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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)



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

For the Quarterly Period Ended June 30, 2006.

or



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

For the transition period from                      to
                    .

Commission File
Number 001-15609



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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 a large accelerated filer, accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of the
Exchange Act.

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x

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

As of August 14, 2006, 7,596,039 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 June 30,
2006

TABLE OF CONTENTS



|                                                                                              |  |   
|--------------------------------------------------------------------------------------------- |  | --
|PART IFINANCIAL INFORMATION                                                                  |  | 3 
|ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)                                                      |  | 3 
|CONSOLIDATED BALANCE SHEETS                                                                   |  | 3 
|CONSOLIDATED STATEMENTS OF OPERATIONS                                                         |  | 4 
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                                         |  | 5 
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                    |  | 6 
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 21
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 27
|ITEM 4. CONTROLS AND PROCEDURES                                                               |  | 28
|PART IIOTHER INFORMATION                                                                     |  | 28
|ITEM 1. LEGAL PROCEEDINGS                                                                     |  | 28
|ITEM 1A. RISK FACTORS                                                                         |  | 28
|ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 40
|ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                       |  | 40
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   |  | 40
|ITEM 5. OTHER INFORMATION                                                                     |  | 40
|ITEM 6. EXHIBITS                                                                              |  | 41
|SIGNATURES                                                                                    |  | 42



2



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##### Table of Contents

PART IFINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PATH 1 NETWORK TECHNOLOGIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                                                                               |  | June 30,2006 |         |   | December 31,2005 |  
|                                                                                                                                                                                                                                               |  | (Unaudited)  |         |   | (Audited)        |  
|ASSETS                                                                                                                                                                                                                                         |  |              |         |   |                  |   |         |  
|Current assets:                                                                                                                                                                                                                                |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                                                                                      |  | $            | 594     |   |                  | $ | 1,636   |  
|Accounts receivable, net                                                                                                                                                                                                                       |  |              | 702     |   |                  |   | 346     |  
|Inventory                                                                                                                                                                                                                                      |  |              | 524     |   |                  |   | 697     |  
|Other current assets                                                                                                                                                                                                                           |  |              | 93      |   |                  |   | 86      |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                                                                                                                                           |  |              | 1,913   |   |                  |   | 2,765   |  
|                                                                                                                                                                                                                                               |  |             
|Property and equipment, net                                                                                                                                                                                                                    |  |              | 134     |   |                  |   | 244     |  
|Issuance costs for mandatorily-redeemable preferred stock and notes payable, net                                                                                                                                                               |  |              | 862     |   |                  |   | 764     |  
|Other assets                                                                                                                                                                                                                                   |  |              | 108     |   |                  |   | 110     |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|TOTAL ASSETS                                                                                                                                                                                                                                   |  | $            | 3,017   |   |                  | $ | 3,883   |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|LIABILITIES AND SHAREHOLDERS DEFICIT                                                                                                                                                                                                          |  |              |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                                                                                                           |  |              |         |   |                  |   |         |  
|Accounts payable and accrued liabilities                                                                                                                                                                                                       |  | $            | 1,549   |   |                  | $ | 1,196   |  
|Accrued compensation and benefits                                                                                                                                                                                                              |  |              | 199     |   |                  |   | 317     |  
|Deferred revenue                                                                                                                                                                                                                               |  |              | 118     |   |                  |   | 144     |  
|Capital lease obligations                                                                                                                                                                                                                      |  |              | 1       |   |                  |   | 3       |  
|Current portion of notes payable, net                                                                                                                                                                                                          |  |              | 2,107   |   |                  |   | 727     |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                                                                                      |  |              | 3,974   |   |                  |   | 2,387   |  
|                                                                                                                                                                                                                                               |  |             
|Mandatorily-redeemable preferred stock, net                                                                                                                                                                                                    |  |              | 1,883   |   |                  |   | 1,280   |  
|Note payable, net of debt discount                                                                                                                                                                                                             |  |              | 458     |   |                  |   | 873     |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                                                                                              |  |              | 6,315   |   |                  |   | 4,540   |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|SHAREHOLDERS DEFICIT                                                                                                                                                                                                                          |  |              |         |   |                  |   |         |  
|Common stock, $0.001 par value; 40,000,000 shares authorized; 7,596,039 and 7,410,754 shares issued and outstanding at June 30, 2006 and
December 31, 2005, respectively; 2,777 shares held in treasury at June 30, 2006 and December 31, 2005 |  |              | 7       |   |                  |   | 7       |  
|Additional paid-in capital                                                                                                                                                                                                                     |  |              | 55,735  |   |                  |   | 55,553  |  
|Deferred compensation                                                                                                                                                                                                                          |  |              |        |   |                  |   | (1,048  | )
|Accumulated deficit                                                                                                                                                                                                                            |  |              | (59,040 | ) |                  |   | (55,169 | )
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|Total shareholders deficit                                                                                                                                                                                                                    |  |              | (3,298  | ) |                  |   | (657    | )
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT                                                                                                                                                                                                    |  | $            | 3,017   |   |                  | $ | 3,883   |  
|                                                                                                                                                                                                                                               |  |              |         |   |                  |   |         |  

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



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##### Table of Contents

Path 1 Network Technologies Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)



|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------- |  | ---------------------------------- | ------ | - | -------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                               |  | For the three monthsended June 30, |        |   | For the six monthsended June 30, |  
|                                               |  | 2006                               |        |   | 2005                             |   |        | 2006 |  |   | 2005   |  
|REVENUES:                                      |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Product revenue                                |  | $                                  | 760    |   |                                  | $ | 1,139  |      |  | $ | 1,265  |   |  | $ | 1,969  |  
|License revenue                                |  |                                    | 4      |   |                                  |   |       |      |  |   | 16     |   |  |   |       |  
|Contract revenue                               |  |                                    |       |   |                                  |   |       |      |  |   |       |   |  |   | 16     |  
|Royalty revenue                                |  |                                    | 11     |   |                                  |   |       |      |  |   | 41     |   |  |   |       |  
|Services revenue                               |  |                                    | 51     |   |                                  |   |       |      |  |   | 118    |   |  |   |       |  
|Other revenue                                  |  |                                    |       |   |                                  |   | 3      |      |  |   |       |   |  |   | 21     |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Total revenues                                 |  |                                    | 826    |   |                                  |   | 1,142  |      |  |   | 1,440  |   |  |   | 2,006  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|COST OF REVENUES:                              |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Cost of product sales                          |  |                                    | 320    |   |                                  |   | 507    |      |  |   | 672    |   |  |   | 773    |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenues                         |  |                                    | 320    |   |                                  |   | 507    |      |  |   | 672    |   |  |   | 773    |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|GROSS PROFIT                                   |  |                                    | 506    |   |                                  |   | 635    |      |  |   | 768    |   |  |   | 1,233  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|OPERATING EXPENSES:                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Engineering research and development           |  |                                    | 521    |   |                                  |   | 1,180  |      |  |   | 1,040  |   |  |   | 2,120  |  
|Sales and marketing                            |  |                                    | 710    |   |                                  |   | 764    |      |  |   | 1,508  |   |  |   | 1,572  |  
|General and administrative                     |  |                                    | 565    |   |                                  |   | 1,057  |      |  |   | 941    |   |  |   | 1,403  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                       |  |                                    | 1,796  |   |                                  |   | 3,001  |      |  |   | 3,489  |   |  |   | 5,095  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|LOSS FROM OPERATIONS                           |  |                                    | (1,290 | ) |                                  |   | (2,366 | )    |  |   | (2,721 | ) |  |   | (3,862 | )
|                                               |  |                                    |        |  
|Other income (expense)                         |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Interest expense, net                          |  |                                    | (526   | ) |                                  |   | (167   | )    |  |   | (976   | ) |  |   | (255   | )
|Other income (expense)                         |  |                                    | 32     |   |                                  |   | (1     | )    |  |   | 5      |   |  |   | (4     | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Total other expense                            |  |                                    | (494   | ) |                                  |   | (168   | )    |  |   | (971   | ) |  |   | (259   | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|LOSS BEFORE INCOME TAXES                       |  |                                    | (1,784 | ) |                                  |   | (2,534 | )    |  |   | (3,692 | ) |  |   | (4,121 | )
|Provision for income taxes                     |  |                                    |       |   |                                  |   |       |      |  |   | (1     | ) |  |   | (1     | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|NET LOSS                                       |  |                                    | (1,784 | ) |                                  |   | (2,534 | )    |  |   | (3,693 | ) |  |   | (4,122 | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Accumulated preferred dividends                |  |                                    | (84    | ) |                                  |   | (94    | )    |  |   | (178   | ) |  |   | (94    | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|NET LOSS AVAILABLE TO COMMON SHAREHOLDERS      |  | $                                  | (1,868 | ) |                                  | $ | (2,628 | )    |  | $ | 3,871  |   |  | $ | 4,216  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|NET LOSS PER COMMON SHARE:                     |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Basic and Diluted                              |  | $                                  | (0.25  | ) |                                  | $ | (0.38  | )    |  | $ | (0.52  | ) |  | $ | (0.61  | )
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Basic and Diluted                              |  |                                    | 7,540  |   |                                  |   | 6,898  |      |  |   | 7,489  |   |  |   | 6,891  |  
|                                               |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  

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



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Path 1 Network Technologies Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                               |  |                                  |        |   |      |   |        |  
|------------------------------------------------------------------------------ |  | -------------------------------- | ------ | - | ---- | - | ------ | -
|                                                                               |  | For the six monthsended June 30, |       
|                                                                               |  | 2006                             |        |   | 2005 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                          |  |                                  |        |   |      |   |        |  
|Net loss                                                                       |  | $                                | (3,697 | ) |      | $ | (4,122 | )
|Adjustments to reconcile net loss to net cash used in operating activities:    |  |                                  |        |   |      |   |        |  
|Depreciation & amortization                                                    |  |                                  | 95     |   |      |   | 121    |  
|Amortization of debt discount and accretion of preferred stock discount        |  |                                  | 992    |   |      |   | 263    |  
|Bad debt expense                                                               |  |                                  | 3      |   |      |   | (62    | )
|Stock-based compensation expense                                               |  |                                  | 303    |   |      |   | 892    |  
|Changes in assets and liabilities:                                             |  |                                  |        |   |      |   |        |  
|Accounts receivable                                                            |  |                                  | (359   | ) |      |   | (113   | )
|Inventory                                                                      |  |                                  | 173    |   |      |   | 229    |  
|Other current assets                                                           |  |                                  | (7     | ) |      |   | 230    |  
|Other assets                                                                   |  |                                  | (20    | ) |      |   | (525   | )
|Accounts payable and accrued liabilities                                       |  |                                  | 343    |   |      |   | (216   | )
|Accrued compensation and benefits                                              |  |                                  | (118   | ) |      |   | (47    | )
|Deferred revenue                                                               |  |                                  | (26    | ) |      |   | (152   | )
|                                                                               |  |                                  |        |   |      |   |        |  
|Net cash used in operating activities                                          |  |                                  | (2,318 | ) |      |   | (3,502 | )
|                                                                               |  |                                  |        |   |      |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                          |  |                                  |        |   |      |   |        |  
|Capitalized software development - internal use tools                          |  |                                  |       |   |      |   | (112   | )
|Purchase of property & equipment                                               |  |                                  |       |   |      |   | (57    | )
|                                                                               |  |                                  |        |   |      |   |        |  
|Net cash used in investing activities                                          |  |                                  |       |   |      |   | (169   | )
|                                                                               |  |                                  |        |   |      |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                          |  |                                  |        |   |      |   |        |  
|Payment on notes and capital lease obligations                                 |  |                                  | (283   | ) |      |   | (10    | )
|Proceeds from exercise of options                                              |  |                                  |       |   |      |   | 221    |  
|Borrowing on revolving line of credit                                          |  |                                  | 1,600  |   |      |   |       |  
|Payment of debt issuance costs                                                 |  |                                  | (41    | ) |      |   |       |  
|Issuance of preferred stock                                                    |  |                                  |       |   |      |   | 5,383  |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Net cash provided by financing activities                                      |  |                                  | 1,276  |   |      |   | 5,594  |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                           |  |                                  | (1,042 | ) |      |   | 1,923  |  
|Cash and cash equivalents, beginning of period                                 |  |                                  | 1,636  |   |      |   | 929    |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                       |  | $                                | 594    |   |      | $ | 2,852  |  
|                                                                               |  |                                  |        |   |      |   |        |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                              |  |                                  |        |   |      |   |        |  
|Interest paid                                                                  |  | $                                | 90     |   |      | $ | 3      |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Income taxes paid                                                              |  | $                                | 1      |   |      | $ | 1      |  
|                                                                               |  |                                  |        |   |      |   |        |  
|SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:        |  |                                  |        |   |      |   |        |  
|Conversion of notes and accrued interest to common stock                       |  | $                                |       |   |      | $ | 102    |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Capitalization of debt issuance costs and relative fair value of debt discount |  | $                                | 701    |   |      | $ | 3,556  |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Conversion of preferred shares                                                 |  | $                                | 99     |   |      | $ |       |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Reclassification of unvested restricted shares per SFAS 123 (R)                |  | $                                | 1,048  |   |      | $ |       |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Issuance of common stock for preferred stock quasi-dividend                    |  | $                                | 127    |   |      | $ |       |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Issuance of restricted stock to executives                                     |  | $                                |       |   |      | $ | 85     |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Return of property and equipment                                               |  | $                                | 37     |   |      | $ |       |  
|                                                                               |  |                                  |        |   |      |   |        |  
|Dividends earned                                                               |  | $                                | 174    |   |      | $ | 94     |  
|                                                                               |  |                                  |        |   |      |   |        |  

The accompanying notes are an integral part of these 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

Path 1 Network Technologies
(Path 1, we, or the Company) prepared the accompanying unaudited consolidated financial statements in accordance with the rules and regulations of the Securities and Exchange Commission (SEC) including
the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Such rules and regulations allow us to condense and omit certain information and footnote disclosures normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States. We believe these condensed consolidated financial statements reflect all adjustments (consisting only of normal, recurring adjustments) that are necessary for a fair presentation of our
consolidated financial position and results of operations for the periods presented. Results of operations for the interim periods presented are not necessarily indicative of results to be expected for the year.

The information included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our fiscal 2005 Form
10-K. 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, 2006.

NOTE 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The Companys consolidated financial statements include the accounts of Path 1 and its wholly-owned
subsidiary. All significant inter-company accounts and transactions have been eliminated.

Management Estimates and Assumptions

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. Significant estimates made by
management include revenue recognition estimates, the viability of recognizing deferred income tax assets, capitalized software costs and the valuation of equity instruments, and the allowance for doubtful accounts. Significant changes in these
estimates may have a material impact on the financial statements.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash, money market funds, and other highly liquid investments with maturities of three months or less when purchased.

Fair Value of Financial Instruments

The carrying value of cash, cash
equivalents, inventory, accounts payable, and accrued liabilities approximates their fair value due to their short maturities.

Concentrations

Substantially all of our cash and cash equivalents are maintained with one major financial institution in the United States. Deposits held with banks
may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal risk.



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We perform ongoing credit evaluations of our customers financial conditions and would limit the amount of credit
extended if deemed necessary but usually we have required no collateral. The Company has not experienced significant credit losses on its customer accounts. Time Warner Cable, Controlware Inc. and WilTel Communications, LLC accounted for 36%, 22%
and 17%, respectively, of total trade receivables as of December 31, 2005 as compared to Level 3 and Time Warner Cable, which accounted for 50% and 34%, respectively, of our trade receivables as of June 30, 2006.

A small number of customers have typically accounted for a large percentage of the Companys annual revenues. Time Warner Cable, Level 3 and Frontiers Co. Ltd.
accounted for 31%, 24% and 12%, respectively, of revenue for the six months ended June 30, 2006 while WilTel Communications, LLC, DirecTv and Frontiers Co. Ltd. accounted for 34%, 19% and 13%, respectively, of revenue for the six months ended
June 30, 2005. The Companys reliance on relatively few customers could have a material adverse effect on the results of its operations on a quarterly basis.

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. The provision is re-measured at each balance sheet date.

Property and Equipment

Property and equipment is stated at cost and depreciated over the estimated useful lives of the assets, ranging from two to five years, using the straight-line method.

Beneficial Conversion Feature

The convertible
features of convertible notes provide for a rate of conversion that is below market value (see Note 7). Such feature is normally characterized as a beneficial conversion feature (BCF). Pursuant to EITF No. 98-5
Accounting For Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratio and EITF No. 00-27, Application of EITF Issue No. 98-5 To Certain Convertible
Instruments, the relative fair values of the BCFs have been recorded as a discount from the face amount of the respective debt instrument. The Company is amortizing the discount using the effective interest method through maturity of such
instruments.

Income Taxes

Deferred income taxes
result primarily from temporary differences between financial and tax reporting. Deferred tax assets and liabilities are determined based on the differences between the financial statement bases and the tax bases of assets and liabilities using
enacted tax rates. A valuation allowance is established to reduce a deferred tax asset to the amount that is expected more likely than not to be realized.

Revenue Recognition

The Company generates revenue primarily from the sale of its video gateway products. The Company sells its products
through direct sales channels and through distributors or resellers. The Company also derives revenue from contract services and license fees.

Product Revenue

The Company recognizes product revenue when persuasive evidence of an arrangement exists, delivery
has occurred, the fee is fixed or determinable, and collection is reasonably assured. Significant management judgments and estimates must be made in connection with the measurement of revenue in a given period. At the time of the transaction, the
Company assesses a number of factors including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of
sell-through to the end user, and current payment terms. Based on the results of the assessment, the Company may recognize revenue when the products are shipped or defer recognition until evidence of sell-through occurs or cash is received.
Estimated warranty costs are calculated based on historical experience and are recorded at the time revenue is recognized. The Companys products generally carry a one-year warranty from the date of purchase.



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Contract and Service Revenue

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. Billings on uncompleted contracts in excess of incurred costs and accrued profits are classified as deferred revenue.

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 collectibility is reasonably assured.

Royalty Revenue

In December 2001, the Company entered into a Technology License Agreement with Visionary Solutions,
Inc. in which Visionary Solutions Inc. was granted access to Path 1 DotCAM ® Technology in exchange for royalties in an amount equal to 6% of the unit cost of the license products sold. The Company recorded $41,000 in royalty revenue for the six months ended June 30, 2006.

Allowances for Doubtful Accounts, Returns and Discounts

The Company
performs credit evaluations of its customers, and historically has not required collateral or deposits. Typically, the Company offers 30 day credit terms to customers based on a satisfactory credit evaluation. The Company establishes allowances for
doubtful accounts based upon current economic trends, contractual terms and conditions and historical customer payment practices, as well as for known or expected events. As of June 30, 2006 the Company the allowance for doubtful accounts
amounted to approximately $15,000.

Indemnification Arrangements and Guarantees

In connection with Financial Accounting Standards Board (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.

The Company provides a limited
warranty for its products. A provision for the estimated warranty cost is recorded at the time revenue is recognized. The amount of liability to be recorded is based on managements best estimate of future warranty costs expected to be incurred
for its products still under warranty at the time of measurement. This estimate is derived from analyzing trends in product failure rates and trends in actual product repair costs incurred. The Companys standard product warranty extends one
year from date of sale; however, the Company may warrant products for periods greater than one year under certain circumstances. The following table summarizes the activity in the liability accrual related to product warranty during the six months
ended June 30, 2006:



|                                                        |  |                             |   
|------------------------------------------------------- |  | --------------------------- | --
|                                                        |  | (in thousands)June 30, 2006
|                                                        |  | (Unaudited)                
|Warranty reserve beginning balance at December 31, 2005 |  | $                           | 10
|Warranty expense accrued during the period              |  |                             |  
|Actual warranty costs incurred during the period        |  |                             |  
|                                                        |  |                             |   
|Warranty reserve ending balance                         |  | $                           | 10
|                                                        |  |                             |   

The Company also undertakes indemnification obligations in the ordinary course of business related to its
products, the licensing of its software, facility lease, and the issuance of securities. Under these arrangements, the Company may indemnify other parties such as business partners, customers, lessors, and underwriters, for certain losses suffered,
claims of intellectual property infringement, claims arising from use of facility, 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



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circumstances, the Companys indemnification obligations could range from immaterial to having a material adverse impact on its consolidated financial
position and its ability to continue in the ordinary course of business.

Research and Development Expenses

Research and development expenditures are charged to expense as incurred. The Company expenses amounts paid to obtain patents or acquire licenses, as the ultimate
recoverability of the amounts paid is uncertain.

Software Development Costs

The Company has capitalized certain of its software development costs in conformity with AICPA SOP 98-1 (SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use. SOP 98-1 requires capitalization of costs once certain criteria are met; costs to be capitalized are limited to: employee wages and related costs to the extent of direct effort in the development; external direct material and services
consumed; and interest expense incurred.

At June 30, 2006, the Company had capitalized a portion of its software engineering and test engineering
costs incurred during prior years for the development of software tools for internal use. These tools comprise various new elements and improvements to existing elements of the Companys Automated Test Program (ATP) that is used to test the
Companys current suite of products and product software code currently under development. The costs capitalized consisted primarily of the salaries and employee benefits of the Companys personnel directly involved in the development
efforts and direct costs associated with third parties hired to assist with the development.

Once internal use software tools are fully-developed and
deployed, the Company amortizes the final capitalized amount over the remaining useful lives, currently estimated to be 30 months. Additionally, at each subsequent balance sheet date the asset is reviewed for impairment and, if impaired, is adjusted
accordingly.

The following table summarizes the activity related to capitalized software development costs during the six months ended June 30, 2006:



|                                                |  |                             |     |  
|----------------------------------------------- |  | --------------------------- | --- | -
|                                                |  | (in thousands)June 30, 2006 |    
|                                                |  | (Unaudited)                 |    
|Capitalized software assets:                    |  |                             |     |  
|Beginning balance                               |  | $                           | 123 |  
|Costs capitalized during the period             |  |                             |    |  
|                                                |  |                             |     |  
|Ending balance                                  |  | $                           | 123 |  
|Accumulated amortization of capitalized assets  |  |                             |     |  
|Beginning balance                               |  | $                           | (33 | )
|Amortization expense recorded during the period |  |                             | (22 | )
|                                                |  |                             |     |  
|Ending balance                                  |  | $                           | (55 | )
|                                                |  |                             |     |  
|Net capitalized software                        |  | $                           | 68  |  
|                                                |  |                             |     |  

Stock-Based Compensation

In December 2004, the FASB issued revised Statement of Financial Accounting Standards No. 123 (SFAS 123(R)), Share-Based Payment. On April 14, 2005, the U.S. Securities
and Exchange Commission adopted a new rule amending the effective dates for SFAS 123(R). In accordance with the new rule, the accounting provisions of SFAS 123(R) became effective for us beginning in the quarter ended March 31, 2006.

We adopted the provisions of SFAS 123(R) on January 1, 2006, the first day of our fiscal 2006. Accordingly, compensation expense for all share-based
awards to employees is measured based on the grant date fair value of those awards and



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recognized over the period during which the employee is required to perform service in exchange for the award (generally over the vesting period of the
award). We have no awards with market or performance conditions. Excess tax benefits, as defined by SFAS 123(R), will be recognized as an addition to additional paid-in capital. Effective January 1, 2006 and for all periods subsequent to that
date, SFAS 123(R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (FSP
123(R)-3. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to
determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123(R). An entity may make a one-time election to
adopt the transition method described in this guidance. An entity may take up to one year from the later of its initial adoption of SFAS 123(R) or the effective date of this guidance, which was November 11, 2005. We are in the process of
determining whether to adopt the alternative transition method provided in FSP 123(R)-3 for calculating the tax effects of share-based compensation pursuant to SFAS 123(R).

We adopted SFAS 123(R) using the modified prospective transition method, which provides for certain changes to the method for valuing share-based compensation. The valuation provisions of SFAS 123(R) apply to new
awards and to awards that are outstanding at the effective date and subsequently modified or cancelled. Estimated compensation expense for awards outstanding at the effective date will be recognized over the remaining service period using the
compensation cost calculated for pro forma disclosure purposes under FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123). Our consolidated financial statements as of and for the quarter
ended June 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, our consolidated financial statements for prior periods were not restated to reflect, and do not include, the impact of SFAS
123(R).

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is
ultimately expected to vest during the period. Share-based compensation expense recognized in our consolidated statements of operations for the first and second quarters of fiscal 2006 included compensation expense for share-based payment awards
granted prior to, but not yet vested as of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and share-based payment awards granted subsequent to December 31, 2005 based
on the grant date fair value estimated in accordance with SFAS 123(R). For share awards granted in fiscal 2006, expenses are amortized under the straight-line attribution method. For share awards granted prior to fiscal 2006, expenses are amortized
under the straight-line single option method prescribed by SFAS 123. As share-based compensation expense recognized in the consolidated statements of operations for the first and second quarters of fiscal 2006 is based on awards ultimately expected
to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures
were estimated to be approximately 20% for both officers and directors and 20% for employees in the first quarter and second quarter of fiscal 2006 based on our historical experience. In our pro forma information required under SFAS 123 for the
periods prior to fiscal 2006, we accounted for forfeitures at the same rate as in fiscal 2006, which is 20%.



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Total estimated share-based compensation expense, related to all of our share-based awards, recognized under SFAS 123(R)
for the three and six months ended June 30, 2006 was comprised of the following:



|                                                                        |  |                                      |       |   |                               |   |       |  
|----------------------------------------------------------------------- |  | ------------------------------------ | ----- | - | ----------------------------- | - | ----- | -
|                                                                        |  | (in thousands except per share data) |      
|                                                                        |  | Three months endedJune 30, 2006      |       |   | Six months endedJune 30, 2006 |  
|Cost of revenues                                                        |  | $                                    | 1     |   |                               | $ | 1     |  
|Engineering research and development                                    |  |                                      | 17    |   |                               |   | 56    |  
|Sales and marketing                                                     |  |                                      | 28    |   |                               |   | 109   |  
|General and administrative                                              |  |                                      | 68    |   |                               |   | 137   |  
|                                                                        |  |                                      |       |   |                               |   |       |  
|Share-based compensation expense before taxes                           |  |                                      | 114   |   |                               |   | 303   |  
|Related income tax benefits                                             |  |                                      |      |   |                               |   |      |  
|Share-based compensation expense                                        |  | $                                    | 114   |   |                               | $ | 303   |  
|                                                                        |  |                                      |       |   |                               |   |       |  
|Shares used to compute basic and diluted net loss per share             |  |                                      | 7,540 |   |                               |   | 7,489 |  
|Net share-based compensation expense per basic and diluted common share |  | $                                    | (0.02 | ) |                               | $ | (0.04 | )
|                                                                        |  |                                      |       |   |                               |   |       |  

Share-based compensation expense recognized under SFAS 123(R) included $61,000 and $132,000 from stock options and
$53,000 and $171,000 from restricted stock awards for the three and six months ended June 30, 2006, respectively. As of June 30, 2006, $332,000 of total unrecognized compensation costs related to non-vested stock options and $432,000
related to non-vested restricted stock awards is expected to be recognized over a weighted average period of 1.75 years and 2.73 years, respectively.

Since we have a net operating loss carryforward as of June 30, 2006, no excess tax benefits for the tax deductions related to share-based awards were recognized in the consolidated statements of operations. Additionally, no incremental
tax benefits were recognized from stock options exercised in the three and six months ended June 30, 2006 which would have resulted in a reclassification to reduce net cash provided by operating activities with an offsetting increase in net
cash provided by financing activities. Share-based compensation expense of nil and $892,000 was recognized during the first and second quarters of 2005.

We maintain three equity compensation plans: (i) the 2000 Stock Option/Stock Issuance Plan (the 2000 Plan), pursuant to which we may issue an aggregate of 710,000 options and shares of common stock to employees, officers,
directors, consultants and advisors, (ii) the 2001 Employee Stock Purchase Plan (the Purchase Plan), pursuant to which our employees are provided the opportunity to purchase our stock through payroll deductions, and (iii) the
2004 Equity Incentive Plan (the 2004 Plan), pursuant to which we may issue a total of 900,000 options and shares of common stock to employees, officers, directors, consultants and advisors. As of June 30, 2006, 475,000 shares of
stock had been granted directly to current and former executives of the Company and there were options outstanding to purchase 53,905 shares of common stock under our 2000 Plan; 596,095 shares of common stock remained 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. As of June 30, 2006, 318,000 shares of stock had been granted directly to current and former executives of the Company and
there were options outstanding to purchase 288,249 shares of common stock; 343,751 shares of common stock remained available for issuance under the 2004 Plan.

In addition, as of June 30, 2006, there were 115,000 shares of common stock subject to outstanding options granted other than under the 2004 Plan, the 2000 Plan or the Purchase Plan. These options were granted as inducement stock
options to Thomas Tullie, our CEO, in 2005.

Stock Options

Options awards are generally granted with an exercise price equal to the fair market value of our common stock at the grant date and have 10-year contractual terms. Options awards typically vest in accordance with one
of the following schedules:



| | a. | Quarterly in equal installments over four years
| | -- | -----------------------------------------------



| | b. | Fully vest and become exercisable on the date of grant
| | -- | ------------------------------------------------------

Certain option
awards provide for accelerated vesting if there is a change in control (as defined in the Plans).

The fair value of each option award is estimated on the
date of grant using a Black-Scholes-Merton option pricing model (Black-Scholes model) that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of our common stock and other factors.
The expected term of options granted is based on analyses of historical



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employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected
term of the option in effect at the time of the grant. Assumptions used in the Black-Scholes model for the three and six month periods ended June 30, 2006 were as follows:



|                                                         |  |              
|-------------------------------------------------------- |  | -------------
|Expected volatility                                      |  | 80%          
|Weighted-average volatility                              |  | 80%          
|Average expected term in years                           |  | 5.0 - 5.9    
|Risk-free interest rate (zero coupon U.S. Treasury Note) |  | 3.55% - 4.55%
|Expected dividend yield                                  |  |             

A summary of option activity under the Plans as of June 30, 2006 and changes since December 31, 2005 are
presented below:



|                                 |  |              |   |  |                                        |      |                                                    |      |                                        |   |  
|-------------------------------- |  | ------------ | - |  | -------------------------------------- | ---- | -------------------------------------------------- | ---- | -------------------------------------- | - | -
|                                 |  | Numbershares |   |  | Weightedaverageexercise priceper share |      | Weightedaverageremainingcontractualterm (in years) |      | Aggregateintrinsic value(in thousands)
|Outstanding at December 31, 2005 |  | 431,466      |   |  | $                                      | 5.52 |                                                    |      |                                        |   |  
|Granted                          |  | 105,000      |   |  | $                                      | 2.70 |                                                    |      |                                        |   |  
|Exercised                        |  |             |   |  | $                                      |     |                                                    |      |                                        |   |  
|Forfeited or expired             |  | (49,312      | ) |  | $                                      | 5.97 |                                                    |      |                                        |   |  
|                                 |  |              |   |  |                                        |      |                                                    |      |                                        |   |  
|Outstanding at March 31, 2006    |  | 487,154      |   |  | $                                      | 4.99 |                                                    | 8.22 |                                        | $ | 
|Granted                          |  |             |   |  |                                        |      |                                                    |      |                                        |   |  
|Exercised                        |  |             |   |  | $                                      |     |                                                    |      |                                        |   |  
|Forfeited or expired             |  | (145,000     | ) |  | $                                      | 3.03 |                                                    |      |                                        |   |  
|                                 |  |              |   |  |                                        |      |                                                    |      |                                        |   |  
|Outstanding at June 30, 2006     |  | 342,154      |   |  | $                                      | 5.65 |                                                    | 7.57 |                                        | $ | 
|                                 |  |              |   |  |                                        |      |                                                    |      |                                        |   |  
|Exercisable at June 30, 2006     |  | 199,136      |   |  | $                                      | 6.69 |                                                    | 6.35 |                                        | $ | 
|                                 |  |              |   |  |                                        |      |                                                    |      |                                        |   |  

There were no options granted or exercised during the quarter ended June 30, 2006.

A summary of the status of our non-vested stock options as of June 30, 2006 and changes since December 31, 2005 are presented below:



|                               |  |              |   |  |                                                 |     
|------------------------------ |  | ------------ | - |  | ----------------------------------------------- | ----
|                               |  | Numbershares |   |  | Weightedaverage grant-date fair
value per share
|Nonvested at December 31, 2005 |  | 243,295      |   |  | $                                               | 2.36
|Granted                        |  | 105,000      |   |  | $                                               | 2.70
|Vested                         |  | (67,377      | ) |  | $                                               | 2.30
|                               |  |              |   |  |                                                 |     
|Nonvested at March 31, 2006    |  | 280,918      |   |  | $                                               | 2.21
|Granted                        |  |             |   |  | $                                               |    
|Forfeited                      |  | (120,001     | ) |  | $                                               | 3.03
|Vested                         |  | (17,900      | ) |  | $                                               | 2.30
|                               |  |              |   |  |                                                 |     
|Nonvested at June 30, 2006     |  | 143,017      |   |  | $                                               | 2.29
|                               |  |              |   |  |                                                 |     

Share-based compensation expense recognized under SFAS 123(R) from stock options was $61,000 for the quarter ended
June 30, 2006 as compared to $71,000 for the quarter ended March 31, 2006. As of June 30, 2006, there was $332,000 of total unrecognized compensation cost, related to non-vested stock options, which is expected to be recognized over a
weighted-average period of 1.75 years. The total fair value of stock options vested during the quarter ended June 30, 2006 was approximately $40,000.



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Restricted stock awards.

Restricted stock awards are grants that entitle the holder to acquire shares of restricted common stock at a fixed price, which is typically nominal. The shares of restricted stock cannot be sold, pledged, or
otherwise disposed of until the award vests. A summary of our outstanding restricted stock awards as of June 30, 2006 and changes since December 31, 2005 are presented below:



|                               |  |              |   |  |                                                 |     
|------------------------------ |  | ------------ | - |  | ----------------------------------------------- | ----
|                               |  | Numbershares |   |  | Weightedaverage grant-date fair
value per share
|Nonvested at December 31, 2005 |  | 364,250      |   |  | $                                               | 2.88
|Vested                         |  | 30,000       |   |  | $                                               | 2.80
|Granted                        |  | (16,250      | ) |  | $                                               | 4.02
|Forfeited                      |  | (10,000      | ) |  | $                                               | 4.24
|                               |  |              |   |  |                                                 |     
|Nonvested at March 31, 2006    |  | 368,000      |   |  | $                                               | 2.78
|Vested                         |  |             |   |  | $                                               |    
|Granted                        |  |             |   |  | $                                               |    
|Forfeited                      |  | (40,000      | ) |  | $                                               | 2.80
|                               |  |              |   |  |                                                 |     
|Nonvested at June 30, 2006     |  | 328,000      |   |  | $                                               | 2.78
|                               |  |              |   |  |                                                 |     

Share-based compensation expense recognized under SFAS 123(R) from restricted stock awards was $53,000 and
$171,000, respectively, for the three and six months ended June 30, 2006. As of June 30, 2006, the total unrecognized compensation cost related to unvested shares was $432,436, which is expected to be recognized over a weighted-average
period of 2.73 years.

Pro Forma Information under SFAS 123 for Periods Prior to Fiscal 2006.

Through fiscal 2005, the Company accounted for equity instruments issued to non-employees using the fair value method in accordance with the provisions of SFAS 123 and
Emerging Issues Task Force 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 Statement of
Financial Accounting Standards No. 148 (SFAS 148), Accounting for Stock-Based CompensationTransition and Disclosure. This statement amends SFAS 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 SFAS 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 makes the following required disclosure under SFAS 148. The table below provides, on a pro forma basis, the effect employee
stock-based compensation would have had on the Companys operating results had the Company used the fair value method of accounting for stock-based compensation arrangements in conformity with SFAS 123 for the three and six months ended
June 30, 2005:



|                                                                                 |  |                                      |        |   |                               |   |        |  
|-------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ----------------------------- | - | ------ | -
|                                                                                 |  | (in thousands except per share data) |       
|                                                                                 |  | Three months endedJune 30, 2005      |        |   | Six months endedJune 30, 2005 |  
|Net income (loss) attributable to common stock                                   |  |                                      |        |   |                               |   |        |  
|As reported                                                                      |  | $                                    | (2,628 | ) |                               | $ | (4,216 | )
|Deduct:                                                                          |  |                                      |        |   |                               |   |        |  
|Stock-based employee compensation expense determined under the fair value method |  |                                      | (79    | ) |                               |   | (143   | )
|                                                                                 |  |                                      |        |   |                               |   |        |  
|Pro forma                                                                        |  | $                                    | (2,707 | ) |                               | $ | (4,359 | )
|                                                                                 |  |                                      |        |   |                               |   |        |  
|Basic and diluted net loss per share                                             |  |                                      |        |   |                               |   |        |  
|As reported                                                                      |  | $                                    | (0.38  | ) |                               | $ | (0.61  | )
|                                                                                 |  |                                      |        |   |                               |   |        |  
|Pro forma                                                                        |  | $                                    | (0.39  | ) |                               | $ | (0.63  | )
|                                                                                 |  |                                      |        |   |                               |   |        |  

Equity instruments issued to non-employees that are fully vested and non-forfeitable were measured at fair value
at the issuance date and expensed in the period over which the benefit was expected to be received. Equity instruments issued to



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non-employees which were either unvested or forfeitable, for which counter-party performance was required for the equity instrument to be earned, were
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 was reached; or 2) the date on which
the counter-partys performance was complete.

Income taxes

The Company accounts for income taxes and the related accounts under the liability method. Deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts
and the income tax basis of assets and liabilities. A valuation allowance is applied against any net deferred tax asset if, based on available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Off-Balance Sheet Arrangements

The Company does not
have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as special purpose entities (SPEs).

Reclassifications

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

NOTE 3  GOING CONCERN

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. This contemplates the realization of assets and the satisfaction of liabilities in the normal course of
business. From January 30, 1998 through June 30, 2006, our accumulated deficit totaled $59 million. We have not yet achieved profitability, and remain a very risky enterprise. We have taken steps to reduce expenses to help manage our cash.
At June 30, 2006, we had negative working capital of $2,061,000 and cash and cash equivalents of $594,000.

On April 25, 2006, the Company
completed a $1.0 million non-convertible revolving note financing with Laurus Master Fund, Ltd. (Laurus) of which the Company drew down $916,000. As part of this agreement Laurus granted a loan to the Company of $600,000 in the form of
an advance in excess of the formula amount of the revolving note which is to be repaid by October 31, 2006. In addition, Laurus granted us a principal payment holiday for the months of April through August 2006. Given our projected cash burn
rate, we will be required to raise additional capital in the very near term. We are currently pursuing efforts to raise additional capital. We cannot ensure that financing would be available to us on acceptable terms, if at all. We may not be able
to successfully find any financing or other strategic opportunities. Our inability to raise capital when needed would seriously harm our business. In addition, additional equity 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. These matters, among others, raise substantial doubt about the
Companys ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The following efforts are currently in process to address this uncertainty:



| |  |  | The Company is in the process of reviewing all options in regard to quickly raising additional sources of capital, including but not limited to incurring new debt and the sale of
equity and assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company has recently completed a revolving line of credit which continues to provide additional sources of working capital in the short term.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company has undertaken efforts to reduce discretionary costs and focus on selling existing products and services.
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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NOTE 4  ACCOUNTS RECEIVABLE, NET

Accounts receivable as of June 30, 2006 and December 31, 2005 consist of the following:



|                                      |  |                |     |   |                  |   |     |  
|------------------------------------- |  | -------------- | --- | - | ---------------- | - | --- | -
|                                      |  | (in thousands) |    
|                                      |  | June 30,2006   |     |   | December 31,2005 |  
|                                      |  | (Unaudited)    |     |   |                  |  
|Receivables, net:                     |  |                |     |   |                  |   |     |  
|Receivables                           |  | $              | 717 |   |                  | $ | 358 |  
|Less: allowance for doubtful accounts |  |                | (15 | ) |                  |   | (12 | )
|                                      |  |                |     |   |                  |   |     |  
|                                      |  | $              | 702 |   |                  | $ | 346 |  
|                                      |  |                |     |   |                  |   |     |  

NOTE 5  INVENTORY

Inventory as of June 30, 2006 and December 31, 2005 consist of the following:



|               |  |                |     |                  |   |    
|-------------- |  | -------------- | --- | ---------------- | - | ---
|               |  | (in thousands)
|               |  | June 30,2006   |     | December 31,2005
|               |  | (Unaudited)    |     |                 
|Inventory:     |  |                |     |                  |   |    
|Raw material   |  | $              | 291 |                  | $ | 399
|Finished goods |  |                | 233 |                  |   | 298
|               |  |                |     |                  |   |    
|               |  | $              | 524 |                  | $ | 697
|               |  |                |     |                  |   |    

NOTE 6  PROPERTY AND EQUIPMENT

Property and equipment as of June 30, 2006 and December 31, 2005 consist of the following:



|                               |  |                |        |   |                  |   |        |  
|------------------------------ |  | -------------- | ------ | - | ---------------- | - | ------ | -
|                               |  | (in thousands) |       
|                               |  | June 30,2006   |        |   | December 31,2005 |  
|                               |  | (Unaudited)    |        |   |                  |  
|Property and equipment, net:   |  |                |        |   |                  |   |        |  
|Computer equipment             |  | $              | 574    |   |                  | $ | 568    |  
|Test equipment                 |  |                | 727    |   |                  |   | 769    |  
|Furniture and fixtures         |  |                | 150    |   |                  |   | 151    |  
|                               |  |                |        |   |                  |   |        |  
|                               |  |                | 1,451  |   |                  |   | 1,488  |  
|Less: accumulated depreciation |  |                | (1,317 | ) |                  |   | (1,244 | )
|                               |  |                |        |   |                  |   |        |  
|                               |  | $              | 134    |   |                  | $ | 244    |  
|                               |  |                |        |   |                  |   |        |  

NOTE 7  NOTES PAYABLE

On April 25, 2006, we entered into a Security Agreement contemplating, and then immediately closed, a revolving line of credit (RLOC) financing transaction with Laurus Master Fund, Ltd. (Laurus), pursuant to
which we issued Laurus a secured non-convertible revolving note in the principal amount of up to $1 million, which matures in 24 months, has a variable interest rate of 200 basis points above prime, and requires monthly payments of accrued interest
beginning May 1, 2006. In the transaction, we also issued to Laurus a seven-year Common Stock Purchase Warrant for the purchase of 662,251 shares of Common Stock, with an exercise price of $1.51 per share. The RLOC is secured by all our assets
pursuant to a previous Master Security Agreement. We have the ability to draw down advances under the revolving line of credit subject to limits primarily based upon our accounts receivable and inventory. We immediately requested and received a
$916,000 advance. As part of this agreement Laurus granted a loan to the Company of $600,000 in the form of an advance in excess of the formula amount of the revolving note which is to be repaid by October 31, 2006. We agreed to and did
register for resale under the Securities Act of 1933 any shares of Common Stock that may in the future be issued by us to Laurus or Laurus assignees upon exercise of the Warrant. In connection with this transaction, we recorded the relative
fair value of $501,000 related to the warrants to purchase common stock. The discount was recorded as additional paid-in capital, and reflected as a debt discount to be amortized over two years beginning in May 2006.



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During the three months ended June 30, 2006, we drew down an additional amount of approximately $684,000 from the
RLOC and paid back approximately $220,000 from our cash receipts. The Company recorded non-cash interest expense of approximately $61,000 for the three months ended June 30, 2006 pertaining to the amortization of the discount for the warrants
and $3,500 of amortization expense of debt issuance costs for the same period. The Company paid $41,000 in fees related to the issuance of the RLOC and is amortizing these fees over the term of the RLOC.

On December 6, 2005, the Company completed a $2.1 million financing with Laurus. The financing consisted of a $2.1 million Secured Convertible Term Note which has a
three-year term and bears interest at a rate equal to prime plus 250 basis points per annum, payable monthly beginning 90 days after closing of the financing in (depending upon the circumstances) registered for resale stock or cash. The monthly
payment includes principal of $60,606 plus accrued interest commencing on March 1, 2006 with the last payment due on November 1, 2008. On April 25, 2006, Laurus granted us a principal payment holiday for the months of April to August
2006. The Note is convertible into shares of the Companys common stock at $2.6316 per share, subject to antidilution adjustments. In connection with the financing, Laurus was also issued a seven-year Warrant to purchase up to 181,362 shares of
the Companys common stock at an exercise price of $2.89 per share. In connection with the financing, the Company paid approximately $156,000 in legal costs and transaction fees which were deducted directly from the proceeds. These fees were
capitalized as debt issuance costs and will be amortized over the life of the note. Net cash received from the financing was approximately $1.9 million. In connection with this transaction, we recorded a liability equal to the cumulative principal
amount net of a $514,000 discount resulting in a net liability totaling approximately $1,586,000. The discount results from an effective beneficial conversion feature, and detachable warrants to purchase common stock with fair values of $244,000 and
$269,000, respectively for the discount of the embedded conversion feature. The discount was recorded as additional paid-in capital, and reflected as debt discount to be amortized over three years beginning in December 2005.

During the three and six months ended June 30, 2006, the Company paid approximately nil and $61,000 of principal, and nil and $51,000 of interest to Laurus,
respectively. The Company recorded non-cash interest expense for the three and six months ended June 30, 2006 of approximately $20,000 and $40,000, respectively, for the discount of the effective beneficial conversion feature. In addition, the
Company recorded non-cash interest expense for the three and six months ended June 30, 2006 of approximately $23,000 and $46,000, respectively for the discount for the related warrants.

The carrying value of the notes payable as of June 30, 2006 is as follows:



|                                                              |  |                |       |   |                  |   |       |  
|------------------------------------------------------------- |  | -------------- | ----- | - | ---------------- | - | ----- | -
|                                                              |  | (in thousands) |      
|                                                              |  | June 30,2006   |       |   | December 31,2005 |  
|                                                              |  | (Unaudited)    |       |   |                  |  
|Laurus notes payable                                          |  |                | 3,700 |   |                  |   | 2,100 |  
|Principal payment of Laurus notes payable                     |  |                | (281  | ) |                  |   |      |  
|Unamortized discount related to warrants                      |  |                | (657  | ) |                  |   | (263  | )
|Unamortized discount related to beneficial conversion feature |  |                | (197  | ) |                  |   | (237  | )
|                                                              |  |                |       |   |                  |   |       |  
|Carrying value of convertible notes payable, net of discount  |  | $              | 2,565 |   |                  | $ | 1,600 |  
|                                                              |  |                |       |   |                  |   |       |  

NOTE 8  MANDATORILY REDEEMABLE PREFERRED STOCK

Series A Convertible Preferred Stock

On January 26, 2005, the
Company entered into a Securities Purchase Agreement (the Agreement) and a related Registration Rights Agreement, with certain accredited investors. On January 27, 2005, pursuant to the Agreement, the Company sold to a group of
accredited investors 556,538 shares of the Companys mandatorily-redeemable 7% Convertible Preferred Stock (the Series A Preferred Stock), and issued to those investors warrants to purchase up to 278,268 shares of the Companys
Common Stock (the Series A Warrants). The per share purchase price of the Series A Preferred Stock (with 0.5 Series A Warrant) was initially $3.25, and the Series A Warrants initially carried an exercise price of $4.20 per share. The
liquidation value per share in the case of voluntary or involuntary liquidation is $3.25, plus an amount equal to the cash value of dividends accrued but unpaid whether or not declared. The Companys gross receipts from the January 27,
2005, sale of Series A Preferred Stock (with Series A Warrants) were $1,808,750. On February 18, 2005, under the Agreement, the Company sold to other accredited investors at a second closing a total of 307,691 shares of Series A Preferred Stock
and



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153,847 Series A Warrants, for $1,000,000. In total, under the two closings, the Company sold 864,229 shares of Series A Preferred Stock and 432,115 Series A
Warrants, for gross receipts of $2,808,750.

The Series A Preferred Stock accrues dividends at the rate of $0.2275 per share per year, and dividends are
cumulative. The preferred stock shall be automatically redeemed on January 27, 2009 for $3.25 per share plus accumulated but unpaid dividends. The Company has the right to redeem the preferred stock earlier upon certain conditions. As of
June 30, 2006, the liquidation preference for the Series A Preferred Stock was $2.6 million.

The financing was led by investor Gryphon Master Fund,
L.P. The Company paid Gryphon Master Fund, L.P. a fee of $30,000 to cover its expenses incurred in connection with this financing.

Series B Convertible
Preferred Stock

On June 1, 2005, pursuant to a Securities Purchase Agreement dated April 26, 2005, the Company sold to accredited investors
led by Castle Creek Technology Partners LLC (Castle Creek), for $2,575,000, a total of 792,306 shares of Series B 7% Convertible Preferred Stock (Series B Preferred Stock) and five-year warrants to purchase up to a total of
396,155 shares of the Companys Common Stock. The purchase price for each combination of one share and 0.5 warrants was $3.25 and the warrants carry an exercise price of $3.25 per share.

The Company paid Castle Creek Partners LLC fees totaling $25,000 to cover its expenses.

The Series B Preferred Stock accrues dividends at the rate of $0.2275 per share per year, and dividends are cumulative. The Series B Preferred Stock was initially convertible at the option of the holder into shares of
Common Stock at a conversion price of $3.25 per share, subject to specified anti-dilution adjustments. The liquidation value per share in the case of voluntary or involuntary liquidation is $3.25, plus an amount equal to the cash value of dividends
accrued but unpaid whether or not declared. The preferred stock shall be automatically redeemed on January 27, 2009 for $3.25 per share plus accumulated but unpaid dividends. The Company has the right to redeem the preferred stock earlier upon
certain conditions. As of June 30, 2006, the liquidation preference for the Series B Preferred Stock was $2.4 million.

During 2005, the conversion
price of the Series B Preferred Stock was reduced to $3.17424, subject to any future weighted average antidilution provisions. This reduced conversion price was established by a one-time Special Re-Set, calculated by a formula based on Current
Market Price at the time of the June 1, 2005 Closing. This also had the effect of reducing the conversion prices of the Series A Preferred Stock to $3.17424 as of June 1, 2005. Also, by private agreements, the exercise price of the 432,115
Series A Warrants was specially reduced from $4.20 to $3.25 upon consummation of the Series B Preferred Stock financing.

In connection with the sales of
Series A Preferred Stock and Series B Preferred Stock, the Company paid cash fees of approximately $380,000 and approximately 84,000 common stock warrants to the Companys placement agent or the placement agents designees.

The settlement with Castle Creek Partners LLC, described under the Lawsuits Related to Laurus Note Payable subheading below, provided certain benefits to the
holders of the Series B Preferred Stock.

In connection with the $2.1 million financing with Laurus, we agreed to a Consent and Waiver agreement dated
February 10, 2006 with Castle Creek, acting as the holder of a majority of our Series B 7% Convertible Preferred Stock. In consideration of the consent (under an allegedly applicable protective provision veto right) and waiver (of a preemptive
participation right) given by Castle Creek, we agreed to provisions which have the economic effect of reducing the conversion price of Castle Creeks Series B 7% Convertible Preferred Stock to $2.6316 per share. We believe consent was not in
fact required. In the Consent and Waiver agreement, we also agreed to offer to each of the respective minority holders of the Series B 7% Convertible Preferred Stock the same benefits and the same burdens of the Consent and Waiver agreement, as if
such minority holder was Castle Creek for such purposes. Each of the minority holders accepted this offer.

Lawsuits/Settlements

On February 10, 2006, the Company entered into a Settlement Agreement with regard to a lawsuit brought against us in January 2006 by Castle Creek,
which holds a majority of our Series B Preferred Stock. The Castle Creek lawsuit was based primarily on a claim that consent of a majority of the Series B Preferred Stock had been required in connection with our December 2005 issuance of a
$2,100,000 secured convertible note and related warrants to Laurus, but that such consent had



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not been obtained. We believe consent was not required. In the Settlement Agreement, Castle Creek, acting as the holder of a majority of the Series B
Preferred Stock, provided such consent.

Under the Settlement Agreement, we agreed to provisions which have the effect of reducing the conversion price of
Castle Creeks Series B Preferred Stock from $3.17424 per share to $2.6316 per share, and we agreed to make payments to Castle Creek which are economically equivalent to regular dividends on the Series B Preferred Stock, including a payment no
later than March 1, 2006. We can choose to make such payments in shares of Common Stock (at 85% of then-current market value) or in cash. We also agreed to provisions which have the economic effect that, if we were to issue shares under the
Laurus arrangement to Laurus at a price lower than Castle Creeks effective conversion price, a portion of Castle Creeks Series B Preferred Stock would, if actually converted shortly thereafter, effectively be convertible at such lower
price.

In the Settlement Agreement, we also agreed to offer to each of the respective minority holders of the Series B Preferred Stock the same benefits
and the same burdens of the Settlement Agreement, as if such minority holder was Castle Creek for such purposes. We did so, and all of the minority holders accepted this offer. In connection with the settlement agreement, the Company
recorded $574,000 at December 31, 2005 of additional discount related to the beneficial conversion feature of the preferred stock since this contingency was outstanding at that date. Also, the Company issued 54,605 shares of common stock to
holders of Series B Preferred Stock on February 24, 2006 as payments economically equivalent to dividends.

We have also been sued in a similar
lawsuit brought in January 2006 by Gryphon Master Fund, L.P. and GSSF Master Fund, LP, which together hold a majority of our Series A Preferred Stock, in the United States District Court for the Northern District of Texas. We have offered to settle
that case on the same terms as were provided to Castle Creek in a Settlement Agreement (including optional extension of the settlements benefits and burdens to each of the respective minority Series A holders). The plaintiffs in the Texas case
have not accepted this offer, and the case is proceeding. We believe our defenses are meritorious. In connection with the Castle Creek settlement agreement, the Company recorded a reserve of $637,000 at December 31, 2005 of additional discount
related to the beneficial conversion feature of the Series A preferred stock since this contingency was outstanding at that date.

On March 16, 2006,
the Company entered into a Modification of Engagement Agreement with regard to a lawsuit brought against us in February 2006 by Silverwood Partners, LLC (Silverwood), who was previously engaged as the Companys investment banker.
The Silverwood lawsuit was based primarily on a claim that fees of approximately $150,000 plus warrants were owed to Silverwood in connection with our December 2005 issuance of a $2,100,000 secured convertible note and related warrants to Laurus,
but that such fees were not paid. The Company recorded a reserve of $150,000 at December 31, 2005, as a contingency related to this claim.

Under the
Modification of Engagement Agreement, in exchange for Silverwood amending its engagement letter agreement with the Company to, among other things, lower the fees Silverwood would receive with regard to certain possible future transactions, the
Company agreed to issue to Silverwood $80,000 of Path 1 common stock at 75% of the closing sale price on the second day before the date on which the Company, knowing that the SEC is prepared to declare effective a resale registration statement
covering such shares, requests the SEC to thereafter declare the registration statement effective. Accordingly, we issued 78,432 shares to Silverwood in May 2006. In addition, we agreed to issue to Silverwood, 31,920 Path 1 common stock warrants
with an initial exercise price of $2.6316 per share, expiring December 6, 2013.

In exchange for Silverwoods agreement to dismiss the lawsuit
with prejudice and to waive all claims that it may have with respect to the Laurus Transaction, we have issued Path 1 Common Stock equal to $20,000 at 75% of the closing sale price on the second day before the date on which the Company, knowing that
the SEC is prepared to declare effective a resale registration statement covering such shares, requests the SEC to thereafter declare the registration statement effective. Accordingly, we issued 19,608 shares to Silverwood in May 2006. In addition,
we agreed to issue to Silverwood, 7,980 Path 1 Common Stock warrants with an initial exercise price of $2.6316 per share, expiring December 6, 2013.

In connection with the RLOC, we agreed to a Consent and Waiver agreement dated April 22, 2006 with Castle Creek, acting as the holder of a majority of our Series B 7% Convertible Preferred Stock. In consideration of the consent (under
an allegedly applicable protective provision veto right) and waiver (of a preemptive participation right) given by Castle Creek, we agreed to provisions which have the economic effect of reducing the conversion price of Castle Creeks Series B
7% Convertible Preferred Stock to $1.51 per share. We believe consent was not in fact required. In the Consent and Waiver agreement, we also agreed to offer to each of the respective minority holders of the Series B 7% Convertible Preferred Stock
the same benefits and the same burdens of the Consent and Waiver agreement, as if such minority holder was Castle Creek for such purposes. Each of the minority holders accepted this offer.

Mandatorily-redeemable convertible preferred shares

In connection
with the sale of the Series A Preferred Stock and Series B Preferred Stock, which are required to be redeemed by the Company if not converted into the Companys common stock, and the issuance of the warrants as part of the financing



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transaction, the Company has recorded a long-term liability under Statement of Financial Accounting Standards No. 150 (SFAS 150),
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 requires that mandatorily-redeemable stock be characterized as a liability and that all payments to, or accruals for the benefit of,
the holders of the stock that are not a return of principal be treated as interest expense.

The following table shows the carrying value of the long-term
liability related to the Companys convertible preferred shares:



|                                                                      |  |                |        |   |                  |   |        |  
|--------------------------------------------------------------------- |  | -------------- | ------ | - | ---------------- | - | ------ | -
|                                                                      |  | (in thousands) |       
|                                                                      |  | June 30,2006   |        |   | December 31,2006 |  
|                                                                      |  | (Unaudited)    |        |   |                  |  
|Amount payable for mandatorily-redeemable preferred shares            |  | $              | 5,025  |   |                  | $ | 5,124  |  
|Unamortized discount related to warrants                              |  |                | (462   | ) |                  |   | (552   | )
|Unamortized discount related to beneficial conversion feature         |  |                | (2,680 | ) |                  |   | (3,292 | )
|                                                                      |  |                |        |   |                  |   |        |  
|Carrying value of mandatorily-redeemable convertible preferred shares |  | $              | 1,883  |   |                  | $ | 1,280  |  
|                                                                      |  |                |        |   |                  |   |        |  

The convertible preferred shares have a cumulative 7% dividend rate and are mandatorily-redeemable for cash if not
converted at the holders sole discretion into the Companys common stock by January 27, 2009. For the three and six months ended June 30, 2006, 15,000 and 30,380 shares of preferred stock were converted into common shares,
respectively. As of June 30, 2006, there were 49,231 and 61,149 shares of Series A and Series B preferred stock converted into common shares, respectively. There were 814,998 Series A and 731,157 Series B preferred shares outstanding as of
June 30, 2006.

Total interest expense related to mandatorily-redeemable convertible preferred shares for the three and six months ended June 30,
2006 includes non-cash interest expense of approximately $45,000 and $90,000, respectively, pertaining to discounts of the related warrants. In addition, non-cash interest expense of approximately $306,000 and $611,000 was recorded pertaining to
discount related to the beneficial conversion feature for the three and six months ended June 30, 2006, respectively. Amortization of issuance costs for mandatorily-redeemable preferred stock for the three and six months ended June 30,
2006, was approximately $35,000 and $69,000, respectively.

NOTE 9  RECENT ACCOUNTING PRONOUNCEMENTS

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections, applying to all voluntary
accounting principle changes as well as the accounting for and reporting of such changes. SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements.
SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect SFAS 154 to affect the Companys financial condition or results of operations.

In June 2006, the FASB issued FASB Interpretation Number 48 (FIN 48), Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109. The interpretation contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax
position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step
is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The provisions are effective for the Company beginning in the first quarter of 2007. The Company is evaluating the impact
this statement will have on its consolidated financial statements.

NOTE 10  COMPUTATION OF NET LOSS PER SHARE

Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period, excluding restricted stock
that has been issued but is not yet vested. Diluted net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period plus additional weighted average common equivalent shares
outstanding during the period. Common equivalent shares result from the assumed exercise of outstanding stock options and warrants (the proceeds of which are then presumed to have been used to repurchase outstanding stock using the treasury stock
method) and the vesting of unvested restricted shares of common stock. In the loss periods, the common equivalent shares have been excluded from the computation of diluted net loss per share, because their effect would have been anti-dilutive. For
the quarter ended June 30, 2006, options to purchase



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670,154 shares of common stock and warrants to purchase 5,056,072 shares of common stock were excluded in the calculation of diluted earnings per share
because of the anti-dilutive effect.

NOTE 11  SHAREHOLDERS EQUITY

Unearned compensation.

Pursuant to SFAS 123(R), unearned compensation with a balance of $1,048,000 at
December 31, 2005 was eliminated against additional paid in capital upon the adoption of SFAS 123(R) on January 1, 2006. The unearned compensation was related to restricted stock awards granted to various employees prior to the adoption of
SFAS 123(R). See Note 2, Significant Accounting Policies  Change in Accounting Method for Share-Based Compensation.

Common stock.

For the three and six months ended June 30, 2006, 15,000 and 30,380 shares of preferred stock were converted into common shares, respectively.
During the three and six months ended June 30, 2006, a total of 15,000 and 30,380 shares of Series B preferred stock was converted into 32,705 and 52,640 shares of common stock, respectively. During the three and six months ended As of
June 30, 2006, warrants to purchase 5,056,072 shares of common stock, at a weighted-average price per share of $4.46 remained outstanding, of which all are exercisable. 670,154 of restricted stock and stock options remained outstanding as of
June 30, 2006; of these, 199,136 options were exercisable as of June 30, 2006.

NOTE 12 - REPORTABLE OPERATING SEGMENTS

The Company does not have more than one reportable operating segment.



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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 pioneer and leader in designing, developing and supplying products that enable the adaptation, transportation and delivery of
broadcast-quality real-time video over private and public Internet Protocol (IP) networks, such as the networks that comprise the Internet.

We currently
offer two primary product lines that cater to different segments of the video market. Our Video Over IP gateway products are used by broadcasters and video service providers to transport live video content in real time between different locations,
within a region, a country or even between countriesa process known as long-haul transmission. Since our products transmit video content over widely available IP communication networks, our customers can use existing
infrastructure, thus lowering their costs and permitting them greater flexibility in the delivery of video content. Our Network Access Gateway products are primarily used by cable companies to supply video-on-demand, or VOD services. Our markets
include cable, broadcast, satellite, telco, video carriers, mobile operators and enterprises.

Despite our two private placements and issuance of a
convertible note payable the year ended December 31, 2005, in which we raised aggregate proceeds of approximately $5.4 million and $2.1 million, respectively, and despite receiving $1.3 million from a revolving line of credit of $1.0
million with an overadvance feature of $600,000, we had just $594,000 in cash remaining by the end of the second quarter of fiscal 2006 and we are pursuing additional sources of financing. We have serious liquidity issues as evidenced by our former
Independent Registered Public Accounting Firms report on our financial statements in our Form 10-K filed on March 23, 2006 which included a going concern qualification. Given our projected cash burn rate, we will be required to
raise additional capital in the very near term.

The performance for the quarter ended June 30, 2006 represents the third sequential quarter of
increased revenue. Revenue for the three months ended June 30, 2006 increased 35% compared to the three months ended March 31, 2006, while revenue increased 18% and 29% for the previous sequential quarters ended March 31, 2006 and
December 31, 2005. However, our revenue fell short from the previous year due to reduced sales of our long-haul gateway products compared to the pervious year.

LIQUIDITY AND CAPITAL RESOURCES

Since our inception on January 30, 1998 we have financed our operations through
a variety of methods including the sale of common equity securities to investors (including our public offering in July/August 2003), sale of common equity to a strategic partner, issuance of convertible notes and a non-convertible revolving note,
and the issuance of convertible preferred stock.

Our cash position on June 30, 2006, was $594,000 and we had negative working capital of $2,061,000.
Despite our two private placements and issuance of a convertible note payable during the year ended December 31, 2005, in which we raised aggregate proceeds of approximately $5.4 million and $2.1 million, respectively, and despite
raising $916,000 in an April 2006 revolving line of credit financing, given our projected cash burn rate, we urgently need to raise additional capital to sustain our operations. From January 30, 1998 through June 30, 2006, we have an
accumulated deficit totaling $59 million.



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We have not yet achieved profitability, and we remain a very risky enterprise. We are trying to take steps to reduce expenses to help manage our cash.

The following efforts are currently in process to address this uncertainty:



| |  |  | The Company is in the process of reviewing all options in regard to quickly raising additional sources of capital, including but not limited to incurring new debt and the sale of
equity and assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company has recently completed a revolving line of credit which continues to provide additional sources of working capital in the short term.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Company has undertaken efforts to reduce discretionary costs and focus on selling existing products and services.
| | - |  | ---------------------------------------------------------------------------------------------------------------------

In April 2006 we successfully closed a bridge financing with Laurus Master Fund Ltd., in which we received a $1 million revolving line of credit which we utilized during
the quarter. We are currently pursuing efforts to raise long term additional capital, and urgently need to do so by September 30, 2006. We cannot ensure that financing would be available to us on acceptable terms, if at all. We may not be able
to successfully find any financing or other strategic opportunities for us. Our inability to raise capital when needed would seriously harm our business. In addition, additional equity may dramatically 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 would need
to curtail our operations significantly and might not be able to continue.

We need to increase our sales substantially to become profitable. For the
foreseeable future, we expect to incur substantial additional expenditures associated with cost of sales, marketing, and research and development. Additional capital will be required to continue operations and fund our plan for future growth and
business development.

Our future capital requirements will depend upon many factors, including the size and timing of gross profits, 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.

Explanations of net cash provided by or used in operating, investing and financing activities year-to-date as of June 30, 2006 and 2005
are provided below:



|                                                     |  |                               |        |   |                               |   |        |                      |  |   |        |  
|---------------------------------------------------- |  | ----------------------------- | ------ | - | ----------------------------- | - | ------ | -------------------- |  | - | ------ | -
|                                                     |  | Six months endedJune 30, 2006 |        |   | Six months endedJune 30, 2005 |   |        | ChangeBetweenPeriods | 
|Net cash (used in) operating activities              |  | $                             | (2,318 | ) |                               | $ | (3,502 | )                    |  | $ | 1,184  |  
|Net cash provided by (used in) investing activities  |  |                               |       |   |                               |   | (169   | )                    |  |   | 169    |  
|Net cash provided by (used in) financing activities  |  |                               | 1,276  |   |                               |   | 5,594  |                      |  |   | (4,318 | )
|                                                     |  |                               |        |   |                               |   |        |                      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents |  | $                             | (1,042 | ) |                               | $ | 1,923  |                      |  | $ | (2,965 | )
|                                                     |  |                               |        |   |                               |   |        |                      |  |   |        |  

Operating Activities

The decrease in cash usage was due primarily to a larger portion of our net loss being composed of non-cash stock-based compensation charges of $303,000 per SFAS 123(R),
and the non-cash amortization of debt discount and accretion of preferred stock discount expenses of $992,000.

Investing Activities

We had no investing activity in fiscal 2006, , compared to capitalized engineering costs of $99,000 and acquired
engineering equipment of $37,000 for the same period in 2005.

Financing Activities

Cash provided by financing activities for the six months ended June 30, 2006 was $1,276,000 primarily due to net cash advances of $1,339,000, including a one-time
$600,000 overadvance which is due on October 31, 2006, on the Laurus revolving line of credit during the second quarter of 2006 as compared to the cash provided by the financing activities of $5,594,000 for the same period ended June 30,
2005 which resulted primarily from the sale of convertible preferred stock.



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At June 30, 2006, we had material commitments related to our obligations under our 2005 preferred stock financings
which could require us to repurchase all our convertible preferred stock for at least $5.03 million in the first quarter of 2009. The Laurus term note matures in December 2008 and the Laurus revolving line of credit matures in April 2008. Our future
capital requirements will depend on 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.

RESULTS OF OPERATIONS

Revenues

Revenues

(in thousands)



|                            |  |                            |     |   |               |   |       |                          |      |      |               |      |   |       |   |  |   |       |   |  |     |  
|--------------------------- |  | -------------------------- | --- | - | ------------- | - | ----- | ------------------------ | ---- | ---- | ------------- | ---- | - | ----- | - |  | - | ----- | - |  | --- | -
|                            |  | Three Months EndedJune 30, |     |   | PercentChange |   |       | Six Months EndedJune 30, |      |      | PercentChange |     
|                            |  | 2006                       |     |   | 2005          |   |       |                          | 2006 |      |               | 2005 |   |      
|Product Revenue             |  | $                          | 760 |   |               | $ | 1,139 |                          |      | -33  | %             |      | $ | 1,265 |   |  | $ | 1,969 |   |  | -36 | %
|Percentage of total revenue |  |                            | 92  | % |               |   | 100   | %                        |      |      |               |      |   | 88    | % |  |   | 98    | % |  |     |  
|Service/Other Revenue       |  | $                          | 66  |   |               | $ | 3     |                          |      | 2100 | %             |      | $ | 175   |   |  | $ | 37    |   |  | 373 | %
|Percentage of total revenue |  |                            | 8   | % |               |   | 0     | %                        |      |      |               |      |   | 12    | % |  |   | 2     | % |  |     |  
|Total Revenue               |  | $                          | 826 |   |               | $ | 1,142 |                          |      | -28  | %             |      | $ | 1,440 |   |  | $ | 2,006 |   |  | -28 | %

For the three months ended June 30, 2006, total revenues declined by $316,000 or 28%, to $826,000 from
$1,142,000 during the three months ended June 30, 2005. Revenues from sales of products in the three months ended June 30, 2006, decreased $379,000, or 33% to $760,000 from $1,139,000 in the same period in 2005. The decrease is due
primarily to a $373,000 reduction in sales of our broadcast long-haul equipment related to a large sale in the previous year to our distributor Frontiers Co. Ltd. This decrease was partially offset by an increase of $54,000 in sales of our cable
equipment. The service and other revenue increased $63,000 to $66,000 during the three months ended June 30, 2006 from $3,000 during the same period in the prior year. The increase was attributable to $55,000 of higher service revenue and
$11,000 of higher royalty revenue related to sales of our licensees products based on DotCAM ® technology.

For the six months ended June 30, 2006, total revenues declined by
$566,000 or 28%, to $1,440,000 from $2,006,000 during the six months ended June 30, 2005. Revenues from sales of products in the six months ended June 30, 2006, decreased $704,000, or 36% to 1,265,000 from 1,969,000 for the same period in
2005. The decrease in product revenue is due primarily to reduced sales of long haul gateway products of $572,000. The service and other revenue increased by $138,000 from $37,000 during the six months ended June 30, 2005 to $175,000 during the
same period ended June 30, 2006. The increase was comprised of a $118,000 in higher service revenue and $41,000 in higher royalty revenue related to sales of our licensees products based on DotCAM ® technology. These increases were offset by a decrease of $16,000 in contract revenue.

Despite the reduced revenue in the three and six months ended June 30, 2006, we believe that if we are successful in capitalizing on our sales
opportunities, revenue will increase. Our revenues can fluctuate from quarter to quarter, based on timing of customer orders and mix of our product sales.



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Cost of Revenues

Cost of Revenues

(in thousands)



|                            |  |                            |     |   |               |   |     |                          |      |     |               |      |   |     |   |  |   |     |   |  |     |  
|--------------------------- |  | -------------------------- | --- | - | ------------- | - | --- | ------------------------ | ---- | --- | ------------- | ---- | - | --- | - |  | - | --- | - |  | --- | -
|                            |  | Three Months EndedJune 30, |     |   | PercentChange |   |     | Six Months EndedJune 30, |      |     | PercentChange |     
|                            |  | 2006                       |     |   | 2005          |   |     |                          | 2006 |     |               | 2005 |   |    
|Cost of Revenue             |  | $                          | 320 |   |               | $ | 507 |                          |      | -37 | %             |      | $ | 672 |   |  | $ | 773 |   |  | -13 | %
|Percentage of total revenue |  |                            | 39  | % |               |   | 44  | %                        |      |     |               |      |   | 47  | % |  |   | 39  | % |  |     |  

Cost of revenues consists of personnel-related costs in providing support to customers, raw materials costs for
the products, and warranty costs as well as an allocation of corporate expenses, such as corporate insurance, facilities, utilities and other.

Cost of
revenues decreased by $187,000, or 37%, to $320,000 in the three months ended June 30, 2006 as compared to $507,000 in the three months ended June 30, 2005. The decrease in cost of revenue was due primarily to lower materials costs of
$148,000 due to the decrease in total units sold and a reduction in personnel-related costs due to reassignment of headcount used in allocating overhead costs. The decrease in cost of revenues combined with the increase in product revenues resulted
in an increase in gross profit percentage to 61% for the three months ended June 30, 2006 as compared to 56% for the same period ended in 2005.

Cost
of revenues decreased by $101,000, or 13%, to $672,000 in the six months ended June 30, 2006 as compared to $773,000 in the six months ended June 30, 2005. The decrease was due primarily to $463,000 materials costs as compared to $547,000
for the same period of the prior year and the $15,000 in lower personnel related expenses due to the reassignment of headcount to research and development. The decrease in cost of revenues combined with the decrease in product revenues resulted in a
decrease in gross profit percentage to 53% for the six months ended June 30, 2006 as compared to 61% for the same period ended in 2005.

We expect the
cost of revenues will fluctuate in absolute dollars and as a percentage of total revenue as the related revenue fluctuates and mix of product sales varies.



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##### Table of Contents

Operating Expenses

Engineering, research and development

(in thousands)



|                                      |  |                            |     |   |               |   |       |                          |      |     |               |      |   |       |   |  |   |       |   |  |     |  
|------------------------------------- |  | -------------------------- | --- | - | ------------- | - | ----- | ------------------------ | ---- | --- | ------------- | ---- | - | ----- | - |  | - | ----- | - |  | --- | -
|                                      |  | Three Months EndedJune 30, |     |   | PercentChange |   |       | Six Months EndedJune 30, |      |     | PercentChange |     
|                                      |  | 2006                       |     |   | 2005          |   |       |                          | 2006 |     |               | 2005 |   |      
|Engineering, research and development |  | $                          | 521 |   |               | $ | 1,180 |                          |      | -56 | %             |      | $ | 1,040 |   |  | $ | 2,120 |   |  | -51 | %
|Percentage of total revenue           |  |                            | 63  | % |               |   | 103   | %                        |      |     |               |      |   | 72    | % |  |   | 106   | % |  |     |  

Engineering, research and development expenses consist of salaries and benefits for engineers and cost of outside
consultants as well as the allocation of corporate expenses, calculated on the basis of headcount, such as corporate insurance, facilities, utilities and other.

Engineering, research and development expenses decreased $659,000, or 56% from $1,180,000 to $521,000 for the three months ended June 30, 2006 as compared to the same period in 2005. The decrease was due primarily to the reduction of
$423,000 in outside consulting and prototype development incurred in the prior year related to the new product development and the reduction of $114,000 in personnel and personnel related expenses due a reduction in headcount. In addition, the stock
based compensation expense decreased by $98,000 due to a reduction in expenses related to direct stock grants to staff executives.

Engineering, research
and development expense decreased $1,080,000, or 51%, from $2,120,000 to $1,040,000 for the six months ended June 30, 2006 as compared to the same period in 2005. The decrease is due primarily to the reduction of $801,000 in consulting expenses
and prototype expenses associated with new product development and the reduction of $203,000 in personnel and personnel related expenses due a reduction in personnel. In addition, stock based compensation expense decreased by $59,000 due to expenses
related to direct stock grants to staff executives.

Sales and marketing

(in thousands)



|                            |  |                            |     |   |               |   |     |                          |      |    |               |      |   |       |   |  |   |       |   |  |    |  
|--------------------------- |  | -------------------------- | --- | - | ------------- | - | --- | ------------------------ | ---- | -- | ------------- | ---- | - | ----- | - |  | - | ----- | - |  | -- | -
|                            |  | Three Months EndedJune 30, |     |   | PercentChange |   |     | Six Months EndedJune 30, |      |    | PercentChange |     
|                            |  | 2006                       |     |   | 2005          |   |     |                          | 2006 |    |               | 2005 |   |      
|Sales and marketing         |  | $                          | 710 |   |               | $ | 764 |                          |      | -7 | %             |      | $ | 1,508 |   |  | $ | 1,572 |   |  | -4 | %
|Percentage of total revenue |  |                            | 86  | % |               |   | 67  | %                        |      |    |               |      |   | 105   | % |  |   | 78    | % |  |    |  

Sales and marketing expenses consist of salaries, cost of benefits, sales commissions and other expenses related
to the direct sales force, as well as allocation of overall corporate expenses, calculated on the basis of headcount, related to such items as corporate insurance, facilities, utilities, and other.

Sales and marketing expenses decreased $54,000, or 7%, to $710,000 from $764,000 for the three months ended June 30, 2006 as compared to the same period in 2005.
The decrease was due primarily to the reduction in personnel-related costs of $82,000 and a reduced stock based compensation of $100,000 due to less expenses related to direct stock grants to staff executives. These decreases were partially offset
by an increase in overhead costs due to reassignment of headcount used in the allocation of overhead.

Sales and marketing expenses decreased $64,000, or
4%, to $1,508,000 from $1,572,000 for the six months ended June 30, 2006 as compared to the same period in 2005. The decrease was due to the reduction of $190,000 in personnel related costs which were partially offset by an increase of $130,000
in overhead costs due to reassignment of headcount used in the allocation of overhead.



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##### Table of Contents

General and Administrative

(in thousands)



|                            |  |                            |     |   |               |   |       |                          |      |     |               |      |   |     |   |  |   |       |   |  |     |  
|--------------------------- |  | -------------------------- | --- | - | ------------- | - | ----- | ------------------------ | ---- | --- | ------------- | ---- | - | --- | - |  | - | ----- | - |  | --- | -
|                            |  | Three Months EndedJune 30, |     |   | PercentChange |   |       | Six Months EndedJune 30, |      |     | PercentChange |     
|                            |  | 2006                       |     |   | 2005          |   |       |                          | 2006 |     |               | 2005 |   |    
|General and administrative  |  | $                          | 565 |   |               | $ | 1,057 |                          |      | -47 | %             |      | $ | 941 |   |  | $ | 1,403 |   |  | -33 | %
|Percentage of total revenue |  |                            | 68  | % |               |   | 93    | %                        |      |     |               |      |   | 65  | % |  |   | 70    | % |  |     |  

General and administrative expenses consist primarily of personnel costs for finance, information technology,
human resources and general management, as well as outside professional services and an overall allocation of corporate expenses, calculated on the basis of headcount, such as corporate insurance, facilities, utilities and other.

General and administrative expenses decreased $492,000, or 47%, to $565,000 from $1,057,000 for the three months ended June 30, 2006 as compared to the same period
in 2005. The decrease is due primarily to the $581,000 reduction in stock compensation expenses due to lower expenses related to direct stock grants to staff executives. This decrease was partially offset by an increase in personnel related expenses
of $42,000 and an increase in overhead costs of $48,000 related to the reassignment of headcount used in the allocation of overhead.

General and
administrative expenses decreased $462,000, or 33%, to $941,000 from $1,403,000 for the six months ended June 30, 2006, as compared to the same period in 2005. The decrease is due primarily to the $513,000 decrease in stock compensation
expenses due to lower expenses related to direct stock grants to staff executives. The decrease was partially offset by an increase in personnel related expenses of $20,000 and overhead costs of $22,000.

Interest Expense, net



|                            |  |                            |     |   |               |   |     |                          |      |     |               |      |   |     |   |  |   |     |   |  |     |  
|--------------------------- |  | -------------------------- | --- | - | ------------- | - | --- | ------------------------ | ---- | --- | ------------- | ---- | - | --- | - |  | - | --- | - |  | --- | -
|                            |  | Three Months EndedJune 30, |     |   | PercentChange |   |     | Six Months EndedJune 30, |      |     | PercentChange |     
|                            |  | 2006                       |     |   | 2005          |   |     |                          | 2006 |     |               | 2005 |   |    
|Net interest expense        |  | $                          | 526 |   |               | $ | 167 |                          |      | 215 | %             |      | $ | 976 |   |  | $ | 255 |   |  | 283 | %
|Percentage of total revenue |  |                            | 64  | % |               |   | 15  | %                        |      |     |               |      |   | 68  | % |  |   | 13  | % |  |     |  

Net interest expense consists primarily of interest obligations on our outstanding debt and equity instruments.
Interest expense was $526,000 and $971,000 for the three and six months ended June 30, 2006, respectively, as compared to $167,000 and $255,000 for the comparable periods in 2005. The increase is due primarily to non-cash charges, characterized
as interest for accounting purposes, related to the issuance of mandatorily-redeemable convertible preferred shares during the first six months of 2005 and related to the issuance of secured debt and warrants in December 2005 and April
2006. Our Series A Preferred Stock was issued during the first quarter of 2005 and our Series B Preferred Stock was issued in the second quarter of 2005. Thus we had a full six months of amortization in 2006. We paid actual
cash interest of approximately $52,000 and $90,000 in the three and six months ended June 30, 2006, versus nil and $3,000 in the corresponding 2005 periods.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon
our condensed consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make a number of assumptions and estimates that
affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. These
items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known.

We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our
estimates if past experience or other assumptions do not turn out to be substantially accurate.



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We believe that the application of our accounting policies for share-based compensation expense, revenue recognition, and
research and development expenses, all of which are important to our financial position and results of operations, require significant judgments and estimates on the part of management.

Revenue Recognition

We generate revenue primarily from the sale of our video gateway products. We sell our products
through direct sales channels and through distributors or resellers. Generally, product revenue is generated from the sale of video gateway products. We also derive revenue from contract services and license fees.

Product Revenue

We recognize
product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured. Significant management judgments and estimates must be made in connection with the
measurement of revenue in a given period. We follow specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, we assesse a number of factors including specific contract and purchase order
terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the
assessment, we may recognize revenue when the products are shipped or defer recognition until evidence of sell-through occurs or cash is received.

Research and Development Expenses

Research and development expenditures are charged to expense as incurred. We expense amounts paid to
obtain patents or acquire licenses, as the ultimate recoverability of the amounts paid is uncertain.

Stock-Based Compensation

We adopted the provisions of SFAS 123(R) on January 1, 2006, the first day of our fiscal 2006. Accordingly, compensation costs for all share-based awards to
employees are measured based on the grant date fair value of those awards and recognized over the period during which the employee is required to perform service in exchange for the award (generally over the vesting period of the award). We have no
awards with market or performance conditions. Effective January 1, 2006 and for all periods subsequent to that date, SFAS 123(R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25). In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123(R). We have applied the provisions of SAB 107 in its
adoption of SFAS 123(R).

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards
that is ultimately expected to vest during the period. Share-based compensation expense recognized in our consolidated statement of operations for the first and second quarters of fiscal 2006 included compensation expense for share-based payment
awards granted prior to, but not yet vested as of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and share-based payment awards granted subsequent to December 31,
2005 based on the grant date fair value estimated in accordance with SFAS 123(R). For share awards granted in fiscal 2006, expenses are amortized under the straight-line attribution method. For share awards granted prior to fiscal 2006, expenses are
amortized under the straight-line single option method prescribed by SFAS 123. As share-based compensation expense recognized in the consolidated statement of operations for the first and second quarters of fiscal 2006 is based on awards ultimately
expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting
forfeitures were estimated to be approximately 20% for both officers and directors and 20% for employees in the first and second quarters of fiscal 2006 based on our historical experience. In our pro forma information required under SFAS 123 for the
periods prior to fiscal 2006, we accounted for forfeitures at the same rate as in fiscal 2006, which is 20%. For the six months ended June 30, 2006, we recorded $303,000 in stock-based compensation expense related to FAS123(R).



|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 June 30, 2006, we did not have any marketable securities or investments in available-for-sale



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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 our $2.1 million term loan and $1.0 million revolving line of credit from Laurus have a floating interest rate and we would have to pay more on interest on the outstanding balance if the interest
rates hike again. An immediate increase of two percentage points in the prime interest rate would result in us having to pay additional interest of approximately $60,000 over the next 12 months under these two notes.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Tom Tullie, our chief executive officer,
and Jeremy Ferrell, our interim chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rule 13a15(e)), concluded that as of June 30,
2006, our disclosure controls and procedures were effective.

PART IIOTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

Please see the disclosures in our Form 10-K
regarding the ongoing lawsuit by Gryphon Master Fund, L.P. and GSSF Master Fund, LP, and the settled lawsuit which had been brought by Castle Creek. There have been no material developments in those matters since the filing of the Form 10-K.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

You should carefully consider the following risks and
uncertainties before you invest in our common stock. Investing in our common stock involves risk. If any of the following risks or uncertainties actually occurs, our business, financial condition or results of operations could be materially
adversely affected. The following are not the only risks and uncertainties we face. Additional risks and uncertainties of which we are unaware or which we currently believe are immaterial could also materially adversely affect our business,
financial condition or results of operations. In any case, the trading price of our common stock could decline, and you could lose all or part of your investment. See also, Note Regarding Forward-Looking Statements.

We need to raise additional capital in the very near future.

Our
cash position was approximately $594,000 at June 30, 2006 and approximately $500,000 as of August 5, 2006. Also, our current ratio of current assets to current liabilities has declined significantly, and we have been taking on secured
debt. Despite our two private placements in 2005 (in which we raised aggregate proceeds of approximately $5.4 million), our secured convertible term note financing in December 2005 (in which we borrowed $2,100,000), and our revolving line of credit
financing in April 2006 (in which we borrowed a net of $1.3 million ), given our projected monthly gross cash burn rate (without contribution from gross margin on sales of product and without litigation expenses) of approximately $350,000, we need
to raise additional capital to sustain our operations. Without significant revenue or additional financing we will not be able to fund operations through the third quarter of 2006. Financing may not be available to us on acceptable terms, if at all.
Our inability to raise capital when needed would destroy or severely harm our business. The report of Swenson Advisors LLP, which was then our auditors, on our 2005 financial statements includes a going-concern qualification, which means
that our auditors expressed substantial doubt as to our ability to continue as a going concern. In addition, additional equity financing may dilute our stockholders interest massively, and additional 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 might not be able to continue.

One of our possible alternatives in our pursuit of additional financing is becoming a private company.

It is likely that the possible outcome of our pursuit of additional financing options will be the privatization of the Company or the sale of the Company to a third
party. In the event that the Company becomes a private entity, we no longer would be required to file Securities Exchange Act reports and various other corporate governance and disclosure requirements applicable to us and our insiders would become
inapplicable; the effect of such privatization would be that our shares would become practically illiquid.



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Possible winding down of operations if we do not secure sufficient financing.

If we do not secure sufficient financing in the very near future and if we do not improve dramatically our customer orders in the current quarter, the board of directors
may consider winding down our operation as the best alternative to all constituencies to whom it owes a fiduciary duty.

Our stock has been delisted
from the American Stock Exchange.

On June 8, 2006, we received notice from the American Stock Exchange (AMEX) of their intention to
strike the common stock of Path 1 from listing and registration on AMEX due to our non-compliance with one of the AMEXs continued listing standards, Section 1003(a)(iv) of the AMEX Company Guide, in that we have sustained losses which are
so substantial in relation to our overall operations or our existing financial resources, or our financial condition has become so impaired that it appears questionable, in the opinion of AMEX, as to whether we will be able to continue operations
and/or meet our obligations as they mature. The actual delisting occurred on June 23, 2006. We have begun to seek to list our stock on the OTC Bulletin Board or, failing that, a lower-tier over-the-counter quotation service. Our stock is
subject to the SECs penny stock rules, which would affect the practices of stockbrokers seeking orders for our stock and which would have a negative effect on our stock price. Currently our stock is trading on the Pink
Sheets and the liquidity of our securities is accordingly reduced.

Our auditors opinion states that the operating losses and our potential
inability to raise additional sources of capital raise substantial doubt about our ability to continue as a going concern.

Our independent registered
public accounting firm at the time, Swenson Advisors, LLP, included a going concern qualification in its audit opinion on our consolidated financial statements for the fiscal year ended December 31, 2005 included in our Annual Report on Form
10-K as a result of our continued operating losses during fiscal 2005 and our potential inability to raise additional sources of capital. The going concern opinion and additional financial disclosures in reports such as this Form 10-Q,
may cause concern to one or more of our constituencies of employees, shareholders, debt holders, customers, vendors, or trade creditors. If any customers, vendors or trade creditors concern changes their business relations with us
by stopping work, ceasing sales, requiring sales on cash terms or other changes, these changes may materially adversely affect our cash flows and results of operations.

Our window of opportunity may be shrinking.

It is difficult for companies like us, with small mass and limited
resources, to compete in the video transport equipment industry against larger businesses. Our disadvantages have been heightened by our recent failures of execution in many aspects of our business including failures to close large product sales and
strategic alliances, failure to focus our research and development on timely introduction of a series of attractive new products, and failure to raise enough new capital from investors to ensure our future; in addition, Claude Gibson, a clerk in our
finance department, embezzled approximately $245,000 from us, primarily in the first half of 2005. After the completion of an internal investigation relating to the embezzlement, we instituted stronger controls and procedures and we recommitted to
compliance with previously existing procedures, but we do not believe that the embezzlement constituted evidence of a material weakness in our internal controls over financial reporting. We filed suit against this former employee, an employment
agency from which we hired this former employee, and our bank, to recover the amount which was embezzled. We settled our lawsuit with the bank and the former employee and the employment agency.

Although we believe our products remain technologically superior, our margin of superiority over certain large competitors may diminish as we presently do not offer an
integrated solution: we have a narrow product offering. Moreover, our industry is now adopting international standards for forward error correction (FEC) and other technologies that today are proprietary. While we believe that our
implementation of these standards is unique, and while an initial comparison test conducted by a major European broadcaster showed that our Vx8000 operating our implementation of the Pro-MPEG Code of Practice (COP) # 3 FEC performed best, the
movement toward industry standards-based products may result in commoditization and may reduce our technological advantages, thereby resulting in lower selling prices and reduced gross margins, and thus negatively impact the results of our
operations. For these and other reasons, our industry has been experiencing consolidation.



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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. As of June 30, 2006, our accumulated deficit was approximately $59.0
million. We have never been profitable. 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.

Changes in senior management may result in difficulties.

John Zavoli, our former CEO, President, Chief Financial
Officer and General Counsel, and David Carnevale, our former Vice President of Corporate Development, separated from the Company in September 2005. Henry Sariowan, our former Vice President of Strategic Technology Planning, separated from the
Company in November 2005, and Daniel McCrary, our former Vice President of Marketing, separated from the Company in January 2006. In November 2005, we appointed Thomas Tullie as CEO and President, replacing directors Frederick Cary and Robert Packer
who had served as interim co-principal executive officers while we searched for a new CEO. Also, in August 2005 we hired Jeremy Ferrell as Controller to replace David Houillion. Mr. Ferrell was promoted to Interim Chief Financial Officer in
November 2005. We hired Richard Segil as Vice President of Marketing in February 2006. Jeffrey Hale and Richard Segil resigned as Vice President of Sales and Vice President of Marketing, respectively, in July 2006. Further changes in management may
occur from time to time. Changes in senior management of small companies are inherently disruptive, and efforts to implement any new strategic or operating goals or methods may also prove to be disruptive.

An ongoing lawsuit with the holders of a majority of our Series A 7% Convertible Preferred Stock is costly and could result in substantial liabilities
that would harm our business.

Gryphon Master Fund, L.P. and GSSF Master Fund, LP, which together hold a majority of our Series A 7%
Convertible Preferred Stock, filed a lawsuit against us in January 2006, in the United States District Court for the Northern District of Texas, alleging that the consent of a majority of the Series A Preferred Stock had been required in
connection with our December 2005 issuance of a $2,100,000 secured convertible note and related warrants to Laurus, but that such consent had not been obtained. We believe such consent was not required. The plaintiffs complaint states that
they are seeking to recover from us an unspecified amount of damages, including interest, attorneys fees and court costs.

We believe our defenses to
the claims in this lawsuit are meritorious, however, due to the inherent uncertainties of litigation, we could incur substantial liabilities if the plaintiffs were to prevail in any respect in connection with their claims. In addition, even if we
were to prevail in all respects or reach a settlement on mutually agreeable terms, the costs and expenses of any defense and/or settlement and have been and could continue to be significant, and the litigation process could be time consuming and
could divert our management and key personnel from our business operations. The occurrence of any of these events could result in substantial liabilities to us and harm our business.

A similar lawsuit had been filed against us in January 2006 by Castle Creek, which holds a majority of our Series B 7% Convertible Preferred Stock, alleging that the consent of a majority of the Series B 7%
Convertible Preferred Stock was required in connection with such issuance. Although we believe such consent was not required and that we had meritorious defenses to Castle Creeks claims, we settled this case on February 10, 2006 in order
to avoid the uncertainties, risks, costs, expenses and diversion described above. We agreed to make payments, in stock and in cash, economically equivalent to accrued dividends on Castle Creeks Series B 7% Convertible Preferred Stock, and we
agreed to issue stock upon any Series B conversion by Castle Creek so such conversion would be economically equivalent to a conversion by Castle Creek at a $2.6316 conversion price. We also agreed to an offer of similar terms to all the other
holders of Series B 7% Convertible Preferred Stock; we did so, and they all accepted the offer. On February 24, 2006, we paid the economic equivalent of accrued dividends to Castle Creek and all such other holders by issuing a total of 54,605
shares of our common stock to them. A total of $124,012 of accrued dividends was thereby relieved.

We have offered to settle the Gryphon/GSSF lawsuit on
the same terms as were provided to Castle Creek. We have also offered optional extension of the proposed settlements benefits and burdens to each of the respective minority Series A holders. The plaintiffs have not accepted this
offer as of the date of this prospectus, and the case is proceeding. If Gryphon/GSSF and, after them, the other respective minority Series A holders were to accept our offer of settlement on the same terms as provided to Castle Creek and
the minority Series B holders (which, as of the date of this prospectus, they have not so accepted), we would expect to issue shares of our common stock from time to time, at market-based rates, as payment of the economic equivalent of accrued
dividends.

In connection with the Laurus line of credit, we entered into a Consent and Waiver agreement dated April 22, 2006 with Castle Creek. In
consideration of the consent and waiver given by Castle Creek, we agreed to provisions which have the



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economic effect of reducing the conversion price of Castle Creeks Series B Preferred Stock from $2.6316 per share to $1.51 per share. In the Consent
and Waiver agreement, we also agreed to offer each of the respective minority holders of the Series B Preferred Stock the same benefits and the same burdens of the Consent and Waiver agreement, as if such minority holder was Castle Creek
for such purposes. We did so, and all of the minority holders accepted this offer.

The issuance of any shares of our common stock as the payment of the
economic equivalent of accrued dividends to the holders of our Series B 7% Convertible Preferred Stock or Series A 7% Convertible Preferred Stock, or the issuance of any additional shares of our common stock upon conversion of shares of
our preferred stock so as to reflect the economic equivalent of a conversion at a $2.6316 or $1.51 conversion price would, in each case, dilute other stockholders ownership in the Company, and the sale of such shares of common stock in the
market could cause the market price of our common stock to decline as a result of the increased supply of shares. In addition, our commitment to make the settlement payments described above (in either stock or cash) could also significantly affect
our ability to raise additional capital, as potential investors may increase the costs of any new financing in light of our obligation to make such settlement payments.

Following our secured convertible term note financing in December 2005, and our secured non-convertible revolving note financing in April 2006, we have a significant amount of debt outstanding and we may not be
able to generate sufficient cash flow to meet our debt service obligations.

On April 25, 2006, we entered into a $1 million non-convertible
secured revolving line of credit with Laurus. The revolving line of credit bears an annual interest rate equal to prime plus 200 basis points per annum, payable monthly in cash. In connection with the financing, we issued to Laurus a seven year
warrant to purchase up to 662,251 shares of Path 1 common stock at an exercise price of $1.51 per share. Additionally, Laurus agreed to postpone five months of principal payments totaling $303,000 related to the $2.1 million convertible note issued
in December 2005. Monthly principal payments will resume in September 2006. This revolving line of credit is secured by all our assets pursuant to a Security Agreement dated April 25, 2006. We have the ability to draw down advances under the
revolving line of credit subject to limits based on our accounts receivable balances and inventory levels.

In December 2005, we issued to Laurus a secured
convertible term note in the principal amount of $2,100,000, at par, which note matures 36 months following issuance, has a variable interest rate of 250 basis points above prime, and requires monthly payments of accrued interest beginning
January 1, 2006 and monthly payments of principal beginning March 1, 2006. We are permitted, in certain circumstances, to make scheduled payments of principal and interest with respect to the note in shares of common stock rather than
cash. If, however, circumstances do not permit us to make such scheduled payments in shares of common stock (including if the average closing price of our common stock for the five trading days immediately preceding the date on which interest
payments are due is less than 115% of the fixed conversion price then in effect with respect to the note), we will be required to make such payments in cash, and we may not be able to generate sufficient cash flows to service and repay this
indebtedness and have sufficient funds left over to achieve profitability in our operations, meet our working capital and capital expenditure needs or compete successfully in our markets.

If we cannot meet our debt service and repayment obligations, we would be in default under the terms of the agreements governing such notes, which would allow the holder
of such notes to declare all borrowings outstanding thereunder to be immediately due and payable. If any of the indebtedness under the notes is thereby accelerated, we may not have sufficient funds available to make the required payments that are
due thereunder.

The Laurus secured convertible term note and revolving note are secured by substantially all of our assets, and this obligation ranks
senior to any rights of stockholders.

The Laurus secured convertible term note and revolving note are secured by a first-priority lien on substantially
all of our assets. In the event of any bankruptcy, liquidation, dissolution, reorganization or similar proceeding against us, the assets that are pledged as collateral securing the secured convertible term note and revolving note must be first used
to pay such notes, as well as any other obligation secured by a priority lien on the collateral, in full, before making any distributions to stockholders, among others. This senior right of the noteholders could cause you to lose all or part of your
investment.

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 Tandberg Television, Thomson, Harris, Aastra and Scientific-Atlanta (a Cisco company), 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, sell a more complete product line or solution, have higher name recognition, have more established



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reputations within the industry and maintain stronger marketing, 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
commercialized by established companies that possess substantially greater financial, marketing, 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
product line is relatively narrow, whereas many of our competitors can offer customers a complete solution that includes products that we do not manufacture or technologies which we have not developed. Our limited product line represents a
significant competitive disadvantage for us.

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 on a timely basis 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 develop these products on a timely basis if the development effort requires more financial resources than we are able to bring to bear, and we may not be able to
introduce successfully any new products 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.
| | - |  | ----------------------------------

Technologies are changing rapidly,
and we will be required to spend significant sums on research and development  particularly for new hardware designs and software development  to produce these next generation products. Our existing products may soon become difficult to
produce because of end-of-life components, because of emerging governmental restrictions on the manufacture and sale of electronic products containing lead parts and components, and because of increasing demand in the market for new standards-based
products.

In order to develop and market successfully 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 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.

We must re-engineer our current platform and products to comply with environmental laws and regulations.

Our products are not currently in compliance with the RoHS (Reduction of certain Hazardous Substances) directive of the European Union which requires
electronic components shipped into Europe after June 30, 2006 to be essentially lead-free. Various states and other countries are contemplating adopting this type of legislation and/or similar WEEE (Waste Electrical and Electronic
Equipment) legislation designed to reduce the potential damage from hazardous substances contained in electronic components and parts. We will need to expend significant engineering resources to conform our existing products to this directive, as we
believe noncompliant products will no longer be viable in some markets after June 30, 2006. In addition, we will continue to need significant engineering resources for sustaining-development work (bug fixes, needed upgrades for specific
customer bids, etc.).

Increased costs associated with complying with these new environmental laws and regulations, when coupled with our existing cost
structure and our limited resources, could delay development of next-generation products.



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Because we will incur significant increased costs in complying the new environmental laws and regulations described
above, in addition to our existing operating, sales, marketing and research and development and general and administrative expenses, and because we have limited resources, our development toward next-generation products could be delayed or
defocused. Development toward next-generation products is a significant factor in our ability to compete in our industry on a going-forward basis, and if we do not successfully develop such next generation products, we may not be able to compete
effectively in our markets in the future and our products may become outdated or even obsolete.

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 or other types of networks that are incompatible with our
current or future products. In addition to competing with video over IP vendors, we compete with existing or incumbent alternative technologies and architectures for transporting live broadcast video that have existed for many years such as
satellite, circuit switched networks and ATM, and our customers may not be willing to move to using an IP network for transporting live video.

If we are
unable to design, develop, manufacture and sell products that incorporate or are compatible with these new or existing architectures or technologies, our business could suffer. Moreover, our industry is rapidly adopting technical standards for
transporting video over IP networks, and many customers appear to prefer standards-based or open standards products such as those operating the Pro-MPEG COP (Code of Practice). Our Vx8000, launched in April 2005, is our first product
that is Pro-MPEG standards-based. This move towards offering standards-based products for transporting video over IP networks may result in increased competition, adversely affect our ability to offer differentiated products incorporating our
proprietary technology, and cause negative impact to our gross profit margins.

Pricing pressure on our products has placed us at a competitive
disadvantage.

We have experienced significant pricing pressure in some of the markets for our products, predominantly the cable market. Due to
competitive factors, cable customers have been willing to pay only reduced amounts for our products. This has placed us at a competitive disadvantage with our competitors which have the financial strength to withstand pricing pressures. Most of our
competitors in the cable market sell a broader array of products as a bundled solution to cable customers, and these competitors can offer substantial discounts to cable customers on products that compete directly with ours, sometimes even as loss
leaders. If we are unable to regain larger margins on such products, we may be forced to exit certain market segments and our results of operations and profitability will be negatively 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 by our customers,
| | - |  | ----------------------------------------------------



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



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



| |  |  | problems in our execution of key functions such as engineering, manufacturing, marketing and/or sales,
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | 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 communication service providers in large, infrequent amounts consistent with past practice,
| | - |  | ------------------------------------------------------------------------------------------------------------------------



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



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



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| |  |  | the willingness and ability of customers to conduct necessary trials and tests of our products prior to sale, and
| | - |  | -----------------------------------------------------------------------------------------------------------------



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

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

The sales cycle for certain of our products is lengthy, which makes forecasting of our customer orders and revenues difficult.

The sales cycle for certain of our products is lengthy, often lasting six months to more than a year. Our customers generally conduct significant technical evaluations and trials of our products as well as competing
products prior to making a purchasing decision, even in cases where they may have previously purchased our products for use in one region of their operations and later seek to deploy our products in another. In addition, purchasing decisions may
also be delayed because of a customers internal budget approval processes. Because of the lengthy sales cycle and the size of customer orders, if orders forecasted for a specific customer for a particular period do not occur in that period,
our revenues and operating results for that particular quarter could suffer. Moreover, a portion of our expenses related to an anticipated order is fixed and difficult to reduce or change, affecting results for a particular period.

The rate of market adoption of our technology is uncertain and we could experience long and unpredictable sales cycles.

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 or 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.

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 contemplating 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 many potential customers measured approaches to 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.

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. 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.

The success of our business is dependent on establishing and expanding
sales and distribution channels for our products.

Third-Party Collaborations. Although we intend to establish strategic relationships with
leading suppliers, integrators and resellers to promote and distribute our products, we may not succeed. 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



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are unable to leverage effectively 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 not be able to profit from growth if we are unable to manage the growth effectively.

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 may 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.

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 broadcasting, cable 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.

Spending by customers in these sectors is dependent on a variety of factors, including:



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



| |  |  | annual budget cycles,
| | - |  | ---------------------



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



| |  |  | access to financing,
| | - |  | --------------------



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



| |  |  | competitive pressures,
| | - |  | ----------------------



| |  |  | discretionary customer spending patterns, and
| | - |  | ---------------------------------------------



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

We believe that the capital markets
more measured approach to providing financing for emerging and even established telecommunications companies, since the bull market that ended in 2000, has 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.



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Product quality problems may negatively affect our revenues and results from operations, as well as disrupt our
research and development efforts.

We produce highly complex products that incorporate leading edge technology including hardware, software and embedded
firmware. In addition to problems relating to the physical quality of manufacturing, 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 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 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 operate under 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 have instructed 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.

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. 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
assimilate successfully 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.

Changes in the mix of product sales, product distribution model or customer base could negatively impact our sales and margins.

We may
encounter a shift in the mix of the various products that we sell  products that have varying selling prices based in part on the type of product sold, competitive conditions in the particular market into which the product is 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 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. 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.



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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 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.

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,
| | - |  | --------------------------------------------------------------------------



| |  |  | announcements of debt or equity financings,
| | - |  | -------------------------------------------



| |  |  | issuances of new securities to outstanding security holders or pro-holder modifications of outstanding securities, in order to procure necessary consents to future financings,
announcements of debt or equity financings,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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,
| | - |  | -----------------------



| |  |  | stock selling by persons to whom we sold securities in one or more private placements at below-market prices,
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | 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,
| | - |  | ------------------------------------------



| |  |  | other 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 ours, fluctuate widely for reasons that may be unrelated to operating
results. These fluctuations, as well as general economic, market and political



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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.

Newly adopted accounting regulations requiring companies
to expense stock options will result in a decrease in our earnings, or an increase in our losses, and our stock price may decline.

The Financial
Accounting Standards Board recently adopted an accounting standard that eliminates the ability to account for share-based compensation transactions using the intrinsic method that we used through 2005. SFAS No. 123(R) generally requires for us
that, beginning in 2006, such transactions be accounted for using a fair-value-based method and recognized as an expense in our consolidated statement of operations. We have expensed stock options vested after December 31, 2005, recorded
stock-based compensation amounting to $303,000 for the six months ended June 30, 2006. Through 2005, we generally only disclosed such expenses on a pro forma basis in the notes to our consolidated financial statements in accordance with
accounting principles generally accepted in the United States.

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 three equity compensation plans: (i) the 2000 Stock
Option/Stock Issuance Plan (the 2000 Plan), pursuant to which we may issue an aggregate of 710,000 options and shares of common stock to employees, officers, directors, consultants and advisors, (ii) the 2001 Employee Stock Purchase
Plan (the Purchase Plan), pursuant to which our employees are provided the opportunity to purchase our stock through payroll deductions, and (iii) the 2004 Equity Incentive Plan (the 2004 Plan), pursuant to which we may
issue a total of 900,000 options and shares of common stock to employees, officers, directors, consultants and advisors. As of June 30, 2006, 475,000 shares of stock had been granted directly to current and former executives of the Company and
there were options outstanding to purchase 53,905 shares of common stock under our 2000 Plan; 596,095 shares of common stock remained 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. As of June 30, 2006, there were options outstanding to purchase 318,000 shares of common stock and 298,000 shares of stock had been granted directly to current executives of the Company under our 2004 Plan;
343,751 shares of common stock remained available for issuance under the 2004 Plan.

In addition, as of June 30, 2006, there were 115,000 shares of
common stock subject to outstanding options granted other than under the 2004 Plan, the 2000 Plan or the Purchase Plan. These options were granted as inducement stock options to Thomas Tullie, our new CEO, in 2005.

We plan to continue to provide our employees opportunities to participate in the Purchase Plan. We also plan to issue options 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. This could result in substantial dilution to all stockholders and increased control by
management.

The conversion or exercise, as applicable, of our outstanding convertible preferred stock, secured convertible term note and warrants could
result in significant ongoing dilution to all stockholders.

As of June 30, 2006, there were outstanding warrants to purchase up to 5,056,072
shares of our common stock with a weighted average exercise price of $4.46 per share. The weighted average remaining life for all of the outstanding warrants as of June 30, 2006 was 2.22 years from June 30, 2006. In addition, at
June 30, 2006, there were 814,998 shares of Series A 7% Convertible Preferred Stock and 731,157 shares of Series B 7% Convertible Preferred Stock outstanding. These shares are convertible into shares of common stock. Also, we issued
a secured convertible term note in the principal amount of $2,100,000 in December 2005 which are convertible into 775,412 shares of common stock. This note is convertible into shares of our common stock, and we are required in certain circumstances
to make scheduled principal and interest payments in shares of our common stock rather than in cash.

The issuance of any shares of our common stock
pursuant to the conversion or exercise of the above securities could significantly dilute your ownership in the Company, and the sale of such shares of common stock in the market could cause the market price of our common stock to decline as a
result of the increased supply of shares, which could in turn cause you to lose a portion of your investment. The significant downward pressure on the market price of our common stock that would result from the sale of a significant amount of such
shares of common stock could also encourage short sales by holders of our securities or others. These short sales occur when an investor commits to sell a security that he or she does not own at



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the time such commitment is made, but that the investor hopes to buy in earnest at a lower price in the future before he or she must deliver the security to
the counterparty on the original sale. Investors typically engage in short selling when they believe that the price of the underlying security will decline before the time of settlement. In the event of a significant increase in short selling of our
common stock, other investors may interpret such increase as a sign that the market price of our common stock will decline, causing further downward pressure on the market price.

Laurus is contractually prevented (subject to default by us or waiver by the holder upon 75 days notice to us) from converting its secured convertible term note and/or exercising its warrants if such conversion
or exercise would result in such holder owning more than 4.99% of our issued and outstanding shares of common stock. Laurus is also further prevented from owning more than 19.99% of our issued and outstanding common stock under any circumstances.
Laurus could, however, effectively avoid these limitations by selling some of the shares of common stock that it acquires upon partial conversion of the secured convertible term note or partial exercise of the warrants and then receiving additional
shares upon further conversion of the note or further exercise of the warrants. In this way, Laurus could sell more shares of our common stock than these contractual limits while never holding more than such limits. The issuance of such shares of
common stock could result in significant ongoing dilution to all stockholders.

The principal and interest payable on the Laurus secured convertible term
note is convertible into shares of our common stock, and under certain circumstances this conversion is mandated. The number of shares of our common stock that are issuable upon conversion of the note is equal to the aggregate amount of the
principal, interest and fees then due and payable with respect to the note divided by the fixed conversion price then in effect. The fixed conversion price is subject to potential future adjustment, which would result in the note becoming
convertible into a greater or lesser number of shares of our common stock.

Our common stock is subject to the rights and preferences of our
mandatorily-redeemable convertible preferred stock.

In January and February 2005, we issued 864,229 shares of 7% Convertible Preferred Stock in a
Series A private placement. These shares had an aggregate original liquidation preference of $2,808,750 above the common stock, have an aggregate cumulative dividend of approximately $200,000 per year, must be redeemable in four years, and are
convertible into common stock (with favorable anti-dilution adjustments if we issue stock below fair market value). Also, without approval of a majority of the 7% Convertible Preferred Stock, we cannot repurchase or redeem common stock (except
pursuant to repurchase agreements with service providers) or borrow money or issue debt securities other than in a strategic transaction, in connection with an acquisition of another entity, or pursuant to an independent-directors-approved
commercial borrowing, secured lending or lease financing transaction.

In the second quarter of 2005, we issued 792,306 shares of Series B 7% Convertible
Preferred Stock, with rights and preferences substantially similar to those of Series A.

As of June 30, 2006, there remain outstanding 814,998 shares
of 7% Convertible Preferred Stock and 731,157 shares of Series B 7% Convertible Preferred Stock.

The agreements governing our outstanding secured
convertible term note and secured non-convertible revolving note contain various covenants which may limit our ability to operate our business.

The
agreements governing our outstanding secured convertible term note and secured non-convertible revolving note contain various provisions that limit our ability to, among other things: declare or pay dividends on our common stock, issue mandatorily
redeemable preferred stock, redeem any preferred stock, effect certain mergers or other corporate transactions, materially alter or change the scope of our business, sell or lease assets, or create or incur additional indebtedness. These
restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs or otherwise restrict corporate activities, any of which could have a material adverse impact on our business. Also, upon our failure
to comply with any of the covenants contained in the agreements governing the secured convertible term note and secured non-convertible revolving note, the holder thereof may accelerate the indebtedness outstanding thereunder, and currently we would
not have sufficient funds available to make the required accelerated payments.

We do not intend to pay cash dividends.

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



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##### Table of Contents

|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

Previously disclosed.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

As of August 15, 2006, we
have an accumulated dividend accrual on our outstanding 7% Convertible (Series A) Preferred Stock of approximately $236,000.



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

Not
applicable.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

None.



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##### Table of Contents

|ITEM 6. | EXHIBITS
|------- | --------



|              |  |                                                                                                                                 
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                     
|10.100        |  | Security Agreement between us and Laurus Mater Fund, Ltd., dated April 25, 2006. (1)                                            
|              | 
|10.101        |  | Secured Non-Convertible Revolving Note in favor of Laurus Master Fund, Ltd., dated April 25, 2006. (1)                          
|              | 
|10.102        |  | Common Stock Purchase Warrant to Purchase Shares of Common Stock in favor of Laurus Master Fund, Ltd., dated April 25, 2006. (1)
|              | 
|10.103        |  | Reaffirmation and Ratification Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                     
|              | 
|10.104        |  | Postponement Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                       
|              | 
|10.105        |  | Registration Rights Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                
|              | 
|10.106        |  | Overadvance Letter between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                           
|              | 
|10.109        |  | Castle Creek Consent and Waiver. (1)                                                                                            
|              | 
|10.110        |  | Form of minority Series B joinder letter (signed by each Series B stockholders) (1)                                             
|              | 
|31.1*         |  | Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).                                         
|              | 
|31.2*         |  | Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).                                         
|              | 
|32.1*         |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).                 
|              | 
|32.2*         |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).                 

---

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



|# | Indicates management contract or compensatory plan or arrangement.
|- | ------------------------------------------------------------------



|(1) | This exhibit was previously filed as part of, and hereby incorporated by reference to, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, filed with the
Commission on May 15, 2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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/    Thomas L. Tullie              
|                                 |  | Thomas L. Tullie                     
|                                 |  | President and Chief Executive Officer
|                                
|Date: August 21, 2006           



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##### Table of Contents

INDEX OF EXHIBITS



|              |  |                                                                                                                                 
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                     
|10.100        |  | Security Agreement between us and Laurus Mater Fund, Ltd., dated April 25, 2006. (1)                                            
|              | 
|10.101        |  | Secured Non-Convertible Revolving Note in favor of Laurus Master Fund, Ltd., dated April 25, 2006. (1)                          
|              | 
|10.102        |  | Common Stock Purchase Warrant to Purchase Shares of Common Stock in favor of Laurus Master Fund, Ltd., dated April 25, 2006. (1)
|              | 
|10.103        |  | Reaffirmation and Ratification Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                     
|              | 
|10.104        |  | Postponement Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                       
|              | 
|10.105        |  | Registration Rights Agreement between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                
|              | 
|10.106        |  | Overadvance Letter between us and Laurus Master Fund, Ltd., dated April 25, 2006. (1)                                           
|              | 
|10.109        |  | Castle Creek Consent and Waiver. (1)                                                                                            
|              | 
|10.110        |  | Form of minority Series B joinder letter (signed by each Series B stockholders) (1)                                             
|              | 
|31.1*         |  | Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).                                         
|              | 
|31.2*         |  | Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).                                         
|              | 
|32.1*         |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).                 
|              | 
|32.2*         |  | Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).                 

---

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



|# | Indicates management contract or compensatory plan or arrangement.
|- | ------------------------------------------------------------------



|(1) | This exhibit was previously filed as part of, and hereby incorporated by reference to, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, filed with the
Commission on May 15, 2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



43