**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **WASHINGTON,
        DC 20549**
 
 **FORM
        10-Q**
 
 (Mark
        One)
 
 **[
        X ]**  **QUARTERLY
        REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
        1934**
 For
        the
        quarterly period ended March
        31, 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 No. 000-26363
 
 **IPIX
        CORPORATION**
 
 (Exact
        name of registrant as specified in its charter)
 
 **DELAWARE**
              
              **52-2213841**(State
                  or other jurisdiction
                incorporation
                  or organization)
              
              (IRS
                  Employer Identification No.)
 
 **12120
        Sunset Hills Road, Suite 410, Reston, Virginia 20190**
 (Address
        of principal executive offices) (Zip Code)
 
 Registrant’s
        telephone number, including area code: **(703)
        674-4100**
 
 
 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, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
        one):
 Large
        accelerated filer / / Accelerated filer / X / Non-accelerated filer /
        /
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 ___ Yes X No
  The
        number of shares outstanding of the registrant's Common Stock, $0.001 par
        value
        per share, as of May 1, 2006 was 27,645,594
 
 
  
  **PART
        I--FINANCIAL INFORMATION**
 
 **Item
        1. Condensed Consolidated Financial Statements**
 
 **IPIX
        CORPORATION**
 **CONDENSED
        CONSOLIDATED BALANCE SHEETS**
 March
                  31,
              
              December
                  31,2006
              
              2005(unaudited)
              
              (1)(in
                  thousands, except share amounts)ASSETSCash
                  and cash equivalents
              
              $
              1,195
              
              $
              4,860Short
                  term investments
              
              
              1,488
              
              
              1,481Accounts
                  receivable, net of allowance for doubtful accounts of $0 at March
                  31, 2006
                  and $0 at December 31, 2005
              
              
              1,299
              
              
              1,348Inventory,
                  net of reserve for obsolesence of $165 at March 31, 2006 and $214
                  at
                  December 31, 20005
              
              
              1,786
              
              
              2,145Prepaid
                  expenses and other current assets
              
              
              845
              
              
              1,158Assets
                  held for sale
              
              
              28
              
              
              28Total
                  current assets
              
              
              6,641
              
              
              11,020Computer
                  hardware, software and other, net
              
              
              1,074
              
              
              1,191Other
                  long term assets
              
              
              80
              
              
              80Total
                  assets
              
              $
              7,795
              
              $
              12,291LIABILITIES
                  AND STOCKHOLDERS' EQUITYCURRENT
                  LIABILITIES:Accounts
                  payable
              
              $
              2,072
              
              $
              2,543Accrued
                  liabilities
              
              
              2,799
              
              
              3,350Deferred
                  revenue
              
              
              69
              
              
              --Total
                  current liabilities
              
              
              4,940
              
              
              5,893Other
                  long term liabilities
              
              
              --
              
              
              53Total
                  liabilities
              
              
              4,940
              
              
              5,946STOCKHOLDERS'
                  EQUITY:Preferred
                  stock , $0.001 par value, 5,001,100 authorized, 245,550 and 246,867
                  shares
                  issued and outstanding
              
              
              -
              
              
              -(Aggregate
                  liquidation value: $6,684 and $6,623)Common
                  stock, $0.001 par value, 50,000,000 authorized, 27,483,874 and
                  27,455,083
                  shares issued
              
              
              27
              
              
              27and
                  outstandingAdditional
                  paid-in capital
              
              
              547,160
              
              
              546,804Accumulated
                  deficit
              
              
              (544,332
              )
              
              (540,486
              )Total
                  stockholders' equity
              
              
              2,855
              
              
              6,345Total
                  liabilities and stockholders' equity
              
              $
              7,795
              
              $
              12,291
 
 (1)
        The
        December 31, 2005 balances were derived from the audited consolidated financial
        statements.
 
 See
        accompanying notes to the unaudited condensed consolidated financial
        statements.
  
  
 **IPIX
        CORPORATION**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS**
 (UNAUDITED)
 
 Three
                  months ended March 31,2006
              
              2005(unaudited)(In
                  thousands except per share data)Revenue:Hardware
              
              $
              612
              
              $
              317Services
              
              
              1,057
              
              
              -Licenses
                  and other
              
              
              239
              
              
              351Total
                  revenue
              
              
              1,908
              
              
              668Cost
                  of revenue:Hardware
              
              
              591
              
              
              170Services
              
              
              955
              
              
              -Licenses
                  and other
              
              
              206
              
              
              196Total
                  cost of revenue
              
              
              1,752
              
              
              366Gross
                  profit
              
              
              156
              
              
              302Operating
                  expenses:Sales
                  and marketing
              
              
              1,955
              
              
              1,715Research
                  and development
              
              
              523
              
              
              666General
                  and administrative
              
              
              1,556
              
              
              2,294Restructuring
              
              
              (13
              )
              
              -Loss
                  on impairment of investment
              
              
              -
              
              
              253Total
                  operating expenses
              
              
              4,021
              
              
              4,928Loss
                  from operations
              
              
              (3,865
              )
              
              (4,626
              )Other
              
              
              19
              
              
              105Loss
                  from continuing operations
              
              
              (3,846
              )
              
              (4,521
              )Loss
                  from discontinued operations, net of taxes
              
              
              -
              
              
              (1,360
              )Net
                  loss
              
              
              (3,846
              )
              
              (5,881
              )Preferred
                  stock dividends
              
              
              (9
              )
              
              (115
              )Net
                  loss available to common stockholders
              
              $
              (3,855
              )
              $
              (5,996
              )Basic
                  and diluted loss per share:Continuing
                  operations
              
              $
              (0.14
              )
              $
              (0.21
              )Discontinued
                  operations
              
              $
              -
              
              $
              (0.06
              )Net
                  loss per common share to common stockholders - basic and
                  diluted
              
              $
              (0.14
              )
              $
              (0.27
              )Weighted
                  average common shares, basic and diluted
              
              
              27,474
              
              
              21,938
 
 See
        accompanying notes to the unaudited condensed consolidated financial
        statements.
 
  -2-
  
 **IPIX
        CORPORATION**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 (UNAUDITED)
 
 Three
                  months ended March 31,2006
              
              2005(unaudited)(In
                  thousands)Cash
                  flows from operating activities:Net
                  loss
              
              $
              (3,846
              )
              $
              (5,881
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
              
              
              155
              
              
              121Change
                  in inventory reserve
              
              
              49
              
              
              32Stock
                  based compensation expense
              
              
              347
              
              
              794Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              49
              
              
              121Inventory
              
              
              310
              
              
              (99
              )Prepaid
                  expenses and other current assets
              
              
              313
              
              
              (166
              )Other
                  long term assets
              
              
              -
              
              
              321Accounts
                  payable
              
              
              (471
              )
              
              (347
              )Accrued
                  liabilities and other
              
              
              (551
              )
              
              157Deferred
                  revenue
              
              
              69
              
              
              53Net
                  cash used in operating activities
              
              
              (3,576
              )
              
              (4,894
              )Cash
                  flows from investing activities:Purchases
                  of computer hardware, software and other
              
              
              (40
              )
              
              (317
              )Purchase
                  of short-term investments
              
              
              (1,488
              )
              
              -Maturity
                  of short-term investments
              
              
              1,481
              
              
              -Repayment
                  of restructuring liability
              
              
              (53
              )
              
              -Net
                  cash used in investing activities
              
              
              (100
              )
              
              (317
              )Cash
                  flows from financing activities:Proceeds
                  from issuance of common stock
              
              
              20
              
              
              1,543Dividend
                  attributable to Series B preferred stick conversion
              
              
              (9
              )
              
              -Repayments
                  of capital lease obligations
              
              
              -
              
              
              (220
              )Net
                  cash provided by financing activities
              
              
              11
              
              
              1,323Net
                  decrease in cash and cash equivalents
              
              
              (3,665
              )
              
              (3,888
              )Cash
                  and cash equivalents, beginning of period
              
              
              4,860
              
              
              12,784Cash
                  and cash equivalents, end of period
              
              $
              1,195
              
              $
              8,896
 
 See
        accompanying notes to the unaudited condensed consolidated financial
        statements
 
  -3-
  
 **NOTES
        TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 
 1.
            THE
                COMPANY 
 IPIX
        Corporation (“IPIX” or “Company”), formerly Internet Pictures Corporation,
        provides mission-critical imaging solutions for commerce, communication and
        security applications. The Company’s solutions create, process and manage a rich
        variety of media including still images, 360° by 360° immersive images and
        video. During the last quarter of 2004, a fundamental restructuring of the
        Company was undertaken in order to position IPIX as the leader in immersive
        imaging technologies for visual intelligence applications. The Company develops
        immersive video and still photography products for major markets in
        surveillance, visual documentation and forensic analysis. This restructuring
        included the merging of the InfoMedia and the Security business units and
        a
        change in sales structure which broadened the Company’s emphasis on direct sales
        and indirect sales channel development. The new structure also enables the
        Company to develop product offerings that include both video and still products
        for customers in the same market. IPIX has aligned its product lines with
        its
        core competencies in immersive video and still technology.
 
 The
        Company’s extensive intellectual property covers patents for 360° imaging, video
        and surveillance applications.
 
 The
        accompanying unaudited, condensed and consolidated financial statements of
        IPIX
        Corporation, a Delaware corporation, have been prepared in accordance with
        accounting principles generally accepted in the United States of America
        ("U.S.
        GAAP") for interim financial information and instructions to Form 10-Q and
        Rule
        10-01 of Regulation S-X. Accordingly, these statements do not include all
        of the
        information and footnotes required by U.S. GAAP for complete financial
        statements. In the opinion of the Company's management, these unaudited,
        condensed and consolidated financial statements reflect all adjustments of
        a
        normal, recurring nature necessary to present fairly the financial position
        of
        the Company and its subsidiaries at March 31, 2006 and December 31, 2005,
        the
        results of operations for the three months ended March 31, 2006 and 2005
        and
        cash flows for the three months ended March 31, 2006 and 2005. Results of
        operations for the three months ended March 31, 2006 are not necessarily
        indicative of results of operations expected for the full fiscal year ending
        December 31, 2006. Please refer to the Company's 2005 Annual Report on Form
        10-K
        for the complete consolidated financial statements for the period ended December
        31, 2005.
 
 2.
            GOING
                CONCERN CONSIDERATIONS 
 The
        accompanying condensed and consolidated financial statements have been presented
        in accordance with U.S. GAAP, which assume the continuity of the Company
        as a
        going concern. During the three months ended March 31, 2006 and in the prior
        fiscal years, the Company experienced, and continues to experience, certain
        issues related to cash flow and profitability. These factors raise substantial
        doubt about the Company's ability to continue as a going concern.
 
 The
        Company has a limited operating history as it will operate in 2006 and upon
        which an evaluation of its business and prospects in 2006 may be made. In
        addition, the Company is subject to generally prevailing economic conditions
        and, as such, the Company’s operating results in 2006 will be dependent upon its
        ability to provide quality products and services, the success of its customers
        and the appropriations processes of various commercial and governmental
        entities. The Company will have to acquire additional working capital through
        financing to supplement working capital from operations to meet its funding
        needs for 2006. There can be no assurance that such additional financing
        will be
        available or if available, that such financing can be obtained on terms
        satisfactory to the Company. If the Company is not able to raise additional
        funds, it will be required to significantly curtail its operations which
        would
        have an adverse effect on its financial position, results of operations and
        cash
        flow. The financial statements do not include any adjustments that might
        result
        from the outcome of this uncertainty. At March 31, 2006, the Company had
        approximately $2.68 million in cash reserves (cash and cash equivalents of
        $1.20 million and short-term investments of $1.48 million). Management
        expects to continue to make investments in the sale and marketing of new
        products for the security market, which may consume available cash reserves.
 
 3. DISCONTINUED
        OPERATIONS
 
 On
        February 11, 2005, the Company and AdMission Corporation, a privately held
        Delaware corporation (“AdMission”), closed the transactions under the asset
        purchase agreement dated January 11, 2005 between the parties (the “Asset
        Purchase Agreement”). Pursuant to the terms of the Asset Purchase Agreement,
        IPIX sold to AdMission certain of its assets (including certain patent rights
        and other intellectual property) and contracts relating to its IPIX AdMission
        business unit (the “AdMission Business”). In consideration for the sale, IPIX
        received 1,035,000 shares of the Series A Convertible Preferred Stock of
        AdMission and a warrant to purchase 200,000 shares of the Common Stock of
        AdMission. Additionally, AdMission assumed certain liabilities associated
        with
        the AdMission business unit. In accordance with FAS 144, the assets and
        liabilities related to the AdMission business were classified as held for
        sale
        at December 31, 2004, and the operations of this business unit were
        considered discontinued operations for each quarter and for each full year
        presented. The preferred stock and warrant were recorded as an asset investment
        in AdMission and subsequently written-down to zero. This write-down was based
        on
        Management’s assessment of the fair market value of the investment related to
        the carrying value of the asset which was based upon AdMission’s first quarter
        loss until the sale date and the marketability of the private company’s stock.
        The sale of assets and liabilities to AdMission consisted of fixed assets
        of
        $253,000, prepaid items of $62,000 and deferred revenue of $62,000. The
        operating
  -4-
 results
        of AdMission for 2005 were also reclassified to discontinued operations.
        During
        the first quarter of 2005, the Company incurred non-cash compensation expenses
        of $794,000 associated with the acceleration of stock options related to
        the
        sale of the AdMission business unit. In connection with the Asset Purchase
        Agreement, IPIX and AdMission entered into a Patent Purchase, License and
        Repurchase Agreement dated as of February 11, 2005 which provides for the
        transfer to AdMission of certain patents relating to the AdMission Business,
        the
        license of those patents back to IPIX for use by IPIX in the conduct of its
        security sector business and certain other limited uses, and repurchase right
        by
        IPIX in the event of certain triggering events by AdMission. The patent
        agreement remains in effect until all of the patents transferred by the
        agreement expire. Patent No. 6,732,162 issued March 4, 2004 “Method of
        Providing Preprocessed Images for a Plurality of Internet Web Sites” expires
        November 15, 2019. An acquired application 09/357,836 was subsequently
        issued on March 17, 2005 as patent No. 6,895,557 “Web-based Media
        Submission Tool” expires July 21, 2019. The agreement does not provide for
        any payment for the license of the patents. The Company has no expectation
        of
        exercising its repurchase right of these patents as there is no present
        indication that the triggering event will occur. IPIX and AdMission also
        entered
        into an IPIX Trademark/Service Mark License Agreement which provides AdMission
        with an eighteen (18) month royalty-free, nonexclusive license to use
        certain IPIX marks and certain other trademarks and business brands in
        connection with the conduct of the AdMission Business.
 
 On
        February 11, 2005, the Company entered into an AdMission Service Agreement
        (the
        Agreement) with AdMission Corporation (AdMission) under which, AdMission
        will
        provide hosting services to the Company for certain computer-based applications.
        The Agreement has variable pricing depending on usage with a minimum financial
        commitment of $10,000 per month. The Company has not in the past exceeded
        the
        usage threshold which would result in payment of fees greater than the minimum
        and the Company does not foresee paying more than the minimum at any point
        in
        the future.
 
 Other
        than the obligation to provide AdMission with a license of certain IPIX marks
        and certain other trademarks and business brands pursuant to the IPIX
        Trademark/Service Mark License Agreement and the requirements of the foregoing
        Agreement, the Company has no continuing obligations to AdMission.
 
 Revenues,
        operating expenses and loss from discontinued operations for the three months
        ended March 31, 2005 are as follows:
 
 Three
                  months ended March 31,2005(unaudited)(In
                  thousands)Revenue
              
              $
              159Cost
                  of Revenue
              
              
              220Gross
                  profit
              
              
              (61
              )Operating
                  expenses:Sales
                  and marketing
              
              
              908Research
                  and development
              
              
              391Total
                  operating expenses
              
              
              1,299Loss
                  from discontinued operations
              
              $
              (1,360
              )
 
 4. CASH,
        CASH EQUIVALENTS AND RESTRICTED SHORT TERM INVESTMENTS
 
 We
        consider all highly liquid debt instruments with a remaining maturity at
        date of
        purchase of three months or less to be cash equivalents. At March 31, 2006,
        we
        had a $1,488 thousand short term investment in the form, a thirty day renewable
        Certificate of Deposit.
 
 5. EQUITY
 
 During
        the three months ended March 31, 2006, we issued 16,665 shares of common
        stock
        upon exercise of employee stock options and we issued 12,126 shares of common
        stock upon the conversion of Series B Preferred Stock. Our total proceeds
        from
        the first quarter exercises of these options were $19.8 thousand. We paid
        $9.3
        thousand in dividends in conjunction with the conversion of Series B Preferred
        Stock. During the three months ended March 31, 2005, we issued 700,096 shares
        of
        common stock upon exercise of stock options. Our total proceeds from the
        first
        quarter 2005 option exercises were $1,455 thousand.
 
 -5-
 6. NET
        LOSS
        PER COMMON SHARE
 
 Basic
        income (loss) per common share is computed by dividing net income (loss)
        available to common stockholders for the period by the weighted average number
        of shares of common stock outstanding. Net income (loss) available to common
        stockholders is calculated as the net income (loss) less cumulative preferred
        stock dividends for the period. If dilutive, the participation right of the
        preferred stock is reflected in the calculation of basic income (loss) per
        share
        using the "if converted" method or the "two class method," if more dilutive.
        Warrant and stock options could potentially dilute basic loss per share in
        the
        future but were not included in the computation of diluted loss per share
        because to do so would have been antidilutive for the three months ended
        March
        31, 2006 and 2005. For all periods presented herein, the Company's diluted
        loss
        per share is equal to its basic loss per share because the effects of exercise
        were anti-dilutive given the losses the Company incurred during such periods.
 
 The
        following table sets forth the computation of basic and dilutive loss per
        common
        share for the periods indicated:
 
 Three
                  months ended March 31,2006
              
              2005(unaudited)(In
                  thousands)Numerator:Loss
                  from continuing operations
              
              $
              (3,846
              )
              $
              (4,521
              )Loss
                  from discontinued operations, net of tax
              
              
              -
              
              
              (1,360
              )Net
                  income (loss)
              
              
              (3,846
              )
              
              (5,881
              )Preferred
                  stock dividends
              
              
              (9
              )
              
              (115
              )Net
                  loss available to common stockholders
              
              
              (3,855
              )
              
              (5,996
              )Denominator:Weighted
                  average shares outstanding -- Basic and diluted
              
              
              27,474
              
              
              21,938Loss
                  per Common Share, Continuing Operations
              
              $
              (0.14
              )
              $
              (0.21
              )Loss
                  per Common Share, Discontinued Operations
              
              
              -
              
              
              (0.06
              )Loss
                  per Common Share, Basic and Diluted
              
              $
              (0.14
              )
              $
              (0.27
              )
 
 The
        following table sets forth potential common stock shares that are not included
        in the diluted net loss per common share calculation because to do so would
        be
        antidilutive for the three months ended March 31, 2006 and 2005 as a result
        of
        the net loss available to common stockholders:
 Three
                  months ended March 31,2006
              
              2005(unaudited)(Shares
                  in thousands)Stock
                  options
              
              
              31
              
              
              1,419Convertible
                  preferred stock
              
              
              3,204
              
              
              2,954Total
              
              
              3,235
              
              
              4,373
 
  -6-
  Not
        included in the table above, were the following rights to purchase common
        stock
        where the average exercise price was greater than the average common share
        price
        during the period and, accordingly, they were excluded from diluted net loss
        per
        common share for the three month periods ended March 31, 2006 and 2005:
 
 Three
                  months ended March 31,2006
              
              2005(unaudited)(Shares
                  in thousands)Average
                  share price of IPIX common stock
              
              $
              1.88
              
              $
              3.70Stock
                  option shares excluded (average exercise price of options $4.52
                  at March
                  31, 2006 and $15.59 at March 31, 2005)
              
              
              2,140
              
              
              1,180Series
                  B Warrants (exercise price $4.34)
              
              
              917
              
              
              917Common
                  Warrants (average exercise price $154.70 in 2006 and $147.41 in
                  2005)
              
              
              20
              
              
              32PIPE
                  Warrants (exercise price $3.11)
              
              
              2,038
              
              
              -5,115
              
              
              2,129
 
 7. RESTRUCTURING
        AND OTHER
 
 During
        the three months ended March 31, 2006, our restructuring accrual, which was
        established by various restructuring actions from 2000 to 2005, was reduced
        by
        $450 thousand. At March 31, 2006 the remaining balance in the lease
        restructuring accrual was $567 thousand.
 
 8. EMPLOYEE
        STOCK BENEFIT PLANS
  *Stock
        Option Program Description*
 
 The
        following describe the status of the Company’s stock option and employee stock
        purchase plans (ESPPs). New common stock will be issued as the result of
        option
        exercises and ESPP purchases. The Company does not anticipate conducting
        any
        stock repurchases and does not anticipate using treasury stock to fulfill
        any
        issuance obligations resulting from option exercises or ESPP
        participation.
 
 *2005
        Stock Incentive Plan*
 
 In
        2005,
        the Company authorized the 2005 Stock Incentive Plan (the “2005 Plan”). The 2005
        Plan authorizes the granting of options and restricted stock awards to acquire
        up to 5,000,000 shares of common stock. As of March 31, 2006, 19,500 options
        are
        outstanding under the 2005 Plan.
 
 *2001
        Equity Compensation Plan*
 
 In
        2001,
        the Company authorized the 2001 Equity Compensation Plan (the “2001 Plan”). The
        2001 Plan authorizes the granting of options and restricted stock awards
        to
        acquire up to 4,056,293 shares of common stock. As of March 31, 2006, 2,163,647
        options are outstanding under the 2001 Plan. The exercise price of all options
        granted is the fair value of the Company’s common stock at the date of grant.
        The options generally vest over a one to three-year period and expire ten
        years
        from the grant date. No further options will be granted under the 2001 Plan.
 
 *2000
        Equity Compensation Plan*
 
 In
        January 2000, the Company authorized the 2000 Equity Compensation Plan (the
“2000 Plan”). The 2000 Plan authorizes the granting of options and restricted
        stock awards to acquire up to 350,000 shares of common stock. As of March
        31,
        2006, 1,950 options are outstanding under the 2000 Plan. The exercise price
        of
        all options granted is the fair value of the Company’s common stock at the date
        of grant. The options generally vest over a two-year period and expire ten
        years
        from the grant date. No further options will be granted under the 2000 Plan.
 
 *1998
        Employee, Director and Consultant Stock Option Plan*
 
 During
        1998, the Company authorized an Employee, Director and Consultant Stock Option
        Plan for a total of 238,000 common shares. The 1998 Plan became effective
        on
        January 1, 1999 once the Company was reorganized. During 1999 and 2000, an
        additional 579,939 and 112,403, respectively, common shares were authorized
        under the 1998 Plan. As of March 31, 2006, 172 options are outstanding under
        the
        1998 Plan. Each option under the 1998 Plan allows for the purchase of common
        stock and expires not later than five or ten years from the date of grant,
        depending on the ownership of the option participants. The vesting terms
        of the
        stock options will be determined on each grant date and are generally two
        or
        three years; however, the amount of options that can be exercised per
        participant in any calendar year will be restricted to an aggregate fair
        market
        value of $0.1 million of the underlying common stock. No further options
        will be
        granted under the 1998 Plan.
 
 -7-
 *1997
        Equity Compensation Plan*
 
 The
        Company authorized the 1997 Equity Compensation Plan, under which 410,503
        shares
        of common stock are authorized and reserved for issuance to selected employees,
        officers, directors, consultants and advisors. As of March 31, 2006, 2,328
        options are outstanding under the 1997 Plan. The exercise price of all options
        granted is the fair value of the Company’s common stock at the date of grant as
        estimated by common stock and convertible preferred stock transactions with
        third parties at or near grant dates. The options generally vest over one
        to
        three-year periods and expire five years after the respective vesting dates.
        No
        further options will be granted under the 1997 Plan.
 
 *Other
        Stock Option Plans*
 
 The
        1994
        Stock Option Plan (the “1994 Plan”), the 1996 Stock Option Plan (the “1996
        Plan”) and the 1997 Stock Option Plan (the “1997 Options Plan”) were originally
        adopted by PictureWorks, Inc., a wholly-owned subsidiary of IPIX, in
        November 1994, May 1996 and November 1996, respectively. Under
        the 1994 Plan, eligible employees, directors and consultants could receive
        options to purchase shares of the Company’s common stock at a price not less
        than 100% and 50% of the fair value on the date of the grant for incentive
        stock
        options and nonqualified stock options, respectively. Under the 1996 Plan
        and
        1997 Options Plans, eligible employees, directors and consultants who owned
        less
        than 10% of all voting classes of stock could receive options to purchase
        shares
        of common stock at a price not less than 110% and 85% of fair value on the
        date
        of grant of incentive stock options and nonqualified stock options,
        respectively. Employees owning greater than 10% of all voting classes of
        stock
        could receive options to purchase shares at a price not less than 110% of
        the
        fair market value for both incentive and nonqualified stock options. As of
        March
        31, 2006, 425,100 options are outstanding under these plans. The options
        granted
        under these plans are exercisable over a maximum term of ten years from the
        date
        of grant and generally vest in various installments over a five-year period
        under the 1994 Plan and a four-year period under the 1996 Plan and 1997 Options
        Plan. No further options or restricted stock awards will be granted under
        the
        1994, 1996, and 1997 Options Plans.
 
 *Employee
        Stock Purchase Plan*
 
 The
        Company has an Employee Stock Purchase Plan (the “Purchase Plan”). Under the
        Purchase Plan, employees meeting certain specific employment qualifications
        are
        eligible to participate and can purchase shares of common stock semi-annually
        through payroll deductions at the lower of 85% of the fair market value of
        the
        stock on the enrollment date or the fair market value of the stock at the
        end of
        the offering period. The Purchase Plan permits eligible employees to purchase
        common stock through payroll deductions for up to 15% of qualified compensation.
        As of March 31, 2006, 865,000 shares were authorized under the Plan, 575,531
        shares had been issued and 289,469 shares were available for issuance under
        the
        Purchase Plan.
 
 A
        summary
        of the Company’s stock option activity under all plans is as follows:
 
 **Shares**
              
              **Weighted
                  Average of Exercise Prices**
              
              **Weighted
                  Average Grant Date Fair Value**
              
              **Stock
                  Options Exercisable**
              
              **Weighted
                  Average Exercise Price**Under
                  option at December  31, 2005
              
              
              2,433,340
              
              
              
              
              
              
              
              
              621,137
              
              $
              6.02Options
                  granted
              
              
              413,500
              
              $
              1.85
              
              $
              1.85Options
                  exercised
              
              
              (16,665
              )
              $
              1.19Options
                  forfeited or expired
              
              
              (217,478
              )
              $
              4.84Under
                  option at March 31, 2006
              
              
              2,612,697
              
              
              
              
              
              
              
              
              693,987
              
              $
              5.60
 
  -8-
  
 The
        following table summarizes significant ranges of outstanding and exercisable
        options as of March 31, 2006:
  
 **OUTSTANDING
                  AND EXERCISABLE BY PRICE RANGE****AS
                  OF 03/31/06****OPTIONS
                  OUTSTANDING**
              
              
              
              **OPTIONS
                  EXERCISABLE****Weighted****Number**
              
              **Average**
              
              **Weighted**
              
              **Number**
              
              **Weighted****Range
                  of**
              
              **Outstanding**
              
              **Remaining**
              
              **Average**
              
              **Exercisable**
              
              **Average****Exercise
                  Prices**
              
              **As
                  of 03/31/06**
              
              **Contractual
                  Life Years**
              
              **Exercise
                  Price**
              
              **As
                  of 03/31/06**
              
              **Exercise
                  Price**$1.0700
              $
              2.1700
              
              533,684
              9.27
              $
              1.7930
              
              97,184
              $
              1.4702$2.2300
              $
              2.5800
              
              674,750
              9.32
              $
              2.3803
              
              64,750
              $
              2.3602$2.6000
              $
              3.0500
              
              557,855
              8.87
              $
              3.0032
              
              235,802
              $
              3.0103$3.1200
              $
              8.2800
              
              841,958
              8.71
              $
              6.4961
              
              291,801
              $
              7.1476$21.1000
              $
              300.0000
              
              4,450
              4.04
              $
              179.1198
              
              4,450
              $
              179.1198$1.0700
              $
              300.000
              
              2,612,697
              9.01
              $
              4.0207
              
              693,987
              $
              5.6028
 The
        minimum fair value of each option grant is estimated on the date of grant
        using
        the Black-Scholes option-pricing model with the following
        assumptions.
  **Q1
                  2006**
              
              **Q1
                  2005**Expected
                  volatility
              
              
              119
              %
              
              154
              %Weighted-average
                  volatility
              
              
              119
              %
              
              154
              %Expected
                  dividends
              
              
              -
              
              
              -Expected
                  term (in years)
              
              
              4
              
              
              4Risk-free
                  rate
              
              
              4.71
              %
              
              5.00
              %
 
 The
        Company used the historic volatility of the Company’s common stock price for a
        period equivalent to the expected term of the options. The dividend yield
        assumption is based on the Company’s history and expectation of dividend
        payouts. The expected life of employee stock options represents the time
        the
        stock options are expected to remain outstanding. The risk-free interest
        rate
        assumption is based upon observed U.S. Treasury securities with maturities
        similar to the expected term of the options.
  As
        stock-based compensation expense of $347,000 recognized in the Condensed
        Consolidated Statement of Operations for the first three months 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. Forfeitures were estimated based
        on
        historical experience. Unamortized expense at March 31, 2006 is
        $2,359,000.
  *Accuracy
        of Fair Value Estimates*
  The
        Company’s determination of fair value of share-based payment awards on the date
        of grant using a Black-Scholes option-pricing model is affected by the Company’s
        stock price as well as assumptions regarding a number of complex and subjective
        variables. These variables include, but are not limited to the Company’s
        expected stock price volatility over the term of the awards, and actual and
        projected employee stock option exercise behaviors. Option-pricing models
        were
        developed for use in estimating the value of traded options that have no
        vesting
        or hedging restrictions and are fully transferable. Because the Company’s
        employee stock options have certain characteristics that are significantly
        different from traded options, and because changes in the subjective assumptions
        can materially affect the estimated value, in management’s opinion, the existing
        valuation models may not provide an accurate measure of the fair value of
        the
        Company’s employee stock options. Although the fair value of employee stock
        options is determined in accordance with SFAS 123(R) and SAB 107 using an
        option-pricing model, that value may not be indicative of the fair value
        observed in a willing buyer/willing seller market transaction.
 
 -9-
 9. INVENTORY
 
 Our
        inventory consists primarily of finished camera products and camera components.
        Our inventory is valued at the lower of cost, or market, using the FIFO method.
        The table below shows our inventory mix as of March 31, 2006 and December
        31,
        2005:
 
 March
                  31,
              
              December
                  31,2006
              
              2005(unaudited)Components
              
              $
              682
              
              $
              1,218Finished
                  goods
              
              
              1,269
              
              
              1,141Inventory
                  reserve
              
              
              (165
              )
              
              (214
              )Inventory,
                  net
              
              $
              1,786
              
              $
              2,145
 
 10.
        COMMITMENTS AND CONTINGENCIES
 
 **Commitments**
 
 The
        Company leases certain office space, co-location space and equipment under
        noncancelable operating leases. Future minimum lease payments under these
        and
        other operating leases are as follows:
 
 2006
              
              $
              9612007
              
              
              1922008
              
              
              52009
              
              
              42010
              
              
              3Thereafter
              
              
              2TOTAL
              
              $
              1,167
 
 On
        February 3, 2005, we entered into a lease agreement with Oak Ridge Technical
        Center Partners - One, L.P. ("Landlord"). The Lease was for a period of five
        years beginning May 1, 2005. The base rent was approximately $313 thousand
        per
        year and would increase by approximately $5 thousand each year beginning
        in
        April 2006. In addition to the base rent, we were required to pay certain
        taxes
        and a pro rata share of operating expenses. We were also responsible for
        the
        costs of certain tenant improvements associated with the new facility, but
        would
        have been entitled to reimbursement for certain costs from the Landlord.
        The
        Lease also provides for three 36 month renewal options at 95% of the then
        prevailing fair market rents.
 
 On
        March
        13, 2006, the Company agreed to terminate, effective March 8, 2006, the lease
        agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
        Partners - One, L.P. The terms of the agreement to terminate included IPIX's
        agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
        lump-sum payment in the amount of $198,500, due and payable immediately;
        (2)
        prorated rent through March 8, 2006 - $5,606, and (3) prorated tenant
        improvement expense though March 8, 2006 - $596.
  Oak
        Ridge
        Technical Center Partners - One, L.P. has agreed to: (1) act as intermediary
        in
        the sale of IPIX’s furniture to a third party for $40,000; and (2) deduct that
        amount from the above payments due from IPIX.
  On
        February 11, 2005, the Company entered into an AdMission Service Agreement
        (the
        Agreement) with AdMission Corporation (AdMission) under which, AdMission
        will
        provide hosting services to the Company for certain computer-based applications.
        The Agreement has variable pricing depending on usage with a minimum financial
        commitment of $10,000 per month. The Company has not in the past exceeded
        the
        usage threshold which would result in payment of fees greater than the minimum
        and the Company does not foresee paying more than the minimum at any point
        in
        the future.
 
 The
        table
        below shows our total contractual obligations as of March 31, 2006:
 
 Payments
                  due by period(In
                  thousands)Total
              
              Less
                  thanone
                  year
              
              1-3
                  years
              
              4-5
                  years
              
              ThereafterOperating
                  leases
              
              $
              1,167
              
              
              961
              
              
              197
              
              
              7
              
              
              2
 
 -10-
 Mr.
        Charles Crew has resigned as CFO of the Company effective April 1, 2006. On
        February 27, 2006, the Company entered into a separation agreement with Mr.
        Crew. The Company and Mr. Crew have agreed to terminate the employment agreement
        between the Company and Mr. Crew dated April 1, 2005 (the "Employment
        Agreement") effective April, 1, 2006. Under the Separation Agreement, the
        Company will pay any portion of Mr. Crew's base salary, vacation time, travel
        and business expense incurred or accrued through April 1, 2006. The Company
        will
        also pay total bonus compensation to Mr. Crew of $20,000 for the fourth quarter
        of 2005 and first quarter of 2006 as provided in Mr. Crew's employment
        agreement. In addition, the Company will pay Mr. Crew a severance payment
        of
        $200,000. Stock options to purchase up to 200,000 shares of Company common
        stock
        granted to Mr. Crew on April 1, 2005 will become fully vested on April 1,
        2006,
        and such options must be exercised on or before June 30, 2006, at which time
        they will expire. For a period of six months after April 1, 2006, the Company
        will reimburse Mr. Crew for the amount of any premium payments for group
        health
        coverage made by Mr. Crew pursuant to the Consolidated Omnibus Budget
        Reconciliation Act of 1985.
 
 **Contingencies**
 
 On
        June 15, 2003, the Company filed an action against Mr. Ford Oxaal and
        his company, Minds-Eye-View, (together, “Oxaal”) in the United States District
        Court for the Eastern District of Tennessee. In the complaint, the Company
        asserted claims for patent infringement, false designation of origin, false
        description or representation, unfair or deceptive acts and tortious
        interference in connection with Oxaal’s competing software product marketed
        under the name “Click Away.” On August 8, 2003, Oxaal filed its answer
        asserting counterclaims for non-infringement, invalidity, unenforceability,
        breach of contract, patent misuse, Lanham Act violations and tortious
        interference. The Company denied all of Oxaal’s allegations. The case was stayed
        pending settlement negotiations, which have since terminated. On March 15,
        2005, a motion was filed by the Company to vacate the stay so that the lawsuit
        can proceed in due course. In September, 2005, the court decided to continue
        the
        stay until the *Grandeye* litigation is completed.
 
 On
        March
        14, 2005, Grandeye, Ltd. filed suit against IPIX in the U.S. District Court
        for
        the Eastern District of Virginia, Norfolk Division, seeking a declaratory
        judgment that (1) its Halocam products do not infringe any valid claim of
        U.S.
        Patents No. 5,359,363 (“the ‘363 patent”), 6,603,502 B2 (“the ‘502 patent”), and
        Re 36,207 (“the ‘207 patent”), all three of which are owned by IPIX; (2) these
        three patents are invalid; and (3) these three patents are unenforceable
        as a
        result of inequitable conduct committed during prosecution of the patent
        applications leading to the patents. Grandeye also asserted various state
        law
        claims alleging damage to its business relationships as a result of alleged
        statements and conduct of IPIX. Grandeye also included in its Complaint a
        claim
        for antitrust violations but has since dismissed that antitrust claim with
        prejudice. IPIX has asserted substantial defenses to Grandeye’s claims and filed
        a counter-suit against Grandeye for infringement of the ‘363 patent, ‘502
        patent, and ‘207 patent. IPIX has vigorously defended, and continues to defend,
        its positions. IPIX has filed a motion seeking summary judgment as to Grandeye’s
        state law claims, and Grandeye has filed a motion seeking a summary judgment
        that its Halocam SP products do not infringe any claims of the ‘363 patent, ‘502
        patent, or ‘207 patent. The parties have opposed each other’s motions and the
        parties’ arguments regarding both summary judgment motions were heard by the
        Court on January 18, 2006. The Court held a hearing during the period November
        7-10, 2005, at which the parties presented their positions regarding the
        proper
        construction of the terms in the patents’ claims. The
        Court has vacated the trial date in the case, and stayed all proceedings
        for 90
        days, so that it can review and decide the parties’ cross motions for summary
        judgment.  A written decision on these motions is still
        pending.
 
 The
        Company intends to vigorously defend each of the above referenced lawsuits.
        Because of the inherent uncertainties related to this type of litigation,
        the
        Company is unable to predict the ultimate outcome of these cases, or the
        likelihood or amount of our potential liability, if any, of these cases.
        However, if the Company is not successful in defending or settling these
        matters, these cases could have a material adverse effect on the business,
        financial condition, results of operations or cash flows of the Company.
        The
        Company will incur substantial costs in defending these lawsuits.
 
 Like
        many
        companies whose success is dependent on emerging technologies and intellectual
        property, the Company is subject to potential technology related claims such
        as
        product state-of-the-art technology and associated marketability. The Company
        may be subject to claims from distributors and others regarding their purchases
        from the Company related to subsequent technological advances and the associated
        market price considerations. The Company is not currently a party to any
        other
        legal proceedings, the adverse outcome of which, individually or in the
        aggregate, is believed could have a material adverse effect on the business,
        financial condition, results of operations or cash flows of the Company.
 
 **Indemnification
        Provisions**
 
 During
        the ordinary course of business, in certain limited circumstances, the Company
        includes indemnification provisions within certain of its contracts. Pursuant
        to
        these agreements, the Company will indemnify, hold harmless and agree to
        reimburse the indemnified party for losses suffered or incurred by the
        indemnified party, generally parties with which the Company has commercial
        relations, in connection with certain intellectual property infringement
        claims
        by any third party with respect to the Company’s products and services. The
        Company discloses indemnification liabilities according to FASB Staff Position
        FIN45-1, “Accounting for Intellectual Property Infringement Indemnifications
        under FAS Interpretation No. 45.” To determine the amount of
        indemnification liability to accrue, a probability analysis of potential
        outcomes based on past claims and cost incurred is performed. To date, there
  -11-
 have
        not
        been any costs incurred in connection with such indemnification clauses;
        therefore, there is no accrual of such amounts at March 31, 2006. Our insurance
        policies do not cover the cost of patent infringement claim defense so if
        a
        claim was filed against the Company or any party we indemnify, we would incur
        legal costs to vigorously defend our patents. Under FAS No. 5, “Loss
        Contingencies,” a claim would be accrued when a loss is probable and the amount
        can be reasonably estimated. At March 31, 2006, no such amounts are accrued.
 
 **Off
        Balance Sheet Arrangements**
 
 At
        March
        31, 2006, the Company had the potential obligation to pay holders of the
        Company’s Series B Preferred Stock $1,773 thousand in cash dividends had
        they elected to convert their Series B Preferred Stock and take accrued
        dividends in cash. These dividends will continue to accrue until such time
        as
        the holders of the Series B Preferred Stock elect to convert at which time
        they have the option to take the dividends in additional shares of common
        stock
        or in cash.
 
 11. EFFECT
        OF
        NEW ACCOUNTING PRONOUNCEMENTS
 
 In
        June 2005, the FASB issued FAS No. 154, Accounting Changes and Error
        Corrections, a replacement of APB Opinion No. 20, Accounting Changes, and
        FASB No. 3, Reporting Accounting Changes in Interim Financial Statements.
        The Statement applies to all voluntary changes in accounting principle, and
        changes the requirements for accounting for and reporting of a change in
        accounting principle. FAS 154 requires retrospective application to prior
        periods’ financial statements of a voluntary change in accounting principle
        unless it is impracticable. It is effective for accounting changes and
        corrections of errors made in fiscal years beginning after December 15,
        2005. Earlier application is permitted for accounting changes and corrections
        of
        errors made occurring in fiscal years beginning after June 1, 2005. The
        Company does not expect the effect of FAS 154 will have material impact on
        its
        financial statements.
 
 In
        November 2005, the FASB issued Staff Position (“FSP”) FAS115-1/124-1, *The
        Meaning of Other-Than-Temporary Impairment and Its Application to Certain
        Investments* ,
        which
        addresses the determination as to when an investment is considered impaired,
        whether that impairment is other than temporary, and the measurement of an
        impairment loss. This FSP also includes accounting considerations
        subsequent to the recognition of an other-than-temporary impairment and requires
        certain disclosures about unrealized losses that have not been recognized
        as
        other-than-temporary impairments. The guidance in this FSP amends FASB
        Statements No. 115, *Accounting
        for Certain Investments in Debt and Equity Securities* ,
        and
        No. 124, *Accounting
        for Certain Investments Held by Not-for-Profit Organizations* ,
        and APB
        Opinion No. 18, *The
        Equity Method of Accounting for Investments in Common Stock* . This
        FSP is effective for reporting periods beginning after December 15,
        2005. We do not believe the adoption of this FSP will have a material
        impact on our financial statements.
  12. CONCENTRATIONS
        OF CREDIT RISK
 
 Financial
        instruments that potentially subject us to a concentration of credit risk
        consist of cash, cash equivalents, short term investments and accounts
        receivable. Cash, cash equivalents and short term investments are deposited
        with
        high quality financial institutions. Our accounts receivable are derived
        from
        revenue earned from customers located in the U.S. and abroad. We perform
        ongoing
        credit evaluations of our customers' financial condition and in certain
        instances require partial or full payment prior to shipment; however, we
        do not
        require collateral from our customers.
 
 The
        following table summarizes the revenue from customers in excess of 10% of
        total
        revenues, or accounts receivable in excess of 10%:
 
 Three
                  months ended March 31,2006
              
              2005Revenue:Number
                  of Customers
              
              
              1
              
              
              1Percentage
                  of Total Revenue
              
              
              53
              %
              
              10
              %Accounts
                  ReceivableNumber
                  of Customers
              
              
              3
              
              
              1Percent
                  of Total Accounts Receivable
              
              
              65
              %
              
              22
              %
 
 At
        March
        31, 2006 three customers each represented more than 10% of total Accounts
        receivable. The three customers were the Defense Advanced Research Projects
        Agency (DARPA), Sentry 360 Security, and NMI Security. The Company has a
        $2.4
        million contract with DARPA to design and build the world’s highest resolution
        digital video camera. Sentry 360 Security and NMI Security are both
        resellers.
 
 For
        the
        three months ended March 31 2006, 53% or $1,009 thousand of our sales were
        from
        DARPA.
  -12-
  
 13. LIQUIDATION
        PREFERENCE AND PREFERRED STOCK DIVIDENDS
 
 On
        September 26, 2001, Image Investor Portfolio, a separate series of Memphis
        Angels, LLC ("Image") and certain strategic investors completed the purchase
        of
        1,115,080 shares of the Series B Preferred Stock for total consideration
        of
        $22,302 thousand. Each share of the Series B Preferred Stock is convertible
        into
        approximately 9.2 shares of our common stock and is entitled to vote on matters
        submitted to holders of common stock on an as-converted basis. As of March
        31,
        2006, 245,550 shares of Series B Preferred Stock remain outstanding with
        a
        liquidation preference, defined below, of $6,684 thousand, which includes
        $1,773
        thousand in accrued dividends in arrears on the Series B Preferred
        Stock.
 
 Holders
        of Series B Preferred Stock, in preference to holders of any other series
        of
        Preferred Stock and in preference to the holders of Common Stock (collectively,
        "Junior Securities"), accrue dividends at the rate of eight percent (8%)
        of the
        price paid per annum on each outstanding share of Series B Preferred Stock
        ("Series B Dividends"). The Series B Dividends are cumulative, accrue daily
        and
        shall be payable, when and if declared by the Board, upon conversion or as
        an
        accretion to the liquidation preference, as defined below. Accrued Series
        B
        Dividends may be paid in cash or common stock, at the election of the Series
        B
        Preferred stockholder. Holders of Series B Preferred Stock participate on
        an
        as-if converted basis in any common stock dividends. At any time that the
        holders of the Series B Preferred Stock hold more than 50% of our voting
        stock,
        a voluntary liquidation, dissolution or winding up of the Company must be
        approved by at least five of the seven members of our board of directors.
        Upon
        any liquidation event, before any distribution or payment shall be made to
        the
        holders of any Junior Securities, the holders of Series B Preferred Stock
        shall
        be entitled to be paid out of the assets of the Company legally available
        for
        distribution, or the consideration received in such transaction, an amount
        per
        share of Series B Preferred Stock equal to the price paid plus all accrued
        and
        unpaid Series B Dividends for each share of Series B Preferred Stock held
        by
        them (the "liquidation preference"). If, upon any such liquidation event,
        the
        assets of the Company are insufficient to make payment in full to all holders
        of
        Series B Preferred Stock of the liquidation preference, then such assets
        shall
        be distributed among the holders of Series B Preferred Stock at the time
        outstanding, ratably in proportion to the full amounts to which they would
        otherwise be respectively entitled.
 
 **Item
        2. Management’s Discussion and Analysis of Financial Condition and Results of
        Operations********
 
 The
        following discussion is intended to assist in the understanding and assessment
        of significant changes and trends related to our results of operations and
        our
        financial condition together with our consolidated subsidiaries. This discussion
        and analysis should be read in conjunction with the consolidated financial
        statements and notes thereto included elsewhere in our Annual Report on
        Form 10-K. Historical results and percentage relationships set forth in the
        statement of operations, including trends which might appear, are not
        necessarily indicative of future operations.
 
 **OVERVIEW**
 
 **Our
        Business**
 
 During
        the last quarter of 2004, a fundamental restructuring of the Company was
        undertaken in order to position IPIX as the leader in immersive imaging
        technologies for visual intelligence applications. The Company develops
        immersive video and still photography products for major markets in
        surveillance, visual documentation and forensic analysis. This restructuring
        included the merging of the InfoMedia and the Security business units and
        a
        change in sales structure which broadened the Company’s emphasis on direct sales
        and indirect sales channel development. The new structure also enables the
        Company to develop product offerings that include both video and still products
        for customers in the same market. IPIX has aligned its product lines with
        its
        core competencies in immersive video and still technology. The restructuring
        was
        completed with the sale of the AdMission business unit in February of 2005.
        In
        accordance with FAS 144, the assets and liabilities related to the AdMission
        business unit were classified as held for sale at December 31, 2004, and
        the operations of this business unit were considered discontinued operations
        for
        all periods presented.
 
 **Products**
 
 The
        Company currently has two main product lines: Immersive Video and Immersive
        Stills.
 
 Immersive
        Video Product Line: develops and delivers products and services that provide
        customers with enhanced situational awareness. The main product in this line
        is
        the CommandView Video. The product line consists of multi-mega-pixel, digital
        cameras, fisheye lens, patented 360° viewing technology and camera management
        software to provide a unique award-winning “see everything” video surveillance
        and security camera system that can see in all directions, simultaneously
        with
        no moving parts and no blind spots. Features include low light performance;
        remote, secure monitoring; digital pan-tilt-zoom; and weather reliability.
 
 Immersive
        Stills Product Line: provides for the creation of 360° panoramic photography and
        movie content. The main product in this line is the Interactive Studio Still
        Photography product. This product provides a single integrated solution for
        panorama photographers that can automate a wide variety of tasks previously
        requiring separate tools. The technology in this product makes creating multiple
        360° images as simple as a drag-and-drop of fisheye source images into the
        application, selecting the output file formats desired and hitting the save
        button. Features include image editors, image format converter tools and
        high
        dynamic range image compositors.
 
 -13-
 **Target
        Markets**
 
 The
        Company markets its immersive video and immersive stills products to commercial
        and government clients for a variety of visual intelligence applications.
        We
        target retail, casino and cultural properties as well as government agencies
        with responsibility for security infrastructure protection related to ports,
        harbors, waterways, dams, conventional and nuclear power stations, utilities,
        airports and mass transit rail systems. Our product offers solutions to the
        military in perimeter force protection, unmanned vehicles and special
        operations. Our products are used for facilities management as well as by
        vertical market data warehouse solutions providers such as insurance and
        mapping. In addition, we historically have targeted the real estate and
        hospitality market, professional photographers, web developers and creators
        of
        visual documentation.
 
 **Business
        Models**
 
 We
        market
        our products through a direct sales force and through channel distributors
        and
        resellers. Additionally, we sell our immersive stills software platform and
        supporting hardware over the internet.
 
 **Business
        Trends and Conditions**
 
 In
        March 2004, the Company launched a new family of 360° real-time video
        camera systems. Shipment of these products to distributors began in late
        June 2004. These new camera systems generate revenues from sales to both
        end-users and resellers. In April 2005, the Company launched the
        CommandViewTM Day/Night Dome camera that combines 360° views in low-light,
        no-light and infrared lighting-assisted environments. The Company continues
        to
        develop additional products and features for the security and surveillance
        market. Also in April 2005 the Company announced an OEM agreement with
        ObjectVideo to market software for intelligent video surveillance. In
        April 2005, a partnership with VistaScape was announced to integrate their
        SiteIQTM surveillance software with the Company’s CommandViewTM cameras. These
        products became available for shipment in the third quarter of 2005. A three
        megapixel version of the CommandViewTM camera was released in January
        2006.
 
 IPIX
        still photography products primarily generate revenues through: licenses
        of
        software and the sale of camera equipment. In the past, “keys” were utilized to
        license the Company’s technology to capture and save a single immersive image.
        With the launch of the IPIX Interactive Studio, IPIX now offers time-based
        seats
        or user licenses which permit an unlimited number of immersive images to
        be
        captured and saved within a specific time period, usually a year.
 
 In
        response to the change in sales structure, the Company hired additional sales
        staff focused on direct and channel sales to market immersive video products.
        The Company currently has approximately 87 resellers in the U.S. and eight
        distributors and resellers internationally.
 
 The
        immersive still photography products for the virtual tour photography solution
        and the IPIX Interactive Studio are sold directly to the U.S. real estate
        market. The Host@IPIX product is being expanded to support a wider range
        of
        imaging technologies. As a result, the Company believes that real estate
        agents/brokers and photographers will benefit from a broader choice of panoramic
        imaging solutions and enhanced marketing capabilities.
 
 Professional
        services are also provided to customers that request specific customizations
        or
        integrations of the Company’s products and services.
 
 **CRITICAL
        ACCOUNTING POLICIES**
 
 The
        following discussion and analysis of financial condition and results of
        operations is based upon the Company’s audited consolidated financial
        statements, which have been prepared in accordance with U.S. GAAP. The
        preparation of these financial statements requires us to make estimates and
        judgments that affect the reported amounts of assets, liabilities, revenues
        and
        expenses, and related disclosure of contingent assets and liabilities. On
        an
        on-going basis, we evaluate our estimates, including those related to revenue
        recognition, stock-based compensation, uncollectible receivables, inventory
        reserves, intangible and other long-lived assets and contingencies. We base
        our
        estimates on historical experience and on various other assumptions that
        are
        believed to be reasonable under the circumstances, the results of which form
        the
        basis for making judgments about the carrying values of assets and liabilities
        that are not readily apparent from other sources. Actual results may differ
        from
        these estimates under different assumptions or conditions.
 
 We
        believe the following critical accounting policies affect our more significant
        judgments and estimates used in the preparation of our consolidated financial
        statements: revenue recognition, stock-based compensation, valuation allowances,
        specifically the allowance for doubtful accounts and inventory reserves,
        valuation of long-lived assets, and significant accruals. We believe that
        full
        consideration has been given to all relevant circumstances that we may be
        subject to, and our financial statements accurately reflect Management’s best
        estimate of the results of operations, financial position and cash flows
        for the
        periods presented.
 
 -14-
 Management
        has discussed the development and selection of the following critical accounting
        policies, estimates and assumptions with the Audit Committee of our Board
        of
        Directors and the Audit Committee has reviewed these disclosures.
 
 **Revenue
        Recognition**
 
 We
        recognize revenue when persuasive evidence of an arrangement exists, delivery
        has occurred or services have been rendered, the contract price is fixed
        or
        determinable, and collectibility is reasonably assured.
 
 We
        derive
        revenue from sales of our hardware, sales of licenses and keys for our software
        and professional services we provide to customers. Professional service revenues
        include effort performed under government contracts. Formerly professional
        services consisted of transaction hosting revenue where a reseller uses image
        management products to enhance their on-line offering. Transaction hosting
        revenue was primarily performed by the AdMission business unit which was
        discontinued in 2004 and sold in the first quarter of 2005.
 
 Transaction
        hosting revenue (which is included in discontinued operations) was recognized
        ratably as transactions were performed provided there was persuasive evidence
        of
        an arrangement, the fee was fixed or determinable and collection of the
        resulting receivable was reasonably assured.
 
 Hardware
        and software revenue is recognized upon shipment, if the contract shipping
        term
        is FOB shipping point, and upon delivery, if the contract shipping term is
        FOB
        destination, provided there are no uncertainties surrounding product acceptance,
        persuasive evidence of an arrangement exists, there are no significant vendor
        obligations, the fees are fixed or determinable and collection is reasonably
        assured. Initial license fees are recognized when a contract exists, the
        fee is
        fixed or determinable, software delivery has occurred and collection of the
        receivable is reasonably assured. If there are continuing obligations, then
        license fees are recognized ratably over the life of the contract. Revenue
        from
        hardware and software sales to distributors is recognized upon shipment
        (“sell-in”) if the distributor relationship does not create substantial
        uncertainty regarding fixed or determinable fees and collectibility. If at
        the
        beginning of an arrangement we determine the arrangement fee is not, or is
        presumed to not be, fixed or determinable, or there is uncertainty over
        collectibility, revenue is deferred and subsequently recognized as amounts
        become due or collected.
 
 The
        Company recognizes revenue in accordance with Statement of Position (“SOP”)
        No. 97-2, “Software Revenue Recognition” and SOP No. 98-9,
“Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
        Transactions.” If a contract requires significant production, modification or
        customization of the software, the arrangement is accounted for as a long-term
        service contract. If it does not, software revenue is realizable when the
        following criteria are met: persuasive evidence of an arrangement exists,
        delivery has occurred or services have been rendered, the seller’s price to the
        buyer is fixed or determinable and collectibility is reasonably assured.
 
 Other
        criteria that must be met include the determination of whether the revenue
        in
        multiple-element arrangements can be recognized separately for each element
        as
        performance occurs and the determination of the fee based on vendor-specific
        objective evidence (“VSOE”) of fair value for each element. The Company
        determines VSOE of fair value of each element by the price charged when the
        same
        element is sold separately or based on Management’s established prices for
        elements such as professional rates on comparable service contracts or the
        price
        of software with the same functionality available in the industry. If Management
        is unable to determine the VSOE of a delivered element, the revenue is
        recognized by the residual method. As performance occurs, the fee for the
        delivered item is determined by the total fee of the arrangement less the
        total
        fair value of the undelivered elements. The total fair value of the undelivered
        elements is deferred and subsequently recognized as performance occurs. If
        Management is unable to determine the VSOE of an undelivered element, all
        revenue from the contract is deferred until the VSOE is established or all
        performance has occurred. If the only undelivered element without VSOE of
        fair
        value is services that can be accounted for separately, the entire fee is
        recognized over the service period.
 
 Our
        professional service revenue under government contracts consist primarily
        of
        services provided by our employees, consultants and the pass through of costs
        for equipment or other third party services. Cost of services consists primarily
        of compensation expenses for program personnel, the fringe benefits associated
        with this compensation, consulting labor and other direct expenses incurred
        to
        complete programs, including cost of equipment. Revenues for cost-reimbursement
        contracts are recorded as reimbursable costs are incurred, including a pro-rata
        share of the contractual fees.
 
 The
        Company recognizes other professional service revenue from long-term service
        contracts in accordance with Accounting Research Bulletin (“ARB”) No. 45,
“Long-Term Construction Type Contracts,” using the relevant guidance in SOP
        81-1, “Accounting for Performance of Construction-Type and Certain
        Production-Type Contracts,” as determined by the terms and conditions of the
        Company’s contracts with its customers. Revenue is typically recognized ratably
        over the contractual periods or as services are performed. In addition, when
        professional service contracts involve software that is essential to the
        functionality of the delivered software product, revenue from the entire
        arrangement is recognized as services are performed on a percentage of
        completion method or not until the contract is completed. In fixed price
        contracts, revenue is recognized based on the percentage of completion method,
        income is recognized at a consistent profit margin over the period of
        performance based on estimated profit margins at completion of the contract.
        This method of accounting requires estimating the total revenues and total
        contract cost at completion of the contract. Estimated losses on contracts
        at
        completion are recognized when identified.
  -15-
  **Stock-Based
        Compensation Expense**
  On
        January 1, 2006, the Company adopted Statement of Financial Accounting Standards
        No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
        requires the measurement and recognition of compensation expense for all
        share-based payment awards made to employees and directors including employee
        stock options and employee stock purchases related to the Employee Stock
        Purchase Plan (“employee stock purchases”) based on estimated fair values. SFAS
        123(R) supersedes the Company’s previous accounting under Accounting Principles
        Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”)
        for periods beginning in fiscal 2006. 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).
  The
        Company adopted SFAS 123(R) using the modified prospective transition method,
        which requires the application of the accounting standard as of January 1,
        2006,
        the first day of the Company’s fiscal year 2006. The Company’s Condensed
        Consolidated Financial Statements as of and for the three months ended March
        31,
        2006 reflect the impact of SFAS 123(R). In accordance with the modified
        prospective transition method, the Company’s Condensed Consolidated Financial
        Statements for prior periods have not been restated to reflect, and do not
        include, the impact of SFAS 123(R). Stock-based compensation expense recognized
        under SFAS 123(R) for the three months ended March 31, 2006 was $347,000,
        which
        consisted of stock-based compensation expense related to employee stock options
        and the ESPP. For the three months ended March 31, 2005, the Company incurred
        non-cash compensation expenses of $794 thousand associated with the acceleration
        of stock options related to the sale of the AdMission business
        unit.
  SFAS
        123(R) requires companies to estimate the fair value of share-based payment
        awards on the date of grant using an option-pricing model. The value of the
        portion of the award that is ultimately expected to vest is recognized as
        expense over the requisite service periods in the Company’s Condensed
        Consolidated Statements of Operations. Prior to the adoption of SFAS 123(R),
        the
        Company accounted for stock-based awards to employees and directors using
        the
        intrinsic value method in accordance with APB 25 as allowed under Statement
        of
        Financial Accounting Standards No. 123, “Accounting for Stock-Based
        Compensation” (“SFAS 123”). Under the intrinsic value method, little stock-based
        compensation expense had been recognized in the Company’s Condensed Consolidated
        Statement of Operations, other than as related to acquisitions and accelerated
        vesting of employee stock options, because the exercise price of the Company’s
        stock options granted to employees and directors equaled the fair market
        value
        of the underlying stock at the date of grant.
  Stock-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. Stock-based compensation expense recognized in the Company’s
        Condensed Consolidated Statement of Operations for the three months ended
        March
        31, 2006 include compensation expense for share-based payment awards granted
        prior to, but not yet vested as of January 1, 2006 based on the grant date
        fair
        value estimated in accordance with the pro forma provisions of SFAS 123 and
        compensation expense for the share-based payment awards granted subsequent
        to
        January 1, 2006 based on the grant date fair value estimated in accordance
        with
        the provisions of SFAS 123(R). Compensation expense for all share-based payment
        awards granted on or prior to December 31, 2005 and compensation expense
        for all
        share-based payment awards granted subsequent to January 1, 2006 is recognized
        using the straight-line single-option method. As stock-based compensation
        expense recognized in the Condensed Consolidated Statement of Operations
        for the
        first quarter 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. In the Company’s pro
        forma information required under SFAS 123 for the periods prior to fiscal
        2006,
        the Company accounted for forfeitures as they occurred.
  Upon
        adoption of SFAS 123(R), the Company maintained the Black-Scholes model for
        valuation for share-based awards granted beginning in fiscal 2006. The Company’s
        determination of fair value of share-based payment awards on the date of
        grant
        using an option-pricing model is affected by the Company’s stock price as well
        as assumptions regarding a number of highly complex and subjective variables.
        These variables include, but are not limited to, the Company’s expected stock
        price volatility over the term of the awards, and actual and projected employee
        stock option exercise behaviors. Because the Company’s employee stock options
        have certain characteristics that are significantly different from traded
        options, and because changes in the subjective assumptions can materially
        affect
        the estimated value, in management’s opinion, the existing valuation models may
        not provide an accurate measure of the fair value of the Company’s employee
        stock options. Although the fair value of employee stock options is determined
        in accordance with SFAS 123(R) and SAB 107 using an option-pricing model,
        that
        value may not be indicative of the fair value observed in a willing
        buyer/willing seller market transaction.
  On
        November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued
        FASB Staff Position No. FAS 123(R)-3 “Transition Election Related to Accounting
        for Tax Effects of Share-Based Payment Awards.” The Company has elected to adopt
        the alternative transition method provided in the FASB Staff Position for
        calculating the tax effects of stock-based compensation pursuant to SFAS
        123(R).
        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 stock-based compensation, and to determine
        the
        subsequent impact on the APIC pool and Consolidated Statements of Cash Flows
        of
        the tax effects of employee stock-based compensation awards that are outstanding
        upon adoption of SFAS 123(R).
 
 -16-
 **Allowances
        for Doubtful Accounts**
 
 Significant
        Management judgments and estimates must be made and used in connection with
        establishing the allowance for doubtful accounts in any accounting period.
        Management specifically analyzes accounts receivable and historical bad debts,
        customer concentrations, customer credit-worthiness, current economic trends
        and
        changes in the customer payment terms when evaluating the adequacy of the
        allowance for doubtful accounts. Material differences could result in the
        amount
        and timing of expense recorded if Management had different judgment or utilized
        different estimates as the latter related to different reporting periods.
 
 **Reserve
        for Inventory Obsolescence**
 
 Significant
        Management estimates must be made and used in conjunction with establishing
        the
        inventory obsolescence reserve in any accounting period. This may occur as
        a
        result of technological advances, out of production sub-assemblies, radical
        changes in market demand or change of suppliers. Management periodically
        reviews
        the inventory aging, turnover, sales forecast as well as input from vendors
        in
        determining the appropriate amount of the reserve.
 
 **Significant
        Accruals, including Restructuring Charges, Discontinued Operations and Sales
        Tax**
 
 We
        recorded restructuring charges associated with vacated facilities and reductions
        in personnel staffing levels. The key assumptions associated with these charges
        include the timing and amount of sub-lease income. In addition, in establishing
        and providing for sales tax accruals, we make judgments based on the actual
        tax
        laws and guidance. While Management believes that its judgments and
        interpretations regarding tax liabilities are appropriate, significant
        differences in actual experience may materially affect the Company’s future
        financial results.
 
 **RESTRUCTURING
        ACTIONS**
 
 During
        the years ended December 31, 2000 thru December 31, 2005, the Company executed
        several restructuring actions and recorded related lease charges during each
        of
        those fiscal years. During the three months ended March 31, 2006, our
        restructuring accrual was reduced by $450 thousand. At March 31, 2006 the
        remaining balance in the lease restructuring accrual was $567 thousand.
 
 On
        March
        13, 2006, the Company agreed to terminate, effective March 8, 2006, the lease
        agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
        Partners - One, L.P. The terms of the agreement to terminate included IPIX's
        agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
        lump-sum payment in the amount of $198,500, due and payable immediately;
        (2)
        prorated rent through March 8, 2006 - $5,606, and (3) prorated tenant
        improvement expense though March 8, 2006 - $596.
  Oak
        Ridge
        Technical Center Partners - One, L.P. has agreed to: (1) act as intermediary
        in
        the sale of IPIX’s furniture to a third party for $40,000; and (2) deduct that
        amount from the above payments due from IPIX.
   -17-
  **RESULTS
        OF OPERATIONS (In thousands, except per share data)
        (Unaudited)**
 
 Three
                  months ended March 31,2006
              
              2005
              
              Difference
              
              PercentageChangeRevenue:Hardware
              
              $
              612
              
              $
              317
              
              $
              295
              
              
              93
              %Services
              
              
              1,057
              
              
              -
              
              
              1,057
              
              
              0
              %Licenses
                  and other
              
              
              239
              
              
              351
              
              
              (112
              )
              
              -32
              %Total
                  revenue
              
              
              1,908
              
              
              668
              
              
              1,240
              
              
              186
              %Cost
                  of revenue:Hardware
              
              
              591
              
              
              170
              
              
              421
              
              
              248
              %Services
              
              
              955
              
              
              -
              
              
              955
              
              
              0
              %Licenses
                  and other
              
              
              206
              
              
              196
              
              
              10
              
              
              5
              %Total
                  cost of revenue
              
              
              1,752
              
              
              366
              
              
              1,386
              
              
              379
              %Gross
                  profit
              
              
              156
              
              
              302
              
              
              (146
              )
              
              -48
              %Operating
                  expenses:Sales
                  and marketing
              
              
              1,955
              
              
              1,715
              
              
              240
              
              
              14
              %Research
                  and development
              
              
              523
              
              
              666
              
              
              (143
              )
              
              -21
              %G&A,
                  restructuring, and impairment
              
              
              1,543
              
              
              2,547
              
              
              (1,004
              )
              
              -39
              %Total
                  operating expenses
              
              
              4,021
              
              
              4,928
              
              
              (907
              )
              
              -18
              %Loss
                  from operations
              
              
              (3,865
              )
              
              (4,626
              )
              
              761
              
              
              -16
              %Other
                  income
              
              
              19
              
              
              105
              
              
              (86
              )
              
              -82
              %Loss
                  from continuing operations
              
              
              (3,846
              )
              
              (4,521
              )
              
              675
              
              
              -15
              %Loss
                  from discontinued operations, net of taxes
              
              
              -
              
              
              (1,360
              )
              
              1,360
              
              
              -100
              %Net
                  loss
              
              $
              (3,846
              )
              $
              (5,881
              )
              $
              2,035
              
              
              -35
              %
 
 
 REVENUE.
        The Company derives its revenue from product sales of its full-360 degree
        technology sold as: hardware sales of camera equipment, services, and licenses
        and other. Total revenue for the three months ended March 31, 2006 was $1.9
        million, an increase of $1.2 million, or 186 % compared to total revenue
        of $668
        thousand for the three months ended March 31, 2005. Hardware sales of the
        Company's Immersive imaging product line were $612 thousand, an increase
        of $295
        thousand or 93% compared to hardware sales of $317 thousand for the same
        period
        of 2005. Services revenue was $1.1 million due to research performed under
        a
        $2.4 million contract with the U. S. Government. There was no Services revenue
        in the same period of 2005. Licenses and other revenue was $239 thousand,
        a
        decrease of $112 thousand, or 32%, from $351 thousand for the three months
        ended
        March 31, 2006 and 2005, respectively. This decrease is primarily attributed
        to
        decreased sales of stills software licenses.
 
 COST
        OF
        REVENUE. The Company's cost of revenue consists of cost of components and
        cost
        of assembly for video and immersive cameras, internally developed software,
        licensed software, fulfillment and shipping costs, customer and technical
        support, internet hosting fees, professional service fees and direct labor.
        Hardware cost of revenue was $591 thousand in the three months ended March
        31,
        2006 compared to $170 thousand in the same period in 2005 and increase of
        248%.
        The Company has historically experienced and expects to experience margin
        fluctuations in the future based on the mix of units of high-margin versus
        low-margin products. Services cost of goods sold was $955 thousand for the
        three
        months ended March 31, 2006. There was no Services revenue or cost of goods
        sold
        in the three months ended March 31, 2005. Services cost of goods sold mainly
        consists of research and development expenses related to the U. S. Government
        project. Cost of license and other revenue was $206 thousand compared to
        $196
        thousand for the same quarter in 2005 an increase of 5%. This is primarily
        due
        to a write-down of license inventory of $187,500 in 2006.
 
 -18-
 SALES
        AND
        MARKETING. Sales and marketing expenses increased $240 thousand, or 14% to
        $1,955 thousand during the quarter ended March 31, 2006 compared to $1,715
        thousand for the same period of March 31, 2005 primarily due to employee
        compensation and expenses related to advertising, marketing and participation
        in
        trade shows. These expenses were focused on supporting the sales effort for
        our
        immersive video product line.
 
 RESEARCH
        AND DEVELOPMENT. Research and development expenses consist mainly of personnel
        costs and facility expenses related to building and enhancing our digital
        media
        infrastructure and immersive imaging technology. Research and development
        expenses were $523 thousand, representing a decline of $143 thousand, or
        21%,
        during the quarter ended March 31, 2006 compared to the quarter ended March
        31,
        2005. This was mainly due to allocation of research and development costs
        to
        cost of goods sold related to the U.S. Government contract.
 
 GENERAL
        AND ADMINISTRATIVE. General and administrative expenses consist primarily
        of
        salaries and related benefits for administrative and executive staff, fees
        for
        outside professional services, insurance and other costs associated with
        being a
        public company. General and administrative expenses were $1,543 thousand,
        a
        decrease of $1,004 thousand or 39% during the quarter ended March 31, 2006
        compared to $2,547 thousand for the quarter ended March 31, 2005 primarily
        a
        result of a decrease in legal fees as well as a decrease in expenses associated
        with compliance with public company regulations including Sarbanes-Oxley
        rules.
 
 OTHER
        INCOME. Other income for the three months ended March 31, 2006 was $19 thousand
        compared to $105 thousand for the same period in 2005. This decrease of $86
        thousand or 82% is primarily due to the sale in the three months ended March
        31,
        2005 of one of our discontinued web domain names; there was no comparable
        income
        in the three months ended March 31, 2006.
 
 LOSS
        FROM
        DISCONTINUED OPERATIONS. There was no loss from discontinued operations in
        the
        three months ended March 31, 2006, compared to a loss of $1,360 thousand
        for the
        three months ended March 31, 2005. The loss in the three months ended March
        31,
        2005 was related to the sale of the AdMission business unit. Prior period
        results have been reclassified to properly classify the business unit as
        discontinued operations.
 
 NET
        LOSS.
        As a result of the factors described above, the net loss for the three months
        ended March 31, 2006 was $3,846 thousand, an improvement of $2,035 or 35%,
        compared to $5,881 thousand for the three months ended March 31, 2005.
 
 **LIQUIDITY
        AND CAPITAL RESOURCES**
 
 Since
        inception, we have financed our operations through our registered public
        offerings, the private placements of capital stock, a convertible debenture,
        a
        convertible promissory note, and warrant and option exercises.
 
 Cash
        flows from operating activities in the first quarter of 2006, reflects a
        net
        loss of $3,846 thousand, compared to net loss of $5,881 thousand in the first
        quarter of 2005, a decrease of 35%. During the first quarter of 2006, the
        Company incurred non-cash compensation expenses of $347 thousand in the three
        months ended March 31, 2006 associated with expense related to stock options
        and
        the Employee Stock Purchase Plan (ESPP). In the three months ended March
        31,
        2005 the Company incurred non-cash compensation expense of $794 thousand
        associated with the accelerated vesting of stock options related to the sale
        of
        the Admissions business unit.
 
 Net
        cash
        used in investing activities in the first quarter of 2006 of $100 thousand
        compared to $317 in the first quarter of 2005, a decrease of 68%, was primarily
        related to the purchase of computer hardware and software as well as repayment
        of a restructuring liability.
 
 Net
        cash
        provided by financing activities of $11,000 in the three months ended March
        31,
        2006 was from $20,000 of stock option exercises less $9,000 in payment of
        Series
        B Preferred Stock dividends. This compares to $1,323 thousand in the first
        quarter of 2005, a decrease of 99% was due to a dramatic decrease in the
        exercise of stock options. Net cash provided by financing activities in the
        first quarter of 2005 was generated by $1,543 thousand of proceeds from the
        exercise of stock options, net of $220 thousand of payments made on capital
        lease obligations.
 
 During
        the quarter ended March 31, 2006 and in prior fiscal periods, we have
        experienced certain going concern issues related to cash flow and profitability.
        In addition, the Company's operating results in 2006 will be dependent upon
        the
        its ability to provide quality products and services and is subject to the
        risk
        of an unfavorable change in demand for its products and services. We finished
        the first quarter of 2006 with approximately $2,683 thousand in cash reserves
        (cash and cash equivalents of $1,195 thousand and short-term investments
        of
        $1,488 thousand). Management expects to continue to make significant investments
        in the development, sale and marketing of new products, which may consume
        much
        of our cash reserves. Management's focus is to manage our cash requirements
        and
        focus our operations on revenue generation and controlled spending. Management
        will need to raise debt or equity financing to fund these
        operations.
  -19-
  **CONTRACTUAL
        OBLIGATIONS**
 
 The
        table
        below shows our total contractual obligations as of March 31, 2006.
 
 Payments
                  due by period(In
                  thousands)Total
              
              Less
                  thanone
                  year
              
              1-3
                  years
              
              4-5
                  years
              
              ThereafterOperating
                  leases
              
              $
              1,167
              
              
              961
              
              
              197
              
              
              7
              
              
              2
 
 
 On
        February 3, 2005, we entered into a lease agreement with Oak Ridge Technical
        Center Partners - One, L.P. ("Landlord"). The Lease was for a period of five
        years beginning May 1, 2005. The base rent was approximately $313 thousand
        per
        year and would increase by approximately $5 thousand each year beginning
        in
        April 2006. In addition to the base rent, we were required to pay certain
        taxes
        and a pro rata share of operating expenses. We were also responsible for
        the
        costs of certain tenant improvements associated with the new facility, but
        would
        have been entitled to reimbursement for certain costs from the Landlord.
        The
        Lease also provided for three 36 month renewal options at 95% of the then
        prevailing fair market rents.
 
 On
        March
        13, 2006, the Company agreed to terminate, effective March 8, 2006, the lease
        agreement it entered into on February 3, 2005 with Oak Ridge Technical Center
        Partners - One, L.P. The terms of the agreement to terminate included IPIX's
        agreement to pay Oak Ridge Technical Center Partners - One, L.P. (1) a one-time,
        lump-sum payment in the amount of $198,500, due and payable immediately;
        (2)
        prorated rent through March 8, 2006 - $5,606, and (3) prorated tenant
        improvement expense though March 8, 2006 - $596.
  Oak
        Ridge
        Technical Center Partners - One, L.P. has agreed to: (1) act as intermediary
        in
        the sale of IPIX’s furniture to a third party for $40,000; and (2) deduct that
        amount from the above payments due from IPIX.
  On
        April
        18, 2005, we entered into a sublease agreement with Thomas Group, Inc. with
        respect to our new corporate headquarters in Reston, Virginia. The sublease
        is
        for a period of 31 months beginning April 15, 2006. The base rent is
        approximately $298 thousand per year and will increase by approximately three
        (3%) percent each year beginning April 1, 2006. In addition to the base rent,
        we
        are responsible for any increases in operating expenses and property taxes
        billed to the landlord and paid by Thomas Group. We are also responsible
        for the
        costs of tenant improvement. All terms and conditions of the master lease
        between Thomas Group and REC Partners, L.P. dated February 15, 2000 are
        incorporated into and made part of the sublease.
 
 **Item
        3. Quantitative and Qualitative Disclosures About Market Risk**
 
 As
        of
        March 31, 2006, we had $2,683 thousand of cash, cash equivalents and short
        term
        investments. Our interest income is sensitive to changes in the general level
        of
        United States interest rates, particularly since the majority of our investments
        are in short term instruments. Due to the nature of our short term investments,
        we concluded that we do not have material market risk exposure.
 
 **Item
        4. Controls and Procedures**
 
 Our
        management, with the participation of our chief executive, has evaluated
        the
        effectiveness of the design and operation of our disclosure controls and
        procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the
        period covered by this report. Based on that evaluation, the chief executive
        officer has concluded that our disclosure controls and procedures are effective
        to ensure that material information relating to us is made known to such
        officers by others within the Company, particularly during the period this
        quarterly report was prepared, in order to allow timely decisions regarding
        required disclosure. There have not been any changes in our internal control
        over financial reporting during the period covered by this report that have
        materially affected, or are reasonably likely to materially affect, our internal
        control over financial reporting.
  **CAUTIONARY
        STATEMENT REGARDING FORWARD-LOOKING STATEMENTS**
 
 This
        quarterly report contains statements about future events and expectations
        which
        are characterized as forward-looking statements. Forward-looking statements
        are
        based on our management's beliefs, assumptions and expectations of our future
        economic performance, taking into account the information currently available
        to
        them. These statements are not statements of historical fact. Forward-looking
        statements involve risks and uncertainties that may cause our actual results,
        performance or financial condition to be materially different from the
        expectations of future results, performance or financial condition we express
        or
        imply in any forward-looking statements.
 
 -20-
 The
        words
        "believe", "may", "will", "should", "anticipate", "estimate", "expect",
        "intends", "objective" or similar words or the negatives of these words are
        intended to identify forward-looking statements. We qualify any forward-looking
        statements entirely by these cautionary factors.
 
 Although
        we believe that the expectations and assumptions reflected in these statements
        are reasonable in view of the information currently available, there can
        be no
        assurance that these expectations will prove to be correct. These
        forward-looking statements involve a number of risks and uncertainties,
        including those set forth below and in our 2005 Annual Report on Form 10-K
        filed
        with the Securities and Exchange Commission on March 21, 2006 under Item
        7,
        "Management's Discussion and Analysis of Financial Condition and Results
        of
        Operations" under the caption "Risk Factors." Actual results may differ
        materially from the results discussed in the forward-looking statements.
        In
        addition to the specific factors discussed in our 2005 Form 10-K, the following
        are among the important factors that could cause actual results to differ
        materially from the forward-looking statements:
 
 -
        changes
        in the demand for our products and services,
 -
        our
        third-party supplier's ability to deliver high quality components to us in
        a
        timely fashion,
 -
        our
        ability to control or effect reductions in costs,
 -
        uncertainty regarding our ability to continue as a going concern,
 -
        our
        ability to raise capital and fund our operations,
 -
        our
        ability to attract and retain highly qualified personnel,
 -
        our
        ability to design, manufacture and deliver high quality products in a timely
        fashion,
 -
        the
        burdens and costs of defending against potential infringement claims,
 
 **PART
        II -- OTHER INFORMATION**
 
 **Item
        1. Legal Proceedings**
 
 On
        June 15, 2003, the Company filed an action against Mr. Ford Oxaal and
        his company, Minds-Eye-View, (together, “Oxaal”) in the United States District
        Court for the Eastern District of Tennessee. In the complaint, the Company
        asserted claims for patent infringement, false designation of origin, false
        description or representation, unfair or deceptive acts and tortious
        interference in connection with Oxaal’s competing software product marketed
        under the name “Click Away.” On August 8, 2003, Oxaal filed its answer
        asserting counterclaims for non-infringement, invalidity, unenforceability,
        breach of contract, patent misuse, Lanham Act violations and tortious
        interference. The Company denied all of Oxaal’s allegations. The case was stayed
        pending settlement negotiations, which have since terminated. On March 15,
        2005, a motion was filed by the Company to vacate the stay so that the lawsuit
        can proceed in due course. In September, 2005, the court decided to continue
        the
        stay until the*Grandeye*litigation is completed.
 
 On
        March
        14, 2005, Grandeye, Ltd. filed suit against IPIX in the U.S. District Court
        for
        the Eastern District of Virginia, Norfolk Division, seeking a declaratory
        judgment that (1) its Halocam products do not infringe any valid claim of
        U.S.
        Patents No. 5,359,363 (“the ‘363 patent”), 6,603,502 B2 (“the ‘502 patent”), and
        Re 36,207 (“the ‘207 patent”), all three of which are owned by IPIX; (2) these
        three patents are invalid; and (3) these three patents are unenforceable
        as a
        result of inequitable conduct committed during prosecution of the patent
        applications leading to the patents. Grandeye also asserted various state
        law
        claims alleging damage to its business relationships as a result of alleged
        statements and conduct of IPIX. Grandeye also included in its Complaint a
        claim
        for antitrust violations but has since dismissed that antitrust claim with
        prejudice. IPIX has asserted substantial defenses to Grandeye’s claims and filed
        a counter-suit against Grandeye for infringement of the ‘363 patent, ‘502
        patent, and ‘207 patent. IPIX has vigorously defended, and continues to defend,
        its positions. IPIX has filed a motion seeking summary judgment as to Grandeye’s
        state law claims, and Grandeye has filed a motion seeking a summary judgment
        that its Halocam SP products do not infringe any claims of the ‘363 patent, ‘502
        patent, or ‘207 patent. The parties have opposed each other’s motions and the
        parties’ arguments regarding both summary judgment motions were heard by the
        Court on January 18, 2006. The Court held a hearing during the period November
        7-10, 2005, at which the parties presented their positions regarding the
        proper
        construction of the terms in the patents’ claims. The
        Court has vacated the trial date in the case, and stayed all proceedings
        for 90
        days, so that it can review and decide the parties’ cross motions for summary
        judgment. A written decision on these motions is still pending.
 
 The
        Company intends to vigorously defend each of the above referenced lawsuits.
        Because of the inherent uncertainties related to this type of litigation,
        the
        Company is unable to predict the ultimate outcome of these cases, or the
        likelihood or amount of our potential liability, if any, of these cases.
        However, if the Company is not successful in defending or settling these
        matters, these cases could have a material adverse effect on the business,
        financial condition, results of operations or cash flows of the Company.
        The
        Company will incur substantial costs in defending these lawsuits.
 
 Like
        many
        companies whose success is dependent on emerging technologies and intellectual
        property, the Company is subject to potential technology related claims such
        as
        product state-of-the-art technology and associated marketability. The Company
        may be subject to claims from distributors and others regarding their purchases
        from the Company related to subsequent technological advances and the associated
        market price considerations. The Company is not currently a party to any
        other
        legal proceedings, the adverse outcome of which, individually or in the
        aggregate, is believed could have a material adverse effect on the business,
        financial condition, results of operations or cash flows of the Company.
 
 -21-
 **Item
        6. Exhibits**
  Exhibit
                    Number
                  
                  Exhibit
                      Description31
                  
                  Rule
                      13a-14(a)/15d-14(a) Certification of Chief Executive Officer
                      and Interim
                      Chief Financial Officer32
                  
                  Section
                      1350 Certification of Chief Executive Officer and Interim Chief
                      Financial
                      Officer
 All
        other
        items in Part II are either not applicable to the Company during the quarter
        ended March 31, 2006, the answer is negative, or a response has been previously
        reported and an additional report of the information is not required, pursuant
        to the instructions to Part II.
 
  -22-
  
 **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.
 
 
 **IPIX
                  CORPORATION**
                (Registrant)By:
              /s/
                  Clara M. ContiClara
                  M. ContiPresident,
                  Chief Executive Officer and Interim Chief Financial Officer
                (Duly
                  Authorized Officer)Date:
              May
                  10, 2006
 
 
 
  -23-