of the Company who will be eligible to receive no more than 1,000,000 shares in
the fiscal year in which such employee commences employment. During the 2004 shareholders meeting, stockholders approved amendments to the 2000 Plan which increased the number of shares of the Companys common stock reserved and available for
grant to 21.3 million. During the 2005 shareholders meeting, stockholders approved amendments to the 2000 Plan which increased the number of shares of the Companys common stock reserved and available for grant to 23.3 million.

Under the 2000 Plan, ISOs and NSOs are granted at a price that is not to be less than 100 percent of the fair market value of the common stock on the
date of grant, as determined by the Board of Directors. Generally, the options granted to new employees under this plan vest over a period of 4 years with 25 percent vesting on the first anniversary date from the date of grant and then monthly
thereafter over the remaining 36 months. Subsequent discretionary stock options, generally vest equally each month over 48 months. Options granted to shareholders who own more than 10 percent of the outstanding stock of the Company at the time of
grant must be issued at prices not less than 110 percent of the estimated fair value of the stock on the date of grant. Options under the 2000 Plan may be granted for periods up to 10 years.

Accounting for share-based compensation

In the first
quarter of fiscal 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payments, which revises SFAS 123, Accounting for Stock-Based Compensation. Prior to fiscal 2006, the
Company applied Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for stock options. Under the APB 25 method, because the Company granted stock
options to employees at exercise prices equal to the fair market value on the date of grant, no compensation cost was recognized for option grants in periods prior to fiscal 2006. In accordance with the Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation, (SFAS 123) and SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, the Company disclosed the pro
forma net loss and net loss per share as if the fair value-based method had been applied in measuring compensation expense for stock-based incentive awards. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 107 (SAB 107) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

Under
SFAS 123(R), the Company is required to select a valuation technique or option-pricing model that meets the criteria as stated in the standard, which includes a lattice model and the Black-Scholes Merton model. For all new stock based compensation
awards granted starting October 1, 2005, and for any modification, cancellation or repurchase of awards granted prior to October 1, 2005, the Company will record compensation cost in the statement of operations based on the fair value of
the award for the requisite service period. The Company adopted the Black-Scholes Merton model. The adoption of SFAS 123(R), applying the modified prospective method, as elected by the Company, requires the Company to value stock options
as of October 1, 2005, the first day of the Companys fiscal year 2006. SFAS 123(R) requires the Company to estimate forfeitures in calculating the expense relating to share-based compensation as opposed to only recognizing these
forfeitures and the corresponding reduction in expense as they occur. This resulted in the Company expensing $468,000 in the third quarter of fiscal 2006 and a total of $1,404,000 for the nine-month period ended June 30, 2006. As of
June 30, 2006, total unrecognized compensation costs related to unvested stock options was $2.6 million, which is expected to be recognized as an expense over a weighted average period of approximately 4 years. The Company adjusted for this
cumulative effect and recognized an increase in stock-based compensation, which was recorded within the research & development and selling, general and administrative (SG&A) expense on the Companys consolidated statement of
operations.

SFAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the
compensation cost recognized for those options to be classified as financing cash flows. Due to the Companys loss position, there were no such tax benefits during the nine months ended June 30, 2006. Prior to the adoption of SFAS 123(R)
those benefits would have been reported as operating cash flows had the Company received any tax benefits related to stock option exercises.

Prior to adopting the provisions of SFAS No. 123(R), the Company recorded estimated compensation expense for employee stock options based upon their intrinsic value on the date of grant pursuant to Accounting Principles Board Opinion
25 (APB 25), Accounting for Stock Issued to Employees and provided the required pro forma disclosures of SFAS No. 123. Because the Company established the exercise price based on the fair market value of the Companys stock at
the date of grant, the stock options had no intrinsic value upon grant, and therefore no estimated expense was recorded prior to adopting SFAS No. 123(R).

The following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123(R) to options granted under the Companys stock option
plans in all periods presented prior to the adoption. For purposes of this pro forma disclosure, the value of the options was estimated using a



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Black-Scholes-Merton (BSM) option-pricing formula and amortized on a straight-line basis over the respective vesting periods of the awards.
Pro-forma disclosures for the three months ended and nine months ended June 30, 2006 are not presented because share-based payments were accounted for under SFAS 123(R) during these periods.



|                                                                                                                                                                                 |  |                                 |        |   |                                |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------- | -
|                                                                                                                                                                                 |  | Three MonthsEnded June 30, 2005 |        |   | Nine MonthsEnded June 30, 2005 |  
|Net loss applicable to common stockholders, as reported                                                                                                                          |  | $                               | (3,829 | ) |                                | $ | (8,485  | )
|Total stock-based employee compensation expense included in the net loss, determined under the recognition and measurement principles of APB
Opinion No. 25, net of income taxes |  |                                 | 14     |   |                                |   | 95      |  
|Total stock-based employee compensation expense determined under fair value based method for all awards, net of income taxes                                                     |  |                                 | (681   | ) |                                |   | (2,045  | )
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |         |  
|Pro forma net loss applicable to common stockholders                                                                                                                             |  | $                               | (4,496 | ) |                                | $ | (10,435 | )
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |         |  
|Loss per share:                                                                                                                                                                  |  |                                 |        |   |                                |   |         |  
|Basic and dilutedas reported                                                                                                                                                    |  | $                               | (0.07  | ) |                                | $ | (0.16   | )
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |         |  
|Basic and dilutedpro forma                                                                                                                                                      |  | $                               | (0.08  | ) |                                | $ | (0.19   | )
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |         |  

Share-Based Compensation Information under SFAS No. 123(R)

The weighted-average fair value of stock-based compensation is based on the single option valuation approach and is estimated on the date of grant using a
Black Scholes Merton based option valuation model. The fair value of forfeitures are estimated and no dividends had been declared. The fair value as of June 30, 2006 was calculated with the following assumptions (annualized percentages):



|                          |  |                                 |  
|------------------------- |  | ------------------------------- | -
|                          |  | Nine Months Ended June 30, 2006 |  
|Estimated fair value      |  | 0.24                            |  
|Expected lives (in years) |  | 4.4                             |  
|Volatility                |  | 118                             | %
|Risk-free interest rate   |  | 5.18                            | %
|Dividend yield            |  | 0                               | %

The Company used implied volatility of market-traded options of the Companys stock
exclusively for the expected volatility assumption input to the Black Scholes Merton model. The risk-free interest rate assumption is based upon the US Treasury yield curve in effect at the time of the grant. The Company has historically not
declared dividends, thus the dividend yield was assumed to be zero in the model.

The following table summarizes stock option activity
under the Companys Stock Option Plans (in thousands, except per share data):



|                               |  |        |   |  |                                         |      |                                           |     |                          |    
|------------------------------ |  | ------ | - |  | --------------------------------------- | ---- | ----------------------------------------- | --- | ------------------------ | ---
|Options                        |  | Shares |   |  | Weighted AverageExercise Price PerShare |      | Weighted AverageRemainingContractual Life |     | AggregateIntrinsic Value
|Outstanding at October 1, 2005 |  | 10,303 |   |  | $                                       | 2.20 |                                           |     |                          |    
|Granted                        |  | 320    |   |  | $                                       | 0.35 |                                           |     |                          |    
|Exercised                      |  | (48    | ) |  | $                                       | 0.14 |                                           |     |                          |    
|Canceled                       |  | (747   | ) |  | $                                       | 1.91 |                                           |     |                          |    
|                               |  |        |   |  |                                         |      |                                           |     |                          |    
|Outstanding at June 30, 2006   |  | 9,828  |   |  | $                                       | 2.17 |                                           | 6.2 |                          | 360
|                               |  |        |   |  |                                         |      |                                           |     |                          |    
|Vested and expected to vest    |  | 9,009  |   |  |                                         | 2.17 |                                           | 5.9 |                          | 345
|                               |  |        |   |  |                                         |      |                                           |     |                          |    
|Exercisable at June 30, 2006   |  | 7,516  |   |  | $                                       | 2.47 |                                           | 5.6 |                          | 316
|                               |  |        |   |  |                                         |      |                                           |     |                          |    

The weighted-average grant date fair value of options granted during the nine months ended
June 30, was $0.35. The total intrinsic value of options exercised during the nine months ended June 30, 2006 was $11,629.



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Significant options groups outstanding at June 30, 2006 and related weighted average exercise prices
and contractual life information are as follows:



|                         |  |                   |  |                                                             |                              |                                         |                                         |                                |           |  |   |      
|------------------------ |  | ----------------- |  | ----------------------------------------------------------- | ---------------------------- | --------------------------------------- | --------------------------------------- | ------------------------------ | --------- |  | - | -----
|                         |  | NumberOutstanding |  | Options Outstanding Weighted AverageContractual Life(Years) |                              | Weighted AverageExercise Price PerShare |                                         | Options Vested and Exercisable
|Range of Exercise Prices |  |                   |  |                                                             | Number Vestedand Exercisable |                                         | Weighted AverageExercise PricePer Share
|$ 0.00 - $ 2.79          |  | 8,102,317         |  | 6.6                                                         |                              | $                                       | 0.83                                    |                                | 5,934,920 |  | $ | 0.78 
|$ 2.79 - $ 5.59          |  | 773,959           |  | 5.3                                                         |                              | $                                       | 4.41                                    |                                | 629,162   |  | $ | 4.45 
|$ 5.59 - $ 8.38          |  | 71,000            |  | 4.6                                                         |                              | $                                       | 6.46                                    |                                | 71,000    |  | $ | 6.46 
|$ 8.38 - $ 13.97         |  | 846,000           |  | 3.6                                                         |                              | $                                       | 11.98                                   |                                | 846,000   |  | $ | 11.98
|$13.97 - $ 16.76         |  | 30,000            |  | 4.4                                                         |                              | $                                       | 16.19                                   |                                | 30,000    |  | $ | 16.19
|$16.76 - $ 22.35         |  | 5,000             |  | 4.3                                                         |                              | $                                       | 21.75                                   |                                | 5,000     |  | $ | 21.75
|                         |  |                   |  |                                                             |                              |                                         |                                         |                                |           |  |   |      
|                         |  | 9,828,276         |  | 6.2                                                         |                              | $                                       | 2.17                                    |                                | 7,516,082 |  | $ | 2.47 

Share based compensation expense attributable to individuals that worked in the following
functions is as follows (in thousands):



|                                        |  |                                |     |                               |   |      
|--------------------------------------- |  | ------------------------------ | --- | ----------------------------- | - | -----
|                                        |  | Three MonthsEnded June 30,2006 |     | Nine MonthsEnded June 30,2006
|Research and development                |  | $                              | 275 |                               | $ | 831  
|Selling, general and administrative     |  |                                | 193 |                               |   | 573  
|Capitalized as part of cost of an asset |  |                                | 0   |                               |   | 0    
|                                        |  |                                |     |                               |   |      
|Total share-based compensation          |  | $                              | 468 |                               | $ | 1,404
|                                        |  |                                |     |                               |   |      

Total cash received as a result of the exercise of options during the three months ended
June 30, 2006 was $3,667.90. Total cash received as a result of options exercised during the nine months ended June 30, 2006 was $8,243.57. There were no equity instruments granted under share-based payment arrangements and therefore there
was no cash used to settle any equity instrument. The Company does not plan to repurchase any shares during the upcoming annual period.

2000
Employee Stock Purchase Plan

In April 2000 the Company adopted the 2000 Employee Stock Purchase Plan (the Purchase
Plan) under which 500,000 shares of common stock has been reserved for issuance. . During the 2005 shareholders meeting, stockholders approved amendments to the Purchase Plan which increased the number of shares of the Companys common
stock reserved for issuance to 1 million.

Eligible employees may elect to withhold up to 15 percent of their salary to purchase shares of
the Companys common stock at a price equal to 85 percent of the market value of the stock at the beginning or ending of a six month offering period, whichever is lower. No more than 5,000 shares may be purchased by an eligible employee during
any calendar year. The Purchase Plan will terminate in 2010. Under the Purchase Plan, no shares were issued during the three months ended June 30, 2006. These shares have been valued using the Black Scholes Merton model to assess the fair value
of the shares. These adjustments have been reflected on the Companys statement of operation.

9. Convertible Debt

In November 2005, the Company entered into the Securities Purchase Agreement with the purchasers named therein (the
Purchasers). The transaction closed on November 8, 2005. Pursuant to the Securities Purchase Agreement, the Purchasers purchased 6% Senior Secured Convertible Debentures (the Debentures) in aggregate principal amount of
$5,000,000 together with Series A Warrants and Series B Warrants. The Company is using the proceeds of the financing to finance on-going operations. The Company has also entered into a Security Agreement dated November 8, 2005 by and between
the Company and the signatories thereto (the Security Agreement), pursuant to which the Debentures are secured by all of the assets of the Company, including the Companys intellectual property. Interest is payable on the Debentures
at a rate of 6% per annum. Monthly principal and interest payments on the Debentures began on April 8, 2006. At the option



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of the Company, interest payments on the Debentures are payable either in cash or in registered Common Stock, subject to certain conditions as specified in
the Debentures.

The Debentures have a term of two years and come fully due on November 8, 2007. The Debentures are convertible at the option of the
holder at any time and from time to time into Common Stock of the Company at a conversion price of $0.37 per share, subject to certain adjustments. Pursuant to the terms of the Debentures, the conversion price will be reset (the Reset
Provision) in the event the Company (i) effects a reverse stock split and/or (ii) has its Common Stock delisted from the Nasdaq Capital Market (such delisting occurred on December 8, 2005). The Reset Provision adjusts the
conversion price on the 60th day following any such reverse stock split or delisting to the lower of either the then conversion price or the volume weighted average price of the Companys Common Stock (VWAP) for the 10 trading days
preceding such reset. Because the VWAP on February 6, 2006 was higher than the conversion price of $0.37 per share, no reset occurred due to the December 8, 2005 delisting. Additionally, in the event that the Company issues Common Stock in
an equity financing at a price less than the then conversion price, the conversion price shall be immediately adjusted to the price at which such Common Stock was issued.

Events of default under the Debentures include:



| |  |  | failure to pay principal or any premium on any Debenture when due;
| | - |  | ------------------------------------------------------------------



| |  |  | failure to pay any interest, late fees or liquidated damages on any Debenture after a period of 3 trading days;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | failure to perform other covenants under the Debenture that is not cured by the earlier of 5 trading days after notice by holder or 10 trading days after the Company is aware of
such default;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | default under the other financing documents that is not cured by the earlier of 5 trading days after notice or 10 trading days after the Company is aware of such default;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any representation or warranty under the financing documents that is untrue or incorrect in any material respect;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | certain events of bankruptcy or insolvency of the Company or any of its subsidiaries;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | any default by the Company or its subsidiaries under any instrument in excess of $150,000 that results in such obligation becoming due and payable prior to maturity;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Company becoming party to a change of control transaction, or disposing of greater than 40% of its assets or redeeming more than a de minimus number of outstanding equity
securities;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure by the Company to have its resale registration statement (the Resale Registration Statement) registering the resale of the Common Stock issuable upon the
conversion of the Debentures and the exercise of the Warrants (as defined below) declared effective by the SEC on or prior to April 7, 2006;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if, during the effectiveness period of the Resale Registration Statement, the effectiveness of the registration statement lapses for any reason or the holder shall not be permitted
to resell registrable securities under such Resale Registration Statement, in either case, for more than 20 consecutive trading days or 30 non-consecutive trading days during any 12 month period, subject to certain limited exceptions;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to deliver Common Stock certificates to a holder prior to the third trading day after a Debenture conversion date; or
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | any breach of the Voting Agreement (the Voting Agreement) entered into by Dr. Adya S. Tripathi in connection with the financing to vote shares of the
Companys Common Stock owned by him in favor of any required stockholder approval of the financing to the extent required in order to maintain the listing of the Companys Common Stock on the Nasdaq Capital Market or any successor entity.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Upon an event of default, 130% of the outstanding principal of the Debentures plus all accrued and unpaid interest shall
become immediately due and payable to the holder of the Debentures.

The Debentures contain various covenants that limit the Companys
ability to:



| |  |  | incur additional debt, other than permitted debt as defined in the Debenture;
| | - |  | -----------------------------------------------------------------------------



| |  |  | repay or repurchase more than a de minimus number of shares of Common Stock;
| | - |  | ----------------------------------------------------------------------------



| |  |  | incur specified liens, other than permitted liens as defined in the Debenture; or
| | - |  | ---------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | amend its certificate, bylaws or charter documents in a material adverse manner to the holder.
| | - |  | ----------------------------------------------------------------------------------------------

In addition, as part of the financing, the Company has agreed to be bound by the following covenants:



| |  |  | not to issue shares of Common Stock or other securities convertible or exercisable for Common Stock until 180 days after the effective date of the Resale Registration Statement;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to assume any corporate debt which is senior to the Debentures;
| | - |  | -------------------------------------------------------------------



| |  |  | either to terminate the Companys existing accounts receivable secured credit facility with Bridge Bank or to enter into an inter-creditor agreement with Bridge Bank by
January 7, 2006 to effect the subordination of the facility to the Debentures;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to repay or repurchase more than a de minimus number of shares of Common Stock;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | not to incur specified liens, other than certain specified permitted liens;
| | - |  | ---------------------------------------------------------------------------



| |  |  | not to amend the Companys current Certificate of Incorporation except to effect a reverse stock split or as the result of a delisting of the Companys Common Stock from
the Nasdaq Capital Market; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to pay cash dividends or distributions on its equity securities.
| | - |  | --------------------------------------------------------------------

Pursuant to the Securities Purchase Agreement, the Company also issued Series A Common Stock Warrants and Series B Common Stock Warrants to the Purchasers. The Series A Common Stock Warrants (the
Series A Warrants) were exercisable from November 8, 2005 until July 1, 2006 to purchase up to 6,756,755 shares of Common Stock (the Series A Share Amount) at an exercise price of $0.37 per share (the
Series A Exercise Price). The Series B Common Stock Warrants (the Series B Warrants and together with the Series A Warrants, the Warrants) are exercisable from May 8, 2006 until
May 8, 2011 to purchase up to 10,135,133 shares of Common Stock (the Series B Share Amount, and together with the Series A Share Amount, the Warrant Share Amount) at an exercise price of $0.43 per share, (the
Series B Exercise Price, and together with the Series A Exercise Price, the Warrant Exercise Price).

The
Warrants contain provisions to adjust the Warrant Exercise Price and the Warrant Share Amount in the event that the Company issues Common Stock in an equity financing at a price less than the then applicable Warrant Exercise Price, in which case
(i) the Warrant Exercise Price shall be reduced to the price at which such Common Stock was issued and (ii) the Warrant Share Amount shall be increased such that the aggregate Warrant Exercise Price payable, after taking into account the
decrease in the Warrant Exercise Price, shall be equal to the aggregate Warrant Exercise Price prior to such adjustment. The Warrants also may be net exercised on a cashless basis. The Warrants contain a call provision, pursuant to which the
Warrants can be called by the Company on 20-days notice if the Common Stock price per share of the Company closes for 10 consecutive trading days at or above (i) 150% of the Series A Exercise Price with respect to the Series A
Warrants and (ii) 250% of the Series B Exercise Price with respect to the Series B Warrants, so long as the Common Stock is traded on the Nasdaq National Market, the Nasdaq Capital Market or the OTC Bulletin Board.

In February 2006, the Company proposed to the holders of the Series A Warrants that upon the exercise of Series A Warrants, the Company would issue new
warrants in exchange for the exercise of the Series A Warrants. On February 14, 2006, the holders of the Series A Warrants exercised their Series A Warrants and the Company issued 6,756,755 shares of common stock for aggregate proceeds of $2.5
million and the Company issued new warrants at a strike price of $0.315 per share on 6,081,079 shares of the Companys common stock; such new warrants terminate on July 1, 2007.

The financing was completed through a private placement to accredited investors and is exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933, as amended. Pursuant to the Registration Rights Agreement with the Purchasers dated November 8, 2005 (the Registration Rights Agreement), the Company agreed to file a Resale Registration Statement covering
the resale of the shares issuable to the investors upon the conversion of the Debentures and the exercise of the Warrants within 30 days of the closing of the financing. In addition, as long as the Debentures remain outstanding, the holders of the
Debentures have the right to participate in the Companys future equity or equity-linked financings. In connection with consummating the financing pursuant to the Securities Purchase Agreement, the Company has paid fees to its financial advisor
of $150,750 and has issued warrants to its financial advisor to purchase up to 233,721 shares of the Companys Common Stock on the same terms as the Series B Warrants (exercisable from May 8, 2006 until May 8, 2011 at an exercise
price of $0.43 per share).

The proceeds to the Company for the Debentures and the Series A Warrants and Series B Warrants issued to the
investors were $5.0 million. The Company paid legal expenses and a finders fee of $150,750 in commissions and Series B



15



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##### Table of Contents

Common Stock Warrants to acquire 233,721 shares of the Companys common stock in connection with the financing. The Series B Common Stock Warrants
issued are exercisable at $0.43 per share. The Company ascribed the value of $95,826 to the finders fee warrants which is recorded along with the finders fee of $150,750 as a warrant liability cost in the balance sheet at
December 31, 2005. The fair value ascribed to the finders fee Series B Common Stock Warrants was estimated on the commitment date using the Black-Scholes-Merton pricing model with the following assumptions: risk-free interest rate of
4.51%; contractual term of 5 years; expected volatility of 145.04%; and expected dividend yield of 0%. The fair value of the finder fee warrants were subsequently revalued to $56,093 at June 30, 2006 using the Black Scholes Merton Model. This
change in value was reflected in the companys consolidated statement of operations for the three and nine month periods ended June 30, 2006.

If the aggregate principal amount owing under the Debentures is converted, the Company will issue 17,125,609 shares, which may be adjusted pursuant to the reset provisions in the Debentures, of its common stock. The
Company did, in fact, trigger such reset provision when the Companys Common Stock was delisted from the NASDAQ on December 8, 2005. The reset provision in the Debentures adjusts the conversion price on the 60th day following the
delisting, or on February 6, 2006, to the lower of either the then conversion price or the volume weighted average price of the Companys Common Stock (VWAP) for the 10 trading days preceding such reset. The VWAP for these 10
days was $0.417, and therefore the Debenture conversion price remained at $0.37. The first payment of principal and accrued but unpaid interest was due on April 8, 2006 and since the Debentures were not converted, additional payments will be
due on the first of each month thereafter with the final payment due on November 8, 2007. The Company may pay accrued interest in cash or in shares of Company common stock, if during the ten trading days immediately prior to such interest
payment the daily VWAP of the Common Stock is equal to or greater than 115% of the conversion price prior to such interest payment. The Company does not currently intend to pay accrued interest with shares of its common stock.

In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities,
(FASB 133), the Company determined that the conversion feature of the Debentures met the criteria of an embedded derivative and therefore the conversion feature of the debt needed to be bifurcated and accounted for as a derivative.
Due to the reset provisions of the Debentures, the debt does not meet the definition of conventional convertible debt because the number of shares which may be issued upon the conversion of the debt is not fixed. Furthermore, there is no
cap on the number of shares that could be issued in the event that the Company is delisted from the Nasdaq or one of the other reset provisions is triggered. Therefore, the conversion feature fails to qualify for equity classification under
EITF 00-19, and must be accounted for as a derivative liability.

The fair value of the conversion option was estimated at the
issuance date, November 8, 2005, using the Black-Scholes-Merton option pricing model using the following assumptions:

Stock price of
$0.45;

Exercise price of $.138;

Contractual term of 2 years;

Volatility of 96.43%;

Expected yield of 0%; and

Risk-free interest rate of 4.51%.

The Company determined the exercise price per share for the conversion feature by computing the discounted net present value (DNPV) of the debt ($5,000,000 plus interest
at 6% over two years, discounted at 18.6%) and dividing the DNPV amount by the total number of shares the debt is convertible into. The 18.6% discount factor is the Companys estimate of the appropriate rate of return that an investor would
expect from a similar debenture not taking into consideration the conversion feature or warrants. As a result, the Company ascribed a value of $4,733,295 to the derivative at the date of issuance. The fair value of the conversion feature was
subsequently revalued to $2,527,026 at June 30, 2006 with the change in value reflected in the Companys consolidated statement of operations for the three month and nine month periods ended June 30, 2006.

The Company ascribed a value at the issuance date, November 8, 2005, of $1,148,648 to the Series A Warrants. The Series A Warrants issued in the
financing transaction were free-standing derivatives accounted for under FAS 133. The fair value as of the issuance date ascribed to the Series A Warrants was estimated on the commitment date using the Black-Scholes-Merton pricing model. On
February 14, 2006, the holders of the Series A Warrants exercised their rights and the Company issued 6,756,755 shares of common stock for aggregate proceeds of $2.5 million. The warrant liability recorded for the Series A Warrants was revalued
before the conversion and then subsequently all were reversed as a result of the



16



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##### Table of Contents

exercise. The Company issued new warrants to these same investors at a strike price of $0.315 per share on 6,081,079 shares of the Companys common
stock expiring on July 1, 2007. The fair value of the new warrants were ascribed a fair value of $1,641,891 which was recorded as a credit to warrant liability and were subsequently revalued to $729,730 at June 30, 2006 using the Black
Scholes Merton method. This change in value was reflected in the Companys consolidated statement of operations for the three month and nine month periods ended June 30, 2006.

The Company ascribed a value at the issuance date, November 8, 2005, of $4,155,405 to the Series B Warrants. The Series B Warrants issued in the
financing transaction are free-standing derivatives accounted for under FAS 133. The fair value ascribed to the Series B Warrants was estimated on the commitment date using the Black-Scholes-Merton pricing model with the following assumptions:

Stock price of $0.45;

Exercise price of $0.43;

Contractual term of 5.0 years;

Volatility of 145.04%;

Expected yield of
0%; and

Risk-free interest rate of 4.51%.

The Black-Scholes-Merton model resulted in a fair value of $0.41 for the Series B Warrants and therefore a warrant liability in the amount of $4,155,405 was recorded as a credit to warrant liability in the
Companys Balance Sheet. The fair value of the Series B Warrants were subsequently revalued to $2,432,432 at June 30, 2006 using the Black-Scholes-Merton model. This change in value was reflected in the Companys consolidated
statement of operations for the three month and nine month periods ended June 30, 2006.

The $5,000,000 face amount of the Debentures
was stripped of its conversion feature due to the accounting for the conversion feature as a derivative, which was recorded using the residual proceeds method, whereby any remaining proceeds after allocating the proceeds to the Warrants and
conversion option would be attributed to the debt. Since the combined fair values of the Warrants and the conversion option at issuance of $10,037,348 was in excess of the total proceeds on the transaction, the debt was recorded at a net zero value.
As a result, the Company recorded the amount of the value ascribed to the conversion feature and the Warrants that exceeded proceeds from the financing of $5,000,000 as interest expense in the Companys consolidated statement of operations for
the nine month ended June 30, 2006. This resulted in a charge of $5.037 million to interest expense leaving a net debt discount value of $5 million. The debt discount of $5 million is being accreted and recognized as interest expense from the
date of issuance to the stated redemption date using the effective yield method.

The following table reflects the
Convertible Debt at June 30, 2006:



|                                         |  |   |            |  
|---------------------------------------- |  | - | ---------- | -
|Convertible Debt                         |  | $ | 4,250,000  |  
|Less: Current portion of debt discount   |  |   | (2,500,000 | )
|Less: Long-term portion of debt discount |  |   | (897,260   | )
|                                         |  |   |            |  
|                                         |  | $ | 852,740    |  
|                                         |  |   |            |  

The debt has the following principal amounts due over the remaining life as follows:



|                              |  |   |          
|----------------------------- |  | - | ---------
|Year ended September 30, 2006 |  | $ | 750,000  
|Year ended September 30, 2007 |  | $ | 3,000,000
|Year ended September 30, 2008 |  | $ | 500,000  



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##### Table of Contents

The following table summarizes the charges to interest, amortization and other expense, net for the three and nine months
ended June 30, 2006:



|                                                  |  |                                    |         |                                    |   |          
|------------------------------------------------- |  | ---------------------------------- | ------- | ---------------------------------- | - | ---------
|                                                  |  | For the 3months endedJune 30, 2006 |         | For the 9months endedJune 30, 2006
|Excess value from conversion feature and warrants |  | $                                  |        |                                    | $ | 5,037,348
|Amortization of finders fees                      |  |                                    | 18,792  |                                    |   | 48,323   
|Amortization of finders warrants                  |  |                                    | 12,077  |                                    |   | 30,848   
|Interest expense on debt                          |  |                                    | 159,480 |                                    |   | 277,015  
|Accretion of debt discount                        |  |                                    | 623,288 |                                    |   | 1,602,740
|Interest expense on capital leases and other      |  |                                    | 85,292  |                                    |   | 113,873  
|Taxes                                             |  |                                    |        |                                    |   | 800      
|                                                  |  |                                    |         |                                    |   |          
|                                                  |  | $                                  | 898,928 |                                    | $ | 7,110,946
|                                                  |  |                                    |         |                                    |   |          

The Series B Warrants and Finders Fee Warrants expire on May 8, 2011. The Company may
call the Series B Warrants and Finders Fee Warrants if the Companys common stock trades at 250% of the Series B and Finders Fee Warrants Exercise Price or above for 10 consecutive trading days after the date that is 10 days
following the effectiveness of the registration statement providing for the resale of the shares issued upon the conversion of the Debentures and exercise of the Warrants (December 21, 2005). The Company would receive proceeds of approximately
$4,458,607 for the Series B Warrants and Finders Fee Warrants if all of the Series B Warrants and Finders Fee Warrants are exercised.

Under the Registration Rights Agreement, the Company was required to file a registration statement providing for the resale of the shares that are issuable upon the conversion of the Debentures and the exercise of the Warrants. Such
registration statement was filed on December 8, 2005, and was declared effective on December 21, 2005. This registration statement on Form S-1 has been updated to maintain effectiveness pursuant to rules promulgated by the SEC.

The Registration Rights Agreements from the Companys March 2005 financing and from its November 2005 financing have clauses for liquidated
damages. The Company could potentially incur significant cash liquidated damages for failure to register or maintain an effective registration statement for the shares underlying the transactions. If the Company fails to have the registration
statement declared effective within the specified period, the Company would be required to pay liquidated damages to the investor(s) until:



| |  |  | The registration statement is declared effective;
| | - |  | -------------------------------------------------



| |  |  | Effectiveness is maintained for a prescribed period; or
| | - |  | -------------------------------------------------------



| |  |  | Investor is no longer incurring damages for the issuers failure to register the securities (e.g. if the securities become freely transferable after a holding period under Rule
144 of the Securities Act of 1933)
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Liquidated damages penalties are paid in cash and the amount is determined by a formula
(in the case of the November 2005 Registration Rights Agreement, 2% of the aggregate purchase price paid by the holder of the securities covered by the Registration Rights Agreement). As of June 30, 2006, the maximum cash penalty that could be
payable in the event of a breech of the Registration Rights Agreement from the November 2005 financing is 130% of the outstanding principle amount of the Debentures plus all accrued and unpaid interest would become immediately due and payable.

In accordance with Emerging Issues Task Force (EITF) Issue 05-4, the Company believes that the effect of the liquidated damages should be
treated under the first view (View A), which states that a registration rights agreement should be treated as a combined unit together with the underlying financial instruments, warrants and derivative debenture and evaluated as a single instrument
under EITF Issue 00-19 and FAS 133. The Company concluded that this view is the most appropriate for the transaction. Accordingly the Registration Rights Agreement and the financial instruments to which it pertains (the warrants and the convertible
debentures) were considered a combined instrument and accounted for accordingly.

10. Warrant Liability

In conjunction with the issuance of convertible debt, the Company has issued various warrants that have registration rights for the underlying shares. As
the contracts must be settled by the delivery of registered shares and the delivery of registered shares is not considered by the Company, pursuant to Emerging Issues Task Force (EITF) 00-19 Accounting for Exercise Finance Instruments Indexed
to, and Potentially Settled in a Companys Own Stock, the net value of the warrants at the date of issuance was recorded as a warrant liability on the balance sheet and the change in fair value from the date of issuance to June 30,
2006 has been included in change in fair value on revaluation of warrant liability.



18



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##### Table of Contents

The following table reflects the number of the warrants outstanding and the warrant liability at
June 30, 2006:



|                                                    |  |               |       |                |           |                         |            |                  |   |            |  
|--------------------------------------------------- |  | ------------- | ----- | -------------- | --------- | ----------------------- | ---------- | ---------------- | - | ---------- | -
|                                                    |  | ExercisePrice |       | ExpirationDate |           | # ofWarrantsOutstanding |            | WarrantLiability |  
|Series B Warrants                                   |  | $             | 0.37  |                | 5/8/2011  |                         | 10,135,133 |                  | $ | 4,155,405  |  
|Finders Fee Warrants                                |  |               | 0.37  |                | 5/8/2011  |                         | 233,721    |                  |   | 95,826     |  
|Warrants from March 2005 Financing                  |  |               | 1.25  |                | 3/3/2008  |                         | 433,334    |                  |   | 177,667    |  
|New Warrants issued February 2006                   |  |               | 0.315 |                | 7/1/2007  |                         | 6,081,080  |                  |   | 1,641,891  |  
|Warrants granted in 1998 (London/Arrillaga)         |  |               | 1.5   |                | 2/2/2008  |                         | 10,000     |                  |   | 0          |  
|Warrants granted in 2000 (AYSIS Corp.)              |  |               | 12    |                | 7/28/2010 |                         | 6,000      |                  |   | 0          |  
|Less Change in fair value of warrant liability for: |  |               |       |                |           |                         |            |                  |   |            |  
|Series B Warrants                                   |  |               |       |                |           |                         |            |                  |   | (1,722,973 | )
|Finders Fee Warrants                                |  |               |       |                |           |                         |            |                  |   | (39,733    | )
|Warrants from March 2005 Financing                  |  |               |       |                |           |                         |            |                  |   | (134,334   | )
|New Warrants issued February 2006                   |  |               |       |                |           |                         |            |                  |   | (912,162   | )
|                                                    |  |               |       |                |           |                         |            |                  |   |            |  
|                                                    |  |               |       |                |           |                         |            |                  | $ | 3,261,588  |  
|                                                    |  |               |       |                |           |                         |            |                  |   |            |  

In October 2005, we proposed amending the warrants issued as part of the March 2005 private
placement. The holders of warrants to exercise 533,333 shares of the Companys common stock agreed to the amendment, which lowered the exercise price of the warrants to $0.50 per share, eliminated the cashless net exercise provision of the
warrant, and advanced the warrant termination date to October 14, 2005. The Company issued 533,333 shares of common stock upon the exercise of such amended warrants on October 14, 2005 for aggregate proceeds of $0.3 million.

The values ascribed to the warrants and conversion feature of the Debentures follow the guidance of the EITF Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, EITF 00-19: Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own
Stock, FAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments
of the FASBs Emerging Issues Task Force. The debt discount associated with the warrants from the November financing is amortized to interest expense over the life of the Debentures or upon earlier conversion of the Debentures using the
effective yield method.

11. Commitments and contingencies

Lease commitments: The Company leases office space and equipment under non-cancelable operating leases. The Company also has a capital lease for research and development related software and a capital lease for
manufacturing test equipment.

On January 20, 2006, the Company signed an amendment to the existing Cadence lease for
development engineering tools with Cadence Design Systems, Inc. (Cadence) revising the payment schedule and extending the optional maintenance through year 2008. The maintenance renewal is optional and may be canceled if 90 day notice is
given to Cadence. The total capital lease principle amount does not change. The total payments that will have been made at the end of the term will be approximately $900,000.

The Companys total commitments on its operating and capital leases and inventory purchases as of June 30, 2006, were as follows (in
thousands):



|                                                   |  |                 |     |               |   |      |  
|-------------------------------------------------- |  | --------------- | --- | ------------- | - | ---- | -
|Year ending June 30, 2006                          |  | OperatingLeases |     | CapitalLeases |  
|2006                                               |  | $               | 313 |               | $ | 94   |  
|2007                                               |  |                 | 590 |               |   | 87   |  
|2008                                               |  |                 | 51  |               |   | 66   |  
|                                                   |  |                 |     |               |   |      |  
|Total minimum lease payments                       |  | $               | 954 |               |   | 247  |  
|                                                   |  |                 |     |               |   |      |  
|Less: amount representing interest                 |  |                 |     |               |   | (79  | )
|                                                   |  |                 |     |               |   |      |  
|Present value of minimum lease payments            |  |                 |     |               |   | 168  |  
|Less: current portion of capital lease obligations |  |                 |     |               |   | (103 | )
|                                                   |  |                 |     |               |   |      |  
|Long-term capital lease obligations                |  |                 |     |               | $ | 65   |  
|                                                   |  |                 |     |               |   |      |  



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##### Table of Contents

Contingencies: From time to time, in the normal course of business, various claims could be made
against the Company. At June 30, 2006, there were no pending claims the outcome of which is expected to result in a material adverse effect on the financial position or results of operations of the Company.

12. Guarantees

In November 2002, the FASB issued
FIN No. 45 Guarantors Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Othersan interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34.
The following is a summary of the Companys agreements that the Company has determined are within the scope of FIN 45.

The Company
provides a limited warranty for up to one year for any defective products. During the quarters ended June 30, 2006 and June 30, 2005, warranty expense was insignificant. The Company no longer caries a reserve for warranty costs.

In March 2004, the Company entered into a Security Agreement to provide collateral for an outstanding standby letter of credit which
continued to be in the amount of $0.2 million at June 30, 2006.

Pursuant to its bylaws, the Company has agreed to indemnify its
officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. The term of the indemnification period is for the officers or directors lifetime. To date, the Company has
not incurred any costs in connection with these indemnification agreements. Accordingly, the Company has no liabilities recorded for these agreements as of June 30, 2006. During the quarter ended December 31, 2004 the Company obtained a
new Directors and Officers (D&O) Liability Insurance policy. This policy has been renewed for 2005 through December 2006. However, this new D&O policy does not cover the lawsuits described in Note 14 below, although the claims
involved in these lawsuits may be covered by the aforementioned indemnification agreements.

The Company enters into indemnification
provisions under (i) its agreements with other companies in its ordinary course of business, typically with business partners, contractors, customers, and its sublandlord and (ii) its agreements with investors. Under these provisions the
Company has agreed to generally indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Companys activities or, in some cases, as a result of the indemnified partys
activities under the applicable agreement. These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights. These indemnification provisions generally
survive termination of the underlying agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. To date, the Company has not incurred any costs in connection
with these indemnification agreements. Accordingly, the Company has no liabilities recorded for these agreements as of June 30, 2006.

13. Recent
Accounting Pronouncements

In March 2005, the FASB issued FSP No. 46(R)-5, Implicit Variable Interests under FASB
Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (FSP 46(R)-5), which provides guidance for a reporting enterprise on whether it holds an implicit variable interest in a variable interest
entity (VIE) or potential VIE when specific conditions exist. FSP 46(R)-5 became applicable to the Company in the quarter ended June 30, 2005. FSP 46(R) had no impact on the Companys consolidated results of operations and financial
condition as of September 30, 2005.

In March 2005, the FASB issued FIN 47, Accounting for Conditional Asset Retirement
Obligations, an interpretation of FASB Statement No. 143 (FIN 47), which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liabilitys fair value can
be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company is currently evaluating the effect that the adoption of FIN 47 will have on the Companys consolidated results of
operations and financial condition, but does not expect it to have a material impact.

In May 2005, the FASB issued SFAS No. 154
Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20, and FASB Statement No. 3 (SFAS 154). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and FASB Statement
No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting
principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those
provisions should be followed. SFAS 154 is effective for accounting changes and corrections of errors



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made in fiscal years beginning after December 31, 2005. The Company does not anticipate that the adoption of this standard will have a material impact
on its consolidated financial statements.

In February 2006, the FASB decided to move forward with the issuance of a final FSP FAS 123R-4,
Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. The guidance in this FSP FAS 123R-4 amends paragraphs 32 and A229 of FASB
Statement No. 123R to incorporate the concept articulated in footnote 16 of FAS 123R. That is, a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employees control does not
meet the condition in paragraphs 32 and A229 until it becomes probable that the event will occur. Originally under FAS 123R, a provision in a share-based payment plan that required an entity to settle outstanding options in cash upon the occurrence
of any contingent event required classification and accounting for the share based payment as a liability. This caused an issue under certain awards that require or permit, at the holders election, cash settlement of the option or similar
instrument upon (a) a change in control or other liquidity event of the entity or (b) death or disability of the holder. With this new FSP, these types of cash settlement features will not require liability accounting so long as the
feature can be exercised only upon the occurrence of a contingent event that is outside the employees control (such as an initial public offering) until it becomes probable that event will occur. The guidance in this FSP shall be applied upon
initial adoption of Statement 123(R). An entity that adopted Statement 123(R) prior to the issuance of the FSP shall apply the guidance in the FSP in the first reporting period beginning after February 2006. Early application of FSP FAS 123R-4 is
permitted in periods for which financial statements have not yet been issued. The Company does not anticipate that this new FSP will have any material impact upon its financial condition or results of operations.

In February 2006, the FASB issued FASB Statement No. 155, Accounting for Certain Hybrid Instruments. This standard amends the guidance in FASB
Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Statement 155 allows financial instruments that
have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. Management is currently evaluating the impact
FASB 155 will have on our consolidated financial statements.

In September 2005, the Financial Accounting Standards Board Emerging Issues
Task Force issued EITF 05-02, The Meaning of Conventional Convertible Debt Instrument in EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own
Stock. EITF 05-02 is effective for new instruments entered into and instruments modified in reporting periods beginning after June 29, 2005. We do not expect there to be a material impact from the adoption of EITF 05-02 on our
consolidated financial position, results of operations, or cash flows.

In June 2006, the FASB issued FASB Interpretation (FIN) No. 48,
Accounting for Uncertainty in Income Taxes, that provides guidance on the accounting for uncertainty in income taxes recognized in financial statements. The interpretation will be adopted by us on January 1, 2007.

We are currently evaluating the impact of adopting FIN 48; however, we do not expect the adoption of this provision to have a material effect on our
financial position, results of operations or cash flows.

14.Litigation

From time to time, the Company becomes subject to various legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of
business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of
these lawsuits would materially adversely affect the Companys business, results of operations, or financial condition. In addition, given the Companys financial condition and that there is not sufficient insurance coverage to offset the
cost of litigation, the costs of defending one or more of these lawsuits will likely adversely affect the Companys financial condition. The Company cannot estimate the loss or range of loss that may be reasonably possible for any of the
contingencies described and accordingly have not recorded any associated liabilities in the Companys consolidated balance sheets. The Company accrues legal costs when incurred.

SEC Investigation

On or about
November 9, 2004, the SEC requested that the Company voluntarily produces documents responsive to certain document requests in the investigation entitled In the Matter of Tripath Technology, Inc. On or about January 25, 2005,
February 14, 2005, and February 16, 2005, the SEC made additional documents requests. On or about March 30, 2005, the SEC issued a subpoena to the Company seeking additional documents. The Company has produced documents in response to
the SECs voluntary requests for documents as well as the subpoena. The Company has cooperated with the SEC in its review of these matters.

On February 24, 2005, the SEC, pursuant to Section 20(a) of the Securities Act and Section 21(a) of the Exchange Act, issued a formal order of private investigation to determine whether there have been any violations of
Section 17(a) of



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the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-13, 13a-14, 13b2-1
and 13b2-2 thereunder.

In a letter dated December 15, 2005, the SEC indicated that the formal investigation of the Company had been
terminated and that no enforcement action has been recommended to the Commission.

Federal Securities Class Actions

Beginning on November 4, 2004, plaintiffs filed four separate complaints purporting to be class actions in the United States District Court for the
Northern District of California alleging that the Company and certain of the Companys present or former officers and/or directors, Dr. Adya S. Tripathi, David Eichler and Graham Wright, violated Sections 10(b) and 20(a) of the
Exchange Act. Plaintiffs purported to represent a putative class of shareholders who purchased or otherwise acquired Tripath securities between January 29, 2004 and October 22, 2004. The complaints contain varying allegations, including
that the Company and the individual defendants made materially false and misleading statements with respect to financial results and with respect to the Companys business, prospects and operations in the Companys filings with the SEC,
press releases and other disclosures. The complaints seek unspecified compensatory damages, attorneys fees, expert witness fees, costs and such other relief as may be awarded by the Court.

On December 22, 2004, the Court entered a stipulation and order consolidating all of these complaints and ordering that the defendants need not
respond to any of these complaints until after plaintiffs file a consolidated complaint. On January 4, 2005, plaintiffs filed motions for the appointment of lead plaintiff. The Court, by Order dated January 28, 2005, appointed Robert
Poteet as the sole lead plaintiff and approved Milberg Weiss Bershad & Schulman LLP as lead counsel.

On July 11, 2005, the
Company entered into a Stipulation and Settlement Agreement (the Stipulation) which was filed with the Court on July 12, 2005. The settlement class consists of all persons who purchased the securities of Tripath between
January 29, 2004 and June 13, 2005, inclusive. Under the terms of the Stipulation, the parties agreed that the class action will be dismissed in exchange for a payment of $200,000 in cash by Tripath and the issuance of 2.45 million
shares of Tripath common stock which shall be exempt from registration pursuant to Section 3(a)(10) of the Securities Act. The Stipulation remains subject to the satisfaction of various conditions, including without limitation final approval of
the Stipulation by the Court, including a finding that the 2.45 million shares of Tripath common stock to be issued are exempt from registration. On October 20, 2005, the Court entered a Preliminary Order for Notice and Hearing in
Connection with Settlement Proceedings.

Following on April 11, 2006 hearing, the Court entered an Order and Final Judgment on
April 18, 2006 which finally approved the settlement, awarded attorneys fees and authorized the reimbursement of expenses and entered judgment dismissing all of the complaints on the merits and with prejudice in favor of the defendants.
Approximately $1.8 million has been accrued for this matter.

Derivative Shareholder Litigation

On December 7, 2004, plaintiff Mildred Lyon filed a purported derivative action in Santa Clara Superior Court against the Company and the following
present or former officers and/or directors of the Company, Dr. Adya S. Tripathi, David P. Eichler, Graham K. Wright, A.K. Acharya, Andy Jasuja and Y.S. Fu. This complaint appears to be based upon the same facts and circumstances as
the federal class actions and makes the following claims: violation of Section 25402 of the California Corporations Code, breach of fiduciary duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate
assets and unjust enrichment. On this basis, the complaint seeks unspecified compensatory damages, treble damages under Section 25502.5(a) of the California Corporations Code, extraordinary equitable and/or injunctive relief, restitution and
disgorgement, attorneys fees, expert witness fees, costs, and such other relief as may be ordered by the Court.

On December 27,
2004, the Court entered a stipulation and order extending the time for the Company to respond to the complaint to February 23, 2005. On February 16, 2005, the Court entered an order further extending the time for us to respond to the
complaint to March 25, 2005. On March 10, 2005, the court ordered that the individual defendants shall have through and including April 25, 2005 to file any motions to quash and/or dismiss for lack of personal jurisdiction, and that
all defendants shall have thirty (30) days from the date the court issues a ruling on any motions to quash and/or dismiss for lack of personal jurisdiction to respond to the complaint, or in the event that no such motions are brought, extended
the time for all defendants to respond to the complaint to April 25, 2005.

On April 4, 2005, the Court ordered that all
deadlines shall be stayed for Defendants filing any motions to quash and/or dismiss for lack of personal jurisdictions, or otherwise respond to the Complaint, until such date as the parties mutually designate to the Court for the Courts
approval.



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On July 24, 2006, the Company entered into a Stipulation of Settlement of Derivative Claims (the
Derivative Stipulation). Under the terms of the Derivative Stipulation, the parties agreed that the action will be dismissed in exchange for implementation of certain corporate governance changes and payment of plaintiffs
attorneys expenses in an amount not to exceed $6,000.00. Except for this payment, the parties shall bear their own attorneys fees in connection with the action. The Derivative Stipulation remains subject to the satisfaction of various
conditions, including without limitation final approval of the Derivative Stipulation by the Court. According to the Courts docket, on July 24, 2006, the Court entered an Order and Final Judgment approving the Derivative Stipulation and
dismissing the action against all parties.

Langley Securities Fraud Litigation

On or about June 2, 2005, plaintiff Langley Partners, L.P. (Langley) filed a complaint in the United States District Court for the
Southern District of New York alleging claims against the Company, Dr. Adya Tripathi, the Companys President and Chief Executive Officer, and David Eichler, the Companys former Chief Financial Officer. Langley alleges that it
entered into a stock purchase agreement with Tripath on or about August 2, 2004 in which Langley purchased 1 million shares of Tripath common stock at a purchase price of $2.00 per share. Langley also alleges that it consented to the
receipt of the Companys Prospectus dated August 2, 2004 and the accompanying Prospectus dated June 1, 2004 which specifically incorporated certain of the Companys filings with the SEC from March through July 2004. The
complaint generally alleges that the Company and the individual defendants made materially false and misleading statements with respect to the Companys financial results and with respect to its business, prospects, internal accounting controls
and design wins on Godzilla products in the Companys filings with the SEC, press releases and other documents. The complaint alleges claims against the Company and the individual defendants for violations of Sections 10(b) and 20(a) of
the Exchange Act, fraud, breach of contract, unjust enrichment and money had and received, rescission and violations of Sections 11 and 15 of the Securities Act. On this basis, the complaint seeks unspecified compensatory damages and
restitution in an amount in excess of $2 million, rescission of the purchase agreement and a return of $2 million, unspecified punitive damages, costs and such other relief as may be awarded by the Court.

On October 6, 2005, the Court entered an Order granting the Companys motion to transfer this action from the Southern District of New York to
the United States District Court for the Northern District of California. On October 18, 2005, the action was transferred to the Northern District of California.

On December 9, 2005, the Company and the individual defendants filed a motion to dismiss the complaint in its entirety which was granted in part and denied in part by the Court on March 7, 2006. In
particular, the Court dismissed the claims under Sections 10(b) and 20(a) of the Exchange Act and for unjust enrichment and money had and received with leave to amend within thirty days. Langley did not file an amended complaint seeking to replead
the dismissed claims. Trial has been scheduled for January 22, 2007 or on a date to be determined by the Court thereafter. The parties have been engaged in discovery.

[The parties have engaged in settlement discussions and have advised the Court that they are very close to reaching a settlement agreement.]

15. Restatement of Previously Reported Quarterly and Transition Period Financial Information

As originally described in the Companys Current Report on Form 8-K dated October 18, 2004 and filed with the Securities and Exchange Commission
on October 22, 2004 (the Prior 8-K), the Companys Audit Committee initiated an internal investigation regarding certain purported product returns (the Product Returns) to one of the Companys distributors,
Macnica Japan (Macnica), by its customers. The Audit Committee investigation and discussion included a review of the Companys compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 Revenue
Recognition in Financial Statements (SAB 104) as applied to the circumstances surrounding the Product Returns. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there
is persuasive evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured. In accordance with SAB 104, the Companys revenue
recognition policy, for sales to distributors, requires that the Company defer recognition of revenue until such time that the distributor sells products to its customers based upon receipt of point-of-sales reports from the distributor. As of the
Audit Committees determination on January 25, 2005, the internal investigation revealed that approximately $1.4 million of a sale of the Companys product to Macnica did not meet the foregoing criteria because the Companys
Country Manager for the Japan Sales Office (who is no longer employed by the Company) had agreed that Macnica could return the product to the Company at Macnicas discretion. The Audit Committee determined that this former employee had agreed
to a term of



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sale that was outside of the Companys standard practices and was not referenced in the documentation related to the sale submitted to the
Companys finance department. Given the discovery of this arrangement for Macnica to return the product, the Companys Audit Committee concluded that the Company should restate certain financial information that was previously reported in
the Companys Form 10-Q for the quarter ended June 30, 2004, filed with the Securities and Exchange Commission on August 6, 2004 (the June 2004 Form 10-Q) to properly reflect its revenue and related financial information
for the referenced periods (the Initial Restatement). Accordingly, the Company advised in the Prior 8-K that the Consolidated Statement of Operations for the three months and six months ended June 30, 2004 and the Consolidated
Balance Sheet as of June 30, 2004 included in the June 2004 Form 10-Q should no longer be relied upon because of errors in such financial statements. The financial impact of the Initial Restatement was reflected in the Companys Transition
Report on Form 10-K/T for the transition period ended September 30, 2004 filed with the Securities and Exchange Commission on February 3, 2005 (the Transition Report).

The Audit Committee directed that the internal investigation continue following reporting of the Initial Restatement. As a result of this further
investigation, on May 5, 2005 the Audit Committee determined that additional sale transactions with Macnica, as well as with an additional distributor of the Company, Uniquest, did not meet the Companys revenue recognition criteria and
the requirements of SAB 104. In certain circumstances, the same former employee of the Company had agreed that Macnica could return the referenced product at Macnicas discretion. This former employee had on these occasions agreed to a term of
sale that was outside of the Companys standard practices and was not referenced in the documentation related to the sale submitted to the Companys finance department. In addition, the Audit Committee determined that, in certain other
circumstances, Macnica had shipped products not to end customers but to other distributors and the Company had relied on point-of-sales reports submitted to the Company by Macnica that indicated the referenced product had been shipped to an end
customer of Macnica when such product had only been shipped to other distributors. Recognition of revenue on sales between distributors instead of to the end customers is not permitted under the Companys revenue recognition policies. Further,
the Audit Committee determined that certain sales transactions with Uniquest did not meet the Companys revenue recognition criteria and the requirements of SAB 104 because in certain circumstances, employees of Uniquest had incorrectly
reported to the Company the date of shipments to end customers.

As a result, the Audit Committee concluded on May 5, 2005 that the
Company should restate certain financial information (the Additional Restatement) that was previously reported in the Companys Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2004, June 30,
2004 and December 31, 2004 as well as certain financial information for the quarter and transition period ended September 30, 2004 and that was previously reported in the Companys Transition Report. The Additional Restatement was
based on the Audit Committees conclusion on such date that the Consolidated Balance Sheets as of March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004 and the related Consolidated Statements of
Operations for the three months ended March 31, 2004, the three and six months ended June 30, 2004, the nine month transition period ended September 30, 2004 and the three months ended December 31, 2004 should no longer be relied
upon because of errors in such financial statements. The Additional Restatement was originally described in the Companys Current Report on Form 8-K dated May 5, 2005 and filed with the Securities and Exchange Commission on May 11,
2005.

Following receipt of a final report on the internal investigation, the Audit Committee determined that the internal investigation
had been completed on June 15, 2005. The internal investigation revealed errors in the Companys financial statements for 2002 and 2003. Such errors included certain shipments between distributors rather than to end customers which were
not noted on the applicable point-of-sales reports, inaccurate shipment dates on certain point-of-sales reports, and inaccurate quantities noted on certain point-of-sales reports. The Company reviewed these errors with reference to the guidelines
set forth in SAB 99. Based upon such review, the Company concluded that such errors were immaterial and thus would not result in a restatement of the 2002 or 2003 financial statements.



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The following tables provide a reconciliation of amounts previously reported in the Companys Form
10-Q for the quarter ended December 31, 2004 with amounts adjusted for the Restatement.

CONSOLIDATED STATEMENT OF OPERATIONS

(unaudited)

(in
thousands, except per share data)



|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|--------------------------------------------------------------------- |  | ----------------------------------- | ------ | - | --------------------- | - | -- | ------------- |  | - | ------ | -
|                                                                      |  | Three Months EndedDecember 31, 2004 |       
|                                                                      |  | PreviouslyReported (1)              |        |   | RestatementAdjustment |   |    | RestatedTotal | 
|Revenue                                                               |  | $                                   | 1,618  |   |                       | $ | 55 | (2)           |  | $ | 1,673  |  
|Cost of revenue                                                       |  |                                     | 1,195  |   |                       |   | 32 | (3)           |  |   | 1,227  |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Gross profit                                                          |  |                                     | 423    |   |                       |   | 23 |               |  |   | 446    |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Operating expenses:                                                   |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Research and development                                              |  |                                     | 1,901  |   |                       |   |   |               |  |   | 1,901  |  
|Selling, general and administrative                                   |  |                                     | 1,428  |   |                       |   |   |               |  |   | 1,428  |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Total operating expenses                                              |  |                                     | 3,329  |   |                       |   |   |               |  |   | 3,329  |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Loss from operations                                                  |  |                                     | (2,906 | ) |                       |   |    |               |  |   | (2,883 | )
|Interest and other income (expense), net                              |  |                                     | 5      |   |                       |   |   |               |  |   | 5      |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Net loss                                                              |  | $                                   | (2,901 | ) |                       | $ | 23 |               |  | $ | (2,878 | )
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Basic and diluted net loss per share                                  |  | $                                   | (0.06  | ) |                       |   |    |               |  | $ | (0.06  | )
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  
|Number of shares used to compute basic and diluted net loss per share |  |                                     | 48,267 |   |                       |   |    |               |  |   | 48,267 |  
|                                                                      |  |                                     |        |   |                       |   |    |               |  |   |        |  



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CONSOLIDATED BALANCE SHEET (UNAUDITED)

(in thousands)



|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|-------------------------------------------- |  | ---------------------- | -------- | - | --------------------- | - | --- | ------------- |  | - | -------- | -
|                                             |  | December 31, 2004      |         
|                                             |  | PreviouslyReported (1) |          |   | RestatementAdjustment |   |     | RestatedTotal | 
|ASSETS                                       |  |                        |          |   |                       |   |     |               |  |   |          |  
|Current assets:                              |  |                        |          |   |                       |   |     |               |  |   |          |  
|Cash, cash equivalents and restricted cash   |  | $                      | 3,932    |   |                       | $ |    |               |  | $ | 3,932    |  
|Accounts receivable, net                     |  |                        | 615      |   |                       |   |    |               |  |   | 615      |  
|Inventories, net                             |  |                        | 3,625    |   |                       |   | 127 | (5)           |  |   | 3,752    |  
|Prepaid expenses and other current assets    |  |                        | 374      |   |                       |   |    |               |  |   | 374      |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Total current assets                         |  |                        | 8,546    |   |                       |   | 127 |               |  |   | 8,673    |  
|Property and equipment, net                  |  |                        | 1,429    |   |                       |   |    |               |  |   | 1,429    |  
|Other assets                                 |  |                        | 129      |   |                       |   |    |               |  |   | 129      |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Total assets                                 |  | $                      | 10,104   |   |                       | $ | 127 |               |  | $ | 10,231   |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY         |  |                        |          |   |                       |   |     |               |  |   |          |  
|Current liabilities:                         |  |                        |          |   |                       |   |     |               |  |   |          |  
|Accounts payable                             |  | $                      | 1,932    |   |                       | $ |    |               |  | $ | 1,932    |  
|Current portion of capital lease obligations |  |                        | 461      |   |                       |   |    |               |  |   | 461      |  
|Current portion of deferred rent             |  |                        | 276      |   |                       |   |    |               |  |   | 276      |  
|Accrued expenses                             |  |                        | 871      |   |                       |   |    |               |  |   | 871      |  
|Deferred distributor revenue                 |  |                        | 730      |   |                       |   | 197 | (4)           |  |   | 927      |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Total current liabilities                    |  |                        | 4,270    |   |                       |   |    |               |  |   | 4,467    |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Long term liabilities                        |  |                        | 479      |   |                       |   |    |               |  |   | 479      |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Stockholders equity:                        |  |                        |          |   |                       |   |     |               |  |   |          |  
|Common stock                                 |  |                        | 50       |   |                       |   |    |               |  |   | 50       |  
|Additional paid-in capital                   |  |                        | 199,396  |   |                       |   |    |               |  |   | 199,396  |  
|Deferred stock-based compensation            |  |                        | (54      | ) |                       |   |    |               |  |   | (54      | )
|Accumulated deficit                          |  |                        | (194,037 | ) |                       |   | (70 | )             |  |   | (194,107 | )
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Total stockholders equity                   |  |                        | 5,355    |   |                       |   | (70 | )             |  |   | 5,285    |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  
|Total liabilities and stockholders equity   |  | $                      | 10,104   |   |                       | $ | 127 |               |  | $ | 10,231   |  
|                                             |  |                        |          |   |                       |   |     |               |  |   |          |  

---

|(1) | As previously reported in the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2004.
|--- | --------------------------------------------------------------------------------------------------------------



|(2) | Reflects an increase in revenue of approximately $55,000 relating to products.
|--- | ------------------------------------------------------------------------------



|(3) | Reflects an increase of approximately $32,000 in the associated cost associated with the increase in revenue.
|--- | -------------------------------------------------------------------------------------------------------------



|(4) | Reflects a net cumulative increase in deferred revenue of approximately $197,000.
|--- | ---------------------------------------------------------------------------------



|(5) | Reflects a net cumulative increase in inventory of approximately $127,000 relating to the deferred cost associated with the deferred revenue.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

This report contains forward looking statements (as such term is defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to us that are based on the beliefs of our management as well as assumptions made by and information currently available to our management. In addition, when used in this report, the words
likely, will, suggests, target, may, would, could, anticipate, believe, estimate, expect, intend,
plan, predict, and similar expressions and their variants, as they relate to us or our management, may identify forward looking statements. Such statements reflect our judgment as of the date of this quarterly report on Form
10-Q with respect to future events, the outcome of which are subject to certain known and unknown risks and uncertainties, including the factors discussed under the caption Risk Factors, and those discussed elsewhere in this quarterly
report on Form 10-Q, which may have a significant impact on our business, operating results or financial condition. Investors are cautioned that these forward looking statements are inherently uncertain. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Although we believe that the expectations reflected in these forward looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward



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looking statements included in this report are based on information available to us as of the date of this report. We undertake no obligation to update or
revise any forward looking statements, whether as a result of new information, future events or otherwise, unless we are required to do so by law.

The following discussion and analysis should be read in connection with the condensed consolidated financial statements and the notes thereto included in Item 1 in this Quarterly Report and in our Annual Report on Form 10-K and
Form 10-K/A for the fiscal year ended September 30, 2005.

Overview

We design and sell digital amplifiers based on our proprietary Digital Power Processing (DPP®) technology. We currently supply amplifiers for audio electronics applications, as well as amplifiers for DSL applications. We were
incorporated in July 1995, began shipping products in the first quarter of 1998 and became a public reporting company in August 2000. We incurred net losses of approximately $10.6 million for the nine months ended June 30, 2006, $10.0 million
in fiscal 2005, $11.7 million in fiscal 2004, and $7.2 million in fiscal 2003. We expect to continue to incur net losses in fiscal 2006, and possibly beyond.

The Company will require more cash during 2006 to fund its operations. Specifically, the Company does not currently have sufficient funds to finance its operations through the end of the month of August 2006, and,
accordingly, the Companys future depends on its ability to secure additional sources financing during the month of August 2006. Management believes that such additional cash requirements might be met by obtaining additional financing. However,
to date, the Company has no commitment from potential financing sources for such additional financing, and the Company can provide no assurances that such financing will be obtained. However, the Company may not be able to obtain additional funds on
terms that would be favorable to its stockholders and the Company, or at all. The Companys prospects in both the short term and in the long term are dependent upon obtaining sufficient financing as needed to fund current working capital needs
and future growth; in the long term, the Companys prospects also are dependent upon ultimately achieving profitability.

On
November 14, 2004 we changed our fiscal year-end from December 31 to September 30, effective as of September 30, 2004.

We sell our products to original equipment manufacturers and distributors. We recognize revenue from product sales upon shipment to original equipment manufacturers, net of sales returns and allowances. Our sales to distributors are made
under arrangements allowing for returns or credits under certain circumstances and we defer recognition on sales to distributors until products are resold by the distributor to the end user. All of our sales are made in United States, or U.S.,
dollars.

As a fabless semiconductor company, we contract with third party semiconductor fabricators to manufacture the silicon
wafers based on our integrated circuit, or IC, designs. Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC. We also contract with third party assembly and test houses to assemble and package our die and conduct
final product testing.

Cost of revenue includes the cost of purchasing finished silicon wafers and the cost of die manufactured by
independent foundries, costs associated with assembly and final product testing, as well as salaries and overhead costs associated with employees engaged in activities related to manufacturing. Research and development expense consists primarily of
salaries and related overhead costs associated with employees engaged in research, design and development activities, as well as the cost of wafers and other materials and related services used in the development process. Selling, general and
administrative expense consists primarily of employee compensation and related overhead expenses and advertising and marketing expenses.

Restatement

As originally described in our Current Report on Form 8-K dated October 18, 2004 and filed with the Securities and Exchange
Commission on October 22, 2004 (the Prior 8-K), our Audit Committee initiated an internal investigation regarding certain purported product returns (the Product Returns) to one of our distributors, Macnica Japan
(Macnica), by its customers. The Audit Committee investigation and discussion included a review of our compliance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 Revenue Recognition in Financial
Statements (SAB 104) as applied to the circumstances surrounding the Product Returns. Under SAB 104, a requirement for revenue recognition is that all of the following criteria must be met: (1) there is persuasive
evidence that an arrangement exists, (2) delivery of goods has occurred, (3) the sales price is fixed or determinable, and (4) collectibility is reasonably assured.



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In accordance with SAB 104, our revenue recognition policy, for sales to distributors, requires that we defer recognition of revenue until such time
that the distributor sells products to its customers based upon receipt of point-of-sales reports from the distributor. As of the Audit Committees determination on January 25, 2005, the internal investigation revealed that approximately
$1.4 million of a sale of our product to Macnica did not meet the foregoing criteria because our Country Manager for the Japan Sales Office (who is no longer employed by us) had agreed that Macnica could return the product to us at
Macnicas discretion. The Audit Committee determined that this former employee had agreed to a term of sale that was outside of our standard practices and was not referenced in the documentation related to the sale submitted to our finance
department. Given the discovery of this arrangement for Macnica to return the product, our Audit Committee concluded that we should restate certain financial information that was previously reported in our Form 10-Q for the quarter ended
June 30, 2004, filed with the Securities and Exchange Commission on August 6, 2004 (the June 2004 Form 10-Q) to properly reflect our revenue and related financial information for the referenced periods (the Initial
Restatement). Accordingly, we advised in the Prior 8-K that the Consolidated Statement of Operations for the three months and six months ended June 30, 2004 and the Consolidated Balance Sheet as of June 30, 2004 included in the June
2004 Form 10-Q should no longer be relied upon because of errors in such financial statements. The financial impact of the Initial Restatement was reflected in our Transition Report on Form 10-K/T for the transition period ended
September 30, 2004 filed with the Securities and Exchange Commission on February 3, 2005 (the Transition Report).

The Audit Committee directed that the internal investigation continue following reporting of the Initial Restatement. As a result of this further investigation, on May 5, 2005 the Audit Committee determined that additional sale
transactions with Macnica, as well as with an additional distributor of the Company, Uniquest, did not meet the our revenue recognition criteria and the requirements of SAB 104. In certain circumstances, the same former employee of the Company
had agreed that Macnica could return the referenced product at Macnicas discretion. This former employee had on these occasions agreed to a term of sale that was outside of our standard practices and was not referenced in the documentation
related to the sale submitted to our finance department. In addition, the Audit Committee determined that, in certain other circumstances, Macnica had shipped product not to end customers but to other distributors and we had relied on point-of-sales
reports submitted to us by Macnica that indicated the referenced product had been shipped to an end customer of Macnica when such product had only been shipped to other distributors. Recognition of revenue on sales between distributors instead of to
the end customers is not permitted under our revenue recognition policies. Further, the Audit Committee determined that certain sales transactions with Uniquest did not meet our revenue recognition criteria and the requirements of SAB 104
because in certain circumstances, employees of Uniquest had incorrectly reported to us the date of shipments to end customers.

As a
result, the Audit Committee concluded on May 5, 2005 that we should restate certain financial information (the Additional Restatement) that was previously reported in our Quarterly Reports on Form 10-Q for the fiscal quarters
ended March 31, 2004, June 30, 2004 and December 31, 2004 as well as certain financial information for the quarter and transition period ended September 30, 2004 and that was previously reported in our Transition Report. The
Additional Restatement was based on the Audit Committees conclusion on such date that the Consolidated Balance Sheets as of March 31, 2004, June 30, 2004, September 30, 2004 and December 31, 2004 and the related
Consolidated Statements of Operations for the three months ended March 31, 2004, the three and six months ended June 30, 2004, the nine month transition period ended September 30, 2004 and the three months ended December 31, 2004
should no longer be relied upon because of errors in such financial statements. The Additional Restatement was originally described in our Current Report on Form 8-K dated May 5, 2005 and filed with the Securities and Exchange Commission
on May 11, 2005. The restated financial statements for the nine months ended September 30, 2004 are included elsewhere in this document.

Following receipt of a final report on the internal investigation, the Audit Committee determined that the internal investigation had been completed on June 15, 2005. The internal investigation revealed errors in the Companys
financial statements for 2002 and 2003. Such errors included certain shipments between distributors rather than to end-customers which were not noted on applicable point-of-sales reports, inaccurate shipment dates on certain point-of-sales reports,
and inaccurate quantities noted on certain point-of-sales reports. The Company reviewed these errors with reference to the guidelines set forth in SAB99. Based upon such review, the Company concluded that such errors were immaterial and thus would
not result in a restatement of the 2002 or 2003 financial statements.

Material Weakness of Internal Controls Over Financial Reporting

In connection with the audit of the Companys consolidated financial statements for the fiscal year ended September 30, 2005, the
Companys independent auditor has identified a number of material weaknesses in our internal controls over financial reporting. Certain of these material weaknesses resulted in adjustments to the Companys fiscal year 2005 annual
consolidated financial statements. If not remediated, such weaknesses could result in material misstatements to the Companys future annual or interim financial statements that would not be prevented or detected. As a result, we have



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received an adverse attestation from our independent auditors regarding Sarbanes-Oxley Section 404 compliance. For a further discussion of these
material weaknesses, see page 52.

Critical Accounting Policies

Use of Estimates:Managements discussion and analysis of 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 of America. 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 ongoing basis, we evaluate our estimates, including those related to product returns, warranty obligations, bad debts, inventory direct costing and valuation, accruals, valuation of
stock options and warrants, income taxes (including the valuation allowance for deferred taxes) and restructuring costs. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from the other sources. Actual results may materially differ from these estimates under
different assumptions or conditions. Material differences may occur in our results of operations for any period if we made different judgments or utilized different estimates.

Revenue Recognition:We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, or
SAB 104, Revenue Recognition in Financial Statements. We recognize revenue when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred,
3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured. The following policies apply to our major categories of revenue transactions.

Sales to OEM Customers: Under our standard terms and conditions of sale, title and risk of loss transfer to the customer at the time product is
delivered to the customer, FOB shipping point, and revenue is recognized accordingly. We accrue the estimated cost of post-sale obligations, including product warranties or returns, based on historical experience. We have experienced minimal
warranty or other returns to date.

Sales to Distributors:Sales to distributors are made under arrangements allowing limited rights
of return, generally under product warranty provisions, stock rotation rights and price protection on products unsold by the distributor. In addition, the distributor may request special pricing and allowances which may be granted subject to our
approval. As a result of these return rights and potential pricing adjustments, we generally defer recognition of revenue until such time that the distributor sells product to its customer based upon receipt of point-of-sale reports from the
distributor.

Allowance for Doubtful Accounts:We provide an allowance for doubtful accounts to ensure trade receivables are not
overstated due to un-collectibility. The collectibility of our receivables is evaluated based on a variety of factors, including the length of time receivables are past due, indication of the customers willingness to pay, significant one-time
events and historical experience. An additional reserve for individual accounts is recorded when we become aware of a customers inability to meet its financial obligations, such as in the case of bankruptcy filings or substantial deterioration
in the customers operating results or financial position. If circumstances related to our customers change, estimates of the recoverability of receivables would be further adjusted.

Inventories: Inventories are stated at the lower of cost or market. This policy requires us to make estimates regarding the market value of our
inventory, including an assessment of excess or obsolete inventory. We determine excess and obsolete inventory based on an estimate of the future demand and estimated selling prices for our products within a specified time horizon, generally 12
months. The estimates we use for expected demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. Actual demand and market conditions may be different from those projected by our
management. If our unit demand forecast is less than our current inventory levels and purchase commitments, during the specified time horizon, or if the estimated selling price is less than our inventory value, we will be required to take additional
excess inventory charges or write-downs to net realizable value which will decrease our gross margin and net operating results in the future. During the quarter ended March 31, 2002, we recorded a provision for excess inventory of approximately
$5 million primarily related to excess inventory for our TA2022 product as a result of a decrease in forecasted sales for this product. In 2004, we increased the inventory reserves by an additional $4.3 million, from $4.9 million to
$9.2 million representing 10.4 million units with a net realizable value of $2.6 million, to account for slow moving, excess, and obsolete inventory. The balance of the previously reserved inventory at September 30, 2005 has a net
realizable value of $5.2 million and represents 8.7 million units. This translates into a reduction of the reserved for inventory during fiscal 2005 of $4.0 million representing 1.7 million units from the overall balance at
September 30, 2004. The balance of the previously reserved inventory at June 30, 2006 has a net realizable value of $3.8 million and represents 7.8 million units. This translates into a reduction of the reserved for inventory during
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fiscal third quarter ended June 30, 2006 of $0.1 million representing a minimal change in units from the overall balance at March 31, 2006.

Stock-Based Compensation: On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment (SFAS 123R). SFAS 123R eliminates the alternative of applying the intrinsic value measurement provisions of APB 25 to stock compensation awards issued to employees. Rather, the new standard requires enterprises to measure the cost
of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the
award, known as the requisite service period (usually the vesting period). On April 14, 2005, the Securities and Exchange Commission (SEC) announced the adoption of a rule that defers the required effective date of SFAS 123R. The
SEC rule provides that SFAS 123R is now effective for registrants as of the beginning of the first fiscal year beginning after June 15, 2005.

SFAS 123R is effective for our fiscal quarter beginning October 1, 2005, and allows for the use of the Modified Prospective Application Method. Under this method, SFAS 123R is applied to new awards and to awards modified, repurchased,
or cancelled after the effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (such as unvested options) that are outstanding as of the date of adoption is recognized as the
remaining requisite services are rendered. The compensation cost relating to unvested awards at the date of adoption shall be based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123. In
addition, companies may use the Modified Retrospective Application Method. This method may be applied to all prior years for which the original SFAS 123 was effective or only to prior interim periods in the year of initial adoption. If the Modified
Retrospective Application Method is applied, financial statements for prior periods will be adjusted to give effect to the fair-value-based method of accounting for awards on a consistent basis with the pro forma disclosures required for those
periods under the original SFAS 123. We have adopted SFAS 123R in our quarter ended June 30, 2006 using the Modified Prospective Application Method.

Change in Year End: On November 14, 2004, our Board of Directors approved a change in our fiscal year end from December 31 to September 30, effective as of September 30, 2004.

Results of Operations

Three months ended June 30, 2006 and
2005

Revenue. Revenue for the three months ended June 30, 2006 was $2.4 million, a decrease of $0.5 million or 17 percent
from revenues of $2.9 million for the three months ended June 30, 2005. The decrease in revenue resulted primarily from sales of the 2024 family with lower ASPs.

Our top five end customers accounted for 59 percent of revenue in the three months ended June 30, 2006 compared to 51 percent of revenue in the
three months ended June 30, 2005. Our primary customers during the three months ended June 30, 2006 were Sharp and Orion, representing 22 percent and 14 percent of revenue respectively. During the three months ended June 30, 2005 our
top five end customers accounted for 51% of the revenue. Our primary customers were Sharp, QCI and Beko representing 23 percent, 10 percent and 7 percent of revenue, respectively.

Our revenue from the U.S. increased from $47,000 in the three months ended June 30, 2005 to $186,000 in the quarter ended June 30, 2006. This
is primarily due to increased shipments of the DSL products.

Gross Profit. Gross profit for the three months ended June 30,
2006 was $0.06 million or 2 percent, compared with a gross profit of 1.6 million or 54 percent for the three months ended June 30, 2005. The lower gross margin during the three months ended June 30, 2006 was primarily attributable to
slow transition of customers from the TAA2024 product to the lower cost version of the TAA2024B and TAA2024C. What resulted was an increase sales volume of the TAA2024 product which has very low margins.

Inventory is reviewed and valued based on a lower of cost or market analysis. The inventory reserve at September 30, 2004 totaled $9.2 million and
included approximately $5.0 million related to excess inventory primarily for the Companys TA2022 product as a result of a decrease in forecasted sales for this product. In September 2004, the Company increased the inventory reserve by an
additional $4.3 million from $4.9 million to $9.2 million to account for slow moving, excess, and obsolete inventory. The additional inventory charge related to slow moving and excess inventory for our TA1101B, TA3020, TA2041, TA2022
and leaded TA2024 products, the TK2350, TK2051, TK2150, TK2050 and TK2052 chipsets, and Kauai2BB and U461 die based on a decline in forecasted sales for these parts. At September 30, 2004 the Company had approximately 10.4 million units of
inventory which had previously been written down to their net realizable value of



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approximately $2.6 million. These components and finished goods did not have a market or sales forecast based on customer demand that could support the
number of units in inventory at that time.

Following the hiring of the Companys newly promoted Vice President of Sales in
January of 2005, the Company began to develop a new strategy to increase sales volume in its target markets. The Company had previously pursued a pricing strategy that had resulted in a lack of competitiveness in many end-customer accounts and
applications.

During the year ended September 30, 2005, our end-customers experienced significant growth which resulted in sales of
previously written down inventory primarily to existing end-customers. In addition, during this period, certain of our customers products have experienced growth beyond previously estimated levels. As a result of these trends, a number of our
existing end-customers developed new designs and applications which offered the Company an opportunity to sell some of our previously written down inventory. For example, sales of our products for flat panel display television applications have
increased as these markets have expanded, reflecting increased consumer demand for flat panel televisions due to the increasingly lower prices of consumer products that are being marketed to the public. The Company was able to address these new
opportunities in the growing flat panel display market as new designs and applications became available in the first calendar quarter of 2005 in connection with our end-customers consumer product design and component sourcing activity. These
options were not known or available at the time the inventory was written down. This additional strategy of addressing our expanding target markets resulted in significant sales during the March 2005, June 2005, September
2005, December 2005 and March 2006 quarters of previously written down inventory. It is not clear to the Company how long the markets for these new design-ins and new applications will be available.

The Company has seen results from executing this strategy and has been able to take advantage of the fast growing flat panel television market as an
opportunity to sell some of the previously written down inventory. This has resulted in higher gross margin as the actual value of the inventory at the time of sale has been greater than was anticipated at the time the inventory was written down.
For the quarter ended June 30, 2006 the gross margin would have been (2.8) percent instead of the reported gross margin of 2 percent were it not for the favorable impact of $0.1 million as a result of the sale of previously written down
inventory which resulted in favorable impact to gross margin of approximately 5 percent. At June 30, 2006 the Company had approximately 6.9 million units still on hand representing a net realizable value of approximately $4.8 million.

Along with our new sales strategy the Company has embarked on a program to reduce manufacturing cost of some of our higher volume
products. This is being accomplished through a combination of negotiation for improved pricing from our vendors along with transitioning of many of our customers for 2024 to 2024B or 2024C both of which are newer versions of this high volume product
with lower production costs. In addition, we continue to utilize our engineering and applications development staff to work closely with our key customers to design-in our existing products as we continue to improve the design of our future
products.

Research and Development. Research and development expenses for the three months ended June 30, 2006 were $1.8
million, approximately flat from $1.7 million for the three months ended June 30, 2005.

Selling, General and Administrative
Expenses. Selling, general and administrative expenses for the three months ended June 30, 2006 were $1.4 million, a decrease of approximately $2.5 million from $3.9 million for the three months ended June 30, 2005. This decrease in
selling, general and administrative expenses was due reductions in legal and accounting expenses which occurred in 2005 and did not reoccur in 2006. The reduction was offset by the charge associated with the implementation of SFAS 123R which had an
unfavorable impact of $0.2 million in the three months ended June 30, 2006. Apart from the impact of SFAS 123R, litigation-related costs and/or financing related expenses, we anticipate that our S,G&A expenses will be flat or decrease
during the remainder of fiscal 2006.

Change in Fair Value on Revaluation of Warrant and Conversion Feature Liability. The change in
fair value on revaluation of warrant liability represents the difference between the fair value of the warrants and conversion feature we issued in connection with our March 3, 2005 private placement on their original issue date and the fair
value of those same warrants on June 30, 2006 using Black-Scholes. The change in fair value on revaluation of warrant liability related to the March 2005 transaction was a decrease of the liability of $34,667 for the three months ended
June 30, 2006 while there was a decrease in the liability of $213,000 for the three months ended June 30, 2005. We issued additional warrants with conversion features in our November 8, 2005 private placement which are also subject to
a revaluation. The change in fair value for the revaluation of the conversion feature to the November 8, 2005 transaction was a decrease of the conversion feature liability of $1.3 million for the three months ended June 30, 2006. We also
issued additional warrants on February 14, 2006. The change in fair value for the revaluation of the warrants related to the February 14, 2006 transaction was a



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reduction of the liability of $0.5 million for the three months ended June 30, 2006. The change in fair value for the revaluation of the warrants
related to the Finder Fee warrants transaction was a decrease of the liability of $ 21,035 for the 3 months ended June 30, 2006. The change in fair value for the revaluation of the Series B Warrants related to the November 8, 2005
transaction was a decrease of the liability of $0.9 million for the three months ended June 30, 2006. While there was no change in fair value or revaluation of warrant liability for the three months ended June 30, 2005 since no warrants
were issued during that period.

Interest, Amortization and Other Expense, net. Net interest expense for the three months ended
June 30, 2006 was $0.9 million, compared with net interest expense of $6,000 for the three months ended June 30, 2005. The changes in interest expense are a result of the recognition of interest paid on the 6% Senior Secured Convertible
Debentures issued in November of 2005, recording the conversion feature related to the debt financing, and amortizing the debt discount and related fees.

Income Taxes. We have incurred only a minimal amount of statutory income tax expense to date. We have recorded a full valuation allowance against our deferred tax assets. Deferred tax assets will be recognized
in future periods only as any taxable income is realized and consistent profits are reported. Deferred tax assets related to items effecting equity will be charged to equity when realized.

Nine Months Ended June 30, 2006 and 2005

Revenue. Revenue for the Nine Months Ended June 30, 2006 was $9.3 million, an increase of $2.0 million or 27 percent from revenues of $7.3 million for the Nine Months Ended June 30, 2005. The increase in revenue resulted
primarily from increased sales of our TA2024 family into the flat panel display television market.

Our top five end customers accounted
for 47 percent of revenue in the Nine Months Ended June 30, 2006 compared to 46 percent of revenue in the Nine Months Ended June 30, 2005. Our primary customers during the Nine Months Ended June 30, 2006 were Sharp and Alcatel
representing 17 percent, 12 percent respectively. Our primary customers during the Nine Months Ended June 30, 2005 were Sharp and KTS representing 14 percent and 11 percent of revenue, respectively.

Our revenue continued to be strong from Japan as our products are used in the production of products in the fast growing consumer markets of flat panel
display TV, DSL and home theater.

Gross Profit. Gross profit for the Nine Months Ended June 30, 2006 was $2.0 million or 22
percent, compared with a gross profit of $3.7 million or 52 percent for the Nine Months Ended June 30, 2005. The lower gross margin achieved during the Nine Months Ended June 30, 2006 was primarily attributable to the sale of 2024 product
which is being sold on average below cost

Inventory is reviewed and valued based on a lower of cost or market analysis. The inventory
reserve at September 30, 2004 totaled $9.2 million and included approximately $5.0 million related to excess inventory primarily for the Companys TA2022 product as a result of a decrease in forecasted sales for this product. In
September 2004, the Company increased the inventory reserve by an additional $4.3 million from $4.9 million to $9.2 million to account for slow moving, excess, and obsolete inventory. The additional inventory charge related to slow
moving and excess inventory for our TA1101B, TA3020, TA2041, TA2022 and leaded TA2024 products, the TK2350, TK2051, TK2150, TK2050 and TK2052 chipsets, and Kauai2BB and U461 die based on a decline in forecasted sales for these parts. At
September 30, 2004 the Company had approximately 10.4 million units of inventory which had previously been written down to their net realizable value of approximately $2.6 million. These components and finished goods did not have a
market or sales forecast based on customer demand that could support the number of units in inventory at that time.

Following the hiring
of the Companys newly promoted Vice President of Sales in January of 2005, the Company began to develop a new strategy to increase sales volume in its target markets. The Company had previously pursued a pricing strategy that had resulted
in a lack of competitiveness in many end-customer accounts and applications.

During the year ended September 30, 2005, our
end-customers experienced significant growth which resulted in sales of previously written down inventory primarily to existing end-customers. In addition, during this period, certain of our customers products have experienced growth beyond
previously estimated levels. As a result of these trends, a number of our existing end-customers developed new designs and applications which offered the Company an opportunity to sell some of our previously written down inventory. For example,
sales of our products for flat panel display television applications have increased as these markets have expanded, reflecting increased consumer demand for flat panel televisions due to the increasingly lower prices of consumer products that are
being marketed to the public. The Company was able to address these new opportunities in the growing flat panel display market as new designs and applications became available in the first calendar quarter of 2005 in connection with our
end-customers consumer product design and component sourcing



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activity. These options were not known or available at the time the inventory was written down. This additional strategy of addressing our expanding target
markets resulted in sales during the March 2005, June 2005, September 2005, December 2005 and March 2006 quarters of previously written down inventory. It is not clear to the Company how long the markets for these new design-ins and
new applications will be available.

The Company has seen results from executing this strategy and has been able to take advantage of the
fast growing flat panel television market as an opportunity to sell some of the previously written down inventory. This has resulted in higher gross margin as the actual value of the inventory at the time of sale has been greater than was
anticipated at the time the inventory was written down. For the Nine Months Ended June 30, 2006 the gross margin would have been 11 percent instead of the reported gross margin of 22 percent were it not for the favorable impact of
$1.0 million as a result of the sale of previously written down inventory which resulted in favorable impact to gross margin of approximately 11 percent. At June 30, 2006 the Company had approximately 7.8 million units still on hand
representing a net realizable value of approximately $4.9 million. The Company expects the favorable impact to its gross margin in the forth quarter of fiscal 2006 ending September 30, 2006 from the sale of previously written down inventory to
be in the range of 0 percent to 10 percent, and therefore would expect to report a gross margin in the range of 20 to 30 percent for such period, although the resulting reported gross profit and gross margin may be different depending on the actual
sale of previously written down inventory.

Along with our new sales strategy the Company has embarked on a program to reduce manufacturing
cost of some of our higher volume products. This is being accomplished through a combination of negotiation for improved pricing from our vendors along with transitioning of many of our customers for 2024 to 2024B or 2024C both of which are newer
versions of this high volume product with lower production costs. In addition, we continue to utilize our engineering and applications development staff to work closely with our key customers to design-in our existing products as we continue to
improve the design of our future products. As we continue the implementation of expected manufacturing cost reductions, engineering and design strategies, we would expect that our gross margin would settle in the range of 30 percent to 40 percent.
This estimate is dependent on our ability to build sustainable sales volume and complete the manufacturing cost reductions, engineering and design strategies on a timely basis.

Research and Development. Research and development expenses for the Nine Months Ended June 30, 2006 were $5.6 million, flat as compared to
the $5.6 million for the Nine Months Ended June 30, 2005.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the Nine Months Ended June 30, 2006 were $4.9 million, a decrease of approximately $2.2 million from $7.1 million for the Nine Months Ended June 30, 2005. This decrease in selling, general and administrative
expenses was due to primarily to decreased legal and accounting fees from the litigation which occurred in 2005. We anticipate that our S, G&A expenses will continue to be flat or decrease during the remainder of fiscal 2006.

Change in Fair Value on Revaluation of Warrant and Conversion Feature Liability. The change in fair value on revaluation of warrant liability
represents the difference between the fair value of the warrants and conversion feature we issued in connection with our March 3, 2005 private placement on their original issue date and the fair value of those same warrants on June 30,
2006 using Black-Scholes. The change in fair value on revaluation of warrant liability related to the March 2005 transaction was a reduction of the liability of $134,000 for the nine months ended June 30, 2006 while there was a decrease in the
liability of $464,000 for the nine months ended June 30, 2005. We issued additional warrants with a conversion feature in our November 8, 2005 private placement which are also subject to a revaluation. We also issued additional warrants on
February 14, 2006. The change in fair value for the revaluation of the Series B Warrants related to the November 8, 2005 transaction was a reduction of the liability of $1.7 million for the nine months ended June 30, 2006. The change
in fair value for the revaluation of the conversion feature to the November 8, 2005 transaction was a reduction of the conversion feature liability of $2.2 million for the nine months ended June 30, 2006. The change in fair value for the
revaluation of the warrants related to the February 14, 2006 transaction was a reduction of the liability of $0.9 million for the nine months ended June 30, 2006. The change in fair value for the revaluation of the warrants related to the
Finder Fee was a reduction of the liability of $39,733 for the nine months ended June 30, 2006.

Interest, Amortization and Other
Expense, net. Net interest expense for the Nine Months Ended June 30, 2006 was $7.1 million, compared with net interest expense of $17,000 for the Nine Months Ended June 30, 2005. The changes in interest expense are a result of the
recognition of interest paid on the 6% Senior Secured Convertible Debentures issued in November of 2005, recording the conversion feature related to the debt financing, and amortizing the debt discount and related fees.

Income Taxes. We have incurred only a minimal amount of statutory income tax expense to date. We have recorded a full valuation allowance against
our deferred tax assets. Deferred tax assets will be recognized in future periods only as any



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taxable income is realized and consistent profits are reported. Deferred tax assets related to items effecting equity will be charged to equity when
realized.

Liquidity and Capital Resources

Since our inception, we have financed our operations through the private sale of our equity securities, primarily the sale of preferred stock, through our initial public offering on August 1, 2000, through a private placement in
January 2002, a financing in August 2004, a private placement in March 2005 and a private placement in November 2005. The January 2002, March 2005 and November 2005 private placements included warrants whereas no warrants were issued in
connection with the August 2004 financing. Net proceeds to us as a result of our initial public offering, our 2002 private placement, our 2004 financing, our March 2005 private placement and our November 2005 private placement were approximately
$45.4 million, $19.9 million, $5.0 million, $4.4 million and $4.8 million, respectively. In addition we received $5.4 million from the exercise of warrants issued in connection with the 2002 private placement, $0.3 million
from the exercise of warrants issued in connection with the March 2005 private placement and $2.5 million from the exercise of the Series A warrants issued in connection with our November 2005 private placement. The Company does not currently have
sufficient funds to finance its operations through the end of the month of August 2006, and, accordingly, the Companys future depends on its ability to secure additional financing during the month of August 2006. To date, the Company has no
commitment from potential financing sources for such additional financing, and the Company can provide no assurances that such financing will be obtained.

Net cash used in operating activities decreased to $1.0 million for the quarter ended June 30, 2006 from $2.3 million for the quarter ended June 30, 2005. The decrease was mainly due to a decrease in legal
fees payable.

Cash used in investing activities was $10,000 thousand for the quarter ended June 30, 2006 compared to cash used of
$27,000 for the quarter ended June 30, 2005.

Cash provided by financing activities was $24,000 for the quarter ended June 30,
2006. Cash provided by financing activities was $250,000 for the quarter ended June 30, 2005.

At June 30, 2006, the Company
continued to maintain a standby letter of credit in the amount of $0.2 million as security for our building lease in San Jose, California.

In October 2005, we proposed amending the warrants issued as part of the March 2005 private placement. The holders of warrants to exercise 533,333 shares of the Companys common stock agreed to the amendment, which lowered the exercise
price of the warrants to $0.50 per share, eliminated the cashless net exercise provision of the warrant, and advanced the warrant termination date to October 14, 2005. The Company issued 533,333 shares of common stock upon the exercise of such
amended warrants on October 14, 2005 for aggregate proceeds of $0.3 million.

In November 2005, the Company entered into a Securities
Purchase Agreement (the Purchase Agreement) and a Registration Rights Agreement (the Registration Rights Agreement), each dated as of November 8, 2005. The financing, a combination of debt and warrants, closed on
November 8, 2005. The 6% Senior Secured Convertible Debentures issued pursuant to the Purchase Agreement are secured by substantially all of the Companys assets including Intellectual Property.

The proceeds to the Company were $5.0 million. The Company paid legal expenses and a finders fee of $150,750 in commissions and Series B Common
Stock Warrants to acquire 233,721 shares of the Companys common stock in connection with the financing. The Series B Common Stock Warrants issued are exercisable at $0.43 per share. The Company ascribed the value of $77,128 to the
finders fee warrants which is recorded along with the finders fees as deferred financing cost in the balance sheet at June 30, 2006. The fair value ascribed to the finders fee Series B Common Stock Warrants was estimated on
the commitment date using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 4. 51%; contractual life of 5 years; expected volatility of 145.04%; and expected dividend yield of 0%. The Company expects to use
the proceeds of the financing to finance on-going operations.

Under the terms of the financing, the Company issued to the investors 6%
Senior Secured Convertible Debentures (the Debentures) in the aggregate principal amount of $5.0 million and Series A Common Stock Warrants (the Series A Warrants) to acquire 6,756,755 shares at an exercise price of $0.37 per
share and Series B Common Stock Warrants (the Series B Warrants and together with the Series A Warrants, the Warrants) to acquire 10,135,133 shares of the Companys common stock at an exercise price of $0.43 per share.
The Debentures accrue interest at the rate of 6% per annum. The first payment was due on April 8, 2006 and additional payments are due on the first of each month thereafter.



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The Debentures are convertible into shares of the Companys common stock at the rate of $0.37 per share (subject to adjustments).

The Company had ascribed a value at the issuance date, November 8, 2005, of $1,148,648 to the Series A Warrants. The Series A Warrants issued in the
financing transaction were free-standing derivatives accounted for under FAS 133. The fair value ascribed to the Series A Warrants was estimated on the commitment date using the Black-Scholes-Merton pricing model with the following assumptions:

Stock price of $0.435;

Exercise price of $0.37;

Contractual term of 0.7 years;

Volatility of 92.04%;

Expected yield of 0%;
and

Risk-free interest rate of 4.51%.

In February 2006, we proposed to the holders of the Series A Warrants issued as part of the November 2005 private placement that in exchange for the exercise of the Series A Warrants the Company would provide the holders of the Series A
Warrants with a quantity of new warrants equal to 90% of the quantity of the Series A Warrants at a strike price of $0.315 per share expiring on July 1, 2007 and the Company ascribed a fair value of $1,641,891 to the new warrants and
subsequently revalued them to $729,730 at June 30, 2006 using the Black-Scholes-Merton model. The holders of the Series A Warrants exercised such Series A Warrants on February 14, 2006 and were issued 6,756,755 shares of the Companys
common stock providing the Company with $2,499,999 in cash. The Company issued new warrants at a strike price of $0.315 per share on 6,081,080 of the Companys common stock expiring on July 1, 2007. The fair value of the Series A Warrants
were subsequently revalued to $1,013,514 before they were exercised using the Black-Scholes-Merton model. This change in value was reflected in the Companys consolidated statement of operations for the period ended March 31, 2006.

The Company has ascribed a value at the issuance date, November 8, 2005, of $4,155,405 to the Series B Warrants. The Series B
Warrants issued in the financing transaction are free-standing derivatives accounted for under FAS 133. The fair value ascribed to the Series B Warrants was estimated on the commitment date using the Black-Scholes-Merton pricing model with the
following assumptions:

Stock price of $0.45;

Exercise price of $0.43;

Contractual term of 5.0 years;

Volatility of 145.04%;

Expected yield of 0%;
and

Risk-free interest rate of 4.51%.

The Black-Scholes-Merton model resulted in a fair value of $0.41 for the Series B Warrants and therefore a warrant liability in the amount of $4,155,405 was recorded as a credit to warrant liability in the Companys Balance
Sheet. The fair value of the Series B Warrants were subsequently revalued to $2,432,432 at June 30, 2006 using the Black-Scholes-Merton model. This change in value was reflected in the Companys consolidated statement of operations for the
three and six month periods ended June 30, 2006.

The $5,000,000 face amount of the Debentures was stripped of its conversion feature
due to the accounting for the conversion feature as a derivative, which was recorded using the residual proceeds method, whereby any remaining proceeds after allocating the proceeds to the Warrants and conversion option would be attributed to the
debt. Since the combined fair values of the Warrants and the conversion option at issuance of $10,037,348 was in excess of the total proceeds on the transaction, the debt was recorded at a net zero value. As a result, the Company recorded the amount
of the value ascribed to the conversion feature and the Warrants that exceeded proceeds from the financing of $5,000,000 as interest expense in the Companys consolidated statement of operations for the three and six month periods ended
June 30, 2006. This resulted in a charge of $5.037 million to interest expense leaving a net debt discount value of $5 million. The



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debt discount of $5 million is being accreted and recognized as interest expense from the date of issuance to the stated redemption date using the effective
yield method.

The values ascribed to the Warrants and conversion feature of the Debentures follow the guidance of the EITF Issue
No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, EITF 00-19: Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled
in, a Companys Own Stock, FAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and ETIF Issue No. 00-27, Application of Issue No. 98-5 to Certain
Convertible Instruments of the FASBs Emerging Issues Task Force. The debt discount from the Warrants and conversion feature of the Debentures is amortized to expense over the life of the Debentures or upon earlier conversion of the
Debentures using the effective interest method. As of June 30, 2006, the Company had amortized to expense approximately $2.8 million of the revaluation of the warrant liability, $2.2 million of the conversion feature and approximately $1.6
million in amortization of the debt discount and related fees. The balance due under the Debentures is shown net of the remaining unamortized discount on the accompanying consolidated balance sheet.

If the aggregate principal amount owing under the Debentures is converted, the Company will issue 17,125,609 shares, which may be adjusted pursuant to
the reset provisions in the Debentures, of its common stock. If the Debentures are not converted, the first payment of principal and accrued but unpaid interest will be due on April 8, 2006 and additional payments will be due on the first of
each month thereafter with the final payment due on November 8, 2007. The Company may pay accrued interest in cash or in shares of Company common stock, if the daily volume weighted average price of the Common Stock is equal to or greater than
115% of the conversion price on the ten trading days prior to the interest payment. The Company does not currently intend to pay accrued interest with shares of its common stock.

The Series A Warrants were exercised in their entirety on February 14, 2006.

The Series B Warrants expire on May 8, 2011. The Company may call the Series B Warrants if the Companys common stock trades at 250% of the
Series B Warrant exercise price or above for 10 consecutive trading days after the date that is 10 days following the effectiveness of the registration statement providing for the resale of the shares issued upon the conversion of the Debentures and
exercise of the Warrants (December 21, 2005). The Company will receive proceeds of approximately $4,458,607 for the Series B Warrants if all of the Series B Warrants are exercised.

The Company also was required to file a registration statement providing for the resale of the shares that are issuable upon the conversion of the
Debentures and the exercise of the Warrants. Such registration statement was filed on December 8, 2005, and was declared effective on December 21, 2005. This registration statement on Form S-1 will need to be updated to maintain
effectiveness pursuant to rules promulgated by the SEC.



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Our total commitments on our operating and capital leases and inventory purchases as of June 30,
2006, were as follows (in thousands):



|                                                   |  |                 |     |               |   |      |  
|-------------------------------------------------- |  | --------------- | --- | ------------- | - | ---- | -
|Year ending December 31,                           |  | OperatingLeases |     | CapitalLeases |  
|2006                                               |  |                 | 313 |               |   | 94   |  
|2007                                               |  |                 | 590 |               |   | 87   |  
|2008                                               |  |                 | 51  |               |   | 66   |  
|                                                   |  |                 |     |               |   |      |  
|Total minimum lease payments                       |  | $               | 954 |               |   | 247  |  
|                                                   |  |                 |     |               |   |      |  
|Less: amount representing interest                 |  |                 |     |               |   | (79  | )
|                                                   |  |                 |     |               |   |      |  
|Present value of minimum lease payments            |  |                 |     |               |   | 168  |  
|Less: current portion of capital lease obligations |  |                 |     |               |   | (103 | )
|                                                   |  |                 |     |               |   |      |  
|Long-term capital lease obligations                |  |                 |     |               | $ | 65   |  
|                                                   |  |                 |     |               |   |      |  

follows (in thousands):

We expect our future liquidity and capital requirements will fluctuate depending on numerous factors including: market acceptance and demand for current
and future products, the timing of new product introductions and enhancements to existing products, the success of on-going efforts to reduce our manufacturing costs as well as operating expenses and need for working capital for such items as
inventory and accounts receivable.

The Companys independent auditors included a going concern qualification in connection with the
issuance of their report of independent auditors in respect of our consolidated financial statements for our fiscal year ending September 30, 2005. The Company has incurred substantial losses and has experienced negative cash flow since
inception and has an accumulated deficit of $212.5 million at June 30, 2006. The Company has therefore prepared its consolidated financial statements on the basis of a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business.

Beginning in August 2001, the Company instituted programs to reduce expenses
including reducing headcount from 144 employees at the end of July 2001 to 56 employees at the end of December 2003 and reducing employees salaries by 10 percent. In September 2002 the Company relocated its headquarters which reduced rent
expense and canceled its D&O policy which reduced insurance expense. These actions resulted in significant cost savings in 2003. The Company reduced its cash used in operating activities from approximately $13 million in 2002 to approximately $4
million in 2003. However, for the nine months ended September 30, 2004, cash used in operating activities increased to $9.1 million and for the year ended September 30, 2005 the Company used $9.8 million in cash. For the three months ended
June 30, 2006, the Company had 57 employees and the cash used by the Company in operating activities was $1.0 million. The cash used by the Company in operating activities for the Nine Months Ended June 30, 2006, was $7.3 million.

During 2004, warrants were exercised which resulted in the Company receiving proceeds totaling approximately $2.3 million. In addition, in
August 2004 we raised $5 million through financing. In March 2005, we completed a private placement which resulted in gross proceeds of $4.4 million. In connection with this private placement we sold 4,833,335 shares of common stock at a price
of $0.90 per share and issued warrants to purchase up to 966,667 shares of common stock with an exercise price of $1.25 per share. In addition, we received $0.3 million from the exercise of warrants issued in connection with the March 2005 private
placement and $2.5 million from the exercise of the Series A Warrants issued in connection with our November 2005 private placement.

At
June 30, 2006, the Company had negative working capital of $5.3 million, including unrestricted cash of $0.7 million.

The Company
will continue to require more cash during 2006 to fund its operations. . Specifically, the Company does not currently have sufficient funds to finance its operations through the end of the month of August 2006, and management, accordingly, the
Companys future depends on its ability to secure additional financing during the month of August 2006. Management believes that such additional cash requirements couldmight be met by first obtaining additional financing. However, to date, the
Company has no commitment from potential financing sources for such additional financing, and the Company can provide no assurances that such financing will be obtained. However, the Company may not be able to obtain additional funds on terms that
would be favorable to its stockholders and the Company, or at all. The Companys prospects in the number of authorized shares both the short term and in the Companys Certificate of Incorporation, we will not be able to raise additional
capital through equity financings except by effecting a reverse stock split. The Companys long term prospects are dependent upon obtaining sufficient financing as needed to fund current working capital needs and future growth, and ; in the
long term, the Companys prospects also are dependent upon ultimately on achieving profitability.



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Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, Inventory Costsan amendment of ARB No. 43, Chapter 4, or SFAS 151. SFAS 151 amends ARB 43, Chapter 4 to clarify that
abnormal amounts of idle freight, handling costs and spoilage should be recognized as current period charges. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. We do not
anticipate that the adoption of this standard will have a material impact on our consolidated financial statements.

In December 2004, the
FASB issued SFAS No. 153 Exchanges of Non-monetary Assetsan amendment of APB opinion No. 29, or SFAS 153. SFAS 153 clarifies that exchanges of non-monetary assets should be measured based on the fair value of
the assets exchanged, with a general exception for exchanges that have no commercial substance. SFAS 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We do not anticipate that the
adoption of this standard will have a material impact on our consolidated financial statements.

In March 2005, the FASB issued FSP
No. 46(R)-5, Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities (FSP 46(R)-5), which provides guidance for a reporting enterprise on whether it
holds an implicit variable interest in a variable interest entity (VIE) or potential VIE when specific conditions exist. FSP 46(R)-5 became applicable to the Company in the quarter ended June 30, 2005. FSP 46(R) had no impact on the
Companys consolidated results of operations and financial condition as of September 30, 2005.

In March 2005, the FASB issued
FIN 47, Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143 (FIN 47), which requires an entity to recognize a liability for the fair value of a conditional asset retirement
obligation when incurred if the liabilitys fair value can be reasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company is currently evaluating the effect that the adoption of FIN 47
will have on the Companys consolidated results of operations and financial condition, but does not expect it to have a material impact.

In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20, and FASB Statement No. 3. (SFAS 154). SFAS 154 replaces APB Opinion
No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This statement
applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement
includes specific transition provisions, those provisions should be followed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 31, 2005. We do not anticipate that the
adoption of this standard will have a material impact on our consolidated financial statements.

In February 2006, the FASB decided to move
forward with the issuance of a final FSP FAS 123R-4, Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event. The guidance in this FSP FAS
123R-4 amends paragraphs 32 and A229 of FASB Statement No. 123R to incorporate the concept articulated in footnote 16 of FAS 123R. That is, a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is
outside the employees control does not meet the condition in paragraphs 32 and A229 until it becomes probable that the event will occur. Originally under FAS 123R, a provision in a share-based payment plan that required an entity to settle
outstanding options in cash upon the occurrence of any contingent event required classification and accounting for the share based payment as a liability. This caused an issue under certain awards that require or permit, at the holders
election, cash settlement of the option or similar instrument upon (a) a change in control or other liquidity event of the entity or (b) death or disability of the holder. With this new FSP, these types of cash settlement features will not
require liability accounting so long as the feature can be exercised only upon the occurrence of a contingent event that is outside the employees control (such as an initial public offering) until it becomes probable that event will occur. The
guidance in this FSP shall be applied upon initial adoption of Statement 123(R). An entity that adopted Statement 123(R) prior to the issuance of the FSP shall apply the guidance in the FSP in the first reporting period beginning after February
2006. Early application of FSP FAS 123R-4 is permitted in periods for which financial statements have not yet been issued. The Company does not anticipate that this new FSP will have any material impact upon its financial condition or results of
operations.

In February 2006, the FASB issued FASB Statement No. 155, Accounting for Certain Hybrid Instruments. This standard amends
the guidance in FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Statement 155 allows
financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to



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bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. Management is currently evaluating
the impact FASB 155 will have on our consolidated financial statements.

In September 2005, the Financial Accounting Standards Board
Emerging Issues Task Force issued EITF 05-02, The Meaning of Conventional Convertible Debt Instrument in EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Companys Own Stock. EITF 05-02 is effective for new instruments entered into and instruments modified in reporting periods beginning after June 29, 2005. We do not expect there to be a material impact from the adoption of EITF
05-02 on our consolidated financial position, results of operations, or cash flows.

In June 2006, the FASB issued FASB Interpretation
(FIN) No. 48, Accounting for Uncertainty in Income Taxes, that provides guidance on the accounting for uncertainty in income taxes recognized in financial statements. The interpretation will be adopted by us on January 1, 2007.
We are currently evaluating the impact of adopting FIN 48; however, we do not expect the adoption of this provision to have a material effect on our financial position, results of operations or cash flows.

Risk Factors

Set forth below and elsewhere in this Report and in the other documents we file with the
Securities and Exchange Commission are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements contained in this Report. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and risks set forth in this Report and our other public filings.

We need to
raise additional capital to continue to operate our business, which may not be available to us.

We incurred net losses of approximately
$10.9 million for the nine months ended June 30, 2006, $10.0 million for the fiscal year ended September 30, 2005, $11.7 million for the nine month transition period ended September 30, 2004, and $7.2 million for the
fiscal year ended December 31, 2003. Because we have had losses, we have funded our operating activities to date from the sale of securities, including our most recent financings in November 2005, March 2005, August 2004 and January
2002 as well as from the proceeds from the related exercise of warrants issued in connection with the 2002 financing, proceeds from the exercise of warrants issued in connection with the March 2005 financing and proceeds from the exercise of
warrants issued in connection with the November 2005 financing.

We will continue to require more cash during 2006 to fund our operations.
Specifically, we do not currently have sufficient funds to finance our operations through the end of the month of August 2006, and, accordingly, our future depends on our ability to secure additional financing during the month of August 2006.
Management believes that such additional cash requirements might be met by obtaining additional financing. However, to date, the Company has no commitment from potential financing sources for such additional financing, and the Company can provide no
assurances that such financing will be obtained on acceptable terms, or at all. Moreover, additional equity financing, if available, would likely be dilutive to the holders of our equity securities, including our common stock, and debt financing, if
available, would likely involve restrictive covenants.

In addition, the terms of the Debentures restrict our ability to complete additional equity or debt
financings containing certain terms without the consent of the holders of the Debentures. There can be no assurance that such consents, if required, will be obtained on acceptable terms, if at all.

In addition, pursuant to the terms of the private transaction under which we sold $5.0 million in principal amount of convertible debentures on
November 8, 2005, we are prohibited from filing any registration statement other than the resale registration statement (except for amendments to registration statements already filed) for 90 days after the effective date of the resale
registration statement, except Form S-8 registration statements in connection with employee stock benefit plans, upon exercise or conversion of outstanding securities and pursuant to acquisitions or other strategic transactions that are not
primarily for the purpose of raising additional capital. We are also subject to certain cash penalties payable to the selling stockholders in the registration statement contemplated by the March 2005 financing under certain circumstances relating to
the timely filing, effectiveness and maintenance of effectiveness of such registration statement. We are further subject to certain cash penalties payable to the selling stockholders listed in the resale registration statement contemplated by our



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financing that closed on November 8, 2005. Such cash penalties are payable under certain circumstances relating to the timely filing, effectiveness and
maintenance of effectiveness of such resale registration statement.

If we cannot raise sufficient additional capital, it would adversely
affect our ability to achieve our business objectives and to continue as a going concern. The Companys independent auditors included a going concern qualification in connection with the issuance of their report of independent auditors in
respect of our consolidated financial statements for our fiscal year ending September 30, 2005. Additionally, in connection with the audit of the Companys consolidated financial statements for the fiscal year ended September 30,
2005, the Companys independent auditor has identified a number of material weaknesses in our internal accounting controls over financial reporting. As a result, the Company has received an adverse attestation regarding Sarbanes-Oxley
Section 404 compliance. These conditions may also adversely affect our ability to raise additional financing and to conduct our business.

Unless
our stockholders approve an increase in the number of authorized shares in our Certificate of Incorporation, we will not be able to raise additional capital through equity financings except by effecting a reverse stock split.

Our current Certificate of Incorporation limits the number of shares of our authorized common stock to 100,000,000. We have issued $5 million and have
outstanding $4.25 million in Debentures convertible into common stock at a conversion price of $0.37 per share, Series B Common Stock Purchase Warrants and Finders Fee Warrants exercisable at an exercise price of $0.43 per share for 10,368,854
shares of common stock and Common Stock Purchase Warrants exercisable at an exercise price of $0.315 per share for 6,081,079 shares of common stock. Both the outstanding Debentures and the outstanding warrants contain provisions, pursuant to which,
under certain contingencies, the conversion or exercise price of such security, as applicable, will be adjusted such that additional shares of our common stock will be issued upon the conversion or exercise of such security. Because of such
provisions, we may not have sufficient authorized common stock to engage in subsequent equity financings unless our stockholders approve an increase in the authorized number of shares of common stock of 100,000,000 or we effect a reverse stock
split. Either course of action is likely to be dilutive to our existing stockholders and may cause the price of our common stock (on a split adjusted basis) to decline.

Our independent registered public accounting firm has issued an adverse attestation on the adequacy of our internal controls over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
2002.

The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a
report of management on internal controls over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the companys internal controls over financial reporting. In addition,
the companys independent registered public accounting firm must attest to and report on managements assessment of the effectiveness of the internal controls over financial reporting. We are required to provide a report on the adequacy of
internal controls over financial reporting beginning with our fiscal year ending September 30, 2005. In connection with the audit of our financial statements for the fiscal year ended September 30, 2005, our independent auditor has
identified a number of material weaknesses in our internal accounting controls over financial reporting. As a result, we have received an adverse attestation regarding compliance with Section 404 of the Sarbanes-Oxley Act of 2002 from our
independent registered public accounting firm. Certain of these material weaknesses resulted in adjustments to the Companys fiscal year 2005 annual consolidated financial statements. If not remediated, such weaknesses could result in material
misstatements to the Companys future annual or interim financial statements that would not be prevented or detected. Although we intend to diligently and vigorously review our internal controls over financial reporting in order to ensure
compliance with the Section 404 requirements on an annual basis, if in the future, our independent registered public accounting firm is still not satisfied with our internal controls over financial reporting or the level at which these controls
are documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules and/or regulations differently from us, then they may decline to attest to managements assessment or may
again issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our consolidated financial statements, which ultimately could negatively impact
our stock price as well as our ability to raise additional financing.

Neither our disclosure controls and procedures nor our internal control over
financial reporting can prevent all errors or fraud, in the past these controls and procedures were not effective and resulted in restatements to our financial results, and we currently have material weaknesses in our internal controls.

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will
prevent all errors or fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be attained. Furthermore, the design of a control system
must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of controls can provide absolute
assurance that all misstatements due to error or fraud, if any, may occur and not be detected on a timely



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basis. These inherent limitations include the possibility that judgments in decision-making can be faulty and that breakdowns can occur because of errors or
mistakes. Our controls and procedures can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Furthermore, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or procedures. While we seek to design our controls and procedures to provide reasonable assurance that information required to be disclosed in our periodic filings is timely
disclosed, these inherent limitations expose us to breakdowns in such controls and procedures. For example, while our certifying officers believed that the design of our controls and procedures would ensure that material information related to the
Company would be made known to them on a timely basis, in light of the circumstances underlying the Initial Restatement and Additional Restatement, these controls and procedures for the financial statement periods covered by the Initial Restatement
and Additional Restatement were not effective. We have made certain changes to our internal controls over financial reporting regarding the review of sales orders designed to address these circumstances, although even these improvements to our
controls and procedures cannot ensure that all errors or fraud will be prevented. Additionally, in connection with the audit of the Companys consolidated financial statements for the fiscal year ended September 30, 2005, the
Companys independent auditor identified a number of material weaknesses in our internal controls over financial reporting. Certain of these material weaknesses resulted in adjustments to the Companys fiscal year 2005 annual consolidated
financial statements. If not remediated, such weaknesses could result in material misstatements to the Companys future annual or interim financial statements that would not be prevented or detected. As a result, we have received an adverse
attestation from our independent auditors regarding Sarbanes-Oxley Section 404 compliance. These conditions may also adversely affect our ability to raise additional financing and to conduct our business.

If we were to have an event of default or breach a covenant under the 6% Senior Secured Convertible Debentures (the Debentures) issued in our November
2005 private placement, 130 percent of the outstanding principal amount of the Debentures plus all accrued and unpaid interest would become immediately due and payable to the holders of the Debentures, and we currently do not have the cash resources
to pay these obligations, which are secured by all of our assets including our intellectual property and would therefore be subject to seizure by the holders of the Debentures in the event of a default or covenant breach.

The 6% Senior Secured Convertible Debentures we issued to institutional investors in our November 2005 private placement contain numerous events of
default and covenants. Events of default under the Debentures include:



| |  |  | failure to pay principal or any premium on any Debenture when due;
| | - |  | ------------------------------------------------------------------



| |  |  | failure to pay any interest, late fees or liquidated damages on any Debenture after a period of 3 trading days;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | failure to perform other covenants under the Debenture that is not cured by the earlier of 5 trading days after notice by holder or 10 trading days after the Company is aware of
such default;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any default under the other financing documents that is not cured by the earlier of 5 trading days after notice or 10 trading days after the Company is aware of such default;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any representation or warranty under the financing documents that is untrue or incorrect in any material respect;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | certain events of bankruptcy or insolvency of the Company or any of its subsidiaries;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | any default by the Company or its subsidiaries under any instrument in excess of $150,000 that results in such obligation becoming due and payable prior to maturity;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Company becoming party to a change of control transaction, or disposing of greater than 40 percent of its assets or redeeming more than a de minimus number of outstanding equity
securities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure by the Company to have the resale registration statement (the Resale Registration Statement) registering the resale of the Common Stock issuable upon the
conversion of the Debentures and the exercise of the Warrants (as defined below) declared effective by the SEC on or prior to April 7, 2006;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if, during the effectiveness period of the Resale Registration Statement, the effectiveness of the registration statement lapses for any reason or the holder shall not be permitted
to resell registrable securities under such Resale Registration Statement, in either case, for more than 20 consecutive trading days or 30 non-consecutive trading days during any 12 month period, subject to certain limited exceptions;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | failure to deliver common stock certificates to a holder prior to the third trading day after a Debenture conversion date; or
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | any breach of the Voting Agreement entered into by Dr. Adya S. Tripathi in connection with the November 8, 2005 financing to vote shares of the Companys common
stock owned by him in favor of any required stockholder approval of the financing to the extent required in order to maintain the listing of the Companys common stock on the Nasdaq Capital Market.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Upon an event of default, 130 percent of the outstanding principal of the Debentures plus all accrued and unpaid interest shall become immediately due
and payable to the holder of the Debentures.

The Debentures contain various covenants that limit the Companys ability to:



| |  |  | incur additional debt, other than permitted debt as defined in the Debenture;
| | - |  | -----------------------------------------------------------------------------



| |  |  | repay or repurchase more than a de minimus number of shares of common stock;
| | - |  | ----------------------------------------------------------------------------



| |  |  | incur specified liens, other than permitted liens as defined in the Debenture; or
| | - |  | ---------------------------------------------------------------------------------



| |  |  | amend its certificate, bylaws or charter documents in a material adverse manner to the holder of the Debenture.
| | - |  | ---------------------------------------------------------------------------------------------------------------

A breach of these covenants that is uncured within the applicable 5 or 10 trading day periods noted above would constitute an event of default under the
Debentures. In addition, as part of the November 2005 private placement financing, the Company has agreed to be bound by the following additional covenants, a breach of which covenants that is uncured within the applicable 5 or 10 trading day
periods noted above would constitute an event of default under the Debentures:



| |  |  | not to issue shares of common stock or other securities convertible or exercisable for common stock until the effective date of the Resale Registration Statement and not to file any
other registration statements (except for amendments to registration statements already filed) until 90 days after the effective date of the Resale Registration Statement;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to assume any corporate debt which is senior to the Debentures;
| | - |  | -------------------------------------------------------------------



| |  |  | either to terminate the Companys existing accounts receivable secured credit facility or to enter into an inter-creditor agreement to effect the subordination of the facility
to the Debentures;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to repay or repurchase more than a de minimus number of shares of common stock;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | not to incur specified liens, other than certain specified permitted liens;
| | - |  | ---------------------------------------------------------------------------



| |  |  | not to amend the Companys current Certificate of Incorporation except to effect a reverse stock split or as the result of a delisting of the Companys common stock from
the Nasdaq Capital Market; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | not to pay cash dividends or distributions on its equity securities.
| | - |  | --------------------------------------------------------------------

We currently do not have the cash resources to pay these obligations, which are secured by all of our assets including our personal and intellectual property, and such assets would therefore be subject to seizure by
the holders of the Debentures in the event of a default or covenant breach. We cannot assure you that we will not have an event of default under the Debentures or experience a covenant breach that would trigger such an event of default.

We have incurred liquidated damages and may incur penalties under the contractual terms of our March 2005 financing and may also incur liquidated damages and
penalties under the contractual terms of our November 2005 financing.

Pursuant to the terms of our March 2005 and November 2005
financings, to the extent that we fail to have our resale registration statements on Form S-1 declared effective within a certain amount of time or remain effective thereafter, we are obligated to pay liquidated damages and penalties. Fiscal
year to date we have not incurred or accrued any liquidated damages. In the future we may incur liquidated damages and penalties and may be obligated to pay such amounts. In the event that we continue to incur liquidated damages and
penalties under the terms of our financings, our cash and marketable securities balances will be adversely affected which would likely have an adverse effect on our continuing operations.



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We have maintained neither Nasdaq National Market listing requirements nor Nasdaq Capital Market listing requirements
and have been delisted from the Nasdaq Capital Market effective at the opening of business on December 8, 2005 and now trade on the OCT Bulletin Board.

On April 25, 2005 we received a deficiency notice from the Nasdaq Stock Market, or Nasdaq, for failing to (1) maintain the Nasdaq National Markets minimum $50 million market value of listed
securities requirement for continued listing and (2) maintain our total assets and total revenue for the most recently completed fiscal year or for two of the last three most recently completed fiscal years above the $50 million
requirement for continued listing. We had a grace period of 30 calendar days, or until May 25, 2005, to cure the deficiency by meeting the $50 million minimum market value of listed securities for 10 consecutive days or such longer period
of time as may be required by Nasdaq, at its discretion.

In addition, on April 26, 2005, we received a deficiency notice from Nasdaq
for failing to maintain the Nasdaq National Markets minimum $1.00 bid price requirement for continued listing. We had a grace period of 180 calendar days, or until October 24, 2005, to cure the deficiency by meeting the minimum $1.00 bid
price for 10 consecutive trading days or such longer period of time as may be required by Nasdaq, at its discretion.

On May 26, 2005,
we received another letter from Nasdaq notifying us that we had not regained compliance with Marketplace Rule 4450(b)(1)(A), which sets a $50 million market value of listed securities requirement for continued listing, during the relevant
grace period. According to this letter, we were subject to delisting from the Nasdaq National Market. We appealed Nasdaqs determination and a hearing before a Nasdaq Listing Qualifications Panel was held on July 14, 2005.

On August 22, 2005, we received a letter from the Office of General Counsel, Nasdaq Listing Qualifications Hearings informing us that the Nasdaq
Listing Qualifications Panel determined to transfer the securities of Tripath from the Nasdaq National Market to the Nasdaq Capital Market, effective at the opening of business on August 24, 2005, and our Common Stock has been traded on the
Nasdaq Capital Market since that time.

On October 26, 2005, we received a Nasdaq Staff Determination letter indicating that we had
not regained compliance with the Minimum Price Requirement, that we are not eligible for an additional 180-day compliance period given that we do not meet the Nasdaq Capital Market initial inclusion criteria set forth in Nasdaq Marketplace Rule
4310(c) and, therefore, our securities would be delisted from the Nasdaq Capital Market at the opening of business on November 4, 2005 unless we requested a hearing before a Nasdaq Listing Qualifications Panel to appeal the delisting
determination. We requested a hearing before a Nasdaq Listing Qualifications Panel and the delisting of our securities was stayed pending the panels decision. Such hearing was held on December 1, 2005.

We closed a $5 million financing on November 8, 2005. We received on November 14, 2005 an Additional Staff Determination letter from Nasdaq
indicating that we failed to comply with (i) the shareholder approval requirements for continued listing set forth in Nasdaq Marketplace Rules 4350(i)(1)(D)(ii) and IM-4350-2 and (ii) the stockholders equity requirements for
continued listing set forth in Nasdaq Marketplace Rule 4310(c)(2)(B), and that our securities were, therefore, subject to delisting from the Nasdaq Capital Market. The Additional Staff Determination letter also notified us that these two matters
would be considered at the hearing on December 1, 2005 in rendering a determination regarding the Companys continued listing of its common stock on the Nasdaq Capital Market.

On December 6, 2005, the Company received a notice from the Counsel to the Panel, Nasdaq Office of General Counsel, Listing Qualifications Hearing
of the Nasdaq Stock Market informing the Company that the Nasdaq Listing Qualifications Panel (the Panel) had denied the Companys request to continue its listing on the Nasdaq Capital Market, and that, accordingly, the Panel would
de-list the Companys shares from the Nasdaq Capital Market effective at the opening of business on Thursday, December 8, 2005. The Panel found that the Company failed to meet the minimum $1.00 bid price per share requirement, as set forth
in Marketplace Rule 4310(c)(4); comply with the shareholder approval requirements under Marketplace Rule 4350(i)(1)(D)(ii) and IM-4350-2; or meet the $2.5 million stockholders equity requirement under Marketplace Rule 4310(c)(2)(B)(i).

On December 8, 2005 shares of common stock of the Company began trading on the Pink Sheets.

On December 30, 2005 the shares of common stock of the Company ceased to trade on the Pink Sheets and began to trade on the OTC Bulletin Board.

Given that our common stock has been delisted from the Nasdaq Capital Market, it will likely be more difficult to trade in or obtain
accurate quotations as to the market price of our common stock. Delisting of our common stock can materially adversely affect the market price, the market liquidity of our common stock, and our ability to raise necessary



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capital and can otherwise have an adverse impact on our business, financial condition, and results of operations. There is no assurance that we will again
satisfy the Nasdaq Capital Markets listing requirements at any time in the future.

Our proposed reverse stock split that was approved by our
stockholders at our September 2005 Annual Meeting, if deemed necessary by our board of directors, may be dilutive, may result in a negative market reaction and, by itself, will not permit us to comply with the Nasdaq Capital Markets listing
requirements for our common stock.

At our annual stockholder meeting held on September 30, 2005, our stockholders approved a
proposal to effect a reverse stock split of our common stock at an exchange ratio ranging from one-for-two to one-for-six and authorized our board of directors to select the appropriate ratio at its discretion. If the reverse stock split is deemed
necessary to be effected by our board of directors and if we issue additional shares of stock beyond the shares contemplated to be issued upon the conversion of the Debentures and the exercise of the warrants issued as part of our November 2005
financing, our proposed reverse stock split would have a dilutive effect upon our existing stockholders. Additionally, the market may react negatively to the proposed reverse stock split and the price of our common stock could decline. Finally, the
proposed reverse stock split, if effected by our board of directors, will not, by itself, permit us to comply with the Nasdaq Capital Markets listing requirements for our common stock. In addition, in the event we reverse split our Common
Stock, the conversion price of the Debentures we issued in our November 2005 private placement would be reset on the 60thcalendar day following such reverse split to the lower of the current $0.37 conversion price or the average of the volume weighted average price per share of our common stock on the applicable trading market 10 days preceding the
reset date.

We have a history of losses and may never achieve or sustain profitability.

As of June 30, 2006, we had an accumulated deficit of $211.7 million. We incurred net losses of approximately $10.0 million for the year
ended September 30, 2005, $11.7 million for the nine months ended September 30, 2004 and $7.2 million for the twelve months ended December 31, 2003. We may continue to incur net losses and these losses may be substantial.
Furthermore, we may continue to generate significant negative cash flow in the future. We will need to generate substantially higher revenue to achieve and sustain profitability and positive cash flow. Our ability to generate future revenue and
achieve profitability will depend on a number of factors, many of which are described throughout this section. If we are unable to achieve or maintain profitability, we will be unable to build a sustainable business. In this event, our share price
and the value of your investment would likely decline and we might be unable to continue as a going concern. The Companys independent auditors have included a going concern qualification in connection with the issuance of their report of
independent auditors in respect to our consolidated financial statements for our fiscal year ending September 30, 2005.

Our quarterly operating
results are likely to fluctuate significantly and may fail to meet the expectations of securities analysts and investors, which may cause our share price to decline.

Our quarterly operating results have fluctuated significantly in the past and are likely to continue to do so in the future. The many factors that could cause our quarterly results to fluctuate include, in part:



| |  |  | level of sales and recognition of revenue;
| | - |  | ------------------------------------------



| |  |  | mix of high and low margin products;
| | - |  | ------------------------------------



| |  |  | availability and pricing of wafers;
| | - |  | -----------------------------------



| |  |  | timing of introducing new products, including, but not limited to, the introduction of new products based on the lower cost Godzilla architecture, lower cost versions of
existing products, fluctuations in manufacturing yields and other problems or delays in the fabrication, assembly, testing or delivery of products;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | market acceptance of our products and our customers products;
| | - |  | --------------------------------------------------------------



| |  |  | rate of development of target markets; and
| | - |  | ------------------------------------------



| |  |  | increases in inventory reserves associated with slow moving, excess and obsolete inventory.
| | - |  | -------------------------------------------------------------------------------------------

A large portion of our operating expenses, including salaries, rent and capital lease are fixed expenses. If we experience a shortfall in revenues
relative to our expenses, we may be unable to reduce our expenses quickly enough to offset the reduction in revenues during that accounting period, which would adversely affect our operating results. Fluctuations in our operating results may also
result in fluctuations in our common stock price. If the market price of our stock is adversely affected, we may experience difficulty in raising capital or making acquisitions. In addition, we may become the object of securities class action
litigation, which occurred in late 2004. As a result, we do not believe that



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period-to-period comparisons of our revenues and operating results are necessarily meaningful. One should not rely on the results of any one quarter as an
indication of future performance.

Our stock price has been and may continue to be highly volatile.

The trading price of our stock has been and may continue to be highly volatile. For example, during the quarter ended June 30, 2006, our common stock
had closing sales prices as low as $0.23 and as high as $0.43 per share. Broad market fluctuations as well as general economic conditions may cause our stock price to decline. We believe that fluctuations of our stock price may continue to be caused
by a variety of factors, including:



| |  |  | announcements of developments related to our business;
| | - |  | ------------------------------------------------------



| |  |  | fluctuations in our financial results;
| | - |  | --------------------------------------



| |  |  | our financial condition and liquidity resources;
| | - |  | ------------------------------------------------



| |  |  | our ability to meet our obligations under the Debentures and other agreements entered into in connection with our November 2005 Financing;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | general conditions in the stock market or around the world, terrorism or developments in the semiconductor and capital equipment industry and the general economy;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | sales or purchases of our common stock in the marketplace;
| | - |  | ----------------------------------------------------------



| |  |  | announcements of our technological innovations or new products or enhancements or those of our competitors;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | developments in patents or other intellectual property rights;
| | - |  | --------------------------------------------------------------



| |  |  | developments in our relationships with customers and suppliers;
| | - |  | ---------------------------------------------------------------



| |  |  | the market listing status of our Common Stock;
| | - |  | ----------------------------------------------



| |  |  | a shortfall or changes in revenue, gross margins or earnings or other financial results from analysts expectations or an outbreak of hostilities or natural disasters; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | acquisition or merger activity.
| | - |  | -------------------------------

Our product shipment patterns make it
difficult to predict our quarterly revenues.

As is common in our industry, we frequently ship more products in the third month of each
quarter than in either of the first two months of the quarter, and shipments in the third month are higher at the end of that month. We believe this pattern is likely to continue. The concentration of sales in the last month of the quarter may cause
our quarterly results of operations to be more difficult to predict. Moreover, if sufficient business does not materialize or a disruption in our production or shipping occurs near the end of a quarter, our revenues for that quarter could be
materially reduced.

Our customers may cancel or defer product orders, which could result in excess inventory.

Our sales are generally made pursuant to individual purchase orders that may be canceled or deferred by customers on short notice without significant
penalty. Thus, orders in backlog may not result in future revenue. In the past, we have had cancellations and deferrals by customers. Any cancellation or deferral of product orders could result in us holding excess inventory, or result in obsolete
inventory over time, which could seriously harm our profit margins and restrict our ability to fund our operations. For example, during the quarter ended September 30, 2004, we recorded a provision for slow moving, excess and obsolete inventory
of approximately $4.3 million. Our inventory and purchase commitments are based on expected demand and not necessarily built for firm purchase commitments for our customers. Because of the required delivery lead time, we need to carry a high
level of inventory in comparison to past sales. We recognize revenue upon shipment of products to the end customer and, in the case of distributor sales, based upon receipt of point-of-sales report from the distributor. Although we have not
experienced customer refusals to accept shipped products or material difficulties in collecting accounts receivable, such refusals or collection difficulties are possible and could result in significant charges against income, which could seriously
harm our revenues and our cash flow.



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We rely on a small number of customers and sales by distributors for most of our revenue and a decrease in revenue
from these customers could seriously harm our business.

A relatively small number of customers have accounted for most of our revenues
to date. Any reduction or delay in sales of our products to one or more of these key customers could seriously reduce our sales volume and revenue and adversely affect our operating results. Our top five end customers accounted for 59 percent and 48
percent of revenue in the three months ended June 30, 2006 and the three months ended June 30, 2005, respectively. Our primary customers during the three months ended June 30, 2006 were Sharp and Orion representing 22 percent and 14
percent respectively. In the June quarter of 2005, our primary customer was Sharp21 percent. We expect that we will continue to rely on the success of our largest customers and on our success in selling our existing and future products to those
customers in significant quantities. We cannot be sure that we will retain our largest customers (whether from inside sales or through our distributors) or that we will be able to obtain additional key customers or replace key customers we may lose
or who may reduce their purchases.

We currently rely on sales of three products for a significant portion of our revenue, and the failure of these
products to be successful in the future could substantially reduce our sales.

We currently rely on sales of our TA2024 digital audio
amplifier product family to generate a significant portion of our revenue. Sales of this product family amounted to 52 percent of our revenue for the three months ended June 30, 2006 and 41 percent of our revenue for the three months ended
June 30, 2005. We have developed additional products and plan to introduce more products in the future, but there can be no assurance that these products will be commercially successful. Consequently, if our existing products are not
successful, our sales could decline substantially.

Our lengthy sales cycle makes it difficult for us to predict if or when a sale will be made, to
forecast our revenue and to budget expenses, which may cause fluctuations in our quarterly results.

Because of our lengthy sales
cycles, we may continue to experience a delay between incurring expenses for research and development, sales and marketing and general and administrative efforts, as well as incurring investments in inventory, and the generation of revenue, if any,
from such expenditures. In addition, the delays inherent in such a lengthy sales cycle raise additional risks of customer decisions to cancel or change product plans, which could result in our loss of anticipated sales. Our new products are
generally incorporated into our customers products or systems at the design stage. To try and have our products selected for design into new products of current and potential customers, commonly referred to as design wins, often requires
significant expenditures by us without any assurance of success. Once we have achieved a design win, our sales cycle will start with the test and evaluation of our products by the potential customer and design of the customers equipment to
incorporate our products. Generally, different parts have to be redesigned to incorporate our devices successfully into our customers products.

The sales cycle for the test and evaluation of our products can range from a minimum of three to six months, and it can take a minimum of an additional six to nine months before a customer commences volume production
of equipment that incorporates our products. Achieving a design win provides no assurance that such customer will ultimately ship products incorporating our products or that such products will be commercially successful. Our revenue or prospective
revenue would be reduced if a significant customer curtails, reduces or delays orders during our sales cycle, or chooses not to release products incorporating our products.

Our ability to achieve revenue growth will be harmed if we are unable to persuade electronic systems manufacturers to adopt our new amplifier technology.

We face difficulties in persuading manufacturers to adopt our products using our new amplifier technology. Traditional amplifiers use design approaches
developed in the 1930s. These approaches are still used in most amplifiers and engineers are familiar with these design approaches. To adopt our products, manufacturers and engineers must understand and accept our new technology. To take advantage
of our products, manufacturers must redesign their systems, particularly components such as the power supply and heat sinks. Manufacturers must work with their suppliers to obtain modified components and they often must complete lengthy evaluation
and testing. In addition, our amplifiers are often more expensive as components than traditional amplifiers. For these reasons, prospective customers may be reluctant to adopt our technology.

We currently depend on consumer electronics markets that are typically characterized by aggressive pricing, frequent new product introductions and intense
competition.

A substantial portion of our current revenue is generated from sales of products that address the consumer electronics
markets, including home theater, computer audio, flat panel TV, gaming, professional amplifiers, set-top box, AV receivers



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and the automotive audio markets. These markets are characterized by frequent new product introductions, declining prices and intense competition. Pricing in
these markets is aggressive, and we expect pricing pressure to continue. In the computer audio segment, our success depends on consumer awareness and acceptance of existing and new products by our customers and consumers, in particular, the
elimination of externally-powered speakers. In the automotive audio segment, we face pressure from our customers to deliver increasingly higher-powered solutions under significant engineering limitations due to the size constraints in car
dashboards. In addition, our ability to obtain prices higher than the prices of traditional amplifiers will depend on our ability to educate manufacturers and their customers about the benefits of our products. Failure of our customers and consumers
to accept our existing or new products will seriously harm our operating results.

The cyclical nature of the semiconductor industry could create
fluctuations in our operating results.

The semiconductor industry has historically been cyclical and characterized by wide fluctuations
in product supply and demand. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Industry downturns have
been characterized by diminished product demand, production overcapacity and accelerated decline in average selling prices, and in some cases have lasted for more than a year. In addition, we may determine to lower our prices of our products to
increase or maintain market share, which would likely harm our operating results. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we have experienced and may experience in
the future substantial period-to-period fluctuations in our results of operations due to general semiconductor industry conditions, overall economic conditions or other factors, many of which are outside our control. Due to these risks, you should
not rely on period-to-period comparisons to predict our future performance.

We may experience difficulties in the introduction of new or enhanced
products, including but not limited to the new Godzilla architecture products, that could result in significant, unexpected expenses or delay their launch, which would harm our business.

Our failure or our customers failure to develop and introduce new products successfully and in a timely manner would seriously harm our ability to
generate revenues. Consequently, our success depends on our ability to develop new products for existing and new markets, introduce such products in a timely and cost-effective manner and to achieve design wins. The development of these new devices
is highly complex, and from time to time we have experienced delays in completing the development and introduction of new products. The successful introduction of a new product may currently take up to 18 months. Successful product development and
introduction depends on a number of factors, including:



| |  |  | accurate prediction of market requirements and evolving standards;
| | - |  | ------------------------------------------------------------------



| |  |  | accurate new product definition;
| | - |  | --------------------------------



| |  |  | timely completion and introduction of new product designs;
| | - |  | ----------------------------------------------------------



| |  |  | our financial, working capital and engineering resources;
| | - |  | ---------------------------------------------------------



| |  |  | availability of foundry capacity;
| | - |  | ---------------------------------



| |  |  | achieving acceptable manufacturing yields;
| | - |  | ------------------------------------------



| |  |  | market acceptance of our products and our customers products; and
| | - |  | ------------------------------------------------------------------



| |  |  | market competition.
| | - |  | -------------------

We cannot guarantee success with
regard to these factors. We introduced our lower cost Godzilla architecture products in January 2004 and have been sampling them in certain customers products since mid-2004. However, we have not received revenues for these
products to date.

We depend on three outside foundries for our semiconductor device manufacturing requirements.

We do not own or operate a fabrication facility, and substantially all of our semiconductor device requirements are currently supplied by three outside
foundries, United Microelectronics Corporation, in Taiwan, STMicroelectronics Group in Europe and Renesas Technology (Mitsubishi Electric) in Japan. Although we primarily utilize these three outside foundries, most of our components are not
manufactured at these foundries at the same time. As a result, each foundry is a sole source for certain products.



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There are significant risks associated with our reliance on outside foundries, including:



| |  |  | the lack of guaranteed wafer supply;
| | - |  | ------------------------------------



| |  |  | limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | the unavailability of or delays in obtaining access to key process technologies.
| | - |  | --------------------------------------------------------------------------------

In addition, the manufacture of integrated circuits is a highly complex and technologically demanding process. Although we work closely with our foundries to minimize the likelihood of reduced manufacturing yields,
our foundries have from time to time experienced lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies.

We provide our foundries with continuous forecasts of our production requirements; however, the ability of each foundry to provide us with semiconductor
devices is limited by the foundrys available capacity. In many cases, we place our orders on a purchase order basis, and foundries may allocate capacity to the production of other companies products while reducing the deliveries to us on
short notice. In particular, foundry customers that are larger and better financed than us or that have long-term agreements with our foundries may cause such foundries to reallocate capacity in a manner adverse to us. While capacity at our
foundries has been available during the last several years, the cyclical nature of the semiconductor industry could result in capacity limitations in a cyclical upturn or otherwise. In addition, our limited capital resources has from time to time
and may in the future result in our not keeping our vendors, including our foundries, as current in our accounts payable to them as they desire which may negatively affect the amount and timing of capacity that is allocated to production of our
products.

If we use a new foundry, several months would be typically required to complete the qualification process before we can begin
shipping products from the new foundry. In the event any of our current foundries suffers any damage or destruction to their respective facilities, or in the event of any other disruption of foundry capacity, we may not be able to qualify
alternative manufacturing sources for existing or new products in a timely manner. Even our current outside foundries would need to have certain manufacturing processes qualified in the event of disruption at another foundry, which we may not be
able to accomplish in a timely enough manner to prevent an interruption in supply of the affected products.

If we encounter shortages or
delays in obtaining semiconductor devices for our products in sufficient quantities when required, delivery of our products could be delayed, resulting in customer dissatisfaction and decreased revenues.

We depend on third-party subcontractors for most of our semiconductor assembly and testing requirements and any unexpected interruption in their services could cause
us to miss scheduled shipments to customers and to lose revenues.

Semiconductor assembly and testing are complex processes, which
involve significant technological expertise and specialized equipment. As a result of our reliance on third-party subcontractors for assembly and testing of our products, we cannot directly control product delivery schedules, which has in the past,
and could in the future, result in product shortages or quality assurance problems that could increase the costs of manufacture, assembly or testing of our products. Almost all of our products are assembled and tested by one of five subcontractors:
ASE in Korea, Malaysia and Taiwan, Hon Hai (formerly AMBIT Microsystems Corporation) in China, Lingsen in Taiwan, STMicroelectronics Group in Malaysia, and ST Assembly Test Services Ltd. in Singapore. We do not have long-term agreements with any of
these suppliers and retain their services on a per order basis. The availability of assembly and testing services from these subcontractors could be adversely affected in the event a subcontractor suffers any damage or destruction to their
respective facilities, or in the event of any other disruption of assembly and testing capacity. Due to the amount of time normally required to qualify assemblers and testers, if we are required to find alternative manufacturing assemblers or
testers of our components, shipments could be delayed. Any problems associated with the delivery, quality or cost of our products could seriously harm our business. In addition, our limited capital resources has from time to time and may in the
future result in our not keeping our vendors, including our foundries, as current in our accounts payable to them as they desire which may negatively affect the amount and timing of capacity that is allocated to production of our products.

Failure to transition our products to more effective and/or increasingly smaller semiconductor chip sizes and packaging could cause us to lose our
competitive advantage and reduce our gross margins.

We evaluate the benefits, on a product-by-product basis, of migrating to smaller
semiconductor process technologies in order to reduce costs and have commenced migration of some products to smaller semiconductor processes. We believe that the transition of our products to increasingly smaller semiconductor processes will be
important for us to reduce manufacturing costs and to remain competitive. Moreover, we are dependent on our relationships with our foundries to migrate to smaller semiconductor processes successfully. We cannot be sure that our future process
migrations will be



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achieved without difficulties, delays or increased expenses. Our gross margins would be seriously harmed if any such transition is substantially delayed or
inefficiently implemented.

Our international operations subject us to risks inherent in doing business on an international level that could harm our
operating results.

We currently obtain almost all of our manufacturing, assembly and test services from suppliers who are located
outside the United States and may further expand our manufacturing activities abroad. Approximately 98 percent and 96 percent of our total revenue for the three months ended June 30, 2006 and for the three months ended June 30, 2005,
respectively, were derived from sales to end customers based outside the United States. In addition, we often ship products to our domestic customers international manufacturing divisions and subcontractors.

Accordingly, we are subject to risks inherent in international operations, which include:



| |  |  | political, social and economic instability;
| | - |  | -------------------------------------------



| |  |  | trade restrictions and tariffs;
| | - |  | -------------------------------



| |  |  | the imposition of governmental controls;
| | - |  | ----------------------------------------



| |  |  | exposure to different legal standards, particularly with respect to intellectual property;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | import and export license requirements;
| | - |  | ---------------------------------------



| |  |  | unexpected changes in regulatory requirements; and
| | - |  | --------------------------------------------------



| |  |  | difficulties in collecting receivables.
| | - |  | ---------------------------------------

All of our
international sales to date have been denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. Conversely, a decrease in
the value of the U.S. dollar relative to foreign currencies would increase the cost of our overseas manufacturing, which would reduce our gross margins.

If we are not successful in developing and marketing new and enhanced products for the DSL high speed communications markets that keep pace with technology and our customers needs, our operating results will suffer.

The market for our DSL products is characterized by rapid technological advances, intense competition and a relatively small number of potential
customers. These conditions could likely result in price erosion on existing products and pressure for cost-reduced future versions. Implementation of our products requires manufacturers to accept our technology and redesign their products. If
potential customers do not accept our technology or experience problems implementing our devices in their products, our products could be rendered obsolete and our business would be harmed. If we are unsuccessful in introducing future products with
enhanced performance, our ability to achieve revenue growth will be seriously harmed.

We may experience difficulties in the development and
introduction of a new amplifier product for use in the cellular phone market, which could result in significant expenses or delay in its launch.

This product is still in research and development and we currently have no design wins or customers for this product. We may not introduce our amplifier product for the cellular phone market on time, and this product may never achieve
market acceptance. Furthermore, competition in this market is likely to result in price reductions, shorter product life cycles, reduced gross margins and longer sales cycles compared with what we have experienced to date with our other products.

Intense competition in the semiconductor industry and in the consumer electronics and communications markets could prevent us from achieving or
sustaining profitability.

The semiconductor industry and the consumer audio and communications markets are highly competitive. We
compete with a number of major domestic and international suppliers of semiconductors in the consumer electronics and communications markets. We also may face competition from suppliers of products based on new or emerging technologies. Many of our
competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing,
distribution, technical and other resources than us. As a result, such competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the promotion and sale of their
products than us. Current and potential competitors have established or may establish



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financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible
that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. In addition, existing or new competitors may in the future develop technologies that more effectively address the transmission of digital
information through existing analog infrastructures at a lower cost or develop new technologies that may render our technology obsolete. There can be no assurance that we will be able to compete successfully in the future against our existing or
potential competitors, or that our business will not be harmed by increased competition.

Our products are complex and may have errors and defects that
are detected only after deployment in customers products, which may harm our business.

Products such as those that we offer may
contain errors and defects when first introduced or as new versions are released. We have in the past experienced such errors and defects, in particular in the development stage of a new product. Delivery of products with production defects or
reliability, quality or compatibility problems could significantly delay or hinder market acceptance of such products, which could damage our reputation and seriously harm our ability to retain our existing customers and to attract new customers and
therefore impact our revenues. Moreover, such errors and defects could cause problems, interruptions, delays or a cessation of sales to our customers. Alleviating such problems may require substantial redesign, manufacturing and testing which would
result in significant expenditures of capital and resources. Despite testing conducted by us, our suppliers and our customers, we cannot be sure that errors and defects will not be found in new products after commencement of commercial production.
Such errors and defects could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, product repair or replacement costs, claims by our
customers or others against us or the loss of credibility with our current and prospective customers. Any such event could result in the delay or loss of market acceptance of our products and would likely harm our business.

We do not have third party insurance coverage to offset the cost of defending the pending securities class action and derivative litigation and, therefore, defending
the litigation matters set forth in this Quarterly Report on Form 10-Q will likely materially and adversely affect our financial condition.

Our financial condition will likely be materially adversely affected by the pendency of the litigation referenced in this Quarterly Report on Form 10-Q because we do not have third-party insurance coverage for either the costs of defending
these lawsuits, including the costs of possible indemnification claims by the individual named defendants, or settling such litigation. We believe that the cost of defending or settling such litigation will have a material adverse effect on our cash
balances and will be another factor requiring us to raise additional funds. In addition, these matters will require devotion of significant management resources which may also adversely affect our business operations.

If we are unable to retain key personnel, we may not be able to operate our business successfully.

We may not be successful in retaining executive officers and other key management and technical personnel. A high level of technical expertise is required
to support the implementation of our technology in our existing and new customers products. In addition, the loss of the management and technical expertise of Dr. Adya S. Tripathi, our founder, president and chief executive officer,
could seriously harm us. We do not have any employment contracts with our employees.

Our intellectual property and proprietary rights may be
insufficient to protect our competitive position.

Our business depends, in part, on our ability to protect our intellectual property.
We rely primarily on patent, copyright, trademark and trade secret laws to protect our proprietary technologies. We cannot be sure that such measures will provide meaningful protection for our proprietary technologies and processes. As of
June 30, 2006, we had 43 issued United States patents, and 10 additional United States patent applications which are pending. In addition, we had 18 international patents issued and an additional 22 international patents pending. We cannot be
sure that any patent will issue as a result of these applications or future applications or, if issued, that any claims allowed will be sufficient to protect our technology. In addition, we cannot be sure that any existing or future patents will not
be challenged, invalidated or circumvented, or that any right granted thereunder would provide us meaningful protection. The failure of any patents to provide protection to our technology would make it easier for our competitors to offer similar
products. In connection with our participation in the development of various industry standards, we may be required to agree to license certain of our patents to other parties, including our competitors that develop products based upon the adopted
standards.

We also rely on copyright, trademark and trade secret laws in the United States and other countries to protect our proprietary
rights. As discussed above, we have several international issued and pending patents in certain foreign countries. However the laws of some foreign countries in which we do business may not protect our copyrights, trademarks and trade secrets to the
same extent as the laws of the United States. We also generally enter into confidentiality agreements with our employees and strategic partners, and generally control access to and distribution of our documentation and other



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proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products, services or
technology without authorization, develop similar technology independently or design around our patents. Some of our customers have entered into agreements with us pursuant to which such customers have the right to use our proprietary technology in
the event we default in our contractual obligations, including product supply obligations, and fail to cure the default within a specified period of time.

We may be subject to intellectual property rights disputes that could divert managements attention and could be costly.

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. From time to time, we may receive in the future notices of claims of infringement, misappropriation or misuse of other
parties proprietary rights. We cannot be sure that we will prevail in these actions, or that other actions alleging infringement by us of third-party patents, misappropriation or misuse by us of third-party trade secrets or the invalidity of
one or more patents held by us will not be asserted or prosecuted against us, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of our patents will not seriously harm our business.
For example, in a patent or trade secret action, an injunction could be issued against us requiring that we withdraw particular products from the market or necessitating that specific products offered for sale or under development be redesigned. We
have also entered into certain indemnification obligations in favor of our customers and strategic partners that could be triggered upon an allegation or finding of our infringement, misappropriation or misuse of other parties proprietary
rights. Irrespective of the validity or successful assertion of such claims, we would likely incur significant costs and diversion of our management and personnel resources with respect to the defense of such claims, which could also seriously harm
our business. If any claims or actions are asserted against us, we may seek to obtain a license under a third partys intellectual property rights. We cannot be sure that under such circumstances a license would be available on commercially
reasonable terms, if at all. Moreover, we often incorporate the intellectual property of our strategic customers into our designs, and we have certain obligations with respect to the non-use and non-disclosure of such intellectual property.

We cannot be sure that the steps taken by us to prevent our, or our customers, misappropriation or infringement of intellectual
property will be successful.

The facilities of several of our key manufacturers and the majority of our customers are located in geographic regions
with increased risks of natural disasters.

Several key manufacturers and a majority of customers are located in the Pacific Rim region.
The risk of earthquakes in this region, particularly in Taiwan, is significant due to the proximity of major earthquake fault lines. Earthquakes, fire, flooding and other natural disasters in the Pacific Rim region likely would result in the
disruption of our foundry partners assembly and testing capacity and the ability of our customers to purchase our products. Labor strikes or political unrest in these regions would likely also disrupt operations of our foundries and customers.
Any disruption resulting from such events could cause significant delays in shipments of our products until we are able to shift our manufacturing, assembly and testing from the affected contractor to another third party vendor. We cannot be sure
that such alternative capacity could be obtained on favorable terms, if at all. Moreover, any such disruptions could also cause significant decreases in our sales to these customers until our customers resume normal purchasing volumes.

Changes in accounting rules for stock-based compensation may adversely affect our operating results, our stock price and our competitiveness in the employee
marketplace.

We have a history of using employee stock options and other stock-based compensation to hire, motivate and retain our
workforce. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment, which has required us, starting in the first quarter of fiscal year 2006, to
measure compensation costs for all stock-based compensation (including stock options and our employee stock purchase plan) at fair value and to recognize these costs as expenses in our statements of operations. The recognition of these expenses in
our statements of operations has resulted in lower earnings per share, which could negatively impact our future stock price. In addition, if we reduced or alter our use of stock-based compensation to minimize the recognition of these expenses, our
ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace.

Terrorist attacks and threats, and government responses thereto, may negatively impact all aspects of our operations, revenues, costs and stock price.

The threat of terrorist attacks involving the United States, the instability in the Middle East, a decline in consumer confidence and continued economic weakness and geo-political instability have had a substantial
adverse effect on the economy. If consumer confidence does not recover, our revenues may be adversely affected for fiscal 2006 and beyond.



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Moreover, any further terrorist attacks involving the U.S. or any additional U.S. military actions overseas may disrupt our operations or those of our
customers and suppliers. These events have had and may continue to have an adverse impact on the U.S. and world economy in general and consumer confidence and spending in particular, which could harm our sales. Any of these events could increase
volatility in the U.S. and world financial markets which could harm our stock price and may limit the capital resources available to us and our customers or suppliers. This could have a significant impact on our operating results, revenues and costs
and may result in increased volatility in the market price of our common stock.

We are subject to anti-takeover provisions that could delay or prevent
an unfriendly acquisition of our company.

Provisions of our restated certificate of incorporation, equity incentive plans, bylaws and
Delaware law may discourage transactions involving an unfriendly change in corporate control. In addition to the foregoing, the stockholdings of our officers, directors and persons or entities that may be deemed affiliates and the ability of our
Board of Directors to issue preferred stock without further stockholder approval could have the effect of delaying, deferring or preventing a third party from acquiring us and may adversely affect the voting and other rights of holders of our common
stock.



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk of loss. Some of the securities that we may
acquire in the future may be subject to market risk for changes in interest rates. To mitigate this risk, we plan to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, which may include commercial paper,
money market funds, government and non-government debt securities. We manage the sensitivity of our results of operations to these risks by maintaining a conservative portfolio, which is comprised solely of highly-rated, short-term investments. We
do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes. Currently we are exposed to minimal market risks. Due to the short-term and liquid nature of our portfolio, if interest rates were
to fluctuate by 10 percent from rates at June 30, 2006 and June 30, 2005, our financial position and results of operations would not be materially affected.



|Item 4. | Controls and Procedures
|------- | -----------------------

Evaluation of Disclosure Controls and
Procedures

The Companys management, with the participation of the Companys chief executive officer and chief financial
officer, evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2006. Based on this evaluation, the Companys chief executive
officer and chief financial officer concluded that as of June 30, 2006, the Companys disclosure controls and procedures were not effective because of the material weaknesses described below and that the remediation efforts of the Company
designed to address these weaknesses have not been in effect for a sufficient amount of time to allow for testing and validation.

Internal Control over
Financial Reporting

Section 404 of the Sarbanes Oxley Act of 2002 (the Act) required the Company to include the
internal control report in the Annual Report on Form 10-K for the year ended September 30, 2005 and in subsequent Annual Reports thereafter.

As previously reported in our Annual Report on Form 10-K for the year ended September 30, 2005, we concluded that as of September 30, 2005, our internal controls over financial reporting were not effective due to:



| |  |  | Lack of sufficient personnel and technical accounting and financial reporting expertise within our accounting and finance function.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls over the period-end financial reporting process, where our Chief Financial Officer was responsible for preparing or compiling certain critical portions of the
quarterly and annual internal financial information and was also responsible for performing a review of this information to monitor the results of operations.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls in the area of inventory, where there were certain instances in which standard inventory costing was not applied correctly. In addition, in certain instances one
individual had authority for certain activities which should be segregated, such as processing of point-of-sale reports, inventory reports and invoicing. We did not have adequate oversight and review of these personnel to compensate for the
inadequate segregation of duties.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Inadequate controls in the area of fixed assets, where we did not ensure that our fixed asset policy was strictly enforced, including instances where the detail listing of assets
was not comprehensive, the capitalization policy was not followed and the depreciation expense was not calculated correctly. In addition, we did not maintain adequate segregation of duties among members of our fixed asset department. In several
instances, we had the same personnel performing duties that were not compatible. Furthermore, we did not have adequate oversight and review of these personnel to compensate for the inadequate segregation of duties.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls in the areas of reconciliation of accrued expenses, where there were certain instances in which we failed to reconcile the supporting documentation for accrued
expenses to the general ledger control account impacting our ability to ensure all transactions flowing through the accounts are properly reflected in the recorded account balances for accrued expenses.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls in the area of payroll/human resources, where our review of payroll reports was not strictly enforced, including our inconsistent tracking of vacation and
tracking of new and terminated employees. In addition, we did not maintain adequate segregation of duties among members of our payroll/human resource departments. In several instances, we had the same personnel performing duties that were not
compatible. Furthermore, management did not have adequate oversight and review of these personnel to compensate for the inadequate segregation of duties.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls in the area of information technology, where we did not maintain effective controls over access to the accounting system and in some cases did not maintain
complete documentation regarding these access rights. Specifically, certain of our accounting users with financial, accounting and reporting responsibilities also had inappropriate access to financial application programs and data. Such access was
not in compliance with segregation of duties requirements nor was this access independently monitored. In addition, the documentation regarding access privileges of certain individuals to the accounting system was not reflective of actual access
privileges. Further, we did not maintain adequate controls in the area of system development.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Lack of internal control reports (under SAS 70) from critical external service providers whose processes are significant to the Companys internal control over financial
reporting. We were unable to obtain a proper Report on Controls Placed in Operation and Test of Operating Effectiveness (in accordance with Statement of Audit Standards No. 70) from two external service providers and we did not have
alternative procedures to test user controls, test controls at service organizations, or request the service organization auditor to perform agreed upon procedures. These include the providers of our payroll service and our stock management
provider. The services performed by these service providers were deemed material and significant to our business and accurate financial reporting.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Remediation Actions to Address Internal Control Deficiencies and Changes to Internal Controls

Management believes the
actions that we have taken since September 30, 2005 and the actions we expect to implement in fiscal year 2006 will address the material weaknesses in our internal control over financial reporting noted above. There can be no assurance,
however, that such actions will fully address these material weaknesses or that other material weaknesses will not develop. Some of these remediation actions are discussed below. As of June 30, 2006 we continue to see weakness in the accounting
and financial reporting area.



| |  |  | In relation to the material weakness in the area of lack of sufficient personnel and technical accounting and financial reporting expertise within the Companys accounting and
finance function, we are committed to hiring a sufficient number of technically-qualified employees and/or consultants to ensure that all significant accounting issues, both routine and non-routine, are identified, researched and properly handled.
As of June 30, 2006, we have made progress in this area by hiring additional employees with technical accounting and financial reporting expertise; recruitment efforts are ongoing to hire additional personnel to achieve our optimal
organizational structure within our finance function.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In relation to the material weakness in the area of inadequate controls over period-end financial reporting, to remedy this deficiency, we ensure that the internal reporting package
is reviewed and signed off by a qualified person other than the preparer. As of June 30, 2006, procedures to achieve this were in place; monitoring has been established to ensure these processes are effective and is ongoing.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In relation to the material weakness in the area of inadequate controls in the areas of inventory, fixed assets, accrued expenses, and payroll/human resources, we
have reviewed job responsibilities and we are strictly
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | enforcing our policies and controls. We will also review job responsibilities for all accounting personnel and ensure that employees are not expected to take
on multiple conflicting duties. Furthermore, we are striving to ensure that our hiring plan is compatible with these defined roles and responsibilities
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In relation to the material weakness in the area of inadequate information technology controls, we periodically review access rights to enforce compliance with our internal policies
and procedures. In addition, we have updated documentation regarding access privileges of certain individuals to the accounting system to reflect actual access privileges.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In relation to the material weakness in the area of lack of internal control reports (under SAS 70) from critical external service providers, we will work with our external service
providers to obtain timely SAS 70 reports; in those instances where a timely report is unavailable, we will design and implement additional internal controls in our organization to provide adequate assurance that material errors by the service
organization would be detected.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Limitations on the Effectiveness of Controls

Tripath Technology Inc.s management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls
or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control systems
objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or
by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree
of compliance with policies or procedures.

PART II. Other Information



|Item 1. | Legal Proceedings
|------- | -----------------

From time to time, the Company
becomes subject to various legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of business. Litigation in general, and securities litigation in particular, can be expensive and disruptive to normal business
operations. Moreover, the results of legal proceedings are difficult to predict. An unfavorable resolution of one or more of these lawsuits would materially adversely affect the Companys business, results of operations, or financial condition.
In addition, given the Companys financial condition and that there is not sufficient insurance coverage to offset the cost of litigation, the costs of defending one or more of these lawsuits will likely adversely affect the Companys
financial condition. The Company cannot estimate the loss or range of loss that may be reasonably possible for any of the contingencies described and accordingly have not recorded any associated liabilities in the Companys consolidated balance
sheets. The Company accrues legal costs when incurred.

SEC Investigation

On or about November 9, 2004, the SEC requested that the Company voluntarily produces documents responsive to certain document requests in the
investigation entitled In the Matter of Tripath Technology, Inc. On or about January 25, 2005, February 14, 2005, and February 16, 2005, the SEC made additional documents requests. On or about March 30, 2005, the SEC
issued a subpoena to the Company seeking additional documents. The Company has produced documents in response to the SECs voluntary requests for documents as well as the subpoena. The Company has cooperated with the SEC in its review of these
matters.

On February 24, 2005, the SEC, pursuant to Section 20(a) of the Securities Act and Section 21(a) of the Exchange
Act, issued a formal order of private investigation to determine whether there have been any violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules
10b-5, 12b-20, 13a-13, 13a-14, 13b2-1 and 13b2-2 thereunder.



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In a letter dated December 15, 2005, the SEC indicated that the formal investigation of the Company
had been terminated and that no enforcement action has been recommended to the Commission.

Federal Securities Class Actions

Beginning on November 4, 2004, plaintiffs filed four separate complaints purporting to be class actions in the United States
District Court for the Northern District of California alleging that the Company and certain of the Companys present or former officers and/or directors, Dr. Adya S. Tripathi, David Eichler and Graham Wright, violated
Sections 10(b) and 20(a) of the Exchange Act. Plaintiffs purported to represent a putative class of shareholders who purchased or otherwise acquired Tripath securities between January 29, 2004 and October 22, 2004. The complaints
contain varying allegations, including that the Company and the individual defendants made materially false and misleading statements with respect to financial results and with respect to the Companys business, prospects and operations in the
Companys filings with the SEC, press releases and other disclosures. The complaints seek unspecified compensatory damages, attorneys fees, expert witness fees, costs and such other relief as may be awarded by the Court.

On December 22, 2004, the Court entered a stipulation and order consolidating all of these complaints and ordering that the defendants need not
respond to any of these complaints until after plaintiffs file a consolidated complaint. On January 4, 2005, plaintiffs filed motions for the appointment of lead plaintiff. The Court, by Order dated January 28, 2005, appointed Robert
Poteet as the sole lead plaintiff and approved Milberg Weiss Bershad & Schulman LLP as lead counsel.

On July 11, 2005, the
Company entered into a Stipulation and Settlement Agreement (the Stipulation) which was filed with the Court on July 12, 2005. The settlement class consists of all persons who purchased the securities of Tripath between
January 29, 2004 and June 13, 2005, inclusive. Under the terms of the Stipulation, the parties agreed that the class action will be dismissed in exchange for a payment of $200,000 in cash by Tripath and the issuance of 2.45 million
shares of Tripath common stock which shall be exempt from registration pursuant to Section 3(a)(10) of the Securities Act. The Stipulation remains subject to the satisfaction of various conditions, including without limitation final approval of
the Stipulation by the Court, including a finding that the 2.45 million shares of Tripath common stock to be issued are exempt from registration. On October 20, 2005, the Court entered a Preliminary Order for Notice and Hearing in
Connection with Settlement Proceedings.

Following a April 11, 2006 hearing, the Court entered an Order and Final Judgment on
April 18, 2006 which finally approved the settlement, awarded attorneys fees and authorized the reimbursement of expenses and entered judgment dismissing all of the complaints on the merits and with prejudice in favor of the defendants.
Approximately $1.8 million has been accrued for this matter.

Derivative Shareholder Litigation

On December 7, 2004, plaintiff Mildred Lyon filed a purported derivative action in Santa Clara Superior Court against the Company and the following
present or former officers and/or directors of the Company, Dr. Adya S. Tripathi, David P. Eichler, Graham K. Wright, A.K. Acharya, Andy Jasuja and Y.S. Fu. This complaint appears to be based upon the same facts and circumstances as
the federal class actions and makes the following claims: violation of Section 25402 of the California Corporations Code, breach of fiduciary duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate
assets and unjust enrichment. On this basis, the complaint seeks unspecified compensatory damages, treble damages under Section 25502.5(a) of the California Corporations Code, extraordinary equitable and/or injunctive relief, restitution and
disgorgement, attorneys fees, expert witness fees, costs, and such other relief as may be ordered by the Court.

On December 27,
2004, the Court entered a stipulation and order extending the time for the Company to respond to the complaint to February 23, 2005. On February 16, 2005, the Court entered an order further extending the time for us to respond to the
complaint to March 25, 2005. On March 10, 2005, the court ordered that the individual defendants shall have through and including April 25, 2005 to file any motions to quash and/or dismiss for lack of personal jurisdiction, and that
all defendants shall have thirty (30) days from the date the court issues a ruling on any motions to quash and/or dismiss for lack of personal jurisdiction to respond to the complaint, or in the event that no such motions are brought, extended
the time for all defendants to respond to the complaint to April 25, 2005.

On April 4, 2005, the Court ordered that all
deadlines shall be stayed for Defendants filing any motions to quash and/or dismiss for lack of personal jurisdictions, or otherwise respond to the Complaint, until such date as the parties mutually designate to the Court for the Courts
approval.

On July 24, 2006, the Company entered into a Stipulation of Settlement of Derivative Claims (the Derivative
Stipulation). Under the terms of the Derivative Stipulation, the parties agreed that the action will be dismissed in exchange



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for implementation of certain corporate governance changes and payment of plaintiffs attorneys expenses in an amount not to exceed $6,000.00.
Except for this payment, the parties shall bear their own attorneys fees in connection with the action. The Derivative Stipulation remains subject to the satisfaction of various conditions, including without limitation final approval of the
Derivative Stipulation by the Court. According to the Courts docket, on July 24, 2006, the Court entered an Order and Final Judgment approving the Derivative Stipulation and dismissing the action against all parties.

Langley Securities Fraud Litigation

On or about June 2, 2005, plaintiff Langley Partners, L.P. (Langley) filed a complaint in the United States District Court for the Southern District of New York alleging claims against the Company, Dr. Adya Tripathi,
the Companys President and Chief Executive Officer, and David Eichler, the Companys former Chief Financial Officer. Langley alleges that it entered into a stock purchase agreement with Tripath on or about August 2, 2004 in which
Langley purchased 1 million shares of Tripath common stock at a purchase price of $2.00 per share. Langley also alleges that it consented to the receipt of the Companys Prospectus dated August 2, 2004 and the accompanying Prospectus
dated June 1, 2004 which specifically incorporated certain of the Companys filings with the SEC from March through July 2004. The complaint generally alleges that the Company and the individual defendants made materially false and
misleading statements with respect to the Companys financial results and with respect to its business, prospects, internal accounting controls and design wins on Godzilla products in the Companys filings with the SEC, press releases and
other documents. The complaint alleges claims against the Company and the individual defendants for violations of Sections 10(b) and 20(a) of the Exchange Act, fraud, breach of contract, unjust enrichment and money had and received, rescission
and violations of Sections 11 and 15 of the Securities Act. On this basis, the complaint seeks unspecified compensatory damages and restitution in an amount in excess of $2 million, rescission of the purchase agreement and a return of
$2 million, unspecified punitive damages, costs and such other relief as may be awarded by the Court.

On October 6, 2005, the
Court entered an Order granting the Companys motion to transfer this action from the Southern District of New York to the United States District Court for the Northern District of California. On October 18, 2005, the action was
transferred to the Northern District of California.

On December 9, 2005, the Company and the individual defendants filed a motion to
dismiss the complaint in its entirety which was granted in part and denied in part by the Court on March 7, 2006. In particular, the Court dismissed the claims under Sections 10(b) and 20(a) of the Exchange Act and for unjust enrichment and
money had and received with leave to amend within thirty days. Langley did not file an amended complaint seeking to replead the dismissed claims. Trial has been scheduled for January 22, 2007 or on a date to be determined by the Court
thereafter. The parties have been engaged in discovery.

The parties have engaged in settlement discussions and have advised the Court that
they are very close to reaching a settlement agreement.



|Item 6. | Exhibits
|------- | --------



|            |  |                                                                                                                                                                                      
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                          
|            | 
|31.1        |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  
|            | 
|31.2        |  | Certification of Acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                           
|            | 
|32.1        |  | Certification by Chief Executive Officer and Acting Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.



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##### Table of Contents

SIGNATURES

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



TRIPATH TECHNOLOGY INC.Date: August 9, 2006By:

/s/ Adya S. TripathiDr. Adya S. TripathiPresident and Chief Executive Officer


EXHIBIT INDEX



|            |  |                                                                                                                                                                                      
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                          
|            | 
|31.1        |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                  
|            | 
|31.2        |  | Certification of Acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                           
|            | 
|32.1        |  | Certification by Chief Executive Officer and Acting Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.



57