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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 September 30, 2003.



or



| ̈ |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from             
to            .



Commission File Number 000-30928



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PATH 1 NETWORK TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)



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|DELAWARE                                                       |  | 13-3989885                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



6215 FERRIS SQUARE,
SUITE 140, SAN DIEGO, CALIFORNIA 92121

(858) 450-4220

(Address, including zip code, and telephone number, including area code, of principal executive offices)



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes ̈No  x



As of October 31, 2003, 6,223,524, shares of the registrants common stock were outstanding.



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##### Table of Contents

PATH 1 NETWORK TECHNOLOGIES INC.



Quarterly Report on Form 10-Q

For the Quarterly Period Ended September 30, 2003



TABLE OF CONTENTS



|PART I 
FINANCIAL INFORMATION                       |  | 3                                                                                    
|---------------------------------------------------- |  | -------------------------------------------------------------------------------------
|                                                     |  |                                                                                      
|ITEM 1.                                              |  | FINANCIAL STATEMENTS (UNAUDITED)                                                     
|                                                     | 
|CONDENSED CONSOLIDATED BALANCE SHEETS                |  | 3                                                                                    
|                                                     | 
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS      |  | 4                                                                                    
|                                                     | 
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS      |  | 5                                                                                    
|                                                     | 
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS |  | 6                                                                                    
|                                                     |  |                                                                                      
|ITEM 2.                                              |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                     |  |                                                                                      
|ITEM 3.                                              |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                                                     |  |                                                                                      
|ITEM 4.                                              |  | CONTROLS AND PROCEDURES.                                                             
|                                                     | 
|PART II 
OTHER INFORMATION                          |  | 28                                                                                   
|                                                     |  |                                                                                      
|ITEM 1.                                              |  | LEGAL PROCEEDINGS                                                                    
|                                                     |  |                                                                                      
|ITEM 2.                                              |  | CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                                                     |  |                                                                                      
|ITEM 3.                                              |  | DEFAULTS UPON SENIOR SECURITIES                                                      
|                                                     |  |                                                                                      
|ITEM 4.                                              |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                                                     |  |                                                                                      
|ITEM 5.                                              |  | OTHER INFORMATION                                                                    
|                                                     |  |                                                                                      
|ITEM 6.                                              |  | EXHIBITS AND REPORTS ON FORM 8-K                                                     
|                                                     | 
|SIGNATURES                                           |  | 31                                                                                   



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##### Table of Contents

PART I  FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS



Path 1 Network Technologies Inc.

Condensed Consolidated Balance Sheets

(in $ thousands)



|                                                                                                                                                                                                                                     |  | September 30,2003 |         |   | December 31,2002 |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | ------- | - | ---------------- | -
|                                                                                                                                                                                                                                     |  | (unaudited)       |         |   | (audited)        |  
|ASSETS                                                                                                                                                                                                                               |  |                   |         |   |                  |  
|Current assets                                                                                                                                                                                                                       |  |                   |         |   |                  |  
|Cash and cash equivalents                                                                                                                                                                                                            |  | $                 | 10,189  |   |                  | $
|Accounts receivable, net                                                                                                                                                                                                             |  |                   | 844     |   |                  |  
|Inventory                                                                                                                                                                                                                            |  |                   | 376     |   |                  |  
|Other current assets                                                                                                                                                                                                                 |  |                   | 93      |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total current assets                                                                                                                                                                                                                 |  |                   | 11,502  |   |                  |  
|                                                                                                                                                                                                                                     |  |                  
|Property and equipment, net                                                                                                                                                                                                          |  |                   | 245     |   |                  |  
|Debt issuance costs, net                                                                                                                                                                                                             |  |                   | 86      |   |                  |  
|Other assets                                                                                                                                                                                                                         |  |                   | 48      |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total assets                                                                                                                                                                                                                         |  | $                 | 11,881  |   |                  | $
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY                                                                                                                                                                                       |  |                   |         |   |                  |  
|Current liabilities                                                                                                                                                                                                                  |  |                   |         |   |                  |  
|Accounts payable and accrued liabilities                                                                                                                                                                                             |  | $                 | 937     |   |                  | $
|Accrued compensation and benefits                                                                                                                                                                                                    |  |                   | 192     |   |                  |  
|Current portion of notes payable                                                                                                                                                                                                     |  |                   | 853     |   |                  |  
|Current portion of leases payable                                                                                                                                                                                                    |  |                   | 13      |   |                  |  
|Deferred revenue                                                                                                                                                                                                                     |  |                   |        |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total current liabilities                                                                                                                                                                                                            |  |                   | 1,995   |   |                  |  
|                                                                                                                                                                                                                                     |  |                  
|Notes payable                                                                                                                                                                                                                        |  |                   | 139     |   |                  |  
|Long-term lease payable                                                                                                                                                                                                              |  |                   | 13      |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total liabilities                                                                                                                                                                                                                    |  |                   | 2,147   |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Stockholders equity (deficit)                                                                                                                                                                                                       |  |                   |         |   |                  |  
|Preferred stock, $0.001 par value; 10,000,000 shares authorized; no shares issued or outstanding                                                                                                                                     |  |                   |        |   |                  |  
|Common stock, $0.001 par value; 40,000,000 shares authorized; 6,198,524 and 1,583,557 shares issued and outstanding at September
30, 2003, and December 31, 2002, respectively; 27,777 shares held in treasury at September 30, 2003 |  |                   | 6       |   |                  |  
|Common stock to be issued                                                                                                                                                                                                            |  |                   |        |   |                  |  
|Additional paid-in capital                                                                                                                                                                                                           |  |                   | 45,254  |   |                  |  
|Deferred compensation                                                                                                                                                                                                                |  |                   |        |   |                  |  
|Accumulated deficit                                                                                                                                                                                                                  |  |                   | (35,526 | ) |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total stockholders equity (deficit)                                                                                                                                                                                                 |  |                   | 9,734   |   |                  |  
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  
|Total liabilities and stockholders equity                                                                                                                                                                                           |  | $                 | 11,881  |   |                  | $
|                                                                                                                                                                                                                                     |  |                   |         |   |                  |  



See accompanying notes
to these condensed consolidated financial statements.



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Path 1 Network Technologies Inc.



Condensed Consolidated Statements of Operations

(in $ thousands, except per share amounts)

(unaudited)



|                                                               |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|-------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | -
|                                                               |  | 2003                            |        |   | 2002                           |  
|Revenues                                                       |  |                                 |        |   |                                |  
|Product sales                                                  |  | $                               | 587    |   |                                | $
|Contract services                                              |  |                                 | 200    |   |                                |  
|License revenue                                                |  |                                 |       |   |                                |  
|Other revenue                                                  |  |                                 |       |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total revenues                                                 |  |                                 | 787    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Cost of revenues                                               |  |                                 |        |   |                                |  
|Cost of product sales                                          |  |                                 | 379    |   |                                |  
|Cost of contract services                                      |  |                                 | 120    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total cost of revenues                                         |  |                                 | 499    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Gross profit                                                   |  |                                 | 288    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Operating expenses, before depreciation and amortization       |  |                                 |        |   |                                |  
|Engineering research and development                           |  |                                 | 405    |   |                                |  
|Sales and marketing                                            |  |                                 | 480    |   |                                |  
|General and administrative                                     |  |                                 | 1,348  |   |                                |  
|Stock-based compensation                                       |  |                                 |       |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total operating expenses, before depreciation and amortization |  |                                 | 2,233  |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Depreciation and amortization expense                          |  |                                 |        |   |                                |  
|Depreciation expense                                           |  |                                 | 39     |   |                                |  
|Amortization expense                                           |  |                                 | 226    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total depreciation and amortization                            |  |                                 | 265    |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total operating expenses                                       |  |                                 | 2,498  |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Operating loss                                                 |  |                                 | (2,210 | ) |                                |  
|Other expenses                                                 |  |                                 |        |   |                                |  
|Interest expense, net                                          |  |                                 | (194   | ) |                                |  
|Loss on sale of securities                                     |  |                                 |       |   |                                |  
|Other expense                                                  |  |                                 | (262   | ) |                                |  
|                                                               |  |                                 |        |   |                                |  
|Total other expenses                                           |  |                                 | (456   | ) |                                |  
|                                                               |  |                                 |        |   |                                |  
|Loss from continuing operations                                |  |                                 | (2,666 | ) |                                |  
|Discontinued operations                                        |  |                                 |       |   |                                |  
|                                                               |  |                                 |        |   |                                |  
|Net loss                                                       |  | $                               | (2,666 | ) |                                | $
|                                                               |  |                                 |        |   |                                |  
|Net loss per common share from continuing operations           |  | $                               | (0.59  | ) |                                | $
|                                                               |  |                                 |        |   |                                |  
|Net loss per common share from discontinued operations         |  | $                               |       |   |                                | $
|                                                               |  |                                 |        |   |                                |  
|Loss per common share - basic and diluted                      |  | $                               | (0.59  | ) |                                | $
|                                                               |  |                                 |        |   |                                |  
|Weighted average common shares outstanding - basic and diluted |  |                                 | 4,528  |   |                                |  
|                                                               |  |                                 |        |   |                                |  



See accompanying notes
to these condensed consolidated financial statements.



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Path 1 Network Technologies Inc.



Condensed Consolidated Statements of Cash Flows

(in $ thousands)

(unaudited)



|                                                                                              |  | Nine Months EndedSeptember 30, |       
|--------------------------------------------------------------------------------------------- |  | ------------------------------ | ------
|                                                                                              |  | 2003                           |       
|Cash flows from operating activities:                                                         |  |                                |       
|Net loss                                                                                      |  | $                              | (4,889
|Adjustments to reconcile net loss to net cash used in operating activities:                   |  |                                |       
|Depreciation and amortization                                                                 |  |                                | 419   
|Amortization of deferred compensation                                                         |  |                                | 72    
|Interest expense paid in stock                                                                |  |                                | 53    
|Accretion of debt discount & debt conversion expense                                          |  |                                | 1,067 
|Notes issued for salary reduction                                                             |  |                                |      
|Loss on extinguishment of debt                                                                |  |                                | 85    
|Loss on investment                                                                            |  |                                |      
|Changes in assets and liabilities                                                             |  |                                |       
|Restricted cash                                                                               |  |                                |      
|Accounts receivable                                                                           |  |                                | (406  
|Inventory                                                                                     |  |                                | 17    
|Other current assets                                                                          |  |                                | (78   
|Other assets                                                                                  |  |                                | (250  
|Accounts payable and accrued liabilities                                                      |  |                                | 6     
|Accrued compensation and benefits                                                             |  |                                | 35    
|Deferred revenue                                                                              |  |                                | (60   
|                                                                                              |  |                                |       
|Cash used in operations                                                                       |  |                                | (3,929
|                                                                                              |  |                                |       
|Cash flows from investing activities:                                                         |  |                                |       
|Sale of marketable securities                                                                 |  |                                |      
|Purchase of property and equipment                                                            |  |                                | (121  
|                                                                                              |  |                                |       
|Cash provided by (used in) investing activities                                               |  |                                | (121  
|                                                                                              |  |                                |       
|Cash flows from financing activities:                                                         |  |                                |       
|Issuance of common stock                                                                      |  |                                | 13,055
|Repurchase of treasury shares                                                                 |  |                                | (93   
|Issuance of convertible notes                                                                 |  |                                | 1,620 
|Repayments of convertible notes                                                               |  |                                | (1,212
|Net borrowings under line of credit                                                           |  |                                | 473   
|Cash from extinguishment of shareholder notes                                                 |  |                                |      
|                                                                                              |  |                                |       
|Cash provided by financing activities                                                         |  |                                | 13,843
|                                                                                              |  |                                |       
|Cash flows from continuing operations                                                         |  |                                | 9,793 
|Cash flows from discontinued operations                                                       |  |                                |      
|                                                                                              |  |                                |       
|Increase (decrease) in cash and cash equivalents                                              |  |                                | 9,793 
|Cash and cash equivalents, beginning of period                                                |  |                                | 396   
|                                                                                              |  |                                |       
|Cash and cash equivalents, end of period                                                      |  | $                              | 10,189
|                                                                                              |  |                                |       
|Supplemental cash flow disclosures:                                                           |  |                                |       
|Issuance of common stock in Felber settlement                                                 |  | $                              |      
|                                                                                              |  |                                |       
|Capitalized debt issuance costs in connection with beneficial conversion charges and warrants |  | $                              | 439   
|                                                                                              |  |                                |       
|Conversion of notes to common stock                                                           |  | $                              | 1,122 
|                                                                                              |  |                                |       
|Purchase of equipment for note payable                                                        |  | $                              | 26    
|                                                                                              |  |                                |       
|Retirement of 4% convertible notes by issuance of 7% convertible notes                        |  | $                              | 228   
|                                                                                              |  |                                |       

See accompanying notes to these condensed consolidated financial statements.



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial Statements



Note 1  Basis Of Presentation



The accompanying condensed consolidated balance sheet at September 30, 2003, the condensed consolidated statements of operations for the three and nine
month periods ended September 30, 2003 and 2002, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2003 and 2002, have been prepared by Path 1 Network Technologies Inc. (the Company)
and have not been audited. The condensed consolidated balance sheet at December 31, 2002 has been audited. These condensed consolidated quarterly financial statements, in the opinion of management, include all adjustments, consisting only of normal
and recurring adjustments, necessary to state fairly the financial information set forth therein, in accordance with accounting principles generally accepted in the United States. These condensed quarterly condensed consolidated financial statements
should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2002 included in the Companys Form 10-K filed March 31, 2003. The interim consolidated financial information contained in this filing
is not necessarily indicative of the results to be expected for any other interim period or for the full year ending December 31, 2003.



Reclassifications



Certain reclassifications have been made to prior periods financial statements to conform to current year presentation.



Recently Issued Accounting Standards



In April 2002, the FASB issued SFAS No. 145 (SFAS No. 145)
Rescission of SFAS No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, ReportingGains and Losses from Extinguishment of Debt, SFAS No. 44, Accounting for Intangible Assets of
Motor Carriers, and SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.SFAS No. 145 requires, among other things, (i) that the modification of a lease that results in a change of the classification of the
lease from capital to operating under the provisions of SFAS No. 13 be accounted for as a sale-leaseback transaction, and (ii) the reporting of gains or losses from the early extinguishment of debt as extraordinary items only if they met the
criteria of Accounting Principles Board Opinion No. 30, Reporting the Results of Operations. The amendment of SFAS No. 13 is effective for transactions occurring on or after May 15, 2002. Although the rescission of SFAS No. 4 is effective
January 1, 2003, the FASB has encouraged early application of the provisions of SFAS No. 145. On August 6, 2003, the Company repurchased $1,180,000 principal amount, plus accrued unpaid interest totaling $25,427, of its 7% convertible notes payable
for an aggregate amount of $1,382,427. The Company recognized a $262,000 ordinary loss on the early extinguishment of these notes. See Note 9.



In July 2002, the FASB issued Statement of Financial Accounting Standard No. 146 (SFAS No. 146), Accounting for Costs Associated with Exit
or Disposal Activities (effective January 1, 2003). SFAS No. 146 replaces current accounting literature and requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Management has assessed the impact of this interpretation and believes it has no material effect on the Companys financial position, results of operations, or cash flows.



In November 2002, the FASB issued FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation addresses the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees. This interpretation also clarifies the requirements related to the recognition of a liability by a guarantor at the inception of a guarantee for the obligations that the guarantor has undertaken in
issuing that guarantee. Management has assessed the impact of this interpretation and have adopted its provisions. See Note 5.



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue No.
00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the adoption of EITF Issue No. 00-21 will have no material impact on its financial
position, results of operations, or cash flows.



In December
2002, the FASB issued SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure. This statement amends FASB Statement No. 123 to provide alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method used on reported results.



The following table summarizes the impact on the Companys net loss had compensation cost been determined based upon the fair value at the grant date
for awards under the stock option plans consistent with the methodology prescribed under SFAS No. 123 (in thousands, except per share data):



|                                                                                                  |  | Three Months EndedSeptember 30, |       
|------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------
|                                                                                                  |  | 2003                            |       
|Net loss, as reported                                                                             |  | $                               | (2,666
|Add: Incremental stock compensation expense determined under the fair value method for all awards |  |                                 | (18   
|                                                                                                  |  |                                 |       
|Pro forma net loss                                                                                |  | $                               | (2,684
|                                                                                                  |  |                                 |       
|Basic and diluted loss per share:                                                                 |  |                                 |       
|As reported                                                                                       |  | $                               | (0.59 
|                                                                                                  |  |                                 |       
|Pro forma                                                                                         |  | $                               | (0.59 
|                                                                                                  |  |                                 |       



In January 2003, the
FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities. This interpretation clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in
which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. It
further clarifies whether an entity shall be subject to consolidation according to the provisions of this interpretation, if by design, certain conditions exist. Management is assessing the impact of this interpretation.



In May 2003, the FASB issued SFAS NO. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equities.This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics
of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. Management
has assessed the impact of this statement and believes that it has no material impact.



On July 23, 2003, the Company effected a one-for-six reverse stock split in anticipation of its public offering and listing on the American Stock Exchange. All per share figures herein reflect such reverse stock
split.



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



Note 2  Public Offering



On July 30, 2003, the Company raised $13.5 million in a public offering of
1,250,000 units consisting of three shares of the Companys common stock and two publicly traded redeemable warrants. The Companys common stock, units and public warrants commenced trading on the American Stock Exchange on July 31, 2003.
On August 29, 2003, the Company raised approximately $2.0 million from the issuance of an additional 187,500 units consisting of three shares of the Companys common stock and two publicly traded redeemable warrants. In total, the Company
raised approximately $15.5 million and issued 1,437,500 units representing 4,312,500 common shares and 2,875,000 warrants to purchase common stock of the Company. On August 30, 2003, in accordance with the units terms, the units separated and
the 4,312,500 common shares and 2,875,000 warrants became outstanding as such rather than as components of units.



Net proceeds, after expenses, from the public offering was approximately $13.1 million. Expenses included $1,164,375 of underwriting discounts, a managing
underwriters non-accountable expense allowance of $349,313, other expenses paid for underwriters of $45,500, and approximately $911,000 of legal, accounting, printing and other expenses. None of these payments went directly or indirectly to
our directors, officers, general partners, affiliates, 10% owners, or any of their associates.



Note 3  Management Estimates And Assumptions



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



Note 4  Inventory



The Company records inventory, which consists primarily of
raw materials used in the production of video gateways and related products, at the lower of cost or market. Cost is determined principally on the average cost method. Provisions for potentially obsolete or slow-moving inventory are made based on an
analysis of inventory levels and future sales forecasts. In the quarter ended September 30, 2003, the Company determined that a provision for potentially obsolete or slow-moving inventory was required and a $142,000 expense was recorded.



Note 5  Revenue Recognition



Product Revenue



Revenue from product sales is recognized when title and risk of loss
transfer to the customer, generally at the time the product is delivered to the customer. Revenue is deferred when customer acceptance is uncertain or when undelivered products or services are essential to the functionality of delivered products.
The estimated cost of warranties is accrued at the time revenue is recognized.



Contract Service Revenue



Revenue from support or maintenance contracts, including extended warranty programs, is recognized ratably over the contractual period. Amounts invoiced
to customers in excess of revenue recognized on support or maintenance contracts are recorded as deferred revenue until the revenue recognition criteria are met. Revenue on engineering design contracts, including technology development agreements,
is recognized on a percentage- of-completion method, based on costs incurred to date compared to total estimated costs, subject to acceptance criteria. Billings on uncompleted contracts in excess of incurred costs and accrued profits are classified
as deferred revenue.



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##### Table of Contents

Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



License Revenue



Revenues from license fees are recognized when persuasive evidence of a sales arrangement exists, delivery and acceptance
have occurred, the price is fixed or determinable, and collectability is reasonably assured.



Allowances for Doubtful Accounts, Returns and Discounts



We establish allowances for doubtful accounts, returns and discounts based on credit profiles of our customers, current
economic trends, contractual terms and conditions and historical payment, return and discount experience, as well as for known or expected events. If there were to be a deterioration of a major customers creditworthiness, or if actual
defaults, returns or discounts were higher than our historical experience, our operating results and financial position could be adversely affected.



Indemnification Arrangements and Guarantees



In connection with the Companys adoption of FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Guarantees of Indebtedness of Others,the following disclosures are made with respect to the Companys product warranties.



We provide a limited warranty for our products. A provision for the estimated warranty cost is recorded at the time revenue is recognized. Liabilities for
the estimated future costs of repair or replacement are established and charged to cost of sales at the time the related revenue is recognized. The amount of liability to be recorded is based on managements best estimates of future warranty
costs after considering historical and projected product failure rates and product repair costs. The Companys standard product warranties are for one year, although in some agreements, it may warrant products for periods in excess of one year.
The Company had no warranty reserves at September 30, 2002. The following table summarizes the activity in the liability accrual related to product warranty during the nine months ended September 30, 2003:



|                                                   |  | (in thousands) |    
|-------------------------------------------------- |  | -------------- | ---
|Balance at December 31, 2002                       |  | $              | 110
|Increase in expense related to change in estimates |  |                | 39 
|Actual warranty costs incurred in the period       |  |                | (34
|                                                   |  |                |    
|Balance at September 30, 2003                      |  | $              | 115
|                                                   |  |                |    



The Company also
undertakes indemnification obligations in the ordinary course of business related to its products, the licensing of its software, and the issuance of securities. Under these arrangements, the Company may indemnify other parties such as business
partners, customers, and underwriters, for certain losses suffered, claims of intellectual property infringement, negligence and intentional acts in the performance of services, and violations of laws including certain violations of securities laws.
The Companys obligation to provide such indemnification in such circumstances would arise if, for example, a third party sued a customer for intellectual property infringement and the Company agreed to indemnify the customer against such
claims. The Company is unable to estimate with any reasonable accuracy the liability that may be incurred pursuant to its indemnification obligations. Some of the factors that would affect this assessment include, but are not limited to, the nature
of the claim asserted, the relative merits of the claim, the financial ability of the parties, the nature and amount of damages claimed, insurance coverage that the Company may have to cover such claims, and the willingness of the parties to reach
settlement, if any. Because of the uncertainty surrounding these circumstances, the Companys indemnification obligations could range from immaterial to having a material adverse impact on its financial position and its ability to continue in
the ordinary course of business.



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



Note 6  Reportable Operating Segments



The Company is a network communications technology company enabling
simultaneous delivery of broadcast quality and interactive video transmissions and other real-time data streams over Internet Protocol (IP) networks. For the purpose of applying SFAS No. 131, management determined that, subsequent to the
discontinuance of the Silicon Systems business unit (Sistolic) in April 2002, it has one operating segment.



Note 7  Discontinued Operations



In March 2002, the Company decided to dispose of its Sistolic business unit. On April 3, 2002, the Company disposed of the assets of this business unit
back to Metar ADC SRL, in exchange for the elimination of the remaining obligations by the Company to Metar ADC SRL and its affiliates, including the payable of $686,000, the return of all stock options granted to an Executive and the Romanian
employees, and a confirmation that performance criteria specified in such Executives employment agreement related to a potential $4 million bonus were never met by him. The Company also received a limited use license to the business
units intellectual property. Metar ADC SRL also received 5,833 shares of the Companys common stock. The Executive resigned on March 27, 2002, as an officer of the Company in anticipation of this transaction.



The results of operations and the loss on disposal for the nine months ended
September 30, 2002, have been included in discontinued operations. The Company recorded a loss of $317,000 from discontinued operations for the nine months ended September 30, 2002.



Note 8  Stock Options



The Company accounts for stock-based compensation arrangements using the intrinsic value method in accordance with the
provisions of Accounting Principles Board Opinion (APB) 25, Accounting for Stock Issued to Employees, Statement of Financial Accounting Standards (SFAS), Interpretation No. 28, Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans, and SFAS Interpretation No 38, Determining the Measurement Date for Stock Option, Purchase, and Award Plans involving Junior Stock. The Company also complies with the disclosure provisions of SFAS No.
123, Accounting for Stock-Based Compensation.



The Company
accounts for equity instruments issued to non-employees using the fair value method in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure. This statement amends FASB Statement No.
123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement No. 123 to require
prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has made the required disclosure under SFAS
No. 148. See Note 1.



Equity instruments issued to
non-employees that are fully vested and non-forfeitable are measured at fair value at the issuance date and expensed in the period over which the benefit is expected to be received. Equity instruments issued to non-employees which are either
unvested or forfeitable, for which counter-party performance is required for the equity instrument to be earned, are measured initially at the fair value and subsequently adjusted for changes in fair value until the earlier of: 1) the date at which
a commitment for performance by the counter-party to earn the equity instrument is reached; or, 2) the date on which the counter-partys performance is complete.



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



During the three-month period ended September 30, 2003, the Company recorded no stock-based
compensation expense related to the amortization of options outstanding to employees and consultants. For the same three-month period in 2002, the Company recognized expense of $43,000 related to the amortization of stock based compensation.



Note 9  Notes Payable



In 2002 and 2003, the Company closed private placements of aggregate $4.4
million in face value of convertible notes payable and warrants and received cash proceeds, net of issuance costs, of approximately $ 3.7 million from accredited investors.



During the nine months ended September 30, 2003, approximately $1.1 million of note principal along with accrued interest
was converted into the Companys common stock. The carrying value of the convertible notes payable, excluding our line of credit, at September 30, 2003, is as follows:



|                                                              |  | (in thousands) |     
|------------------------------------------------------------- |  | -------------- | ----
|Face value of convertible notes payable                       |  | $              | 699 
|Unamortized discount related to warrants                      |  |                | (22 
|Unamortized discount related to beneficial conversion feature |  |                | (141
|                                                              |  |                |     
|Carrying value of convertible notes payable, net of discount  |  | $              | 536 
|                                                              |  |                |     



| |  | Interest expense for the nine months ended September 30, 2003, includes coupon interest of approximately $126,000; non-cash interest expense of $103,000 pertaining to the discount
related to the warrants; and non-cash interest expense of $360,000 pertaining to the discount related to the beneficial conversion feature.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Amortization of debt issuance costs for the nine months ended September 30, 2003, was $297,000.
| | - | -----------------------------------------------------------------------------------------------



On August 6, 2003, the Company repurchased $1.2 million in face value of convertible notes, plus accrued unpaid interest,
for approximately $1.4 million. The Company recorded a loss of $262,000 related to the early extinguishment of the notes.



On February 14, 2003, the Company entered into a $1 million revolving line of credit with Laurus. This revolving line of credit (the LOC) is
secured by the Companys accounts receivables and other assets, and the Company has the ability to draw down advances under the LOC subject to limits. Under the terms of the LOC, Laurus can convert advances made to the Company into common stock
at a fixed conversion price of $6.78 per share. In connection with the LOC, the Company issued warrants to purchase 12,500 shares of the Companys Common Stock at $6.78 per share. On February 14, 2003, the Company borrowed a $300,000 advance
under the LOC. The Company recorded a non-cash debt discount of $23,000 in its quarter ended March 31, 2003. During the three months ended September 30, 2003, the Company obtained an additional $200,000 advance under the LOC. The Company has repaid
$27,000 under the terms of the LOC. The carrying value of the LOC at September 30, 2003, is as follows:



|                                                              |  | (in thousands) |    
|------------------------------------------------------------- |  | -------------- | ---
|Face value of convertible LOC                                 |  | $              | 473
|                                                              | 
|Unamortized discount related to warrants                      |  |                | (18
|Unamortized discount related to beneficial conversion feature |  |                |   
|                                                              |  |                |    
|Carrying value of convertible notes payable, net of discount  |  | $              | 455
|                                                              |  |                |    



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Path 1 Network Technologies Inc.



Notes to the Unaudited Condensed Consolidated Financial
Statements(Continued)



The maturities of the Companys notes payable at September 30, 2003, are as follows (in
thousands of dollars):



|Short-term notes payable consist of the following at September 30, 2003: |  |   |    
|------------------------------------------------------------------------ |  | - | ---
|Laurus Master Funds Ltd (less unamortized debt discount of $73,000)1     |  |   | 398
|Laurus Master Funds Ltd (less unamortized debt discount of $18,000)2     |  |   | 455
|                                                                         |  |   |    
|                                                                         |  | $ | 853
|                                                                         |  |   |    



Long-term notes
payable consist of the following at September 30, 2003:



|12% Laurus Master Funds notes due May, 2004 (less unamortized debt discount of $73,000) (convertible into a minimum of 92,353
shares of common stock) |  |   | 398  |  
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ---- | -
|Laurus Master Funds $1 million line of credit (less unamortized debt discount of $18,000) (convertible into 71,667 shares of
common stock)            |  |   | 455  |  
|7% Euro notes due May, 2005 (less unamortized debt discount of $90,000) (convertible into 58,718 shares of common
stock)                              |  |   | 139  |  
|Less: Current maturities included in current liabilities                                                                                              |  |   | (853 | )
|                                                                                                                                                      |  |   |      |  
|                                                                                                                                                      |  | $ | 139  |  
|                                                                                                                                                      |  |   |      |  

---

|1 | Notes payable to Laurus Master Funds Ltd 1 bear interest at 12.0% and are convertible into the Companys stock at a variable rate not to exceed $5.10 per share.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 | Notes payable to Laurus Master Funds Ltd 2 is a $1 million A/R secured revolving line of credit expiring in February, 2006 that bears interest at Prime + 1.75% and drawn-down
amounts are convertible into the Companys stock at a rate of $6.78 per share.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



At September 30, 2003, the maturities of long-term debt, net of discount, are as follows:



|2003 |  | $ | 204
|---- |  | - | ---
|2004 |  |   | 649
|2005 |  |   | 139
|     |  |   |    
|     |  | $ | 992
|     |  |   |    



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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Forward Looking Statements



This document may contain forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can
identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict,
potential or continue, the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.



Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements.
Except to the extent required by federal law, we disclaim any duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.



You are also urged to carefully review and consider the various disclosures
made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made in this Item 2 or in our annual report on Form 10-K and other reports and filings made with the
Securities and Exchange Commission.



OVERVIEW



We are an industry leader in developing and supplying video router or
gateway products that enable the transportation and distribution of real-time, high-quality video over Internet Protocol (IP) networks, such as the networks that comprise the Internet. Our products are currently used in two different segments of the
video market. Our products are used by a variety of providers to transmit high-quality, real-time video to one or more locations throughout the United States or the world (which we refer to as long-haul transmission). Our products are
also used by cable companies to supply video-on-demand services. We do not sell our products to end consumers. Our customers include cable, broadcast and satellite companies, movie studios, carriers, and government and educational institutions and
system integrators that supply them. We refer to these customers as communication service providers, or simply as providers.



Long Haul Customers



Our long haul customers use our products to transmit high-quality, real-time video to one or a number of locations over existing IP networks. This ability
to send video over IP networks significantly reduces the current need of long haul providers to rent dedicated high bandwidth connections to service the specified locations. Our products not only provide a cost advantage to our customers, but also
enable increased flexibility in terms of where and when the video is transmitted.



Customers using our products for long-haul transmission include DreamWorks LLC, a major film production studio, for domestic and international creative collaborations using high-definition video cameras. C-SPAN uses
our products to televise real-time, interactive classrooms between Washington, D.C. and the University of Denver. PanAmSat, a major satellite communications provider, uses our Cx1000 product on the Level (3) backbone to interconnect earth stations
for video routing with the least delay. RTVI, a Russian television network, runs live broadcast-quality Russian language programming between Moscow and New York using our long haul product, and is expanding its network internationally. Currently,
Level (3) offers full and part-time video services using our Cx1000 product to deliver broadcast video in key US and European cities.



Cable Company Customers



The versions of our Chameleon vidX product line designed for cable television companies allow them to use existing digital set-top boxes already in consumer homes to provide
video-on-demand services, a significant



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competitive advantage over satellite providers. Today, consumers who desire to have personalized video recording in the home, must purchase the necessary
digital video recorder (DVR) and subscribe to a service. We believe that the drawbacks to DVRs are requiring the purchase of additional equipment in the home or the swapping out of the existing in-home set top box for a new set top box
with local storage. Using our products, cable companies could offer network-based (with our equipment sitting at the edge of the network) personalized video recorder capabilities to their subscribers to compete with in-home DVR service providers.
Cable company subscribers in this case would not require a DVR in the home to enjoy on-demand viewing.



The more efficient use of existing bandwidth (both into the home and within the network) allows cable companies to increase the volume of content (whether
movies, television or live events) available for delivery whenever requested by the cable subscriber, or to increase the number of subscribers served with existing content volume. We believe that the desire for video-on-demand  indeed, all
content-on-demand - will continue to rise as consumers become increasingly aware of its availability and benefits, and as IP networks enabled by our products provide access to significant amounts of interactive programming previously unavailable.
Cable companies currently using our products include companies such as TimeWarner and Cablevision.



Additionally, our products will provide cable companies with flexibility to deliver high definition television, which could potentially overwhelm the
bandwidth capacity of current delivery technologies despite the apparent present-day glut of bandwidth. High definition television requires at least five times the bandwidth currently required for standard television transmissions. Using our
products, providers can avoid incurring significant capital expenditures to increase the capacity of existing infrastructure, and can avoid significant recurring costs to maintain and support the expanded networks resulting from high definition
television and increased numbers of channels. Should these providers use existing methods of transmission, they might eventually be forced to decrease programming or other services to conserve bandwidth.



Liquidity And Capital Resources



Since our inception on January 30, 1998 through July 2003 we financed our
operations primarily through the sale of common equity securities to investors and strategic partners, as well as from the issuance of convertible notes. On July 31, 2003, we successfully completed a $13,500,000 public offering of 1.25 million units
and the listing of our common stock and units on the American Stock Exchange. A unit consisted of three shares of common stock and two warrants, each warrant to purchase a share of common stock at $5.40 per share. On August 29, 2003, our
underwriters exercised their over-allotment option and we raised additional proceeds of $2,025,000 from the sale of 187,500 units, bringing total gross proceeds from the public offering (the IPO) to $15.5 million. On August 30, 2003, the
units separated in accordance with their terms, and the IPOs common stock (4,312,500 shares) and warrants (2,875,000 warrants) now trade on the American Stock Exchange directly rather than as components of units.



From January 30, 1998 through September 30, 2003, we incurred losses totaling
$35.5 million. We have not yet achieved profitability, and we remain a risky enterprise. In light of the IPO, we believe that our existing capital resources will enable us to fund operations for at least the next twelve months. At September 30,
2003, we had working capital of $9.5 million. Cash and cash equivalents at September 30, 2003 totaled $10.2 million, versus only $396,000 at December 31, 2002.



In 2002, we raised a total of $2.6 million from the issuance of convertible debt securities. A total of $471,000 remains outstanding as of September
30, 2003; the balance of the convertible debt was repaid or converted into common stock. In connection with the 2002 convertible debt, we also issued 145,776 warrants to purchase our common stock with an average exercise price of $8.57.



In 2003, prior to the IPO, we issued a total of $1.8 million face value
convertible notes payable for net proceeds of $1.4 million cash and the refinancing of $228,000 of principal and interest due for notes issued during 2002 that had reached maturity. A total of $228,000 of this convertible debt remains outstanding at



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September 30, 2003. The balance was repaid or converted into common stock. In connection with the 2003 convertible debt, we also issued 131,801 warrants to
purchase our common stock with an average exercise price of $6.00.



Also, on February 14, 2003, we entered into a $1 million revolving line of credit with Laurus. This revolving line of credit (the LOC) is secured by our accounts receivables and other assets, and we have the ability to draw down
advances under the LOC subject to limits. Under the terms of the LOC, Laurus can convert advances made to us into our common stock at a fixed conversion price of $6.78 per share. In connection with the LOC, we issued warrants to purchase 12,500
shares of our common stock at $6.78 per share. At September 30, 2003, the outstanding principal balance under the LOC was $473,000.



We are not yet profitable. For the foreseeable future, we expect to incur substantial additional expenditures associated with cost of sales, marketing,
and research and development, in addition to increased costs associated with staffing for management,. Additional capital may be required to implement our business strategies and fund our plan for future growth and business development.



At September 30, 2003, we had no material commitments other than our
operating leases. Our future capital requirements will depend upon many factors, including the timing of research and product development efforts, the possible need to acquire new technology, the expansion of our sales and marketing efforts, and our
expansion internationally. We expect to continue to expend significant amounts in all areas of our operations.



Cash used in operations was approximately $3.9 million for the nine months ended September 30, 2003, compared to $3.4 million for the same period in 2002.
The increase in cash used in operations for the nine months ended September 30, 2003, compared to the same period in the prior year, was due primarily to the $596,000 adjustment in 2002 for the loss on investment.



Cash used in investing activities for the nine months ended September 30,
2003, was $121,000, compared to cash provided of $439,000 for the same period ended September 30, 2002. Cash provided by investing activities for the nine month period ended September 30, 2002, was primarily the result of our sale of marketable
portfolio securities in early 2002.



Cash provided by financing
activities for the nine month period ended September 30, 2003, was $13.8 million, compared to cash provided of $2.4 million for the same period ended September 30, 2002. Our successful public offering in July and August 2003 provided cash, after
expenses, of $13.1 million for the nine months ended September 30, 2003.



Results Of Operations



Three Months Ended
September 30, 2003 vs. Three Months Ended September 30, 2002



For quarter ended September 30, 2003, net revenue decreased $45,000 or 5%, to $787,000, compared to $832,000 during the three-month period ended September 30, 2002. Revenues from sales of products in the third quarter ended September 30,
2003, increased to $587,000, or approximately 9%, from $537,000 in the third quarter ended September 30, 2002. The increase in product revenues in the third quarter resulted from a more favorable product sales mix, and improved demand for our Cx1000
product from the long haul broadcast market. Contract revenues increased nearly 91% to $200,000 in the third quarter ended September 30, 2003 from $105,000 in the same quarter last year. The increase in contract revenue resulted from our development
work on potential new products. We expect contract services revenue to fluctuate significantly from quarter to quarter in the future. In the third quarter ended September 30, 2003, revenues from license fees were nil, compared to $190,000 in the
same quarter last year. Third quarter 2002 license revenues resulted from a one-time license fee from one of our business partners for the rights to resell our Chameleon vidX 1801 product for a limited time. We anticipate that license revenues will fluctuate significantly from quarter to
quarter in the future.



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Cost of revenues decreased by $32,000 or nearly 6% to $499,000 in the quarter ended September 30, 2003,
from $531,000 in same quarter last year. The decline in cost of sales reflects in part continued reductions in the cost of manufacturing our products, which we primarily outsource to third parties, partially offset by the $142,000 provision for
obsolete and slow-moving inventory accrued in the period and slightly lower sales for the period. There was no provision for obsolete and slow-moving inventory at September 30, 2002. Cost of products sold consists primarily of raw material costs,
warranty costs and labor associated with manufacturing, which we now outsource on a turn-key basis. Cost of contract services increased to $120,000 in the quarter ended September 30, 2003 from $31,000 in the same quarter last year reflecting our
development efforts on potential new products such as an integrated QAM gateway product. Cost of contract services consists primarily of engineering payroll costs as well as other expenses for technical services.



Gross profit totaled $288,000 for the quarter ended September 30, 2003,
compared to gross profit of $301,000 in the same quarter last year. The decrease in gross profit for the current year period versus the prior year period is mainly attributable to the establishment of a $142,000 provision for obsolete and
slow-moving inventory. Gross profit for the three-month period ended September 30, 2003, before the effect of the of the inventory charge was $430,000, a 43% increase over the same three-month period in the prior year. The figures in the preceding
sentence are non-GAAP financial measures; we include them because we feel they benefit investors by enabling them to assess a more normalized, ongoing basis for our gross profit and gross profit margin. We take these particular non-GAAP financial
measures into account in our own business planning and our evaluation of our operations. In the third quarter ended September 30, 2003, gross profit from product sales was $208,000, or 72% of total gross profit. Product gross profits increased in
the third quarter compared to the same quarter last year both because of increased overall product sales, product mix and cost improvements from outsourcing. Our profit margin on product sales was 35% in the third quarter of 2003, versus 7% in the
third quarter of 2002. Gross profit from contract services was $80,000, or 28% of total gross profit in the third quarter ended September 30, 2003.



Engineering research and development expenses for the quarter ended September 30, 2003, decreased nearly 15% to $405,000 from $479,000 in the quarter
ended September 30, 2002. The decrease is due primarily to reduced cost of R&D personnel, and reduced expenditures to acquire development services and tools for our new products. We have increased engineering headcount and other engineering
expenses for new product development and other sustaining engineering efforts, so engineering research and development expenses are expected to be higher in future quarters.



Sales and marketing expenses for the quarter ended September 30, 2003, nearly tripled to $480,000 from $161,000 for the
quarter ended September 30, 2002. The increase in sales and marketing expenses is primarily due to increased sales and marketing personnel, marketing campaigns and trade shows, and costs associated with developing channel partners. We expect that
sales and marketing expenses will increase in the future as we grow our channel partner network and pursue international opportunities.



General and administrative expenses for the quarter ended September 30, 2003, increased to $1.3 million from $532,000 in the same quarter the prior year.
The increase results principally from non-cash debt conversion expenses of $506,000. We expect our spending on business infrastructure to increase in future quarters.



Stock-based compensation expense is a non-cash expense item that is recognized as a result of stock options having exercise
prices below estimated fair value. Stock-based compensation expense is calculated as the difference between exercise prices and estimated fair market value on the date of grant. We have historically recorded compensation expense related to the
outstanding options to consultants and some employees for the amount of options that vest in that period. In the quarter ended September 30, 2003, we incurred a nil non-cash charge for stock-based compensation, versus $43,000 non-cash compensation
charge in the same quarter ended September 30, 2002.



Amortization expense for the quarter ended September 30, 2003, was $226,000, compared to nil for the same quarter last year. The increase in amortization expense resulted from accelerated amortization of debt issuance costs resulting from
the early retirement of convertible debt.



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Interest expense for the quarter ended September 30, 2003 was $194,000 versus $326,000 of expense in the
same quarter ended September 30, 2002. The decrease in interest expense predominantly results from the early retirement of debt.



Other expense for the quarter ended September 30, 2003 totaled $262,000, compared to nil for the same quarter last year. Other expense principally arose
from a loss recognized at the time of our post-IPO repurchase of outstanding convertible notes.



Nine Months Ended September 30, 2003 vs. Nine Months Ended September 30, 2002



For the nine months ended September 30, 2003, revenue increased approximately 41% to $2.2 million, over $1.5 million in the same period ended September
30, 2002. This increase in revenues resulted primarily from higher contract service revenues related to developing potential new products, and from higher product sales. We expect that contract service revenue and license revenue will fluctuate
significantly quarter to quarter.



For the nine months ended
September 30, 2003, cost of sales totaled $1.1 million, compared to $900,000 for the same period ended September 30, 2002. Our cost of sales for the nine months ended September 30, 2003 reflected lower cost of products resulting primarily from
outsourcing the manufacture of our products offset by the $142,000 provision for obsolete and slow-moving inventory, together with higher costs of performing contact services due to our increased contract service activities.



For the nine months ended September 30, 2003, gross profit increased nearly
74% to $1.1 million, or 50% of revenue, from $628,000, or 41% of revenue, in the same period in 2002. Product gross profit increased to 38% of product revenue in the nine months ended September 30, 2003, from 29% of product revenue in the same
period in 2002 primarily as a result of cost improvements from outsourcing, increased overall product sales and favorable product mix.



Engineering research and development expenses decreased nearly 21% to $1.1 million for the first nine months of 2003, compared to $1.4 million for the
nine months ended September 30, 2002, principally due to reduced cost of R&D personnel, and reduced expenditures to acquire development services and tools for our new products. We anticipate increased research and development expenses as we
focus on product development and improvements.



Sales and
marketing expenses increased to $1.1 million from $486,000 for the nine months ended September 30, 2003 and 2002, respectively. The increase in sales and marketing expenses results principally from increased sales and marketing personnel, marketing
campaigns and trade shows, and costs associated with developing channel partners. We expect that sales and marketing expenses will increase in the future as we grow our channel partner network and pursue international opportunities.



General and administrative expenses increased to $2.5 million from $1.8
million for the nine months ended September 30, 2003 and 2002, respectively. The increase in general and administrative expenses results principally from non-cash expenses related to debt conversion expense.



Stock-based compensation expense is a non-cash expense item that is
recognized as a result of stock options having exercise prices below estimated fair value. Stock-based compensation expense is calculated as the difference between exercise prices and estimated fair market value on the date of grant. We have
historically recorded compensation expense related to the outstanding options to consultants and some employees for the amount of options that vest in that period. Stock-based compensation totaled $50,000 and $216,000 for the nine months ended
September 30, 2003 and 2002, respectively.



Amortization
expense for the nine months ended September 30, 2003, was $297,000, compared to $73,000 for the same period last year. The increase in amortization expense resulted from accelerated amortization of debt issuance costs resulting from the early
retirement of convertible debt.



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Interest expense totaled $589,000 and $883,000 for the nine months ended September 30, 2003 and 2002,
respectively. The decrease in interest expenses resulted principally from the early retirement of long term obligations.



Other expense totaled $262,000 for the nine months ended September 30, 2003. Other expense was nil for the nine months ended September 30, 2002.



We sold all of our remaining portfolio securities in 2002,
realizing a $590,000 loss.



Discontinued Operations



We decided to dispose of our Silicon Systems business unit
(Sistolic) after a large semiconductor company, with whom we entered into a non-exclusive licensing agreement and an engineering services agreement related to Sistolics technology, informed us that they were terminating their
agreements in March 2002. Due to this material and adverse turn of events, we decided that we could no longer sustain the negative cash flow from Sistolic. On April 3, 2002, we disposed of the assets of this business unit back to Metar ADC SRL and
its President (Executive) in exchange for the elimination of our remaining obligations to Metar ADC SRL and its affiliates, including the payable of $686,000, the return of all stock options granted to the Executive and the Romanian
employees, and a confirmation that performance criteria specified in the Executives employment agreement with us related to a potential $4 million bonus were never met by him. We also received a limited use license to the business units
intellectual property. In addition, the Romanian facility lease was transferred to Metar ADC SRL and the Romanian employment contracts were terminated. Metar ADC SRL was permitted to hire any and all Romanian employees. Metar ADC SRL also received
5,833 shares of our common stock. The Executive resigned on March 27, 2002, as an officer of the Company in anticipation of this transaction. The $317,000 loss from discontinued operations for the nine months ended September 30, 2002 arose solely
from Sistolic.



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RISK FACTORS



Investment in our common stock involves a high degree of risk. The risks and uncertainties described below are not the only
ones we face. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer.



OUR LIMITED SALES HISTORY AND LIMITED REVENUES TO DATE MAKE IT DIFFICULT TO EVALUATE OUR PROSPECTS.



We were founded in January 1998 and have only been selling our products commercially since 2002, which makes an evaluation
of our prospects difficult. Because of our limited sales history, we have limited insight into trends that may emerge and affect our business. In addition, we have generated only limited revenues to date from sales of our products and the income
potential of our business and market are unproven. An investor in our securities must consider the challenges, expenses and difficulties we face as our sales and marketing efforts mature.



WE RECENTLY LAUNCHED OUR INITIAL COMMERCIAL PRODUCTS AND SERVICES AND THEY MAY NOT GAIN CUSTOMER ACCEPTANCE.



In 2002, we launched our two primary commercial products into the long haul
video transport market and announced the deployment of our Chameleon vidX product line in our first quarter of 2003. These products are in the early stages of commercial deployment. We may not be able to gain customer acceptance of any of our products due to our lack of an established track
record, our financial condition, competition, price or a variety of other factors. If our products and services are not accepted by potential customers, or if these customers do not purchase our products and services at the levels we anticipate, our
operating results may be materially adversely affected.



OUR QUARTERLY
FINANCIAL RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY.



Our quarterly operating results are difficult to predict and may fluctuate significantly from period to period, particularly because our sales prospects are uncertain and our sales are made on a purchase order basis. In addition, we have
not proven our ability to execute our business strategy with respect to establishing and expanding sales and distribution channels. Fluctuations may result from:



| |  | decreased spending on new products such as ours by communication service providers or their suppliers,
| | - | ------------------------------------------------------------------------------------------------------



| |  | the timing of new product offerings, acquisitions, licenses or other significant events by us or our competitors,
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | our ability to establish a productive sales force or partner with communication service providers or their suppliers,
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | demand and pricing of the products we offer,
| | - | --------------------------------------------



| |  | Purchases of our products by communiation service providers in large, infrequent amounts consistent with past practice,
| | - | -----------------------------------------------------------------------------------------------------------------------



| |  | consumer acceptance of the services our products enable,
| | - | --------------------------------------------------------



| |  | interruption in the manufacturing or distribution of our products, and
| | - | ----------------------------------------------------------------------



| |  | general economic and market conditions, including war, and other conditions specific to the telecommunications industry.
| | - | ------------------------------------------------------------------------------------------------------------------------



As a result, we may experience significant, unanticipated quarterly losses.



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WE FACE COMPETITION FROM ESTABLISHED AND DEVELOPING COMPANIES, MANY OF WHICH HAVE SIGNIFICANTLY GREATER RESOURCES, AND
WE EXPECT SUCH COMPETITION TO GROW.



The markets for our
products, future products and services are competitive. We face direct and indirect competition from a number of established companies, including Scientific-Atlanta, as well as development stage companies, and we anticipate that we will face
increased competition in the future as existing competitors seek to enhance their product offerings and new competitors emerge. Many of our competitors have greater resources, higher name recognition, more established reputations within the industry
and stronger manufacturing, distribution, sales and customer service capabilities than we do.



The technologies that our competitors and we offer are expensive to design, develop, manufacture and distribute. Competitive technologies may be owned and distributed by established companies that possess
substantially greater financial, technical and other resources than we do and, as a result, such companies may be able to develop their products more rapidly and market their products more extensively than we can.



Competitive technologies that offer a similar or superior capacity to
converge and transmit audio, video and telephonic data on a real-time basis over existing networks may currently exist or may be developed in the future. We cannot assure you that any technology currently being developed by us is not being developed
by others or that our technology development efforts will result in products that are competitive in terms of price or performance. If our competitors develop products or services that offer significant price or performance advantages as compared to
our current and proposed products and services, or if we are unable to improve our technology or develop or acquire more competitive technology, we may find ourselves at a competitive disadvantage and our business could be adversely affected. In
addition, competitors with greater financial, marketing, distribution and other resources than we have may be able to leverage such resources to gain wide acceptance of products inferior to ours.



OUR CUSTOMER BASE IS CONCENTRATED AND THE LOSS OF ONE OR MORE OF OUR KEY CUSTOMERS WOULD
HARM OUR BUSINESS.



Historically, a significant majority
of our sales have been to relatively few customers, including Scientific-Atlanta. We expect that sales to relatively few customers will continue to account for a significant percentage of our net sales for the foreseeable future. Almost all of our
sales are made on a purchase order basis, and none of our customers has entered into a long-term agreement requiring it to purchase our products. The loss of, or any reduction in orders from, a significant customer would harm our business.



OUR CRITICAL RELATIONSHIP WITH SCIENTIFIC-ATLANTA AS BOTH A CUSTOMER AND AS
A COMPETITOR MAY JEOPARADIZE OUR SUCCESS.



In 2002,
approximately 66% of our revenues were from sales to Scientific-Atlanta and its subsidiary, BarcoNet N.V. Our revenues from Scientific-Atlanta, as a percentage of our total revenues, have declined for the nine months ended September 30, 2003, and we
anticipate that our 2003 revenues from Scientific-Atlanta will, as a percentage of our total revenues, will be lower than in previous periods resulting in part from increased revenues from the long haul broadcast market. Should our level of business
with Scientific-Atlanta change, our results could be negatively impacted.



Our technology uses non-proprietary industry standard interfaces and designs for video transport (known as IP/gigabit Ethernet). We are aware that Scientific-Atlanta has developed a product line that operates with an
alternative to the open industry standard of IP/gigabit Ethernet.



We believe transporting video directly over a proprietary standard eliminates the flexibility offered through open standards such as IP/gigabit Ethernet. Nonetheless, Scientific-Atlantas development, marketing and sale of its
proprietary standard-based products may compete directly with our development, marketing and sales efforts. Since Scientific-Atlanta has greater financial, marketing, and other resources than we do, Scientific-Atlanta may



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be able to develop its products more rapidly and market its products more extensively than we can. Because of Scientific-Atlantas name recognition,
industry-reputation and other reasons, Scientific-Atlantas products could become the standard for delivery of real-time, broadcast-quality video, in which case the sale of our products could materially suffer. Scientific-Atlantas
products may be superior to ours in terms of price or performance, or inferior to ours but backed by superior marketing and support capabilities. As a result, we may not be able to compete successfully with Scientific-Atlanta, and our ability to
gain market share for our products could be adversely affected.



Our relationship with Scientific Atlanta, as both a significant customer and a significant competitor, may have adverse consequences to our business. While general risks are associated with any competitor and any customer, the conflicting
interests of Scientific-Atlanta (as a result of being both) magnifies these risks. Scientific-Atlanta may decide to pursue its proprietary standard based products and downplay or even discontinue its relationship with us, as both a reseller and an
outside manufacturer. Loss of sales to Scientific-Atlanta and its distribution network to communication service providers could adversely affect our business.



THE RATE OF MARKET ADOPTION OF OUR TECHNOLOGY IS UNCERTAIN AND WE COULD EXPERIENCE LONG AND UNPREDICTABLE SALES CYCLES, ESPECIALLY IF THE SLOWDOWN IN THE
TELECOMMUNICATIONS INDUSTRY PERSISTS.



Our products are
based on new technology and, as a result, it is extremely difficult to predict the timing and rate of market adoption of our products, as well the rate of market adoption of applications enhanced by our products such as video-on-demand. Accordingly,
we have limited visibility into when we might realize substantial revenue from product sales. This is compounded by our inability to foresee when, if ever, delivery of video over IP networks will be significantly embraced by communication service
providers.



We are providing new and highly technical products
and services to enable new applications. Thus, the duration of our sales efforts with prospective customers in all market segments is likely to be lengthy as we seek to educate them on the uses and benefits of our products. This sales cycle could be
lengthened even further by potential delays related to product implementation as well as delays over which we have little or no control, including:



| |  | the length or total dollar amount of our prospective customers planned purchasing programs in regard to our products;
| | - | ----------------------------------------------------------------------------------------------------------------------



| |  | changes in prospective customers capital equipment budgets or purchasing priorities;
| | - | -------------------------------------------------------------------------------------



| |  | prospective customers internal acceptance reviews; and
| | - | -------------------------------------------------------



| |  | the complexity of prospective customers technical needs.
| | - | ---------------------------------------------------------



These uncertainties, combined with the worldwide slowdown in capital spending in the telecommunications business that began in 2001, and the slowdown in
corporate spending on technology generally as well as new technologies such as ours, substantially complicate our planning and may reduce prospects for sales of our products. If our prospective customers curtail or eliminate their purchasing
programs, decrease their budgets or reduce their purchasing priority, our results of operations could be adversely affected.



WE HAVE INCURRED LOSSES SINCE INCEPTION AND WILL LIKELY NOT BE PROFITABLE AT LEAST FOR THE NEXT SEVERAL QUARTERS.



We have incurred operating losses since our inception in January 1998, and
we expect to incur losses and negative cash flow for at least the next several quarters. As of September 30, 2003, our accumulated deficit was approximately $35.5 million. We expect to continue to incur significant operating, sales, marketing,
research and development and general and administrative expenses and, as a result, we will need to generate significant revenues to achieve profitability. Even if we do achieve profitability, we cannot assure you that we can sustain or increase
profitability on a quarterly or annual basis in the future.



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THE SUCCESS OF OUR BUSINESS IS DEPENDENT ON ESTABLISHING AND EXPANDING SALES AND DISTRIBUTION CHANNELS FOR OUR
PRODUCTS.



Third-Party Collaborations. We intend to
partner with the leading suppliers to communication service providers, including Scientific-Atlanta, to promote and distribute our products, both as an outside equipment manufacturer to suppliers and with suppliers acting as resellers of our
products. We may not be able to identify adequate partners, and even if identified, we may not be able to enter into agreements with these entities on commercially reasonable terms, or at all. To the extent that we enter into any such agreements
with third parties, any revenues we receive from sales of our products in those markets will depend upon the efforts of such third parties, which in most instances will not be within our control. If we are unable to effectively leverage a partner to
market our products more broadly than we can through our internal sales force, our business could be adversely affected.



Internal Sales Force. We have limited experience in marketing and selling our products. We intend to expand our direct and indirect sales force and
independent channel partners domestically and internationally for the promotion of our product lines and other future products to suppliers and communication service providers of all kinds. Competition for quality sales and marketing personnel and
channel partners is intense. In addition, new employees, particularly new sales and marketing employees, will require training and education concerning our products and will also increase our operating expenses. There can be no assurance that we
will be successful in attracting or retaining qualified sales and marketing personnel and partners. As a result, there can be no assurance that the sales force we are able to build will be of a sufficient size or quality to effectively market our
products.



WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL IN THE FUTURE WHEN
NEEDED, WHICH COULD PREVENT US FROM GROWING.



While we
recently completed a public offering resulting in gross proceeds of $15.5 million, we have not yet achieved profitability and cannot be certain that such financing will be adequate or sufficient for our future needs. We may be required to raise
additional capital, and we cannot ensure that financing would be available to us on acceptable terms, if at all. Our inability to raise capital when needed could seriously harm our business. In addition, additional equity financing may dilute our
stockholders interest, and debt financing, if available, may involve restrictive covenants and could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on debt. If adequate funds
are not available, we may need to curtail our operations significantly.



WE
MAY NOT BE ABLE TO PROFIT FROM GROWTH IF WE ARE UNABLE TO EFFECTIVELY MANAGE THE GROWTH.



We anticipate that we will need to grow in the future. This anticipated growth will place strain on our managerial, financial and personnel resources. The pace of our anticipated expansion, together with the
complexity of the technology involved in our products and the level of expertise and technological sophistication incorporated into the provision of our design, engineering, implementation and support services, demands an unusual amount of focus on
the operational needs of our future customers for quality and reliability, as well as timely delivery and post-installation and post-consultation field and remote support. In addition, new customers, especially customers that purchase novel and
technologically sophisticated products such as ours, generally require significant engineering support. Therefore, adoption of our platforms and products by customers would increase the strain on our resources.



To reach our goals, we will need to hire rapidly, while at the same time
investing in our infrastructure. We expect that we will also have to expand our facilities. In addition, we will need to successfully train, motivate and manage new employees; expand our sales and support organization; integrate new management and
employees into our overall operations; and establish improved financial and accounting systems. Indeed, even without consideration of future needs imposed by any future growth of our business, we need to upgrade several of these areas even to
support our present levels of business, because during the pre-IPO periods of tight cash, we focused our resources on areas other than business infrastructure.



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We may not succeed in anticipating all of the changing demands that growth would impose on our systems,
procedures and structure. If we fail to effectively manage our expansion, if any, our business may suffer.



WE WILL DEPEND ON CABLE, BROADCASTING AND SATELLITE INDUSTRY SPENDING FOR A SUBSTANTIAL PORTION OF OUR REVENUE AND ANY DECREASE OR DELAY IN SPENDING IN THESE INDUSTRIES WOULD NEGATIVELY IMPACT OUR RESOURCES,
OPERATING RESULTS AND FINANCIAL CONDITION.



Demand for our
products will depend on the magnitude and timing of spending by cable television operators, broadcasters, satellite operators and carriers for adopting new products for installation with their networks.



These spending patterns are dependent on a variety of factors, including:



| |  | access to financing;
| | - | --------------------



| |  | annual budget cycles;
| | - | ---------------------



| |  | the status of federal, local and foreign government regulation of telecommunications and television broadcasting;
| | - | -----------------------------------------------------------------------------------------------------------------



| |  | overall demand for communication services and the acceptance of new video, voice and data services;
| | - | ---------------------------------------------------------------------------------------------------



| |  | evolving industry standards and network architectures;
| | - | ------------------------------------------------------



| |  | competitive pressures;
| | - | ----------------------



| |  | discretionary customer spending patterns;
| | - | -----------------------------------------



| |  | general economic conditions.
| | - | ----------------------------



Recent developments in capital markets have reduced access to funding for potential and existing customers causing delays in the timing and scale of
deployments of our equipment, as well as the postponement of certain projects by our customers. The timing of deployment of our equipment can be subject to a number of other risks, including the availability of skilled engineering and technical
personnel.



WE NEED TO DEVELOP AND INTRODUCE NEW AND ENHANCED PRODUCTS IN A
TIMELY MANNER TO REMAIN COMPETITIVE.



Broadband
communications markets are characterized by continuing technological advancement, changes in customer requirements and evolving industry standards. To compete successfully, we must design, develop, manufacture and sell new or enhanced products that
provide increasingly higher levels of performance and reliability. However, in addition to the technological and managerial risks inherent in any product development effort, we may not be able to successfully develop or introduce these products if
the development effort requires more financial resources than we are able to bring to bear, or if our products:



| |  | are not cost effective,
| | - | -----------------------



| |  | are not brought to market in a timely manner,
| | - | ---------------------------------------------



| |  | are not in accordance with evolving industry standards and architectures, or
| | - | ----------------------------------------------------------------------------



| |  | fail to achieve market acceptance.
| | - | ----------------------------------



In order to successfully develop and market certain of our planned products for digital applications, we may be required to enter into technology
development or licensing agreements with third parties. We cannot assure you that we will be able to enter into any necessary technology development or licensing agreement on terms



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acceptable to us, or at all. The failure to enter into technology development or licensing agreements when necessary could limit our ability to develop and
market new products and, accordingly, could materially and adversely affect our business and operating results.



DELIVERY OF REAL-TIME, BROADCAST-QUALITY VIDEO VIA IP NETWORKS IS A NEW MARKET AND SUBJECT TO EVOLVING STANDARDS.



Delivery of real-time, broadcast-quality video over IP networks is novel and
evolving and it is possible that communication service providers or their suppliers will adopt alternative architectures and technologies for delivering real-time, broadcast-quality video over IP networks that are in compatible with our current or
future products. If we are unable to design, develop, manufacture and sell products that incorporate or are compatible with these new architectures or technologies, our business could suffer.



WE RELY ON SEVERAL KEY SUPPLIERS OF COMPONENTS, SUB-ASSEMBLIES AND MODULES THAT WE USE TO
MANUFACTURE OUR PRODUCTS, AND WE ARE SUBJECT TO MANUFACTURING AND PRODUCT SUPPLY CHAIN RISKS.



We purchase components, sub-assemblies and modules from a limited number of vendors and suppliers that we use to manufacture and test our products. Our
reliance on these vendors and suppliers involves several risks including, but not limited to, the inability to purchase or obtain delivery of adequate supplies of such components, sub-assemblies or modules, increases in the prices of such items,
quality, and overall reliability of our vendors and suppliers. Although in many cases we use standard parts and components for our products, certain components are presently available only from a single source or limited sources. Some of the
materials used to produce our products are purchased from foreign suppliers. We do not generally maintain long-term agreements with any of our vendors or suppliers. Thus we may thus be unable to procure necessary components, sub-assemblies or
modules in time to manufacture and ship our products, thereby harming our business.



We also recently signed an agreement with a leading parts vendor to provide turnkey outsourced manufacturing services. To reduce manufacturing lead times and to ensure adequate component supply, we may instruct our
vendor to procure inventory based on criteria and forecasts as defined by us. If we fail to anticipate customer demand properly, an oversupply of parts, obsolete components or finished goods could result, thereby adversely affecting our gross
margins and results of operations.



We may also be subject to
disruptions in our manufacturing and product-testing operations that could have a material adverse affect on our operating results.



UNANTICIPATED DELAYS OR PROBLEMS ASSOCIATED WITH OUR PRODUCTS AND IMPROVEMENTS MAY CAUSE CUSTOMER DISSATISFACTION OR DEPRIVE US OF OUR FIRST TO MARKET
ADVANTAGE.



Delays in developing and releasing products
and improvements are not uncommon in the industry in which we compete. In the event of performance problems with our product offerings, delays of more than a few months in releasing improvements could result in decreased demand for a particular
product and adverse publicity, which could further reduce demand for particular products or our products generally.



PRODUCT QUALITY PROBLEMS MAY NEGATIVELY AFFECT OUR REVENUES AND RESULTS FROM OPERATIONS.



We produce highly complex products that incorporate leading edge technology including hardware, software and embedded
firmware. Our software and other technology may contain bugs that can prevent our products from performing as intended. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects either in
individual products or which could affect numerous shipments that, in turn, could create customer dissatisfaction, reduce sales opportunities, or affect gross margins if the cost of



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remedying the problems exceed our reserves established for this purpose. Our inability to cure a product defect may result in the failure of a product line,
serious damage to our reputation, and increased engineering and product re-engineering costs that individually or collectively would have a material adverse impact on our revenues and operating results.



WE MAY NOT BE ABLE TO HIRE AND ASSIMILATE KEY EMPLOYEES.



Our future success will depend, in part, on our ability to attract and
retain highly skilled employees, including management, technical and sales personnel. Despite the recent economic slowdown, significant competition exists for employees in our industry and in our geographic region. We may be unable to identify and
attract highly qualified employees in the future. In addition, we may not be able to successfully assimilate these employees or hire qualified personnel to replace them. The loss of services of any of our key personnel, the inability to attract or
retain key personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to meet key objectives such as timely and effective product introductions.



WE ARE DEPENDENT ON OUR KEY EMPLOYEES FOR OUR FUTURE SUCCESS.



Our success depends on the efforts and abilities of our senior management
and certain other key personnel. If any of these key employees leaves or is seriously injured and unable to work and we are unable to find a qualified replacement, then our business and results of operations could be materially harmed.



CHANGES IN THE MIX OF OUR PRODUCT SALES, PRODUCT DISTRIBUTION MODEL OR CUSTOMER BASE
COULD NEGATIVELY IMPACT OUR SALES AND MARGINS.



We may
encounter a shift the mix of the various products that we sell  products that have varying selling prices based in part on the type of product sold, applicable sales discounts, licensed product feature sets, whether we sell our products as an
OEM, and whether the sale is a direct sale or an indirect channel sale through our VARs and resellers. Any change in any of these variables could result in a material adverse impact on our gross sales, gross margins and operating results.



WE MAY BE UNABLE TO OBTAIN FULL PATENT PROTECTION FOR OUR CORE TECHNOLOGY
AND THERE IS A RISK OF INFRINGEMENT.



Since the beginning
of 2001, we have submitted several patent applications and provisional patent applications on topics surrounding our core technologies to supplement our existing patent portfolio. There can be no assurance that these or other patents will be issued
to us, or, if additional patents are issued, that they or our three existing patents will be broad enough to prevent significant competition or that third parties will not infringe upon or design around such patents to develop competing products. In
addition, we have filed patent applications in several foreign countries. There is no assurance that these or any future patent applications will be granted, or if granted, that they will not be challenged, invalidated or circumvented.



In addition to seeking patent protection for our products, we intend to
rely upon a combination of trade secret, copyright and trademark laws and contractual provisions to protect our proprietary rights in our products. There can be no assurance that these protections will be adequate or that competitors have not or
will not independently develop technologies that are substantially equivalent or superior to ours.



There has been a trend toward litigation regarding patent and other intellectual property rights in the telecommunications industry. Although there are
currently no lawsuits pending against us regarding possible infringement claims, there can be no assurance such claims will not be asserted in the future or that such assertions will not materially adversely affect our business, financial conditions
and results of operations. Any such suit, whether or not it has merit, would be costly to us in terms of employee time and defense costs and could materially adversely affect our business.



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If an infringement or misappropriation claim is successfully asserted against us, we may need to obtain a
license from the claimant to use the intellectual property rights. There can be no assurance that such a license will be available on reasonable terms if at all.



WE ARE SUBJECT TO LOCAL, STATE AND FEDERAL REGULATION.



Legislation affecting us (or the markets in which we compete) could adversely impact our ability to implement our business
plan on a going-forward basis. The telecommunications industry in which we operate is heavily regulated and these regulations are subject to frequent change. Future changes in local, state, federal or foreign regulations and legislation pertaining
to the telecommunications field may adversely affect prospective purchasers of telecommunications equipment, which in turn would adversely affect our business.



THE MARKET PRICE OF OUR COMMON STOCK COULD BE VOLATILE AND YOUR INVESTMENT COULD SUFFER A DECLINE IN VALUE.



The market prices for our common stock is likely to be volatile and could be
susceptible to wide price fluctuations due to a number of internal and external factors, many of which are beyond our control, including:



| |  | quarterly variations in operating results and overall financial condition;
| | - | --------------------------------------------------------------------------



| |  | economic and political developments affecting technology spending generally and adoption of new technologies and products such as ours;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------



| |  | customer demand or acceptance of our products and solutions;
| | - | ------------------------------------------------------------



| |  | short-selling programs;
| | - | -----------------------



| |  | changes in IT spending patterns and the rate of consumer acceptance of video-on-demand;
| | - | ---------------------------------------------------------------------------------------



| |  | product sales progress, both positive and negative;
| | - | ---------------------------------------------------



| |  | the stock markets perception of the telecommunications equipment industry as a whole;
| | - | --------------------------------------------------------------------------------------



| |  | technological innovations by others;
| | - | ------------------------------------



| |  | cost or availability of components, sub-assemblies and modules used in our products;
| | - | ------------------------------------------------------------------------------------



| |  | the introduction of new products or changes in product pricing policies by us or our competitors;
| | - | -------------------------------------------------------------------------------------------------



| |  | proprietary rights disputes or litigation;
| | - | ------------------------------------------



| |  | initiation of or changes in earnings estimates by analysts;
| | - | -----------------------------------------------------------



| |  | additions or departures of key personnel; and
| | - | ---------------------------------------------



| |  | sales of substantial numbers of shares of our common stock or securities convertible into or exercisable for our common stock.
| | - | ------------------------------------------------------------------------------------------------------------------------------



In addition, stock prices for many technology companies, especially
early-stage companies such as us, fluctuate widely for reasons that may be unrelated to operating results. These fluctuations, as well as general economic, market and political conditions such as interest rate increases, recessions or military or
political conflicts, may materially and adversely affect the market price of our common stock, thereby causing you to lose some or all of your investment.



In addition, if the average daily trading volume in our common stock is low, the resulting illiquidity could magnify the effect of any of the above
factors on our stock price.



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OUR OUTSTANDING WARRANTS AND THE STOCK OPTIONS AND BONUS STOCK WE OFFER TO OUR EMPLOYEES, NON-EMPLOYEE DIRECTORS,
CONSULTANTS AND ADVISORS COULD RESULT IN ONGOING DILUTION TO ALL STOCKHOLDERS.



We maintain two equity compensation plans: (i) the 2000 Stock Option/Stock Issuance Plan (the 2000 Plan), pursuant to which we may issue options and common stock to employees, officers, directors,
consultants and advisors, and (ii) the 2001 Employee Stock Purchase Plan (the Purchase Plan), approved by our stockholders in February 2002, pursuant to which our employees are provided the opportunity to purchase our stock through
payroll deductions. As of September 30, 2003, there were options outstanding to purchase 602,504 shares of common stock under our 2000 Plan; 107,496 shares of common stock remain available for issuance under the 2000 Plan. A maximum of 41,667 shares
of common stock have been authorized for issuance under the Purchase Plan.



In addition, as of September 30, 2003, there were 89,952 shares of common stock subject to outstanding options granted other than under the 2000 Plan or Purchase Plan. These non-plan options were granted to various
employees, directors, consultants and advisors.



We plan to
continue to provide our employees opportunities to participate in the Purchase Plan. We also plan to issue options, either under the 2000 Plan or otherwise, to purchase sizable numbers of shares of common stock to new and existing employees,
officers, directors, advisors, consultants or other individuals as we deem appropriate and in our best interests. These ongoing purchases of our common stock (as well as future option grants by us and subsequent exercises of options) could result in
substantial dilution to all stockholders and increased control by management.



Currently, there are outstanding warrants to purchase up to 3,169,591 shares of our common stock with a weighted average exercise price of $5.60 per share. The weighted average remaining life for all of the currently
outstanding warrants is 4.7 years.



WE DO NOT INTEND TO PAY CASH DIVIDENDS.



We have never paid cash dividends on our capital stock
and do not anticipate paying any cash dividends in the foreseeable future.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We would be exposed to changes in interest rates primarily from any marketable securities and investments in certain available-for-sale securities. Under our current policies, we do not use interest rate derivative
instruments to manage exposure to interest rate changes. At September 30, 2003, we did not have any marketable securities or investments in available-for-sale securities, nor did we have any sales denominated in a currency other than the United
States dollar. Our cash equivalents principal would not be materially changed by changes in interest rates, but as the short term instruments mature and roll over, we would be able to earn more interest in the future if interest rates rise. A
one percentage point (100 basis point) increase in interest rates would result in approximately $90,000 annual increase in our income from cash equivalents, assuming our cash equivalents principal balance remained at its September 30, 2003 level.
Our $1 million revolving line of credit from Laurus has a floating interest rate.



ITEM 4. CONTROLS AND PROCEDURES



(a) Evaluation of disclosure controls and procedures



Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rules 13a-14(c) and
15d-14(c)) as of a date (the Evaluation Date) within 90 days before the filing date of this quarterly report, have concluded that as



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of the Evaluation Date, our disclosure controls and procedures were effective and designed to ensure that material information relating to us and our
consolidated subsidiaries would be made known to them by others within those entities.



(b) Changes in internal controls



There were no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the Evaluation
Date.



PART II - OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



We are not
a party to any material legal proceedings.



ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS



On July 23, 2003, we effected a one-for-six reverse stock split of our common stock. All of our outstanding derivative securities were correspondingly adjusted.



On July 30, 2003, the SEC declared effective the registration statement (SEC
file no. 333-105638) for our initial public offering of units through underwriters led by Paulson Investment Company, Inc. The units, each consisting of three shares of common stock and two warrants, each to purchase one share of common stock, began
trading on the American Stock Exchange on July 31, 2003, and on August 5, 2003, we closed the sale of the units (including the constitutent 3,750,000 shares of common stock and 2,500,000 common stock warrants) to the underwriters for an aggregate
offering price to the public of $13,500,000. The underwriters over-allotment option was exercised and on August 29, 2003, we closed the sale of an additional 187,500 units (including 562,500 shares of common stock and 375,000 common stock
warrants) to the underwriters for an aggregate offering price to the public of $2,025,000.



In total, we registered the initial issuance of 1,562,500 units, 7,812,500 shares of common stock and 3,125,000 common stock warrants. The aggregate offering amount of the units is $17,145,000, not including the
$16,875,000 aggregate exercise price of the warrants included within the units. Accordingly, the aggregate offering amount of all the common stock included within the units (also including the common stock underlying the warrants) is $34,020,000.
Expenses against the $15,525,000 sold include $1,164,375 of underwriting discounts, a managing underwriters non-accountable expense allowance of $349,313, other expenses paid for underwriters of $45,500, and $910,676 of other expenses. None of
these payments went directly or indirectly to our directors, officers, general partners, affiliates, 10% owners, or any of their associates. Accordingly, our net offering proceeds were $13,055,136.



To date we have used such net proceeds to pay $1,380,000 in accrued accounts
payable, to repurchase $1,180,000 principal amount of our 7% convertible debentures, to repurchase 27,777 shares of common stock from Ronald Fellman for $92,997, and to fund our continuing negative cash flow, including the payment of cash
bonuses to Frederick Cary and John Zavoli totaling $100,000. Except as discussed in the previous sentence, none of these payments went directly or indirectly to our directors, officers, general partners, affiliates, 10% owners, or any of their
associates. Pending use for working capital, research and development efforts and marketing and sales programs, the Company has invested the remaining $9,000,000 of net proceeds in short-term government obligations.



On August 30, 2003, in accordance with their terms, the units separated.
Thereafter, the common stock and warrants within the units sold to the public have traded on the American Stock Exchange directly, rather than as components of units.



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In connection with our public offering, we issued purchase warrants to certain of the underwriters to
purchase units of our securities (each unit consisting of three shares of our common stock and two warrants, each to purchase one share of common stock) in consideration of their services as underwriters. Specifically, we issued a purchase warrant
to Paulson Investment Company, Inc. to purchase up to 111,200 units, and a purchase warrant to I-Bankers Securities Incorporated to purchase up to 13,800 units. The per unit exercise price is $12.96 and the purchase warrants are exercisable for five
years from the effective date of our public offering.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



Not applicable.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



Not applicable.



ITEM 5. OTHER INFORMATION



On October
30, 2003, Yendo Hu resigned as our Vice President, Engineering to accept a management position with a venture-capital-backed startup company.



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



Exhibits.The following exhibits are included as part of this report. References to Path 1 or us in this Exhibit List mean Path 1 Network Technologies Inc., a Delaware corporation.



|Exhibit Number |  | Description                                                                                                                                  
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|               | 
|1.1            |  | Underwriting Agreement dated July 30 , 2003 between the Company and Paulson Investment Company, Inc. *                                       
|               | 
|3.1.2          |  | Certificate of Amendment of Certificate of Incorporation, as filed July 22, 2003 (incorporated by reference to Form 8-K filed July 23, 2003).
|               | 
|4.1            |  | Specimen of Common Stock Certificate (incorporated by reference to Form SB-2/A, Amendment No. 3, filed July 25, 2003).                       
|               | 
|4.2            |  | Form of Unit Certificate (incorporated by reference to Form SB-2/A, Amendment No. 3, filed July 25, 2003).                                   
|               | 
|4.3            |  | Warrant Agreement (including form of Warrant to Purchase Common Stock) *                                                                     
|               | 
|4.4            |  | Purchase Warrant dated July 30, 2003, issued to Paulson Investment Company, Inc. *                                                           
|               | 
|4.5            |  | Purchase Warrant dated July 30, 2003, issued to I-Bankers Securities Incorporated. *                                                         
|               | 
|10.32.1        |  | Amendment to Consulting Agreement between us and Del Mar Consulting Group, Inc. dated September 16, 2003.*                                   
|               | 
|10.80          |  | Letter Agreement between Ronald Fellman and us dated September 12, 2003. *                                                                   
|               | 
|31             |  | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 *                                                                         
|               | 
|32             |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002. *                                                                         

---

|* | Filed Herewith
|- | --------------



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##### Table of Contents

Reports on Form 8-K.



On July 23, 2003, the Company filed a report on Form 8-K to report the
one-for-six reverse split of the Companys common stock. (Items 5 and 7)



We furnished, on Form 8-K, Item 12, during this fiscal quarter, a copy of an announcement of historical financial results. Pursuant to SEC staff guidance, such furnished Form 8-K information need not be listed in this
Item 6 of Form 10-Q.



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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 the undersigned thereunto duly authorized.



Path 1 Network Technologies Inc.



|By:                                                              |  | /s/    FREDERICK A. CARY
|---------------------------------------------------------------- |  | ------------------------
|                                                                 | 
|Frederick A. Cary                                               
|President and Chief Executive Officer                           
|                                                                 | 
|By:                                                              |  | /s/    JOHN R. ZAVOLI   
|                                                                 | 
|John R. Zavoli                                                  
|Chief Financial Officer, General Counsel and Corporate Secretary
|                                                                
|Date: November 13, 2003                                         



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##### Table of Contents

Exhibit List



References to us or Path 1 in this Exhibit List mean Path 1 Network Technologies inc., a Delaware
corporation



|1.1     |  | Underwriting Agreement dated July 30, 2003 between the Company and Paulson Investment Company, Inc. *                                        
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|        | 
|3.1.2   |  | Certificate of Amendment of Certificate of Incorporation, as filed July 22, 2003 (incorporated by reference to Form 8-K filed July 23, 2003).
|        | 
|4.1     |  | Specimen of Common Stock Certificate (incorporated by reference to Form SB-2/A, Amendment No. 3, filed July 25, 2003).                       
|        | 
|4.2     |  | Form of Unit Certificate (incorporated by reference to Form SB-2/A, Amendment No. 3, filed July 25, 2003).                                   
|        | 
|4.3     |  | Warrant Agreement (including form of Warrant to Purchase Common Stock) *                                                                     
|        | 
|4.4     |  | Purchase Warrant dated July 30, 2003, issued to Paulson Investment Company, Inc. *                                                           
|        | 
|4.5     |  | Purchase Warrant dated July 30, 2003, issued to I-Bankers Securities Incorporated *                                                          
|        | 
|10.32.1 |  | Amendment to Consulting Agreement between us and Del Mar Consulting Group, Inc. dated September 16, 2003.*                                   
|        | 
|10.80   |  | Letter Agreement between Ronald Fellman and us dated September 12, 2003. *                                                                   
|        | 
|31      |  | Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 *                                                                         
|        | 
|32      |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002. *                                                                         

---

|* | Filed Herewith
|- | --------------



32