UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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~~September 30, ~~2005~~2006.

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

For the transition period from to .

Commission File Number 001-15609

PATH 1 NETWORK TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)

DELAWARE

13-3989885

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

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

(858) 450-4220

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

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 ana large accelerated filer, (accelerated filer or a non-accelerated filer, as defined in ~~Exchange Act~~ Rule 12b-2) of the Exchange Act. ~~Yes ¨ No x~~

AsLarge ofaccelerated ~~April~~filer ¨ Accelerated ~~30,~~filer ¨ Non-accelerated ~~2005,~~filer x ~~6,882,221 shares of the registrant’s common stock were outstanding.~~

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

As of November 5, 2006, 9,405,417 shares of the registrant’s common stock were outstanding.

PATH 1 NETWORK TECHNOLOGIES INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended ~~March 31~~September 30, ~~2005~~2006

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION			3
PART I—FINANCIAL INFORMATION	3
	ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED)	3
ITEM 1. FINANCIAL STATEMENTS	3
	CONSOLIDATED BALANCE SHEETS		3
CONDENSED CONSOLIDATED BALANCE SHEETS	3
	CONSOLIDATED STATEMENTS OF OPERATIONS		4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)	4
	CONSOLIDATED STATEMENTS OF CASH FLOWS		5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)	5
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	6
	ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23
	ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	30
	ITEM 4.	CONTROLS AND PROCEDURES	31
ITEM 4. CONTROLS AND PROCEDURES	30
PART II – OTHER INFORMATION			31
PART II—OTHER INFORMATION	31
	ITEM 1.	LEGAL PROCEEDINGS	31
ITEM 1. LEGAL PROCEEDINGS	31
	ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	31
ITEM 1A. RISK FACTORS	31
	ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	31
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	43
	ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	43
	ITEM 5.	OTHER INFORMATION	31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	43
	ITEM 6.	EXHIBITS	32
ITEM 5. OTHER INFORMATION	43
SIGNATURES			33
ITEM 6. EXHIBITS	44
SIGNATURES	45

PART I – —FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

~~Path~~PATH 1 ~~Network~~NETWORK ~~Technologies~~TECHNOLOGIES ~~Inc~~INC.

~~Consolidated~~CONDENSED ~~Balance~~CONSOLIDATED ~~Sheets~~BALANCE SHEETS

(in thousands, except ~~shares~~share data)

	March 31,2005			December 31,2004
	September 30,2006			December 31,2005
	(unaudited)			(audited)
	(Unaudited)			(Audited)
ASSETS
Current assets
Current assets:
Cash and cash equivalents	$	~~1,755~~389		$	~~929~~1,636
Accounts receivable, net		~~949~~451			~~810~~346
Inventory		~~497~~587			~~541~~697
Other current assets		~~376~~112			~~468~~86
Total current assets		31,~~577~~539			2,~~748~~765
Property and equipment, net		~~333~~98			~~352~~244
Debt issuance costs, net		1			4
Issuance costs for mandatorily-redeemable preferred stock and notes payable, net		880			764
Issuance costs for mandatorily-redeemable preferred stock		274			-
Other assets		96			110
Other assets		190			60
TOTAL ASSETS	$	2,613		$	3,883
Total assets	$	4,375		$	3,164
LIABILITIES AND SHAREHOLDERS’ DEFICIT
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current liabilities
Accounts payable and accrued liabilities	$	1,534		$	1,196
Accounts payable and accrued liabilities	$	655		$	752
Accrued compensation and benefits		135			317
Accrued compensation and benefits		135			176
Deferred revenue		258			144
Deferred revenue		240			256
Capital lease obligations		—			3
Current portion of leases payable		16			21
Current portion of notes payable, net		1,468			727
Current portion of notes payable, net		93			78
Total current liabilities		3,395			2,387
Total current liabilities		1,139			1,283
Mandatorily-redeemable preferred stock, net		2,205			1,280
Mandatorily-redeemable preferred shares, net (note 11)		745			-
Note payable, net of debt discount		726			873
Total liabilities		16,~~884~~326			14,~~283~~540
Stockholders’ equity
SHAREHOLDERS’ DEFICIT
Preferred stock, $0.001 par value; 10,000,000 shares authorized; 864,229 and nil shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively (note 11)		-			-
Common stock, $0.001 par value; 40,000,000 shares authorized; 9,405,417 and 7,410,754 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively; 2,777 shares held in treasury at September 30, 2006 and December 31, 2005		9			7
Common stock, $0.001 par value; 40,000,000 shares authorized; 6,841,606 and 6,820,606 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively; 2,777 shares held in treasury		7			7
Additional paid-in capital		56,549			55,553
Additional paid in capital		51,025			48,743
Deferred compensation		—			(1,048	)
Deferred compensation		(1,442	)		(1,357	)
Accumulated deficit		(60,271	)		(55,169	)
Accumulated deficit		(47,099	)		(45,512	)
Total shareholders’ deficit		(3,713	)		(657	)
Total stockholders’ equity		2,491			1,881
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIT	$	2,613		$	3,883
Total liabilities and stockholders’ equity	$	4,375		$	3,164

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

~~Path~~PATH 1 ~~Network~~NETWORK ~~Technologies~~TECHNOLOGIES ~~Inc~~INC.

~~Consolidated~~CONDENSED ~~Statements~~CONSOLIDATED ofSTATEMENTS ~~Operations~~OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,
	For the three months ended September 30,						For the nine months ended September 30,
	2005			2004
	2006			2005			2006			2005
Revenues
REVENUES:
Product revenue	$	~~830~~870		$	~~351~~384		$	2,134		$	2,352
License revenue		-12			20—			28			—
Contract revenue		16—			-—			—			16
Other revenue		18			18
Royalty revenue		9			—			49			6
Total revenues		864			389
Services revenue		40			20			159			22
Cost of revenues
Other revenue		—			—			—			13
Cost of product revenues		266			410
Total revenues		931			404			2,370			2,409
Gross profit		598			(21	)
COST OF REVENUES:
Operating expenses
Cost of product sales		355			369			1,026			1,142
Engineering, research and development		940			656
Total cost of revenues		355			369			1,026			1,142
Sales and marketing		808			1,350
GROSS PROFIT		576			35			1,344			1,267
General and administrative		346			775
OPERATING EXPENSES:
Total operating expenses		2,094			2,781
Engineering research and development		413			1,175			1,453			3,296
Operating loss		(1,496	)		(2,802	)
Sales and marketing		392			949			1,900			2,521
Other expenses
General and administrative		482			711			1,424			2,114
Interest expense, net		(88	)		(30	)
Total operating expenses		1,287			2,835			4,777			7,931
Other expense		(3	)		(3	)
LOSS FROM OPERATIONS		(711	)		(2,800	)		(3,433	)		(6,664	)
Total other expenses		(91	)		(33	)
Other income (expense):
Net loss	$	(1,587	)	$	(2,835	)
Interest expense, net		(505	)		(217	)		(1,475	)		(470	)
Net loss per share	$	(0.24	)	$	(0.42	)
Other income (expense)		74			7			71			3
Weighted average shares used in loss per share calculation		6,746			6,676
Total other expense, net		(431	)		(210	)		(1,404	)		(467	)
LOSS BEFORE INCOME TAXES		(1,142	)		(3,010	)		(4,837	)		(7,131	)
Provision for income taxes		—			—			(1	)		(1	)
NET LOSS		(1,142	)		(3,010	)		(4,838	)		(7,132	)
Accumulated preferred dividends		(89	)		(94	)		(264	)		(188	)
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS	$	(1,231	)	$	(3,104	)	$	(5,102	)	$	(7,320	)
NET LOSS PER COMMON SHARE:
Basic and Diluted	$	(0.15	)	$	(0.45	)	$	(0.66	)	$	(1.06	)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic and Diluted		8,174			6,941			7,735			6,890

~~See~~The accompanying notes toare an integral part of these consolidated financial statements.

~~Path~~PATH 1 ~~Network~~NETWORK ~~Technologies~~TECHNOLOGIES ~~Inc~~INC.

~~Consolidated~~CONDENSED ~~Statements~~CONSOLIDATED ofSTATEMENTS ~~Cash~~OF ~~Flows~~CASH FLOWS

(in thousands)

(unaudited)

	Three MonthsEnded March 31,
	For the nine monthsended September 30,
	2005			2004
	2006			2005
Cash flows from operating activities:
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(14,~~587~~838	)	$	(27,~~835~~132	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		59143			~~108~~186
Bad debt expense		(58	)		-
Amortization of debt discount and loan fees and accretion of preferred stock discount		1,500			605
Accretion of debt discount		93			54
Recoveries of bad debt		(6	)		(60	)
Changes in assets and liabilities
Stock-based compensation expense		413			1,011
Accounts receivable		(81	)		81
Changes in assets and liabilities:
Inventory		44			(464	)
Accounts receivable		(99	)		166
Other current assets		92			(203	)
Inventory		110			5
Other assets		(306	)		1
Other current assets		(26	)		283
Accounts payable and accrued liabilities		(96	)		500
Other assets		(20	)		(524	)
Accrued compensation and benefits		(41	)		256
Accounts payable and accrued liabilities		421			323
Deferred revenue		(16	)		113
Accrued compensation and benefits		(182	)		236
Cash used in operations		(1,897	)		(2,389	)
Deferred revenue		114			(77	)
Cash flows from investing activities:
Net cash used in operating activities		(2,470	)		(4,978	)
Purchase of property and equipment		(37	)		(111	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalization of software development costs		(99	)		-
Capitalized software development - internal use tools		—			(113	)
Cash used in investing activities		(136	)		(111	)
Purchase of property and equipment		—			(96	)
Cash flows from financing activities:
Net cash used in investing activities		—			(209	)
Exercise of options		75			-
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock		-			239
Payment on notes and capital lease obligations		(981	)		(15	)
Repayment of notes		(5	)		(4	)
Proceeds from exercise of options		—			251
Issuance of preferred stock		2,789			-
Borrowing on revolving line of credit		1,840			—
Cash provided by financing activities		2,859			235
Issuance of common stock		405			—
Increase (decrease) in cash		826			(2,265	)
Payment of debt issuance costs		(41	)		—
Cash and cash equivalents, beginning of period		929			7,807
Issuance of preferred stock		—			5,384
Cash and cash equivalents, end of period	$	1,755		$	5,542
Net cash provided by financing activities		1,223			5,620
Supplemental cash flow disclosures:
Net increase (decrease) in cash and cash equivalents		(1,247	)		433
Capitalized costs associated with beneficial conversion charges and warrants	$	2,122		$	-
Cash and cash equivalents, beginning of period		1,636			929
Conversion of notes and accrued interest to common stock	$	-		$	331
Cash and cash equivalents, end of period	$	389		$	1,362
Acquisition of equipment	$	-		$	9
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Issuance of restricted stock to executives	$	85		$	-
Interest paid	$	213		$	3
Income taxes paid	$	1		$	1
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Conversion of notes and accrued interest to common stock	$	—		$	102
Capitalization of debt issuance costs and relative fair value of debt discount	$	809		$	3,333
Conversion of preferred shares	$	109		$	—
Reclassification of unvested restricted shares per SFAS 123 (R)	$	1,048		$	—
Issuance of common stock for preferred stock quasi-dividend	$	198		$	—
Issuance of restricted stock to executives	$	—		$	116
Return of property and equipment	$	37		$	—
Dividends accrued	$	264		$	188
Waiver of cash compensation	$	112		$	—

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

Path 1 Network Technologies Inc.

~~Notes~~NOTES toTO ~~the~~THE ~~Unaudited~~UNAUDITED ~~Consolidated~~CONDENSED ~~Financial~~CONSOLIDATED ~~Statements~~FINANCIAL STATEMENTS

~~Note~~NOTE 1 – ~~Basis~~BASIS ofOF ~~Presentation~~PRESENTATION

~~The~~Path ~~accompanying~~1 ~~consolidated~~Network ~~balance~~Technologies ~~sheet~~Inc. (“Path ~~at March 31~~1,” ~~2005~~“we,” or the ~~consolidated~~“Company”) ~~statements~~prepared ~~of operations for~~ the ~~three-month~~accompanying ~~periods~~unaudited ~~ended~~consolidated ~~March~~financial ~~31,~~statements ~~2005~~in ~~and~~accordance ~~2004,~~with ~~and~~ the ~~consolidated~~rules ~~statements~~and regulations of ~~cash flows for~~ the ~~three-month~~United ~~periods ended~~States ~~March~~Securities ~~31, 2005~~ and ~~2004,~~Exchange ~~have~~Commission ~~been prepared by Path 1 Network Technologies Inc.~~ (the “~~Company~~SEC”) ~~and~~including ~~have~~the ~~not~~instructions ~~been~~to ~~audited.~~Form ~~The~~10-Q ~~consolidated~~and ~~balance~~Rule 10-01 ~~sheet~~of ~~at December 31, 2004 has been audited~~Regulation S-X. ~~These~~Such ~~consolidated~~rules ~~quarterly~~and ~~financial statements,~~regulations inallow ~~the~~us ~~opinion~~to ofcondense ~~management,~~and ~~include~~omit ~~all~~certain ~~adjustments,~~information ~~consisting only of normal~~ and ~~recurring~~footnote ~~adjustments,~~disclosures ~~necessary~~normally toincluded ~~state~~in ~~fairly the~~ financial ~~information~~statements prepared ~~set forth therein,~~ in accordance with accounting principles generally accepted in the United States. ~~These~~We ~~quarterly~~believe these condensed consolidated financial statements ~~should~~reflect beall ~~read~~adjustments in(consisting ~~conjunction~~only ~~with~~of ~~the~~normal, ~~financial~~recurring ~~statements~~adjustments) ~~and~~that ~~notes~~are ~~thereto~~necessary for a ~~the~~fair ~~year~~presentation ~~ended~~of ~~December~~our ~~31,~~consolidated ~~2004~~financial position and results of operations for the periods presented. ~~The~~Results ~~interim~~of ~~consolidated~~operations ~~financial~~for ~~information contained~~the ininterim ~~this~~periods ~~filing~~presented isare not necessarily indicative of ~~the~~ results to be expected for ~~any other interim period or for~~ the ~~full~~ year ~~ending December 31, 2005~~.

~~Reclassifications~~The information included in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (referred to herein as the “Form 10-K”). The interim consolidated financial information contained in this filing is not necessarily indicative of the results to be expected for any other interim period or for the full fiscal year ending December 31, 2006.

~~Certain~~NOTE ~~reclassifications~~2 ~~have~~– ~~been~~SUMMARY ~~made~~OF toSIGNIFICANT ~~prior~~ACCOUNTING POLICIES ~~periods financial statements to conform to current year presentation.~~

~~Recently~~Principles ~~Issued~~of ~~Accounting~~Consolidation ~~Standards~~

~~In March 2005, the FASB issued Interpretation No.47 (FIN 47), Accounting~~The ~~for~~Company’s ~~Conditional~~consolidated ~~Asset~~financial ~~Retirement~~statements ~~Obligations.~~include ~~FIN 47 clarifies that an entity must record a liability for a “conditional” asset retirement obligation if~~ the ~~fair~~accounts ~~value~~ of ~~the~~Path ~~obligation~~1 ~~can~~and beits ~~reasonably~~wholly-owned ~~estimated.~~subsidiary, ~~The~~Path ~~provision~~1 ~~is effective~~Holdings ~~no later than the end of fiscal years ending after December 15,2005~~Inc. WeAll ~~have~~significant ~~not~~inter-company ~~determined~~accounts ~~what~~and ~~effect,~~transactions ~~if any, FIN 47 will~~ have onbeen ~~our financial condition or results of operations~~eliminated.

OnManagement ~~December~~Estimates 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), or SFAS 123(R), Share-Based Payment, which is a revision of SFAS 123. SFAS 123(R) supersedes APB Opinion No. 25, and amends SFAS 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values and pro forma disclosure will no longer be an alternative. The Company has not yet quantified the impact that adoption of SFAS 123(R) will have on its financial statements, but expects such impact to be material. On April 14, 2005, the U.S. Securities and Exchange Commission announced, in Staff Accounting Bulletin No. 107, a deferral of the effective date of SFAS 123(R) until the first interim period beginning after December 15, 2005. The Company expects to adopt SFAS 123(R) effective in its first fiscal quarter beginning January 1, 2006. The Company is currently determining how or if the adoption of SFAS 123(R) will impact the magnitude or form of its share-based compensation to employees. Assumptions

InThe ~~November~~preparation ~~2004,~~of ~~the~~consolidated ~~FASB~~financial ~~issued~~statements ~~Statement~~in ofconformity ~~Financial~~with ~~Accounting~~accounting ~~Standards No.~~principles ~~151,~~generally ~~Inventory~~accepted ~~Costs,~~in anthe ~~Amendment~~United States of ~~ARB~~America ~~No.~~requires ~~43,~~management ~~Chapter~~to 4make ~~(SFAS~~estimates ~~151).~~and ~~SFAS~~assumptions ~~151~~that ~~clarifies~~affect ~~that~~the ~~abnormal~~reported amounts of assets ~~idle~~and ~~facility~~liabilities ~~expense,~~at ~~freight,~~the ~~handling~~date ~~costs,~~of the financial statements and ~~wasted~~the ~~materials~~reported ~~(spoilage)~~amounts ~~should~~of beexpenses ~~recognized~~during asthe ~~current-~~reporting period ~~charges~~. ~~and~~Actual ~~requires~~results ~~the~~could ~~allocation~~differ offrom ~~fixed~~those ~~production~~estimates. ~~overhead~~Significant toestimates ~~inventory~~made ~~based~~by onmanagement ~~the~~include ~~normal~~revenue ~~capacity~~recognition estimates, of the ~~production~~viability ~~facilities.~~of ~~SFAS~~recognizing ~~151~~deferred isincome ~~effective~~tax ~~for~~assets, ~~inventory~~capitalized software costs, ~~incurred~~the ~~during~~valuation ~~fiscal~~of ~~years~~equity ~~beginning~~instruments, ~~after~~and ~~June 15,~~the ~~2005. Adoption~~allowance offor ~~SFAS~~doubtful ~~151~~accounts. isSignificant ~~not~~changes ~~expected~~in tothese estimates may have a material impact on the ~~Company’s~~ financial ~~condition, results of operations or cash flows~~statements.

InCash ~~November~~and ~~2004,~~Cash ~~the~~Equivalents FASB issued Statement of Financial Accounting Standards No. 153, Exchanges of Non-monetary Assets, an Amendment of APB No. 29 (SFAS 153). SFAS 153 requires that exchanges of productive assets for similar productive assets should be measured based on the fair value of the assets

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

Fair Value of Financial Instruments

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

~~exchanged~~Concentrations except in those instances in which the exchanges of non-monetary assets do not have commercial substance. SFAS 153 is effective prospectively for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Adoption of SFAS 153 is not expected to have a material impact on the Company’s financial condition, results of operations or cash flows.

~~Note~~Substantially 2all –of ~~Stock-based~~our ~~Compensation~~cash and cash equivalents are maintained with one major financial institution in the United States. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal risk.

~~The~~We ~~Company~~perform ~~currently~~ongoing ~~accounts~~credit ~~for~~evaluations ~~stock-based~~of ~~compensation~~our ~~arrangements~~customers’ financial conditions and would ~~using~~limit the ~~intrinsic~~amount ~~value~~of ~~method~~credit inextended ~~accordance~~if ~~with~~deemed ~~the~~necessary ~~provisions~~but ofusually ~~Accounting~~we ~~Principles~~have ~~Board~~required ~~Opinion~~no ~~(“APB”)~~collateral. ~~25,~~The ~~Accounting~~Company ~~for~~has ~~Stock~~not ~~Issued~~experienced tosignificant ~~Employees,~~credit ~~SFAS~~losses ~~Interpretation~~on Noits customer accounts. 28Time Warner Cable, ~~Accounting~~Controlware ~~for~~Inc. ~~Stock~~and ~~Appreciation~~WilTel ~~Rights~~Communications, ~~and~~LLC ~~Other~~accounted ~~Variable~~for ~~Stock~~36%, ~~Option~~22% orand ~~Award~~17%, ~~Plans~~respectively, ~~and~~of ~~SFAS~~total ~~Interpretation~~trade ~~No.~~receivables 38as of December 31, ~~Determining~~2005 ~~the~~as ~~Measurement~~compared ~~Date~~to ~~for~~Frontiers ~~Stock~~Co. ~~Option~~Ltd., ~~Purchase,~~Time ~~and~~Warner ~~Award~~Cable ~~Plans~~and ~~involving~~Level ~~Junior~~3 ~~Stock~~Communications, Inc., ~~The~~which ~~Company~~accounted ~~also~~for ~~complies~~34%, ~~with~~26% ~~the~~and ~~disclosure~~15%, ~~provisions~~ respectively, of our ~~SFAS~~trade ~~123,~~receivables ~~Accounting~~as ~~for~~of ~~Stock-Based~~September 30, ~~Compensation~~2006.

~~The Company~~A ~~accounts~~small ~~for~~number ~~equity instruments issued to non-employees using the fair value method in accordance with the provisions~~ of ~~SFAS~~customers ~~123~~have ~~and~~typically ~~Emerging~~accounted ~~Issues Task Force Issue No. 96-18, Accounting~~ for ~~Equity~~a ~~Instruments~~large ~~that~~percentage ~~are~~of ~~Issued~~the ~~to Other~~Company’s ~~than~~annual ~~Employees~~revenues. ~~for~~Level ~~Acquiring,~~3 ~~or in Conjunction with Selling~~Communications, ~~Goods or Services~~Inc., InTime ~~December~~Warner ~~2002~~Cable, ~~the~~and ~~FASB~~Controlware ~~issued~~GmbH ~~Statement~~accounted offor ~~Financial Accounting Standards No. 148 (SFAS 48)~~27%, ~~Accounting~~22% ~~for Stock-Based Compensation—Transition~~ and ~~Disclosure.~~ ~~This~~11%, ~~statement~~respectively, ~~amends SFAS 123 to provide alternative methods~~ of ~~transition~~revenue for ~~a voluntary change to~~ the ~~fair~~nine ~~value~~months ~~based~~ended ~~method~~September 30, of2006 ~~accounting~~while ~~for~~WilTel ~~stock-based~~Communications, ~~employee compensation. In addition~~LLC, ~~the~~Time ~~statement~~Warner ~~amends the disclosure~~Cable, ~~requirements~~DirecTv ofand ~~SFAS~~Frontiers ~~123~~Co. toLtd. ~~require~~accounted ~~prominent~~for ~~disclosures~~28%, in16%, ~~both~~16% ~~annual~~ and ~~interim~~11%, ~~financial~~respectively, ~~statements about the method~~ of ~~accounting~~revenue for ~~stock-based employee compensation and~~ the ~~effect~~nine ofmonths ~~the~~ended ~~method~~September 30, ~~used on reported results~~2005. The Company’s ~~makes the~~reliance ~~following~~on ~~required~~relatively ~~disclosure~~few ~~under~~customers ~~SFAS~~could ~~148.~~have ~~The~~a ~~table~~material ~~below~~adverse ~~provides,~~effect on ~~a pro forma basis~~its business, ~~the~~financial ~~effect~~condition ~~employee~~and ~~stock-based compensation would have had on our operating~~ results ~~had the Company used the fair value method~~ of ~~accounting~~operations. ~~for stock-based compensation arrangements in conformity with SFAS 123 (in thousands, except per share amounts):~~

	Three Months Ended March 31,
	2005			2004
Net loss, as reported	$	(1,587	)	$	(2,835	)
Unrecorded stock-based employee compensation resulting from options vested during the period		64			6
Pro forma net loss	$	(1,651	)	$	(2,841	)
Basic and diluted loss per share:
As reported	$	(0.24	)	$	(0.42	)
Pro forma	$	(0.24	)	$	(0.43	)

Inventory

~~Equity~~The ~~instruments issued~~Company torecords ~~non-employees~~inventory, ~~that~~which ~~are~~consists ~~fully~~primarily ~~vested~~of ~~and~~raw ~~non-forfeitable~~materials ~~are~~used ~~measured~~in atthe ~~fair~~production ~~value~~of atvideo ~~the~~gateways ~~issuance date~~ and ~~expensed~~related inproducts, ~~the~~at ~~period over which~~ the ~~benefit~~lower isof ~~expected~~cost toor ~~be received~~market. ~~Equity~~Cost ~~instruments~~is ~~issued~~determined toprincipally ~~non-employees~~on ~~which~~the ~~are~~average ~~either~~cost ~~unvested~~method. orProvisions ~~forfeitable,~~ for ~~which~~potentially ~~counter-party~~obsolete ~~performance~~or isslow-moving ~~required~~inventory ~~for the equity instrument to be earned,~~ are ~~measured~~made ~~initially~~based aton ~~the~~an ~~fair~~analysis ~~value and subsequently adjusted for changes in fair value until the earlier~~ of: 1)inventory ~~the~~levels ~~date~~and ~~at which~~future asales ~~commitment~~forecasts. ~~for~~The ~~performance~~provision byis ~~the counter~~re-~~party~~measured toat ~~earn~~each ~~the~~balance ~~equity~~sheet ~~instrument is reached; or 2) the~~ date ~~on which the counter-party’s performance is complete~~.

~~During~~Property ~~the three-month periods ended March 31, 2005~~ and ~~2004,~~Equipment the Company recorded no stock-based compensation expense related to the amortization of options outstanding to employees and consultants. Stock-based compensation expense is expected to be higher in future quarters due to the planned vesting dates for restricted stock awards granted in earlier periods to company executives.

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

Beneficial Conversion Feature

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

Income Taxes

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

~~Note~~Revenue 3Recognition ~~– Private Offering~~

On January 26, 2005, the Company entered into a Securities Purchase Agreement (the “Agreement”) and a related Registration Rights Agreement, with certain accredited investors. On January 27, 2005, pursuant to the Agreement, the Company sold to a group of accredited investors 556,538 shares of the Company’s mandatorily-redeemable 7% Convertible Preferred Stock (the “Preferred Stock”), and issued to those investors warrants to purchase up to 278,268 shares of the Company’s Common Stock (the “Warrants”). A Warrant to purchase one-half share of Common Stock was issued in connection with the purchase of each share of Preferred Stock. The per share purchase price of the Preferred Stock (with 0.5 Warrant) was $3.25, and the Warrants carry an exercise price of $4.20 per share. The Company’s gross receipts from the sale of the shares of Preferred Stock (with Warrants) were $1,808,750. On February 18, 2005, under the Agreement, the Company sold to other accredited investors at a second closing a total of 307,691 shares of Preferred Stock and 153,847 Warrants, for $1,000,000. In total, under the two closings, the Company sold 864,229 shares of Preferred Stock and 432,115 Warrants, for gross receipts of $2,808,750.

The Preferred Stock accrues dividends at the rate of $0.2275 per share per year, and dividends are cumulative. The Preferred Stock is convertible at the option of the holder into shares of Common Stock at a conversion price of $3.25 per share, subject to specified anti-dilution adjustments. The Preferred Stock shall be automatically redeemed in four years for $3.25 per share plus accumulated but unpaid dividends. The Company has the right to redeem the Preferred Stock earlier upon certain conditions.

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

Note 4 – Management Estimates and Assumptions

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

Note 5 – Inventory

The Company records inventory, which consists primarily of raw materials used in the production of video gateways and related products and finished goods, at the lower of cost or market. Cost is determined principally on the average cost method. Provisions for potentially obsolete or slow-moving inventory are made based on an analysis of inventory levels and future sales forecasts. The provision is re-measured at each balance sheet date. At March 31, 2005, the Company had accrued approximately $127,000 for potentially obsolete or slow-moving inventory.

Note 6 – Revenue Recognition

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

Product Revenue

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

8Contract and Service Revenue

~~Table~~Revenue on engineering design contracts, including technology development agreements, is recognized on a percentage-of-completion method, ~~Contents~~based on costs incurred to date compared to total estimated costs. Billings on uncompleted contracts in excess of incurred costs and accrued profits are classified as deferred revenue.

terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, the Company may recognize revenue when the products are shipped or defer recognition until evidence of sell-through occurs or cash is received. Estimated warranty costs are calculated based on historical experience and are recorded at the time revenue is recognized. Our products generally carry a one-year warranty from the date of purchase.

Contract Service Revenue

Revenue on engineering design contracts, including technology development agreements, is recognized on a percentage-of-completion method, based on costs incurred to date compared to total estimated costs, subject to acceptance criteria. Billings on uncompleted contracts in excess of incurred costs and accrued profits are classified as deferred revenue.

License Revenue

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

Royalty Revenue

In December 2001, the Company entered into a Technology License Agreement with Visionary Solutions, Inc. in which Visionary Solutions Inc. was granted access to Path 1 DotCAM ^® Technology in exchange for royalties in an amount equal to 6% of the unit cost of the licensed products sold. The Company recorded $49,000 in royalty revenue for the nine months ended September 30, 2006 compared to $6,000 for the same period in the prior year.

Allowances for Doubtful Accounts, Returns and Discounts

The Company performs credit evaluations onof ~~all~~its ~~prospective~~ customers, and historically has not required collateral or deposits. Typically, the Company offers 30 day credit terms to customers based on a satisfactory credit evaluation. The Company establishes allowances for doubtful accounts based upon current economic trends, contractual terms and conditions and historical customer payment practices, as ~~the~~ well as for known or expected events. IfAs ~~there were to be a deterioration~~ of ~~a major customer’s creditworthiness~~September 30, or2006 ifthe ~~actual~~allowance ~~defaults~~for ~~were~~doubtful ~~higher~~accounts ~~than~~amounted ~~our~~to ~~historical~~approximately ~~experience~~$6, ~~our operating results and financial position could be adversely affected~~000.

~~Note~~8 ~~7 – Warranty Reserves, Indemnification Arrangements and Guarantees~~

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

~~The~~Indemnification ~~Company~~Arrangements provides a limited warranty for its products. A provision for the estimated warranty cost is recorded at the time revenue is recognized. Liabilities for the estimated future costs of repair or replacement are established and ~~charged~~Guarantees to cost of sales at the time the related revenue is recognized. The amount of liability to be recorded is based on management’s best estimate of future warranty costs expected to be incurred for its products still under warranty at the time of measurement. This estimate is derived from analyzing trends in product failure rates and trends in actual product repair costs incurred. The Company’s standard product warranty extends one year from date of sale; however, the Company may warrant products for periods greater than one year under certain circumstances. The following table summarizes the activity in the liability accrual related to product warranty during the three months ended March 31, 2005:

	(in thousands)
Balance at December 31, 2004	$	29
Warranty expense accrued in the current period		3
Actual warranty costs incurred in the period		(6	)
Change in accrual related to change in estimates		-
Balance at March 31, 2005	$	26

In connection with Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others”, the following disclosures are made with respect to the Company’s product warranties.

The Company ~~also~~provides a limited ~~undertakes~~warranty ~~indemnification~~for ~~obligations~~its inproducts. A provision for the ~~ordinary~~estimated ~~course~~warranty cost is recorded at the time revenue is recognized. The amount of ~~business~~liability ~~related~~to be recorded is based on management’s best estimate of future warranty costs expected to be incurred for its products, still under warranty at the ~~licensing~~time of ~~its~~measurement. ~~software,~~This estimate is derived from analyzing trends in product failure rates and ~~the~~trends ~~issuance~~in ofactual ~~securities~~product repair costs incurred. ~~Under~~The ~~these~~Company’s ~~arrangements~~standard product warranty extends one year from date of sale; however, the Company may ~~indemnify~~warrant ~~other~~products ~~parties~~for ~~such~~periods asgreater ~~business partners,~~than ~~customers,~~one ~~and~~year ~~underwriters,~~under ~~for~~ certain ~~losses~~circumstances. ~~suffered,~~The following table summarizes the activity in the liability accrual related to product warranty during the nine months ended September 30, 2006:


	(in thousands)
	September 30, 2006
	(Unaudited)
Warranty reserve beginning balance at December 31, 2005	$	10
Warranty expense accrued during the period		—
Actual warranty costs incurred during the period		1

Warranty reserve ending balance	$	11

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

Research and Development Expenses

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

Software Development Costs

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

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

~~claims~~Once ofinternal ~~intellectual~~use ~~property~~software ~~infringement,~~tools ~~negligence~~are ~~and~~fully-developed ~~intentional acts in the performance of services,~~ and ~~violations of laws including certain violations of securities laws. The Company’s obligation to provide such indemnification in such circumstances would arise if~~deployed, ~~for example, a third party sued a customer for intellectual property infringement and~~ the Company ~~agreed~~amortizes ~~to indemnify~~ the ~~customer~~final ~~against~~capitalized ~~such~~amount over ~~claims. The Company is unable to estimate with any reasonable accuracy~~ the ~~liability~~remaining ~~that~~useful ~~may~~lives, becurrently ~~incurred~~estimated ~~pursuant~~ to ~~its~~be ~~indemnification~~30 ~~obligations~~months. ~~Some of the factors that would affect this assessment include~~Additionally, ~~but~~at ~~are not~~each ~~limited~~subsequent ~~to,~~balance ~~the~~sheet ~~nature~~date of the ~~claim~~asset ~~asserted,~~is ~~the~~reviewed ~~relative~~for ~~merits~~impairment ~~of the claim, the financial ability of the parties, the nature~~ and ~~amount of damages claimed~~, ~~insurance coverage that the Company may have to cover such claims, and the willingness of the parties to reach settlement,~~ if ~~any. Because of the uncertainty surrounding these circumstances~~impaired, ~~the~~is ~~Company’s~~adjusted ~~indemnification obligations could range from immaterial to having a material adverse impact on its financial position and its ability to continue in the ordinary course of business~~accordingly.

~~Note~~The 8following –table ~~Capitalized~~summarizes ~~Software~~the ~~Development~~activity ~~Costs~~related to capitalized software development costs during the nine months ended September 30, 2006:

The Company capitalizes certain software development costs in accordance with FASB Statement of Financial Accounting Standards 86 (SFAS 86), Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed and AICPA SOP 98-1 (SOP 98-1), Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. During the three months ended March 31, 2005, the Company capitalized approximately $99,000 of engineering costs, consisting of $96,000 related to product development under SFAS 86 and $3,000 for development of internal use software tools under SOP 98-1.


	(in thousands)
	September 30, 2006
	(Unaudited)
Capitalized software assets:
Beginning balance	$	123
Costs capitalized during the period		—

Ending balance	$	123
Accumulated amortization of capitalized assets
Beginning balance	$	(33	)
Amortization expense recorded during the period		(34	)

Ending balance	$	(67	)

Net capitalized software	$	56

~~The~~Stock-Based ~~costs~~Compensation capitalized under SFAS 86 during the quarter ended March 31, 2005 consisted primarily of the salaries and employee benefits of the Company’s personnel directly involved in the various software development efforts and direct costs associated with third parties hired to assist with these developments. These capitalized costs were costs incurred to create product masters subsequent to the software product under development achieving technological feasibility as a working model as required by SFAS 86. The Company will capitalize similar future costs incurred to bring this product to general release to the public at which time capitalization will cease and amortization will begin.

~~While~~In ~~capitalization of costs under SFAS 86 to date~~December 2004, ~~and~~the ~~for~~FASB ~~the~~issued ~~development~~revised Statement of aFinancial ~~particular~~Accounting ~~software~~Standards ~~product~~No. 123 to(R) (“SFAS ~~be sold~~123(R)”), ~~has~~“Share-Based ~~been~~Payment.” ~~recorded~~On ~~under~~April 14, ~~the working model provisions~~2005, ~~SFAS~~the 86SEC adopted ~~also~~a ~~provides~~new ~~for~~rule ~~capitalization~~amending ofthe ~~costs~~effective ~~incurred~~dates ~~once a~~for ~~product~~SFAS ~~has~~123(R). ~~achieved~~In ~~technological~~accordance ~~feasibility~~with ~~under~~the anew ~~more~~rule, ~~structured~~the ~~detail~~accounting ~~program~~provisions ~~design~~of ~~model.~~SFAS ~~The~~123(R) ~~Company~~became ~~plans~~effective tofor ~~use~~us ~~the~~beginning ~~detail program design methodology~~ in the ~~future~~quarter ~~for~~ended ~~software~~March 31, ~~development efforts~~2006.

AtWe ~~March~~adopted 31the provisions of SFAS 123(R) on January 1, ~~2005~~2006, the ~~Company~~first ~~had~~day ~~net~~of ~~software~~our ~~capitalizations~~fiscal ~~totaling $110,000~~2006. ~~The~~Accordingly, ~~capitalized~~compensation ~~amount~~expense ~~will~~for beall ~~amortized~~share-based ~~over~~awards anto employees ~~expected~~is ~~twenty-four~~measured ~~month~~based ~~period~~on ~~beginning~~the ingrant ~~the~~date ~~second~~fair ~~quarter~~value of ~~2005.~~those ~~The~~awards ~~amount~~and ofrecognized ~~annual~~over ~~expense~~the toperiod beduring ~~recognized~~which ~~will be~~ the ~~greater~~employee ofis ~~the~~required ~~amount~~to ~~that~~perform ~~would~~service bein ~~amortized~~exchange ~~using~~for the ~~straight-line~~ ~~method~~award (generally over the ~~remaining~~vesting ~~economic~~period ~~life~~ of the ~~product~~award). ~~including~~We ~~the~~have ~~period~~no awards ~~being~~with ~~reported~~market ~~and~~or ~~the~~performance ~~amount~~conditions. ~~that~~Excess ~~would~~tax bebenefits, ~~amortized~~as defined by ~~the~~SFAS ~~ratio~~123(R), ~~actual~~will ~~period~~be ~~sales~~recognized ofas ~~the~~an ~~product~~addition ~~bear~~ to ~~the~~additional ~~total~~paid-in ofcapital. ~~current~~Effective January 1, 2006 and ~~anticipated~~for ~~future~~all ~~sales~~periods subsequent to that date, SFAS 123(R) ofsupersedes ~~the~~our ~~product~~previous accounting under Accounting Principles Board Opinion No. 25, ~~The~~“Accounting ~~following~~for ~~table~~Stock ~~summarizes~~Issued ~~activity~~to ~~within~~Employees” (“APB 25”). In March 2005, the ~~capitalized~~SEC ~~software~~issued ~~and~~Staff ~~related~~Accounting ~~amortization~~Bulletin ~~accounts~~No. 107 (“SAB ~~during~~107”) relating to SFAS 123(R). The Company has applied the ~~three~~provisions ~~months~~of ~~ended~~SAB ~~March~~107 ~~31,~~in ~~2005:~~its adoption of SFAS 123(R).

	(in thousands)
Capitalized software assets:
Balance at December 31, 2004	$	11
Costs capitalized during the period		99
Impairment write-down of asset during the period		-
Balance at March 31, 2005	$	110
Accumulated amortization of capitalized software assets:
Balance at December 31, 2004	$	-
Amortization expense recorded during the period		-
Balance at March 31, 2005	$	-

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

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

~~Note~~Share-based 9compensation –expense ~~Off~~recognized ~~Balance~~during ~~Sheet~~the ~~Arrangements~~period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Share-based compensation expense recognized in our consolidated statements of operations for the three and nine months ended September 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested, as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with SFAS 123(R). For share awards granted in fiscal 2006, expenses are amortized under the straight-line attribution method. For share awards granted prior to fiscal 2006, expenses are amortized under the straight-line single option method prescribed by SFAS 123. As share-based compensation expense recognized in the consolidated statements of operations for the three and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 20% for both officers and directors and 20% for employees in fiscal 2006 based on our historical experience. In our pro forma information required under SFAS 123 for the periods prior to fiscal 2006, we accounted for forfeitures as they occurred.

~~The~~Total ~~Company~~estimated ~~does~~share-based ~~not~~compensation ~~have~~expense, ~~off-balance~~related ~~sheet~~to ~~arrangements,~~all ~~financings,~~of orour ~~other~~share-based ~~relationships~~awards, ~~with~~recognized ~~unconsolidated~~under ~~entities~~SFAS or123(R) ~~other~~for ~~persons,~~the ~~also~~three ~~known~~and asnine ~~special~~months ~~purpose~~ended ~~entities~~September 30, ~~(“SPEs”).~~2006 was comprised of the following:

Note 10 – Reportable Operating Segments


	(in thousands except per share data)
	Three months ended September 30, 2006			Nine months ended September 30, 2006
Operations	$	1		$	2
Engineering research and development		15			71
Sales and marketing		27			135
General and administrative		67			205

Share-based compensation expense before taxes		110			413
Related income tax benefits		—			—
Share-based compensation expense	$	110		$	413

Shares used to compute basic and diluted net loss per share		8,174			7,735
Net share-based compensation expense per basic and diluted common share	$	(0.01	)	$	(0.05	)


	(in thousands except per share data)
	Three months ended September 30, 2006			Nine months ended September 30, 2006
Stock-based compensation expense from:
Stock options	$	61		$	192
Restricted stock awards		49			221

Total	$	110		$	413

WeAs doof ~~not~~September 30, ~~have~~2006, ~~more~~$271,000 ~~than~~of ~~one~~total ~~reportable~~unrecognized ~~operating~~compensation ~~segment~~costs related to non-vested stock options and $382,000 related to non-vested restricted stock awards is expected to be recognized over a weighted average period of 1.50 years and 2.48 years, respectively.

~~Note~~Since 11we –have ~~Long~~a net operating loss carryforward as of September 30, 2006, no excess tax benefits for the tax deductions related to share-~~Term~~based ~~Liabilities~~awards were recognized in the consolidated statements of operations. Additionally, no incremental tax benefits were recognized from stock options exercised in the three and nine months ended September 30, 2006 which would have resulted in a reclassification to reduce net cash provided by operating activities with an offsetting increase in net cash provided by financing activities. Share-based compensation expense of $234,000 and $1,126,000 was expensed during the three and nine months ended September 30, 2005, respectively.

Notes Payable

The carrying value of the Company’s convertible note payable, excluding the Company’s line of credit, at March 31, 2005, is as follows:

	(in thousands)
Face value of convertible notes payable	$	102
Unamortized discount related to warrants		(2	)
Unamortized discount related to beneficial conversion feature		(7	)
Carrying value of convertible notes payable	$	93

The outstanding convertible note payable matures in May 2005. Under the terms of the note, the note principal is convertible at the holder’s option into 26,179 shares of common stock.

The Company maintains a $1 million revolving line of credit (“the LOC”) with Laurus Master Fund LLC. The LOC is secured by the Company’s accounts receivables and other assets, and the Company has the ability to draw down advances under the LOC subject to limits. Under the terms of the LOC, Laurus can convert advances made to the Company into common stock at a fixed conversion price of $6.78 per share. The LOC expires in February 2006. The amount outstanding under the LOC at March 31, 2005, is zero.

Mandatorily-redeemable convertible preferred shares (see Note 3)

In connection with the sale of the convertible preferred shares, which are required to be redeemed by the Company if not converted to the Company’s common stock by January 27, 2009, and the issuance of the warrants as part of the financing transaction, the Company has recorded a long-term liability under FASB Statement of Financial Accounting Standards No. 150 (SFAS 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 requires that mandatorily-redeemable stock be characterized as a liability and that all payments to, or accruals for the benefit of, the holders of the stock that are not a return of principal be treated as interest expense.

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

	(in thousands)
Amount payable for mandatorily-redeemable preferred shares (convertible into a maximum of 864,229 common shares)	$	2,809
Unamortized discount related to warrants		(380	)
Unamortized discount related to beneficial conversion feature		(1,684	)
Carrying value of mandatorily-redeemable convertible preferred shares	$	745

The convertible preferred shares have a cumulative 7% dividend rate and are mandatorily-redeemable for cash if not converted at the holder’s sole discretion into the Company’s common stock by January 27, 2009.

The maximum amount the Company may be required to pay to redeem the convertible preferred stock is approximately $2.8 million.

IfPro ~~all~~Forma ofInformation ~~the~~under ~~convertible~~SFAS ~~preferred~~123 ~~shares~~for ~~had~~Periods ~~been~~Prior ~~converted into the Company’s common stock on March 31, 2005, The Company would have been required~~ to ~~issue~~Fiscal ~~864,229 common shares with a total fair value of approximately $5~~2006.~~1 million.~~

~~Total~~Through ~~interest~~fiscal ~~expense~~2005, the Company accounted for equity instruments issued to non-employees using the ~~three~~fair ~~months~~value ~~ended~~method ~~March~~in 31accordance with the provisions of SFAS 123 and EITF Issue No. 96-18, ~~2005~~“Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, ~~includes~~or ~~coupon~~in ~~interest~~Conjunction onwith ~~notes~~Selling, ~~payable~~Goods ofor ~~approximately~~Services.” $1In December 2002,~~700;~~ ~~non~~the FASB issued SFAS No. 148 (“SFAS 148”), “Accounting for Stock-~~cash~~Based ~~interest~~Compensation—Transition and Disclosure.” This statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value ~~expense~~based method of ~~approximately~~accounting ~~$17~~for stock-based employee compensation. In addition,~~300~~ ~~pertaining~~the tostatement ~~discounts~~amends ~~related~~the disclosure requirements of SFAS 123 to ~~warrants;~~require prominent disclosures in both annual and ~~non~~interim financial statements about the method of accounting for stock-~~cash~~based ~~interest~~employee ~~expense~~compensation and the effect of ~~approximately~~the ~~$76,000~~method ~~pertaining~~used toon ~~discounts~~reported ~~related~~results. toThe Company makes the ~~beneficial~~following ~~conversion~~required ~~features~~disclosure under SFAS No. 148. The table below provides, on a pro forma basis, the effect employee stock-based compensation would have had on the Company’s operating results had the Company used the fair value method of accounting for stock-based compensation arrangements in conformity with SFAS 123 for the three and nine months, respectively, ended September 30, 2005:

Amortization of debt issuance costs for the three months ended March 31, 2005, was approximately $3,000.


	(in thousands except per share data)
	Three months ended September 30, 2005			Nine months ended September 30, 2005
Net income (loss) attributable to common stock
As reported	$	(3,104	)	$	(7,320	)
Deduct:
Stock-based employee compensation expense determined under the fair value method		(25	)		(169	)

Pro forma	$	(3,129	)	$	(7,489	)

Basic and diluted net loss per share
As reported	$	(0.45	)	$	(1.06	)

Pro forma	$	(0.45	)	$	(1.09	)

~~Note~~Equity 12instruments issued to non-employees that are fully vested and non-forfeitable were measured at fair value –at ~~Subsequent~~the ~~Events~~issuance date and expensed in the period over which the benefit was expected to be received. Equity instruments issued to non-employees which were either unvested or forfeitable, for which counter-party performance was required for the equity instrument to be earned, were measured initially at the fair value and subsequently adjusted for changes in fair value until the earlier of: 1) the date at which a commitment for performance by the counter-party to earn the equity instrument was reached; or 2) the date on which the counter-party’s performance was complete.

OnOff-Balance ~~April~~Sheet ~~26,~~Arrangements 2005, the Company entered into a Securities Purchase Agreement with certain accredited investors for the private placement sale of $2,595,000 worth of Series B 7% convertible preferred stock and associated common stock warrants. This transaction is, subject to approval of our shareholders, expected to close in the second quarter of 2005. The Series B 7% convertible preferred stock will have terms and conditions similar to those of the 7% convertible preferred stock, including mandatory redemption on January 27, 2009 if not previously converted or redeemed.

~~ITEM~~The 2.Company ~~MANAGEMENT’S~~does ~~DISCUSSION~~not ~~AND~~have ~~ANALYSIS~~off-balance OFsheet ~~FINANCIAL~~arrangements, ~~CONDITION~~financings, ~~AND~~or ~~RESULTS~~other OFrelationships ~~OPERATIONS~~with unconsolidated entities or other persons, also known as special purpose entities.

~~Forward~~Reclassifications ~~Looking Statements~~

~~This~~Certain ~~document~~reclassifications ~~may~~have ~~contain~~been ~~forward-looking~~made ~~statements. These statements relate~~ to ~~future~~prior ~~events~~period ~~or our future~~ financial ~~performance. In some cases, you can identify forward-looking~~ statements byto ~~terminology~~conform ~~such~~to ascurrent ~~“may,”~~year “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminologypresentation. ~~These statements are only predictions. Actual events or results may differ materially.~~

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

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

OVERVIEW

We are an industry pioneer and leader in designing, developing and supplying products that enable the adaptation, transportation and delivery of broadcast-quality real-time video over private and public Internet Protocol (IP) networks, such as the networks that comprise the Internet. We currently offer two primary product lines that cater to different segments of the video market. Our Video Over IP gateway products are used by broadcasters and video service providers to transport live video content in real time between different locations, within a region, a country or even between countries—a process known as “long-haul transmission”. Since our products transmit video content over widely available IP communication networks, our customers can use existing infrastructure, thus lowering their costs and permitting them greater flexibility in the delivery of video content. Our Network Access Gateway products are primarily used by cable companies to supply video-on-demand, or VOD services. Our markets include cable, broadcast, satellite, telco, video carriers, mobile operators and enterprises.

~~Our~~NOTE ~~principal~~3 ~~executive~~– ~~offices~~GOING ~~are~~CONCERN located at 6215 Ferris Square, Suite 140, San Diego, California 92121. Our telephone number is (858) 450-4220, and our Internet website address is www.path1.com. We were incorporated in Delaware in January 1998.

~~INDUSTRY~~The ~~BACKGROUND~~accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern. This contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. From January 30, 1998 through September 30, 2006, our accumulated deficit totaled approximately $60 million. We have not yet achieved profitability, and remain a very risky enterprise. We have taken steps to reduce expenses to help manage our cash. As of September 30, 2006, we had negative working capital of approximately $1.9 million and cash and cash equivalents of $389,000.

~~Current~~As ~~technologies~~discussed ~~for~~in ~~transmitting~~further ~~real-time,~~detail ~~high-quality~~in ~~video~~Note ~~over~~7 ~~long~~below, ~~distances~~on ~~require~~April 25, ~~an established and fully dedicated circuit for the duration of a transmission~~2006, ~~regardless of whether~~ the ~~circuit~~Company iscompleted ~~being~~a ~~used~~$1.0 bymillion ~~the end~~non-~~user.~~convertible ~~The~~revolving ~~concept~~note isfinancing ~~similar~~with toLaurus aof ~~traditional~~which ~~telephone~~the ~~network—a~~Company ~~call~~drew isdown ~~placed~~$916,000. aAs ~~circuit~~part ~~between~~of ~~two~~this ~~(or~~agreement ~~multiple) points is established and thereafter~~Laurus ~~remains~~granted ~~open~~a ~~for~~loan ~~the~~to ~~duration of~~ the ~~call~~Company ~~(regardless~~ of ~~whether~~$600,000 ~~anyone~~in ~~is speaking). These technologies typically require that~~ the ~~network~~form beof ~~designed~~an toadvance bein ~~able~~excess toof ~~handle twice~~ the ~~expected~~formula ~~average~~amount ~~capacity in order to prevent congestion during peak usage. These technologies also require procuring expensive, dedicated bandwidth that remains open at all times regardless~~ of ~~usage.~~the ~~Dedicated~~revolving ~~bandwidth~~note which is ~~often~~to ~~priced~~be onrepaid aby ~~monthly basis~~January 1, ~~requiring significant cost regardless of usage~~2007.

~~Cable~~On ~~and~~August 30, ~~satellite~~2006, ~~companies~~the ~~have~~Company ~~historically~~entered ~~used~~into a Purchase Agreement with certain accredited investors pursuant to which the Company sold to investors an aggregate of 1,620,000 shares of the Company’s common ~~technologies~~stock ~~that~~(the ~~typically~~“Common ~~require~~Stock”) ~~all~~at ~~available~~a ~~packages~~purchase price of ~~programs~~$0.25 beper ~~broadcast~~share for aggregate gross proceeds of $405,000 (the “Financing”). In connection with the Financing, the Company issued to ~~every~~Laurus ~~subscriber~~Master Fund, Ltd. As(“Laurus”) a warrant ~~result~~to purchase up to an aggregate of 350,000 ~~limited~~shares ~~bandwidth~~of ~~remains~~Common ~~available~~Stock with an exercise price of $0.50 per share. The fair value of the warrants amounted to $107,000 and was capitalized as debt issuance costs which is being amortized over the remaining life of the convertible note. In exchange for ~~video~~the Warrant, Laurus agreed to (i) defer the repayment of the $600,000 over-advance related to the RLOC (as defined below) from October 1, 2006 to January 1, 2007, (ii) continue the principal repayment holiday on ~~demand~~the $2.1 million Secured Convertible Term Note from September 1, 2006 until January 1, 2007, (iii) not declare default and ~~similar~~accelerate ~~interactive~~either ~~services~~the ~~requiring~~RLOC ~~two-way~~or ~~communication~~the Secured Convertible Term Note based on noncompliance with covenants related to the Company’s delisting from the American Stock Exchange (“AMEX”) and allow the Company to get listed on the OTC.BB Asno alater than December 31, 2006, and ~~result~~(iv) authorize the sale of certain of the Company’s patents so that the Company can use the proceeds of the sale for operating capital. The Warrant is exercisable until August 29, ~~such~~2011 ~~services~~and ~~are~~may ~~currently~~be ~~available~~exercised by Laurus only onpursuant to a cash ~~limited~~payment. ~~basis~~In ~~and~~connection inwith ~~select~~the ~~markets~~Financing, the Company’s Chief Executive Officer, Thomas L. Tullie, waived compensation amounting to $40,500 pursuant to an Officer Waiver of Cash Compensation agreement dated August 30, 2006. In addition, each member of the Company’s Board of Directors waived monthly cash compensation for the entire year for an aggregate amount of $96,000 pursuant to a Form of Board of Directors Wavier of Cash Compensation dated August 30, 2006.

~~The~~Given ~~rise~~our projected cash burn rate, we will be required to raise additional capital in the very near term. We are currently pursuing efforts to raise additional capital and considering the sale of IPcertain assets. We cannot ensure that financing will be available to us on acceptable terms, if at all. We may not be able to successfully find any financing or other strategic opportunities. Our inability to raise capital when needed would seriously harm our business. In addition, additional equity may dilute our stockholders’ interest, and ~~packet-based~~debt ~~networks~~financing, if available, may involve restrictive covenants and could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on debt. These matters, among others, raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

IPThe ~~networks~~following ~~have~~efforts ~~been~~are currently ~~predominantly~~in ~~used~~process to ~~carry~~address ~~data~~this ~~traffic~~uncertainty: such as web site pages, e-mail and file transfers. Over the past few years, voice traffic, or VoIP, has been added to these networks as a replacement for more expensive circuit-switched telephony networks. Video is the most recent extension of data types that can be transported over IP networks. As a result, IP networks have become a powerful and flexible platform capable of supporting data, voice and video, all converged on the same network infrastructure.

• The ~~advent~~Company ofis ~~IP and packet-based networks has resulted~~ in ~~a dramatic increase in~~ the ~~transmission~~process ~~and exchange~~ of ~~data,~~reviewing ~~information~~all ~~and~~options ~~ideas.~~in IPregard ~~networks chop data into small packets that are addressed~~ to ~~and~~quickly ~~received~~raising byadditional ~~designated addresses.~~sources ~~These packets are capable~~ of ~~being~~capital, ~~transmitted~~including ~~over~~but ~~networks~~not ~~independent~~limited ~~of one another. Divided and reassembled by switches and directed from source~~ to ~~destination~~incurring bynew ~~routers,~~debt ~~IP networks minimize wasted bandwidth by using bandwidth in quick bursts~~ and only when needed. IP networks typically require a design that only increases total network capacity by approximately 25% to handle peak load conditions. In addition, IP networks were designed to overcome failure of any particular portion of the ~~network.~~sale ~~In the event a particular pathway on the network fails, alternate routes to the same destination are available. But because each packet travels independent~~ of ~~the~~equity ~~others~~ and ~~possibly by a different pathway, certain packets can be delayed or delivered out of order relative to others, or may not ever arrive at the intended destination~~assets.

• The ~~impact~~Company ofhas ~~late~~recently orcompleted ~~missing packets on~~ a ~~transmission~~revolving ~~depends~~line ~~in large part on the form~~ of ~~communication.~~credit ~~With~~which ~~respect~~continues to ~~written~~provide ~~text, for instance, delay in the arrival of packets will likely not be noticed by the recipient. For this reason, email is~~ an ~~ideal~~additional ~~form~~source of ~~communication~~working ~~for~~capital ~~IP networks. But~~ in the ~~case~~short ~~of transmissions that must be delivered continuously, such as real-time, high-quality video, even a few milliseconds of delay may be noticeable by the viewer~~term. As the majority of video consumers have become accustomed to high-quality delivery, new service offerings must provide quality at least as good as that to which the target viewing audience has become accustomed. Thus, IP networks have historically not been well-suited for delivery of real-time, high-quality video. While it is currently possible to view video clips (such as movie trailers) over the Internet, the inability of current IP networks to deliver real-time, broadcast quality video requires that the clips first be downloaded, and then played. This download-and-play approach has limited application because, for instance, a 2.5-hour movie may generally take 6 hours to download over T1 or some types of DSL lines.

•

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

•

The Company is exploring the process of selling all the assets of the Company to a third party.

~~THE~~NOTE ~~PATH~~4 1– ~~SOLUTION~~ACCOUNTS RECEIVABLE, NET

WeAccounts ~~have~~receivable ~~developed~~as ~~the technologies and products that have overcome the above mentioned inherent limitations~~ of ~~IP networks for transporting live~~September 30, ~~broadcast~~ ~~quality~~2006 ~~video, thereby enabling broadcasters, telecos, carriers, satellite operators~~ and ~~cable companies to transport live video over these types of networks and thus enjoy the significant lower capital and operating costs of video transport~~December 31, ~~higher~~2005 ~~reliability~~consist ~~and quality and other benefits over legacy circuit switched networks, satellite, ATM and other platforms. Our products provide significant benefits for contribution and primary distribution~~ of ~~video. Our products perform three primary functions: First, they process and prepare multiple video feeds for delivery over an IP network. Second, they combine video streams arriving over~~ the IP network into single streams for delivery to the end-viewer. Third, and perhaps most important, they condition the video data to avoid impairments or disruptions that would otherwise deteriorate the quality of the video signal. Our products provide benefits and enable services as followsfollowing:

• Feasibility—IP offers wider bandwidths than are currently available on alternate video transmission methods (such as satellite and DS-3);


	(in thousands)
	September 30, 2006			December 31, 2005
	(Unaudited)
Accounts receivable	$	448		$	358
Other receivables		9			—

		457			358
Less: allowance for doubtful accounts		(6	)		(12	)

Receivables, net	$	451		$	346

•NOTE ~~Efficiency—by~~5 ~~using~~– ~~bandwidth~~INVENTORY ~~only when needed, a greater amount of content can be passed over a provider’s network.~~

•Inventory ~~Decreased~~as ~~capital costs—the extensive installed base~~ of IPSeptember 30, ~~networks~~2006 and ~~the~~December 31, ~~equipment~~2005 ~~used~~consist ~~to support them results in economies~~ of ~~scale and~~ the ~~availability~~following: ~~of cost-effective products;~~

• Decreased operations costs—IP networks, designed to be fault-tolerant and self-correcting, reduce the need for redundant back-up networks and significantly reduce maintenance and support costs; and


	(in thousands)
	September 30, 2006		December 31, 2005
	(Unaudited)
Inventory:
Raw materials	$	520	$	399
Finished goods		67		298

	$	587	$	697

•NOTE ~~Customization~~6 ~~and~~– ~~flexibility—the~~PROPERTY ~~software~~AND ~~architecture~~EQUIPMENT underpinning our products allows providers to increase the volume of video traffic being delivered simply by the remote activation of additional ports or features within our products, rather than incurring costs associated with new equipment installation.

•Property ~~Content~~and onequipment ~~demand—no~~as ~~longer~~of ~~compelled to broadcasting content uniformly to all end-users~~September 30, ~~providers~~2006 ~~can~~and ~~send specific content to only those requesting it~~December 31, ~~further~~2005 ~~reducing~~consist ~~bandwidth~~of ~~constraints (both into~~ the ~~home~~following: ~~and within the network);~~

We believe our technology can be used for a wide variety of purposes by communication service providers.


	(in thousands)
	September 30, 2006			December 31, 2005
	(Unaudited)
Property and equipment, net:
Computer equipment	$	574		$	568
Test equipment		727			769
Furniture and fixtures		150			151

		1,451			1,488
Less: accumulated depreciation & amortization		(1,353	)		(1,244	)

	$	98		$	244

MARKETS WE SERVE

Broadcast TV

Broadcasters and news organizations often gather their live content outside the studio, and they may need to move this high quality video in real time over long distances to reach production and aggregation facilities. In the broadcast industry, video is both distributed (for example, a video program that a broadcaster broadcasts to its viewers) as well as contributed (for instance, the video clips from multiple sources that are transported between and among broadcast studios or affiliates to be assembled into a video segment such as a news report or feature story that is, in turn, distributed for broadcast to viewers). For both the distribution and contribution of broadcast quality video, broadcasters have traditionally used satellite links or procured dedicated bandwidth on fiber lines, both of which are very expensive and usually require multi-year contracts. Our products allow the same video to be moved over existing IP networks at significantly reduced cost. In 2004, roughly 50% of our product revenues were derived from the long haul broadcast market.

Video Carriers

Video carriers offer permanent and temporary video transport solutions to broadcasters as an outsourced, bundled service. These carriers own or lease the network infrastructure and rent time and capacity to content owners for delivery of live video material that may be delivered to studios, network affiliates, broadcast centers or headend facilities for ultimate distribution into homes. Our Cx1000 and Ax100 products are currently being

~~used~~NOTE by7 ~~video~~– ~~carriers~~NOTES toPAYABLE deliver broadcast video in key US and international cities. Customers using our products for long-haul transmission include the Vyvx division of WilTel Communications which used our Cx1000 product to carry both the live primary and backup high definition (“HD”) broadcasts of Super Bowl XXXIX® and Super Bowl XXXVIII® over Vyvx’s HD VenueNet. Vyvx accounted for approximately 8% of our product revenue in 2004.

~~Satellite~~On ~~Providers~~April 25, 2006, we entered into a Security Agreement contemplating, and then immediately closed, a revolving line of credit financing transaction with Laurus, pursuant to which we issued Laurus a secured non-convertible revolving note (the “RLOC”) in the principal amount of up to $1 million, which matures in 24 months, has a variable interest rate of 200 basis points above prime, and requires monthly payments of accrued interest beginning May 1, 2006. In the transaction, we also issued to Laurus a seven-year Common Stock Purchase Warrant for the purchase of 662,251 shares of Common Stock, with an exercise price of $1.51 per share. The RLOC is secured by all our assets pursuant to a Master Security Agreement previously entered into with Laurus. We have the ability to draw down advances under the RLOC subject to limits primarily based upon our accounts receivable and inventory. We immediately requested and received a $916,000 advance. As part of this agreement Laurus granted a loan to the Company of $600,000 in the form of an advance in excess of the formula amount of the revolving note which was to be repaid by October 1, 2006. We agreed to and did register for resale under the Securities Act of 1933, as amended (the “Securities Act”) any shares of Common Stock that may in the future be issued by us to Laurus or Laurus’ assignees upon exercise of the Warrant. In connection with this transaction, we recorded the relative fair value of $501,000 related to the warrants to purchase Common Stock. The discount was recorded as additional paid-in capital, and reflected as a debt discount to be amortized over two years beginning in May 2006. The Company paid $41,000 in fees related to the issuance of the RLOC and is amortizing these fees over the term of the RLOC.

~~Satellite~~On ~~providers~~August 30, ~~broadcast~~2006, ~~signals~~in toconnection ~~earth~~with the ~~from~~issuance ~~satellites~~of ~~nearly 22~~1,620,000 ~~miles~~ ~~above~~shares ~~sea level. Because~~ of ~~the~~Common ~~coverage~~Stock ~~area~~to ~~(or~~certain ~~“footprint”)~~accredited ~~from~~investors, ~~that~~Laurus ~~altitude,~~agreed ~~satellite~~to ~~broadcasts~~defer ~~are~~the ~~capable~~repayment of ~~reaching~~the ~~vast~~$600,000 ~~areas.~~over-advance ~~Uplinking~~related ~~content~~ to the ~~satellite~~RLOC ~~for~~from ~~subsequent~~October 1, ~~broadcast~~2006 ~~back~~ to ~~Earth~~January 1, ~~however~~2007, ~~must~~continue bethe principal ~~done~~repayment atholiday ~~earth~~on ~~stations~~the ~~located~~Secured inConvertible ~~areas~~Term ~~with~~Note ~~characteristics~~from ~~favorable~~September 1, ~~for~~2006 ~~uplinking.~~until ~~Currently~~January 1, ~~many~~2007 ~~satellite~~and ~~providers~~not ~~collect~~declare ~~content~~default atand ~~these~~accelerate ~~uplink~~the ~~earth~~Convertible ~~stations.~~Term AsNote abased ~~result,~~on ~~content~~non-compliance ~~often~~with ~~“hops”~~covenants ~~from~~related ~~its source~~ to ~~and~~the Company’s delisting from the ~~Earth~~ ~~via~~AMEX. ~~interim~~In ~~earth~~exchange ~~stations~~for ~~and~~these ~~interim~~concessions, ~~satellites~~the ~~until~~Company ~~its~~issued ~~reaches~~to ~~the~~Laurus ~~uplink~~a ~~earth~~warrant ~~station~~to ~~positioned~~purchase up to ~~deliver~~an ~~the~~aggregate ~~content~~of up350,000 toshares ~~the~~of ~~intended~~Common ~~satellite~~Stock ~~for~~with ~~broadcast~~an toexercise ~~satellite~~price ~~subscribers~~of $0.50 ~~Moreover,~~per ~~satellites~~share. ~~have~~The afair ~~maximum~~value ~~15-year useful~~of ~~life~~the warrants amounted to $107,000 ~~requiring~~and ~~satellite~~was ~~providers~~capitalized toas ~~periodically~~debt ~~revisit~~issuance ~~the~~costs ~~extreme~~which ~~expense~~is ofbeing ~~launching~~amortized ~~and~~over ~~maintaining~~the aremaining ~~satellite~~life inof ~~orbit~~the convertible term note.

~~Our~~During ~~Cx1000~~the ~~product~~three ~~line~~and nine ~~allows~~months ~~satellite~~ended ~~providers~~September 30, to2006, ~~gather~~we ~~content~~drew atdown ~~uplink~~an ~~earth~~additional ~~stations~~amount ~~without~~of ~~the~~approximately ~~need~~$240,000 toand ~~hop~~$924,000, ~~the content through interim satellites~~respectively, ~~reducing~~from the ~~strain~~RLOC ~~on,~~ and ~~cost~~paid ~~of,~~back ~~satellite~~approximately ~~networks~~$800,000 and ~~their maintenance~~$1.1 Inmillion, ~~addition~~respectively, tofrom ~~the~~our ~~cost-savings,~~cash ~~collecting~~receipts ~~information~~for atthe ~~uplink~~same period. ~~earth~~For ~~stations~~the ~~via~~three IPand ~~networks,~~nine asmonths ~~opposed~~ended toSeptember 30, ~~satellite hops~~2006, ~~increases~~ the ~~speed~~Company bypaid ~~which information~~approximately ~~moves~~$29,000 ~~from~~and ~~source~~$43,000, torespectively, ~~consumer. Use~~ of ~~our~~interest, ~~products~~pertaining ~~enables satellite providers~~ to ~~avoid some of~~ the ~~delay~~RLOC. ~~associated~~The ~~with~~Company ~~“live”~~recorded ~~satellite~~non-cash ~~feeds.~~interest ~~Each~~expense ~~satellite~~of ~~hop~~approximately ~~introduces~~$63,000 aand $105,000 ~~half-second~~for ~~delay~~the ~~whereas~~three anand ~~existing~~nine ~~terrestrial fiber~~months ~~international~~ended ~~circuit~~September 30, ~~has~~2006, ~~less~~respectively, ~~than~~pertaining ato ~~quarter-second~~the ~~delay.~~amortization ~~PanAmSat~~of isthe andiscount ~~example~~for ofthe awarrants ~~satellite~~and ~~provider~~$5,000 ~~using~~and ~~our~~$9,000, ~~Cx1000~~respectively, ~~product~~of ~~over~~amortization ~~terrestrial~~expense ~~fiber~~of todebt ~~interconnect~~issuance ~~earth~~costs ~~stations~~ for ~~video routing with~~ the ~~least delay~~same period.

AsOn ~~cable~~December 6, ~~operators~~2005, ~~expand~~ the ~~number~~Company completed a $2.1 million financing with Laurus. The financing consisted of ~~channels~~a ~~offered~~$2.1 ~~and~~million ~~introduce~~Secured ~~services~~Convertible ~~such~~Term asNote ~~VOD~~which has a three-year term and ~~HDTV,~~bears ~~satellite~~interest ~~providers~~at ~~are~~a ~~seeking~~rate equal to ~~protect~~prime ~~and~~plus ~~expand~~250 ~~their~~basis ~~subscriber~~points ~~base~~per annum, payable monthly beginning 90 days after closing of the financing in (depending upon the circumstances) registered for resale stock or cash. The monthly payment includes principal of $60,606 plus accrued interest commencing on March 1, 2006 with the last payment due on November 1, 2008. On April 25, 2006, Laurus granted us a ~~number~~principal payment holiday for the months of ~~ways~~April to August 2006. ~~Satellite~~The ~~operators~~Note ~~now~~is ~~have~~convertible into shares of the ~~right~~Common Stock at $2.6316 per share, subject to ~~provide~~antidilution ~~local~~adjustments. ~~channels~~In connection with the financing, Laurus was also issued a seven-year Warrant to ~~local~~purchase ~~markets~~up to in181,362 shares of Common Stock at an exercise price of $2.89 per share. In connection with the ~~United~~financing, ~~States~~the Company paid approximately $156,000 in legal costs and ~~have~~transaction ~~made~~fees which were deducted directly from the proceeds. These fees were ~~available~~capitalized ~~local~~as ~~channels~~debt inissuance ~~most~~costs and will be amortized over the life of the ~~largest~~note. ~~metropolitan~~Net ~~markets~~cash received from the financing was approximately $1.9 ~~Recent~~million. ~~advances~~In connection with this transaction, we recorded a liability equal to the cumulative principal amount net of a $514,000 discount resulting in ~~digital~~a ~~compression~~net ~~technology~~liability ~~and~~totaling ~~terrestrial~~approximately ~~transport~~$1,586,000. ~~now~~The ~~allow~~discount ~~satellite~~results ~~operators~~from toan ~~cost-effectively~~effective ~~add~~beneficial ~~new~~conversion ~~high~~feature, ~~definition~~and ~~channels~~detachable warrants to ~~their~~purchase ~~line~~Common Stock with fair values of $244,000 and $269,000, respectively for the discount of the embedded conversion feature. The discount was recorded as additional paid-upin capital, and reflected as debt discount to ~~further~~ ~~expand~~be ~~their~~amortized ~~video~~over ~~entertainment~~three ~~offerings~~years beginning in December 2005.

~~Mobile~~During ~~Video~~the three and nine months ended September 30, 2006, the Company paid approximately $0 and $61,000 of principal, and approximately $55,000 and $92,000 of interest to Laurus, respectively, for the same period. The Company recorded non-cash interest expense for the three and nine months ended September 30, 2006 of approximately $20,000 and $61,000, respectively, for the discount of the effective beneficial conversion feature. In addition, the Company recorded non-cash interest expense for the three and nine months ended September 30, 2006 of approximately $22,000 and $67,000, respectively for the discount for the related warrants.

Mobile operators are launching video content services for their subscribers. Our products enable content owners, mobile content aggregators and wireless carriers to offer live video to mobile devices in addition to the streaming media content in their current offerings. Path 1 products can be used to transport over IP networks a variety of compressed videos that can be carried over MPEG-2 transport streams, including MPEG-2, MPEG-4, and VC-1 videos, at speeds of up to 214 Mbps. Our products serve as the critical quality of service assurance, preserving the quality of the video content throughout the entire network up to the point of handoff to a transcoder in the local wireless network. Transcoding further compresses the video to data rates from 40 to 200 Kbps for transmission over the cellular network. Because of the significant compression required to transport video to a mobile device, our products are critical for preserving the quality of the video prior to transcoding.

Cable Companies

Cable companies are quickly migrating to an all-digital environment. However, they still have to contend with a large portion of their infrastructure using legacy analog technologies. Our products can play a key role in the digital migration plan for cable operators. Our Chameleon vidX™ products are designed for cable companies to allow them to use existing digital set-top boxes already in consumer homes to provide video-on-demand services, a significant competitive advantage over satellite providers. The more efficient use of existing

~~bandwidth~~The ~~(both~~carrying ~~into~~value ~~the~~of ~~home and within~~ the ~~network)~~notes ~~allows~~payable ~~cable~~as ~~companies to increase the volume~~ of ~~content (whether movies~~September 30, ~~television~~2006 oris ~~live~~as ~~events)~~follows: ~~available for delivery whenever requested by the cable subscriber, or to increase the number of subscribers served with existing content volume.~~

Our products enable cable companies to deliver HD television that can potentially overwhelm the bandwidth capacity of current delivery technologies. Using our products, providers can avoid incurring significant capital expenditures to increase the capacity of existing infrastructure, and can avoid significant recurring costs to maintain and support the expanded networks resulting from HD television and increased numbers of channels.


	(in thousands)
	September 30, 2006			December 31, 2005
	(Unaudited)
Laurus notes payable	$	3,940		$	2,100
Principal payment of Laurus notes payable		(978	)		—
Unamortized discount related to warrants		(592	)		(263	)
Unamortized discount related to beneficial conversion feature		(176	)		(237	)

Carrying value of convertible notes payable, net of discount	$	2,194		$	1,600

~~Enterprise~~ NOTE 8 – MANDATORILY REDEEMABLE PREFERRED STOCK

~~Certain~~Series ~~industries~~A ~~require~~Convertible ~~delivery~~Preferred ofStock exceptionally high resolution, real-time video. Military and other government units require a unique level of sound and picture quality upon which they can make critical, high-consequence decisions. Movie studios demand similar standards upon which to make artistic or editorial decisions regarding their multi-million dollar productions.

ToOn ~~attain~~January 26, 2005, the Company ~~level~~entered ofinto ~~resolution~~a ~~required~~Securities byPurchase ~~studios~~Agreement (the “Agreement”) and ~~for~~a ~~government~~related ~~applications~~Registration ~~requires~~Rights ~~data~~Agreement, towith becertain ~~delivered~~accredited ~~uncompressed~~investors. ~~Compression~~On January 27, a2005, ~~common~~pursuant ~~means~~to ~~for~~the ~~transporting high-resolution data~~Agreement, isthe ~~designed~~Company sold to a group of ~~eliminate~~accredited ~~what~~investors ~~would~~556,538 ~~typically~~shares beof ~~redundant~~the orCompany’s ~~unnecessary~~mandatorily-redeemable ~~information~~7% Convertible Preferred Stock (the “Series A Preferred Stock”), orand issued to ~~allow~~those ~~data~~investors warrants to ~~fit~~purchase onup ~~satellites’~~to ~~limited~~278,268 ~~bandwidth~~shares of Common Stock (the “Series A Warrants”). ~~Because~~The per share purchase price of the ~~unerring~~Series ~~detail~~A ~~required~~Preferred byStock ~~these~~(with ~~industries~~0.5 Series A Warrant) was initially $3.25, ~~what~~and isthe ~~generally~~Series ~~acceptable~~A ~~TV-quality~~Warrants ~~degradation becomes~~initially ~~unacceptable~~carried an exercise price of $4.20 per share. The ~~opposing~~liquidation ~~requirements~~value per share in the case of ~~exceptionally~~voluntary ~~high~~or ~~resolution~~involuntary ~~and~~liquidation ~~high~~is ~~bit-rate~~$3.25, ~~make~~plus ~~most~~an ~~delivery~~amount ~~methods~~equal to the cash value of dividends accrued but unpaid whether or not declared. The Company’s gross receipts from the January 27, 2005, sale of Series A Preferred Stock (~~such~~with asSeries ~~satellite~~A Warrants) ~~unusable~~were $1,808,750. ~~Our~~On ~~Cx1000~~February 18, ~~product~~2005, ~~enables~~under the ~~delivery~~Agreement, the Company sold to other accredited investors at a second closing a total of ~~exceptionally~~307,691 ~~high~~shares ~~resolution~~of Series A Preferred Stock and 153,847 ~~high~~Series ~~bit-rate~~A Warrants, for $1,000,000. In total, under the two closings, the Company sold 864,229 shares of Series A Preferred Stock and 432,115 Series A Warrants, for gross receipts of $2,808,750. The financing was led by investor Gryphon Master Fund, L.P. The ~~real-time~~Company ~~video~~paid Gryphon Master Fund, L.P. (“Gryphon”) a fee of $30,000 to cover its expenses incurred in connection with this financing.

~~OUR~~The ~~SALES~~Series A ~~AND~~Preferred ~~MARKETING~~Stock ~~STRATEGY~~accrues dividends at the rate of $0.2275 per share per year, and dividends are cumulative. The Series A Preferred Stock shall be automatically redeemed on January 27, 2009 for $3.25 per share plus accumulated but unpaid dividends. The Company has the right to redeem the Series A Preferred Stock earlier upon certain conditions. As of September 30, 2006, the liquidation preference for the Series A Preferred Stock was approximately $3.0 million.

InSeries ~~the~~B ~~United~~Convertible ~~States,~~Preferred weStock have historically sold our products principally through our own direct sales force which is organized geographically to support customer requirements. In 2004, we initiated a new sales and marketing strategy that focuses on building partnering relationships with key industry partners where our products are complementary and can be sold as a solution. We also established new partnering relationships with Harmonic Inc. and Packet Video Network Solutions, an Alcatel company. We are continuing to develop similar type partnering relationships where we expect to engage in joint sales and marketing efforts with our partners in pursuing new business opportunities.

WeOn ~~sell~~June 1, 2005, pursuant to ~~international~~a ~~customers~~Securities ~~through~~Purchase ~~independent~~Agreement ~~distributors~~dated ~~and~~April 26, ~~integrators.~~2005, ~~International~~the ~~distributors~~Company ~~are~~sold ~~generally~~to ~~responsible~~accredited ~~for~~investors ~~importing the~~led ~~products~~by ~~and~~Castle ~~providing~~Creek ~~certain~~Technology ~~installation~~Partners LLC (“Castle Creek”), ~~technical~~for ~~support~~$2,575,000, ~~and~~a ~~other~~total ~~services~~of to792,306 ~~customers~~shares inof ~~their~~Series ~~territory.~~B ~~Our~~7% ~~direct~~Convertible Preferred ~~sales~~Stock ~~force~~(“Series B Preferred Stock”) and ~~distributors~~five-year ~~are~~warrants ~~supported~~to bypurchase up to a ~~highly~~total ~~trained~~of ~~technical~~396,155 ~~staff~~shares ~~including~~of ~~sales~~Common ~~engineers~~Stock. ~~who~~The ~~work closely~~purchase ~~with~~price ~~operators~~for toeach ~~develop~~combination ~~technical~~of ~~proposals~~one share and ~~design~~0.5 ~~systems~~warrants towas ~~optimize~~$3.25 ~~system~~and ~~performance~~the ~~and~~warrants ~~economic~~carry ~~benefits~~an exercise price of $3.25 per share. The Company paid Castle Creek Partners LLC fees totaling $25,000 to ~~operators~~cover its expenses.

AnThe ~~element~~Series ofB ~~our~~Preferred ~~strategy~~Stock accrues isdividends toat ~~aggressively~~the ~~pursue~~rate ~~(within~~of ~~our~~$0.2275 ~~financial~~per share per year, and ~~other~~dividends ~~means)~~are ~~opportunities~~cumulative. toThe ~~introduce~~Series ~~our~~B ~~products~~Preferred ~~into~~Stock was initially convertible at the ~~market~~option ~~and that~~of ~~create~~the ~~demand~~holder ~~for~~into ~~our~~shares ~~products~~of Common Stock at a conversion price of $3.25 Asper ~~such~~share, subject weto ~~have~~specified ~~entered~~anti-dilution ~~into~~adjustments. ~~selling~~The ~~arrangements~~liquidation ~~with~~value ~~major~~per ~~equipment~~share ~~providers~~in ~~and~~the ~~system~~case ~~integrators,~~of ~~both~~voluntary ~~domestically~~or ~~and~~involuntary ~~abroad~~liquidation is $3.25, toplus ~~enable~~an ~~greater~~amount ~~market~~equal ~~penetration~~to the cash value of ~~our~~dividends ~~products.~~accrued Webut ~~intend~~unpaid towhether ~~continue~~or not declared. The Series ~~our~~B ~~pursuit~~Preferred ofStock ~~those~~shall ~~strategic~~be ~~relationships~~automatically ~~where~~redeemed weon ~~believe~~January 27, we2009 ~~are~~for ~~capable~~$3.25 ofper ~~expanding~~share ~~our~~plus ~~sales~~accumulated ~~opportunities~~but ~~within~~unpaid dividends. The Company has the ~~markets~~right weto ~~currently~~redeem ~~serve~~the asSeries ~~well~~B asPreferred ~~those~~Stock ~~markets~~earlier ~~that~~upon ~~may~~certain ~~emerge~~conditions. inAs of September 30, 2006, the ~~future~~liquidation preference for the Series B Preferred Stock was approximately $2.4 million.

~~Our~~During ~~marketing organization develops strategies for product lines and~~2005, ~~in conjunction~~the ~~with~~conversion ~~our~~price ~~sales force, identifies evolving technical and application needs~~ of the ~~customers~~Series soB ~~that~~Preferred ~~our~~Stock ~~product~~was ~~development~~reduced ~~resources~~to ~~can~~$3.17424, besubject ~~most~~to ~~effectively~~any ~~and~~future ~~efficiently~~weighted ~~deployed~~average toantidilution ~~meet anticipated product requirements~~provisions. ~~Our~~This ~~marketing organization~~reduced isconversion ~~also responsible for setting~~ price ~~levels,~~was ~~demand~~established ~~forecasting~~by ~~and~~a ~~general~~one-time ~~support~~Special ~~of the sales force~~Re-Set, ~~particularly~~calculated atby ~~major~~a ~~accounts.~~formula based

~~OUR~~ on ~~TECHNOLOGY~~Current Market Price at the time of the June 1, 2005 Closing. This also had the effect of reducing the conversion price of the Series A Preferred Stock to $3.17424 per share as of June 1, 2005. Also, by private agreements, the exercise price of the 432,115 Series A Warrants was specially reduced from $4.20 to $3.25 upon consummation of the Series B Preferred Stock financing.

~~Flexible~~In ~~Product~~connection ~~Architecture~~with the sales of Series A Preferred Stock and Series B Preferred Stock, the Company paid cash fees of approximately $380,000 and issued to the Company’s placement agent or the placement agent’s designees, a warrant to purchase approximately 84,000 shares of Common Stock.

InThe asettlement with ~~market~~Castle ~~that~~Creek isdescribed ~~largely~~under ~~comprised~~the “Lawsuits/Settlements” subheading below, provided certain benefits to the holders of ~~equipment~~the ~~based~~Series onB ~~fixed~~Preferred ~~hardware~~Stock. ~~designs,~~In ~~Path~~connection with the $2.1 ~~has~~million ~~chosen~~financing towith ~~utilize~~Laurus, ~~designs~~we ~~based~~agreed onto ~~high-powered~~a ~~network~~Consent and ~~processors~~Waiver agreement dated February 10, 2006 with ~~specialized~~Castle ~~applications~~Creek, ~~software~~acting ~~(firmware)~~as tothe ~~implement~~holder of a ~~wide~~majority ~~variety~~of our Series B Preferred Stock. In consideration of ~~products~~the ~~without~~consent ~~requiring~~(under an ~~equally~~allegedly ~~large~~applicable ~~number~~protective ofprovision ~~unique~~veto ~~hardware~~right) ~~platforms.~~and ~~Our~~waiver ~~common~~(of ~~hardware~~a preemptive ~~platform~~participation isright) ~~scalable~~given by Castle Creek, ~~and~~we ~~helps~~agreed to ~~control~~provisions ~~product~~which ~~cost~~have the economic effect of reducing the conversion price of Castle Creek’s Series B Preferred Stock to $2.6316 per share. We believe consent was not in fact ~~and~~required. ~~reduce~~In ~~inventory~~the ~~risk~~Consent ~~while~~and Waiver agreement, we also ~~minimizing~~agreed ~~time~~to offer to ~~market~~each ~~for~~of ~~new~~the ~~features~~respective minority holders of the Series B Preferred Stock the same benefits and ~~functions~~the same burdens of the Consent and Waiver agreement, as if such minority holder was “Castle Creek” for such purposes. Each of the minority holders accepted this offer.

~~Path~~Lawsuits/Settlements 1 products can be field-upgraded, field repaired and even re-purposed for different uses by changing the firmware loaded into the same hardware platform. In most cases these changes can be made through the network, rather than requiring on-site personnel or factory returns. This product architecture, and the resulting flexibility it affords, has proven to be a unique differentiator for us.

~~The~~Castle ~~video~~Creek ~~over~~Technology IPPartners network environment is still considered to be a mix of the video world with its hundreds of standards and proprietary approaches, and the IP/data world with its much more regularized standards and proprietary implementations. Path 1 products bridge between these two worlds, so flexibility to deal with non-standard, proprietary implementations in different networks has been a major Path 1 strength. This flexibility allows us to provide our customers with quick product changes that allow video to be sent over IP networks in spite of equipment and network design idiosyncrasies that would otherwise prevent proper communications from taking place.

AsOn ~~network~~February 10, ~~changes~~2006, ~~take~~the ~~place,~~Company ~~either~~entered oninto a ~~planned~~Settlement orAgreement anwith ~~emergency~~regard ~~basis,~~to ~~Path~~a 1lawsuit ~~boxes~~brought ~~can~~against beus ~~upgraded~~in toJanuary ~~meet~~2006 ~~the~~by ~~new~~Castle ~~needs~~Creek, ~~with~~which ~~minimal~~holds ~~impact~~a tomajority of our Series B Preferred Stock (the ~~networks~~“Settlement Agreement”). ~~For~~The Castle ~~example,~~Creek alawsuit ~~customer~~was ~~may~~based ~~begin~~primarily ~~with~~on a 4claim ~~port~~that ~~software-enabled~~consent ~~version~~of a majority of the Series B Preferred Stock had been required in connection with our ~~Chameleon products.~~December At2005 ~~any~~issuance ~~point~~of ~~the~~a ~~same~~$2,100,000 ~~equipment~~secured ~~can~~convertible benote ~~field-upgraded~~and torelated ~~add~~warrants ~~input~~to orLaurus, but ~~output~~that ~~ports~~such orconsent ~~increase~~had ~~video~~not ~~stream~~been ~~counts~~obtained. orWe ~~rates—through~~believe ~~network-downloaded~~consent ~~licensing~~was ~~changes~~not required. In the ~~case~~Settlement ofAgreement, ~~our~~Castle ~~Cx1000~~Creek, ~~and~~acting ~~Ax100~~as ~~products,~~the ~~these~~holder ~~products~~of ~~can be~~a ~~upgraded~~majority ~~with~~of ~~our~~the ~~RepliCaster™~~Series ~~upgrade~~B ~~to provide~~Preferred ~~for~~Stock, ~~video~~provided ~~stream~~such ~~replication~~consent.

~~Product~~Under ~~Technology~~the –Settlement ~~Long~~Agreement, ~~Haul~~we agreed to provisions which have the effect of reducing the conversion price of Castle Creek’s Series B Preferred Stock from $3.17424 per share to $2.6316 per share, and we agreed to make payments to Castle Creek which are economically equivalent to regular dividends on the Series B Preferred Stock. We can choose to make such payments in shares of Common Stock (at 85% of then-current market value) or in cash. We also agreed to provisions which have the economic effect that, if we were to issue shares under the Laurus arrangement to Laurus at a price lower than Castle Creek’s effective conversion price, a portion of Castle Creek’s Series B Preferred Stock would, if actually converted shortly thereafter, effectively be convertible at such lower price.

~~Path~~In ~~1 products are designed to overcome~~ the ~~inherent limitations~~Settlement inAgreement, IPwe ~~networks~~also ~~that~~agreed ~~would otherwise make it difficult if not impossible~~ to ~~transport~~offer ~~live, broadcast quality video over these networks. IP networks, in general, are not perfect in their timing and in their ability~~ to ~~prevent~~each ~~packet loss. Through the use~~ of ~~proprietary technologies, however, our long-haul products restore timing that may have been skewed as~~ the ~~packets~~respective ~~traveled~~minority ~~through~~holders ~~the~~of ~~networks. Our products also have~~ the ~~ability~~Series toB ~~restore~~Preferred ~~lost~~Stock ~~or out of order packets through~~ the ~~use~~same ofbenefits either Path 1 proprietary forward error correction or through Pro-MPEG standards-based forward error correction. Packet loss often occurs in large blocks, due to a variety of network problems. Path 1 proprietary forward error correction and ~~transport~~the ~~restore~~same ~~losses~~burdens of ~~thousands~~the ofSettlement ~~consecutive packets~~Agreement, ~~which~~as isif ~~extremely~~such ~~valuable~~minority inholder ~~networks~~was ~~that are particularly~~ “~~bursty~~Castle Creek” infor ~~nature~~such purposes. ~~This~~We ~~resiliency~~did ~~has~~so, ~~allowed~~and ~~some~~all of ~~our customers to transport high quality video over~~ the ~~public~~ ~~Internet.~~minority ~~Moreover,~~holders ~~our~~accepted ~~customers~~this ~~can send live video over MPLS networks without concern for the impact of network fast re-routing~~offer.

~~Even~~In inconnection with the ~~case~~Settlement ofAgreement, the ~~emerging~~Company recorded ~~international~~$574,000 ~~standards~~at ~~for~~December 31, ~~transporting~~2005 ~~live~~of ~~video~~additional ~~over~~discount IPrelated ~~networks,~~to ~~Path~~the 1beneficial ~~provides~~conversion afeature ~~unique~~of ~~differentiated~~the ~~solution. In~~Series ~~contrast~~B toPreferred ~~most~~Stock ofsince ~~our~~this ~~competitors,~~contingency ~~our~~was ~~implementation~~outstanding ofat ~~Pro-MPEG~~that ~~standard~~date. ~~forward~~The ~~error~~Company ~~correction~~issued in54,605 ~~the~~and ~~Vx8000~~186,228 ~~our~~shares ~~first~~of Common ~~standards-based~~Stock ~~transport~~to ~~gateway,~~holders ~~enables~~of ~~handling~~Series ~~the~~B ~~maximum~~Preferred ~~allowed~~Stock ~~number~~on ofFebruary 24, ~~consecutive~~2006 ~~lost~~and ~~packets.~~September 6, ~~This~~2006, ~~is possible~~respectively, ~~due~~as topayments ~~the~~economically ~~large~~equivalent ~~memory~~to ~~buffers~~dividends ~~and~~valued ~~processor-driven~~at ~~implementation~~approximately in$124,000 ~~our~~and ~~products~~$71,000, respectively.

~~Our~~In ~~Cx1000~~connection iswith ~~one~~the RLOC, we agreed to a Consent and Waiver agreement dated April 22, 2006 with Castle Creek, acting as the holder of a majority of our Series B Preferred Stock (the ~~few~~“Consent ~~products~~and inWaiver Agreement”). In consideration of the ~~market~~consent ~~that~~(under isan ~~capable~~allegedly applicable protective provision veto right) and waiver (of ~~SDI~~a ~~data~~preemptive ~~rates.~~participation ~~With~~right) ~~advanced~~given ~~features~~by Castle Creek, ~~such~~we asagreed to provisions which have the ~~ability~~economic effect of reducing the conversion price of Castle Creek’s Series B Preferred Stock to ~~replicate~~$1.51 aper ~~single~~share. ~~SDI~~We ~~stream~~believe ~~into~~consent ~~three~~was ~~streams,~~not ain ~~Cx1000~~fact ~~can~~required. ~~transmit~~In athe ~~full~~Consent 1and Waiver Agreement, we also agreed to offer ~~Gigabit/second~~to ~~stream~~each of ~~video~~the ~~into~~respective minority holders of the ~~network.~~Series ~~The~~B ~~RepliCaster™~~Preferred ~~feature~~Stock ~~has~~the ~~been~~same ~~especially~~benefits ~~useful~~and ~~when~~the ~~MPLS~~same ~~networks~~burdens ~~are~~of ~~not~~the ~~appropriate~~Consent and Waiver Agreement, as if each such minority holder was “Castle Creek” for such purposes. Each of the minority holders accepted this offer.

~~Product~~Gryphon ~~Technology~~Master –Fund ~~Multiplexing, De-multiplexing, and Pass-thru~~

AWe ~~large~~have ~~amount~~also ofbeen ~~legacy~~sued ~~equipment~~in ~~used~~a insimilar ~~video~~lawsuit ~~transport~~brought ~~networks~~in ~~has~~January ~~been designed~~2006 toby ~~output~~Gryphon orand ~~input~~GSSF inMaster ~~video~~Fund, ~~ASI~~LP, ~~format.~~which ~~Our~~together ~~Chameleon~~hold ~~vidX~~a ~~products~~majority ~~can~~of ~~convert~~our ~~multiple~~Series ~~ASI~~A ~~video~~Preferred ~~streams~~Stock, toin ~~Ethernet-based~~the ~~Internet~~United ~~Protocol~~States ~~and~~District ~~can~~Court ~~also~~for ~~take~~the Northern ~~Ethernet-based~~District ~~Internet~~of ~~Protocol~~Texas. ~~streams~~We ~~containing~~have ~~MPEG~~offered 2to ~~video~~settle ~~and~~that ~~convert~~case ~~to ASI~~on ~~video.~~the ~~Doing~~same soterms ~~allows~~as ~~legacy~~were ~~equipment~~provided to beCastle ~~used~~Creek in ~~today~~the Settlement Agreement (including optional extension of the settlement’s IPbenefits ~~networks~~and burdens to each of the respective minority holders of Series A Preferred Stock). The ~~flexibility~~plaintiffs ~~provided~~in by the ~~Path~~Texas 1case ~~technology~~have ~~provides~~not ~~multiplexing,~~accepted ~~de-multiplexing~~this offer, and ~~pass-thru~~the ofcase ~~ASI~~is ~~streams~~proceeding. ~~utilizing~~We believe our defenses are meritorious. The Company recorded a ~~Chameleon~~reserve ~~vidX~~of ~~unit~~$637,000 at ~~both~~December 31, ~~ends~~2005 of additional discount related to the beneficial conversion feature of the IPSeries ~~network~~A Preferred Stock since this contingency was outstanding at that date.

~~Product~~Silverwood ~~Development~~Partners

~~Our~~On ~~product~~March 16, ~~development~~2006, ~~efforts~~the ~~are~~Company ~~continuous~~entered into a Modification of Engagement Agreement with regard to a lawsuit brought against us in February 2006 by Silverwood Partners, ~~and~~LLC ~~are~~(“Silverwood”), who was previously engaged as the Company’s investment banker. The Silverwood lawsuit was based primarily on ~~customer requirements~~a ~~for~~claim ~~increased~~that ~~performance~~fees of approximately $150,000 ~~flexibility~~plus ~~and~~warrants ~~functionality.~~were ~~These~~owed ~~efforts~~to ~~include~~Silverwood ~~upgrades~~in connection with our December 2005 issuance of a $2,100,000 secured convertible note and ~~functional~~related ~~enhancements~~warrants to ~~current~~Laurus, ~~products~~but ~~and~~that ~~ultimately~~such ~~the~~fees ~~development~~were not paid. The Company recorded a reserve of approximately $150,000 at December 31, 2005, as a ~~new~~contingency ~~generation~~related ofto ~~products~~this claim.

~~Our~~Under ~~most~~the ~~recent~~Modification ~~new~~of ~~product~~Engagement isAgreement, in exchange for Silverwood amending its engagement letter agreement with the ~~Vx8000~~Company to, aamong ~~multi~~other ~~port~~things, ~~ASI~~lower ~~and~~the IPfees ~~product~~Silverwood would receive with regard to certain possible future transactions, the Company agreed to issue to Silverwood $80,000 of Common ~~capable~~Stock at 75% of ~~handling~~the upclosing sale price on the second day before the date on which the Company, knowing that the SEC is prepared to 8declare ~~ports~~effective ofa ~~ASI~~resale ~~video~~registration ~~for~~statement ~~long~~covering ~~haul~~such IPshares, ~~transport.~~requests ~~This~~the ~~product~~SEC ~~makes~~to ~~use~~thereafter ofdeclare the registration ~~latest~~statement ~~Pro-MPEG~~effective. ~~Code~~Accordingly, ofwe ~~Practice~~issued #378,432 ~~forward~~shares ~~error~~to ~~correction~~Silverwood ~~and~~in ~~RTP~~May ~~transport~~2006. In addition, we agreed to issue to Silverwood, 31,920 Path 1 Common Stock warrants with an initial exercise price of $2.6316 per share, expiring December 6, 2013.

~~Our~~In ~~next~~exchange ~~generation~~for ~~products~~Silverwood’s ~~will~~agreement ~~make~~to ~~use~~dismiss the lawsuit with prejudice and to waive all claims that it may have with respect to the Laurus transaction, we have issued Common Stock equal to $20,000 at 75% of ~~higher~~the ~~performance~~closing ~~network~~sale ~~processors~~price ~~developed~~on bythe ~~Intel~~second ~~and~~day ~~FPGAs~~before bythe ~~Xilinx~~date on which the Company, knowing that the SEC is prepared to declare effective a resale registration ~~and~~statement ~~Altera~~covering such shares, requests the SEC to thereafter declare the registration statement effective. ~~The~~Accordingly, ~~use~~we ofissued ~~higher~~19,608 ~~performance~~shares ~~electronics~~to ~~will~~Silverwood ~~increase~~in ~~flexibility~~May of2006. ~~our~~In ~~products~~addition, ~~and~~we ~~also~~agreed ~~increase~~to ~~capacity~~issue to ~~handle~~Silverwood ~~uncompressed~~a ~~High~~warrant ~~Definition~~to ~~video~~purchase asup ~~well~~to asan aggregate of 7,980 shares of Common Stock with an ~~increased~~initial ~~number~~exercise price of ~~High~~$2.6316 ~~Definition~~per ~~and~~share, ~~Standard~~expiring ~~Definition streams~~December 6, 2013.

~~COMPETITION~~Mandatorily-redeemable convertible preferred shares

WeIn ~~face~~connection ~~competition~~with inthe ~~each~~sale of the ~~target~~Series ~~markets~~A ~~for~~Preferred ~~our~~Stock ~~products, services~~ and ~~products~~Series inB ~~development.~~Preferred ~~Our~~Stock, ~~competition~~which ~~includes~~are ~~vendors~~required ~~that~~to ~~produce~~be redeemed ~~products~~by ~~for~~the ~~legacy~~Company ~~video~~if ~~transport~~not ~~networks~~converted ~~such~~into asthe ~~satellite,~~Company’s ~~circuit~~Common ~~switch~~Stock, ~~Radio Frequency (RF), ATM~~ and ~~other~~the ~~transport~~issuance ~~platforms.~~of Wethe ~~also~~warrants ~~compete~~as ~~with~~part ~~vendors~~of ~~that produce products that enable~~ the ~~transport~~financing ~~of video over IP networks including~~transaction, ~~but~~the ~~not~~Company ~~limited~~has ~~to,~~recorded ~~companies~~a ~~such as Scientific~~long-~~Atlanta,~~term ~~Tandberg~~liability ~~Television,~~under ~~Thomson,~~SFAS ~~Harris and Aastra~~No. 150 A(“SFAS ~~number of established and development-stage or start-up~~150”), ~~companies~~Accounting infor ~~these~~Certain ~~markets~~Financial ~~offer~~Instruments ~~similar~~with orCharacteristics ~~alternative technological solutions for convergence~~ of ~~real-time~~both ~~data,~~Liabilities ~~such as audio~~ and ~~video~~Equity. ~~over~~SFAS IP150 ~~networks,~~requires asthat ~~well as real~~mandatorily-~~time,~~redeemable ~~high-quality~~stock ~~transition~~be ofcharacterized ~~video~~as ~~over~~a IPliability ~~networks.~~and ~~We anticipate~~ that we ~~will~~all ~~face~~payments ~~increased~~to, ~~competition~~or inaccruals ~~the future as adoption rates~~ for ~~video~~the ~~over~~benefit ~~IP transport increase~~of, the ~~and~~holders asof ~~competitors~~the ~~offering~~stock ~~video~~that ~~over~~are IPnot ~~products~~a ~~and~~return ~~solutions~~of ~~enhance~~principal ~~their~~be ~~product~~treated ~~offerings~~as ~~and~~interest ~~new competitors emerge~~expense. ~~Our competitors have significantly greater resources and industry clout and, therefore, could threaten the viability of our business.~~

~~Many~~The offollowing ~~our~~table ~~competitors~~shows ~~have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in~~ the ~~industry~~carrying ~~than~~value ~~we do. As a result, certain~~ of ~~these~~the ~~competitors may be able to develop products that directly compete with ours and may be able to succeed with inferior product~~long-term ~~offerings.~~liability ~~These~~related ~~competitors may also be able~~ to ~~adapt to new or emerging technologies and changes in customer requirements more readily, take advantage of acquisition and other opportunities more effectively, devote greater resources to~~ the ~~marketing~~ ~~and~~Company’s ~~sale~~convertible ofpreferred ~~their~~shares: products and adopt more aggressive pricing policies than we can. In addition, these competitors have entered and will likely continue to enter into joint ventures or consortiums to provide additional value-added services competitive with those provided by us.

LIQUIDITY AND CAPITAL RESOURCES


	(in thousands)
	September 30, 2006			December 31, 2005
	(Unaudited)
Amount payable for mandatorily-redeemable preferred shares	$	5,015		$	5,124
Unamortized discount related to warrants		(416	)		(552	)
Unamortized discount related to beneficial conversion feature		(2,394	)		(3,292	)

Carrying value of mandatorily-redeemable convertible preferred shares	$	2,205		$	1,280

~~Since~~The ~~our~~convertible ~~inception~~preferred onshares have a cumulative 7% dividend rate and are mandatorily-redeemable for cash if not converted at the holder’s sole discretion into the Company’s Common Stock by January 27, 2009. For the three and nine months ended September 30, ~~1998~~2006, we3,077 ~~have financed~~and ~~our~~33,457 ~~operations~~shares ~~primarily~~of ~~through~~preferred ~~the~~stock ~~sale~~were ofconverted into common ~~equity~~shares, respectively. ~~securities~~As toof ~~investors~~September 30, ~~(including~~2006, ~~our~~52,308 ~~public~~and ~~offering~~61,149 inshares ~~July/August~~of ~~2003)~~Series A and ~~strategic~~Series ~~partners~~B Preferred Stock converted into 55,555 asand ~~well~~85,062 ascommon ~~from~~shares, ~~the~~respectively. ~~issuance~~There were 811,921 Series A and 731,158 Series B preferred shares outstanding as of ~~convertible~~September 30, ~~notes~~2006.

~~From~~Total ~~January~~interest ~~30,~~expense ~~1998~~related ~~through~~to ~~March~~mandatorily-redeemable ~~31,~~convertible ~~2005,~~preferred weshares ~~incurred~~for ~~losses~~the ~~totaling~~three ~~$47.1~~and ~~million.~~nine Wemonths ~~have~~ended September 30, ~~not~~2006 ~~yet achieved~~includes ~~profitability~~non-cash interest expense of approximately $45,000 and we$136,000, ~~remain~~respectively, apertaining ~~risky~~to ~~enterprise~~discounts of the related warrants. WeIn ~~believe~~addition, ~~that~~non-cash ~~our~~interest ~~existing~~expense ~~capital~~of ~~resources~~approximately ~~will~~$281,000 ~~enable~~and us$898,000 was recorded pertaining to ~~fund~~discount ~~operations~~related ~~for~~to atthe ~~least~~beneficial conversion feature for the ~~next~~three ~~twelve~~and nine months. Atended ~~March 31~~September 30, ~~2005~~2006, werespectively. ~~had~~Amortization ~~working~~of ~~capital~~issuance ofcosts ~~$2.4~~for ~~million.~~mandatorily-redeemable ~~Cash~~preferred stock for the three and ~~cash~~nine ~~equivalents~~months atended ~~March~~September 30, 312006, ~~2005~~was ~~totaled~~approximately $~~1.8~~35,000 ~~million~~and $104,000, respectively.

~~In addition~~NOTE to9 ~~the~~– ~~$2,808,750~~COMPUTATION weOF ~~raised~~NET inLOSS ~~the~~PER first quarter of 2005 by a private placement of 7% convertible preferred stock and associated common stock warrants, we entered into an agreement on April 26, 2005 to raise an additional $2,595,000 by aSHARE private placement of Series B 7% convertible preferred stock and associated common stock warrants. This transaction is, subject to shareholder approval, expected to close in the second quarter of 2005. The Series B 7% convertible preferred stock will have terms and conditions similar to those of the 7% convertible preferred stock, including mandatory redemption on January 27, 2009 if it has not previously been converted or redeemed.

~~The~~Basic ~~$2,808,750~~net ~~private~~loss ~~placement~~per common share is ~~reflected~~computed onby ~~our~~dividing ~~balance~~net ~~sheet~~loss asby ~~a long~~the weighted-~~term~~average ~~liability~~number atof ~~its~~common ~~net~~shares ~~carrying~~outstanding ~~value.~~during ~~The~~the 7%period, excluding ~~convertible~~restricted ~~preferred~~ stock that has been issued but is ~~treated~~not asyet avested. ~~liability,~~Diluted ~~rather~~net ~~than~~loss ~~equity,~~per ~~for~~common ~~accounting~~share ~~purposes~~is ~~because~~computed ofby ~~its~~dividing ~~mandatory~~net ~~redemption~~loss ~~feature.~~by Asthe aweighted-average ~~result~~number of common shares outstanding during the ~~transaction,~~period weplus ~~recorded~~additional aweighted average ~~liability~~common ~~equal~~equivalent toshares ~~the~~outstanding ~~aggregate~~during ~~redemption~~the ~~price~~period. ~~and~~Common aequivalent ~~discount~~shares ~~totaling~~result ~~approximately~~from ~~$2,122,000~~the ~~that~~assumed ~~was~~exercise ~~booked~~of tooutstanding ~~additional~~stock ~~paid-in~~options ~~capital.~~and ~~The~~warrants ~~discount~~(the ~~results~~proceeds ~~from~~of anwhich ~~embedded~~are ~~beneficial~~then ~~conversion~~presumed ~~feature~~to ~~and~~have ~~detachable~~been ~~warrants~~used to ~~purchase common~~repurchase outstanding stock using ~~with~~the ~~fair~~treasury ~~values~~stock ofmethod) ~~$1,748,000~~ and ~~$374,000,~~the ~~respectively.~~vesting ~~These~~of ~~deferred~~unvested ~~interest~~restricted ~~charges~~shares ~~will~~of beCommon ~~amortized~~Stock. onIn anthe ~~effective~~loss ~~yield~~periods, ~~basis~~the ~~over~~common ~~four~~equivalent ~~years,~~shares orhave ~~sooner~~been ifexcluded ~~any~~from ~~preferred~~the ~~stock~~computation isof ~~previously~~diluted ~~redeemed~~net orloss ~~converted~~per share, ~~resulting~~because intheir effect would have ~~non~~been anti-~~cash~~dilutive. ~~interest~~For ~~expense~~the ~~each~~ quarter. Atended ~~March~~September 30, 312006, ~~2005~~warrants to purchase 350,000 ~~the~~shares ~~net~~of ~~carrying~~Common ~~value~~Stock, 775,285 shares of ~~the~~common ~~liability~~stock ~~for~~related ~~our~~to ~~mandatorily-redeemable~~the 7%Convertible ~~preferred~~Term ~~stock~~Note ~~was~~and ~~$745,000~~5.4 million ~~The~~shares ~~remaining~~of ~~unamortized~~common ~~discount~~stock related to ~~beneficial~~ the conversion ~~feature~~of the Series A and ~~detachable~~ ~~warrants~~B ~~was~~Preferred ~~$1,684,000~~Stock ~~and~~were ~~$380,000,~~excluded ~~respectively~~in the calculation of diluted earnings per share because of the anti-dilutive effect.

InNOTE ~~February~~10 ~~2003,~~– weSHAREHOLDERS’ ~~entered~~EQUITY into a $1 million revolving line of credit with Laurus. This revolving line of credit (“the LOC”) is secured by our accounts receivables and other assets, and we have the ability to draw down advances under the LOC subject to limits. Under the terms of the LOC, Laurus can convert advances made to us into our common stock at a fixed conversion price of $6.78 per share. The balance outstanding on our LOC was nil at March 31, 2005.

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

AtPursuant ~~March 31, 2005, we had material commitments related~~ to ~~our~~SFAS ~~obligations under our recent preferred stock financing which could require us to repurchase all our 7% convertible preferred stock for $2.8 million in the first quarter of 2009~~123(R), ~~our~~unearned ~~operating~~compensation ~~leases, and a convertible note~~ with a ~~face~~balance ~~amount~~ of $~~102~~1,048,000 ~~which~~at isDecember 31, ~~due in May~~ 2005. ~~Our~~was ~~future~~eliminated ~~capital~~against ~~requirements~~additional ~~will~~paid ~~depend~~in capital upon ~~many factors, including~~ the ~~timing~~ adoption of ~~research~~SFAS ~~and~~123(R) ~~product~~on ~~development efforts~~January 1, ~~the~~2006. ~~possible~~The ~~need~~unearned tocompensation ~~acquire~~was ~~new~~related ~~technology,~~to ~~the~~restricted ~~expansion~~stock ofawards ~~our~~granted ~~sales~~to ~~and~~various ~~marketing~~employees ~~efforts,~~prior ~~and~~to ~~our~~the ~~expansion~~adoption ~~internationally.~~of WeSFAS ~~expect~~123(R). toSee ~~continue~~Note to2, ~~expend~~“Summary ~~significant amounts~~of inSignificant ~~all~~Accounting ~~areas~~Policies of— Stock-Based ~~our operations~~Compensation.”

~~Cash~~Common used in operations was approximately $1.9 million for the three months ended March 31, 2005, compared to $2.4 million for the same period in 2004. The decrease in cash used in operations for the three months ended March 31, 2005, compared to the same period in the prior year, was due primarily to our lower net loss partially offset by the net change in our balance sheet accounts. Cash used in operations for the quarter ended March 31, 2005 also reflects front-loaded third-party engineering expense related to contract payments associated with the ongoing development of our next generation product platform. The $306,000 increase in “other assets” in the first quarter of 2005 was primarily due to the capitalized costs associated with the issuance of our 7% convertible preferred stock.

For the three and nine months ended September 30, 2006, 3,077 and 33,457 shares of preferred stock were converted into 3,150 and 55,790 common shares, respectively. As of September 30, 2006, warrants to purchase 5,488,967 shares of Common Stock, at a weighted-average price per share of $4.41, remained outstanding, of which all are exercisable. 654,402 of restricted stock and stock options remained outstanding as of September 30, 2006; of these, 214,929 options were exercisable as of September 30, 2006.

On September 5, 2006 we paid quasi-dividends under the Settlement Agreement to Castle Creek and the minority holders, issuing a total of 186, 228 shares of Common Stock to them. A total of $70,694 of accrued dividends were thereby relieved.

On August 30, 2006, the Company entered into a Purchase Agreement with certain accredited investors pursuant to which the Company sold to investors an aggregate of 1,620,000 shares of the Company’s Common Stock at a purchase price of $0.25 per share for aggregate gross proceeds of $405,000 (See Notes 3 and 7). As a result of the sale of our Common Stock for less than market value pursuant to the financing, anti-dilution provisions in our debt and preferred stock covenants were triggered which resulted in an increase in the number of shares of our Common Stock of approximately 140,000 and 251,000 shares that will be issued to our debt and preferred holders, respectively, if and when they choose to convert their securities to Common Stock.

NOTE 11 – EQUITY INCENTIVE PLANS

~~Cash~~ Plan ~~used~~and inthe ~~investing~~Purchase ~~activities~~Plan, ~~for~~ the ~~three~~“Plans”), ~~months~~pursuant ~~ended~~to ~~March~~which ~~31,~~we ~~2005,~~may ~~was~~issue ~~$136~~a total of 900,000, ~~compared~~options and shares of Common Stock to employees, ~~$111~~officers,~~000~~ ~~for~~directors, ~~the~~consultants ~~same~~and ~~period~~advisors. ~~ended~~As ~~March~~of 31September 30, ~~2004.~~2006, In475,000 shares of stock had been granted directly to current and former executives of the ~~2005~~Company ~~period,~~and wethere ~~capitalized~~were ~~$99~~options outstanding to purchase 50,~~000~~153 shares of ~~engineering~~Common Stock ~~costs~~under ~~and~~our ~~acquired~~2000 ~~$37~~Plan; 599,~~000~~847 shares of ~~engineering~~Common ~~equipment.~~Stock Inremained available for issuance under the ~~2004~~2000 ~~quarter,~~Plan. weA ~~purchased~~maximum ~~$120~~of 41,~~000~~667 shares of ~~equipment~~common stock have been authorized for ~~use~~issuance inunder ~~our~~the ~~engineering~~Purchase ~~lab~~Plan. As of September 30, 2006, 318,000 shares of stock had been granted directly to current and ~~for~~former ~~sales~~executives of the Company and ~~marketing~~there ~~display~~were ~~equipment~~options outstanding to purchase 281,249 shares of Common Stock; 355,751 shares of Common Stock remained available for issuance under the 2004 Plan.

~~Cash~~In ~~provided by~~addition, ~~financing~~as ~~activities~~of ~~for the three-month period ended March 31~~September 30, ~~2005~~2006, ~~was~~there ~~$2.9~~were ~~million compared to cash provided of $235~~115,000 ~~for~~shares ~~the~~of ~~same~~Common ~~period~~Stock ~~ended~~subject ~~March~~to ~~31,~~outstanding ~~2004.~~options ~~The~~granted ~~cash~~other ~~provided~~than ~~by financing activities in 2005 resulted primarily from the~~under ~~sale of 7% convertible preferred stock while~~ the ~~2004~~Plans. ~~provision~~These ~~resulted~~options ~~primarily~~were ~~from~~granted ~~the~~as ~~exercise~~inducement ofstock ~~warrants~~options ~~issued~~to inThomas ~~2003~~Tullie, in our 7%CEO, ~~convertible~~in ~~notes offering~~2005.

~~RESULTS~~Stock OFOptions ~~OPERATIONS~~

~~Three~~Options ~~Months~~awards ~~Ended~~are ~~March~~generally ~~31,~~granted ~~2005~~with vsan exercise price equal to the fair market value of our Common Stock on the grant date and have 10-year contractual terms. Options ~~Three~~awards ~~Months~~typically ~~Ended~~vest ~~March~~in ~~31,~~accordance ~~2004~~with one of the following schedules:

For the quarter ended March 31, 2005, net revenue increased $475,000, or 122%, to $864,000, compared to $389,000 during the three-month period ended March 31, 2004. Revenues from sales of products in the first quarter ended March 31, 2005, increased to $830,000, or approximately 136%, from $351,000 in the first quarter ended March 31, 2004. The increase in product revenues in the quarter ended March 31, 2005, versus the same period in the prior year was principally the result of a ~~shift in product mix to higher priced long-haul products in the current year period from lower priced cable products in the prior year period~~. AQuarterly ~~majority of our sales~~ in ~~the~~equal ~~first~~installments ~~quarter~~over offour 2005 came from shipments of long-haul products to Vyvx. The mix of our product sales and the prices at which we sell them may fluctuate from period to period. Contract revenues in the first quarter ended March 31, 2005 were $16,000. We had no contract revenues in the prior year quarter. In the first quarter ended March 31, 2005, revenue from license fees was nil compared to $20,000 in the 2004 period. First quarter 2004 license revenues resulted from a final-stage license fee from an agreement entered into between us and Visionary Solutions in 2002. Under the agreement, which, in part, granted the licensee the right to incorporate our TrueCircuit technology into their products, Visionary Solutions was required to pay $20,000 to us at the time that the licensee first produced their products for sale. Other revenues, consisting of royalties, product repairs charges and service agreements fees, were $18,000 for the three months ended March 31, 2005 and March 31, 2004. years

~~Cost of revenues decreased by $144,000, or (35%), to $266,000 in the quarter ended March 31, 2005, from $410,000 in the same quarter last year~~b. ~~The~~Fully ~~decrease~~vest inand ~~cost~~become ofexercisable ~~sales~~on ~~results primarily from a 39% reduction in total units shipped along with a 10% decrease in direct cost per unit produced during~~ the ~~current~~date ~~period versus the prior year period. Cost~~ of ~~products sold consists primarily of raw material costs, warranty costs and labor associated with manufacturing.~~ grant

~~Gross~~Certain ~~profit~~option ~~totaled~~awards ~~$598,000~~provide for ~~the~~accelerated ~~quarter~~vesting ~~ended~~if ~~March~~there ~~31,~~is ~~2005, compared to~~ a ~~gross loss of $21,000 in the same quarter last year. The increase in gross profit for the current year period versus the prior year period is mainly attributable to the~~ change in ~~product~~control ~~mix from being heavily weighted towards cable~~ (~~including shipment~~as ofdefined ~~cable products sold at particularly unfavorable prices to a single customer)~~ in ~~2004~~the ~~to being heavily weighted towards our long-haul products in 2005~~Plans).

~~Engineering,~~The ~~research~~fair value ~~and~~of ~~development~~each ~~expenses~~option ~~for~~award is estimated on the ~~quarter~~date ~~ended~~of ~~March~~grant ~~31,~~using ~~2005,~~a ~~increased~~Black-Scholes-Merton ~~43%~~option topricing ~~$940,000~~model ~~from~~(“Black-Scholes ~~$656,000 in~~model”) that uses the ~~quarter~~assumptions ~~ended~~noted ~~March~~in ~~31,~~the ~~2004~~following table. ~~The~~Expected ~~increase~~volatilities isare ~~due~~based ~~primarily~~on tohistorical volatility ~~higher~~of ~~costs~~our ~~related~~Common toStock ~~contract~~and ~~employees~~other ~~for~~factors. ~~engineering~~The ~~efforts~~expected ~~related~~term toof ~~new~~options ~~product~~granted ~~development~~is based on analyses of historical employee termination rates and option exercises. WeThe ~~continue~~risk-free tointerest ~~spend~~rates ~~heavily~~are based on ~~engineering~~the ~~expenses~~U.S. Treasury yield for ~~new~~a ~~product~~period ~~development~~consistent ~~and~~with ~~other~~the ~~sustaining~~expected ~~engineering~~term ~~efforts;~~of ~~thus,~~the ~~engineering,~~option ~~research~~in ~~and~~effect ~~development~~at ~~expenses~~the ~~are~~time ~~expected~~of tothe begrant. ~~higher~~Assumptions used in ~~future~~the ~~quarters~~Black-Scholes asmodel wefor ~~work~~the tothree ~~expand~~and ~~our~~nine ~~product~~months ~~offerings.~~ended September 30, 2006 were as follows:

Sales and marketing expenses for the quarter ended March 31, 2005, decreased 40% to $808,000 from $1.35 million for the quarter ended March 31, 2004. The $542,000 decrease in sales and marketing expenses is primarily due to a one-time charge of $400,000 in the 2004 period for the repurchase of the exclusive marketing rights to the integrated QAM product we had developed for Aurora Networks and a most-favored-nation pricing right which Aurora Networks had as a reseller of our products.


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

~~General~~A ~~and~~summary ~~administrative~~of ~~expenses~~option ~~for~~activity ~~the~~under ~~quarter ended March 31, 2005, decreased 55% to $346,000 from $775,000 in~~ the ~~same~~Plans ~~quarter~~as of ~~the prior year. The $429~~September 30,~~000~~ ~~decrease~~2006 ~~results~~and ~~principally~~changes ~~from~~since ~~a one-time charge of $260~~December 31,~~000~~ in2005 ~~the 2004 period for our former CEO’s severance arrangement as provided for in his employment agreement with us,~~are ~~along~~presented ~~with~~below: ~~reduced spending on outside consulting fees ($38,000) and lower spending on investor relations ($28,000).~~

Depreciation and amortization expense for the quarter ended March 31, 2005, was $59,000, compared to $108,000 for the same quarter last year. The decrease in depreciation and amortization expense resulted principally from accelerated amortization of debt issuance costs resulting from the early conversion of convertible debt in the earlier period.


	Number of shares		Weighted average exercise price per share		Weighted Average remaining contractua- term (in years)	Aggregate intrinsic value (in thousands)
Outstanding at December 31, 2005	431,466		$	5.52
Granted	105,000			2.70
Exercised	—			—
Forfeited or expired	(49,312	)		5.97

Outstanding at March 31, 2006	487,154		$	4.99	8.22	$	—

Granted	—
Exercised	—			—
Forfeited or expired	(145,000	)		3.03

Outstanding at June 30, 2006	342,154		$	5.65	7.57	$	—

Granted	—
Exercised	—			—
Forfeited or expired	(10,752	)		10.51

Outstanding at September 30, 2006	331,402		$	5.49	7.64	$	—


Exercisable at September 30, 2006	214,929		$	6.71	7.18

~~Net~~There ~~interest~~were ~~expense~~no ~~for~~options ~~the~~granted ~~quarter~~or ~~ended~~exercised ~~March~~during ~~31, 2005 was $88,000 versus $30,000 of expense in~~ the ~~same~~ quarter ended ~~March 31~~ September 30, ~~2004~~2006. ~~The increase in interest expense predominantly results from non-cash deferred interest charges related to the issuance of mandatorily-redeemable convertible preferred shares during the 2005 period.~~

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

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


	Number of shares		Weighted average grant- date fair value per share
Nonvested at December 31, 2005	243,295		$	2.36
Granted	105,000			2.70
Vested	(67,377	)		2.30

Nonvested at March 31, 2006	280,918		$	2.21

Granted	—
Forfeited	(120,001	)		3.03
Vested	(17,900	)		2.30

Nonvested at June 30, 2006	143,017		$	2.29

Granted	—
Forfeited	(4,055	)		10.51
Vested	(22,489	)		2.30

Nonvested at September 30, 2006	116,473		$	2.41

~~Our~~Share-based ~~limited~~compensation ~~sales~~expense ~~history~~recognized under SFAS 123(R) from stock options was $61,000 and ~~limited~~$192,000 ~~revenues~~for the three months and nine months ended September 30, 2006, respectively. As of September 30, 2006, there was $271,000 of total unrecognized compensation cost, related to ~~date~~non-vested ~~make~~stock itoptions, ~~difficult~~which is expected to ~~evaluate~~be ~~our~~recognized over a ~~prospects~~weighted-average period of 1.50 years. The total fair value of stock options vested during the quarter ended September 30, 2006 was approximately $52,000.

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

We have incurred losses since inception and will likely not be profitable at least for the next several quarters.

We have incurred operating losses since our inception in January 1998, and we expect to incur losses and negative cash flow for at least the next several quarters. As of March 31, 2005, our accumulated deficit was approximately $47.1 million. We expect to continue to incur significant operating, sales, marketing, research and development and general and administrative expenses and, as a result, we will need to generate significant revenues to achieve profitability. Even if we do achieve profitability, we cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future.

We face competition from established and developing companies, many of which have significantly greater resources, and we expect such competition to grow.

~~emerge.~~Restricted ~~Many~~stock of our competitors have greater resources, sell a more complete product line or solution, have higher name recognition, have more established reputations within the industry and maintain stronger marketing, manufacturing, distribution, sales and customer service capabilities than we doawards.

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


	Number of shares		Weighted average grant- date fair value per share
Nonvested at December 31, 2005	364,250		$	2.88
Granted	30,000			2.80
Vested	(16,250	)		4.02
Forfeited	(10,000	)		4.24

Nonvested at March 31, 2006	368,000		$	2.78

Granted	—			—
Vested	—			—
Forfeited	(40,000	)		2.80

Nonvested at June 30, 2006	328,000		$	2.78

Granted	—			—
Vested	(5,000	)		3.10
Forfeited	—			—

Nonvested at September 30, 2006	323,000		$	2.78

Share-based compensation expense recognized under SFAS 123(R) from restricted stock awards was $49,000 and $221,000, respectively, for the three and nine months ended September 30, 2006. As of September 30, 2006, the total unrecognized compensation cost related to unvested shares was $382,000, which is expected to be recognized over a weighted-average period of 2.48 years.

NOTE 12 – SUBSEQUENT EVENTS

We entered into a Patent Purchase Agreement with Great Links G.B. LLC (the “Great Links Agreement”), effective November 17, 2006 to sell all right, title and interest in certain patents, provisional patent applications and non-provisional patent applications for $535,000. As part of the Great Links Agreement, the Company receives a royalty-free, non-exclusive, non-sublicensable right and license to practice the methods and to make, have made, use, distribute, lease, sell, offer for sale, import, export, develop and otherwise dispose of and exploit any products covered by the patents. The Company retains the sole right to the Technology License Agreement with Visionary Solutions, Inc. for current and future royalties. On August 30, 2006, the Company issued to Laurus a warrant to purchase up to an aggregate amount of 350,000 shares of Common Stock of the Company with an exercise price of $0.50 per share, in exchange for the permission to sell the patents covered under the Great Links Agreement. The fair value of the warrants amounted to $107,000 and was capitalized as debt issuance costs which is being amortized over the remaining life of the convertible note.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

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

OVERVIEW

We currently offer two primary product lines that cater to different segments of the video market. Our Video Over IP gateway products are used by broadcasters and video service providers to transport live video content in real time between different locations, within a region, a country or even between countries—a process known as “long-haul transmission.” Since our products transmit video content over widely available IP communication networks, our customers can use existing infrastructure, thus lowering their costs and permitting them greater flexibility in the delivery of video content. Our Network

Access Gateway products are primarily used by cable companies to supply video-on-demand, or VOD services. Our markets include cable, broadcast, satellite, telco, video carriers, mobile operators and enterprises.

The performance for the quarter ended September 30, 2006 represents our fourth sequential quarter of increased revenue. Revenue for the three months ended September 30, 2006 increased 13% compared to the three months ended June 30, 2006, while revenue increased 35%, 18% and 29% for the previous sequential quarters ended June 30, March 31, 2006 and December 31, 2005, respectively. Our revenue for the nine months ended September 30, 2006 is slightly less than our revenue for the same period during 2005, however we have reduced our operating expenses for the nine months ended September 30, 2006 as compared to the same period during 2005 by $3.2 million due to our aggressive cost reductions implemented as we continue to pursue long term financing.

Despite our two private placements and issuance of a convertible note payable during the year ended December 31, 2005, in which we raised aggregate proceeds of approximately $5.4 million and $2.1 million, respectively, despite raising $916,000 in an April 2006 revolving line of credit financing, and despite raising $405,000 form the issuance of Common Stock to accredited investors in August 2006, we had just $389,000 in cash remaining at September 30, 2006 and we are pursuing additional sources of financing. We have serious liquidity issues as evidenced by our former Independent Registered Public Accounting Firm’s report on our financial statements in our Form 10-K for the fiscal year ended December 31, 2005, filed on March 23, 2006 which included a “going concern” qualification. Given our projected cash burn rate, we will be required to raise additional capital in the very near term or proceed with selling all of the assets of the Company to a third party.

For additional information about the risks and uncertainties that may affect our business and prospects, please see “Risk Factors.”

Our address of record is 6215 Ferris Square, Suite 140, San Diego, CA 92121. Our telephone number is (858)450-4220 and our e-mail address is investors@path1.com. Additional information about Path 1 can be found on our website at www.path1.com, and in our periodic and current reports filed with the SEC. Copies of our current and periodic reports filed with the SEC are available at the SEC Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying costs. Please call the SEC at 1-800-SEC-0330 for more information. Our SEC filings are also available online at www.sec.gov and our website. No portion of our corporate or product websites are incorporated by reference into this report.

LIQUIDITY AND CAPITAL RESOURCES

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

Our cash position on September 30, 2006, was $389,000 and we had negative working capital of $1.9 million. Despite our two private placements and issuance of a convertible note payable during the year ended December 31, 2005, in which we raised aggregate proceeds of approximately $5.4 million and $2.1 million, respectively, despite raising $916,000 in an April 2006 revolving line of credit financing, and despite raising $405,000 form the issuance of Common Stock to accredited investors in August 2006, given our projected cash burn rate, we urgently need to raise additional capital to sustain our operations. From January 30, 1998 through September 30, 2006, we have an accumulated deficit totaling $60 million. We have not yet achieved profitability, and we remain a very risky enterprise. We are trying to take steps to reduce expenses to help manage our cash.

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

•

We are in the process of reviewing all options in regard to quickly raising additional sources of capital, including but not limited to incurring new debt and the sale of equity and assets.

•

We have recently completed a revolving line of credit which continues to provide additional sources of working capital in the short term.

•

We have undertaken efforts to reduce discretionary costs and focus on selling existing products and services.

•

We are exploring the process of selling all the assets of the Company to a third party.

In August 2006 we closed a Common Stock financing with certain accredited investors in which the Company sold 1,620,000 shares of Common Stock at a purchase price of $0.25 for aggregate gross proceeds of $405,000. In exchange for a warrant to purchase 350,000 shares of the Company’s Common Stock, Laurus agreed to (i) defer the repayment of the $600,000 over-advance related to the RLOC from October 1, 2006 to January 1, 2007, (ii) continue the principal repayment holiday on the $2.1 million Secured Convertible Term Note from September 1, 2006 until January 1, 2007, (iii) not declare default and accelerate either the RLOC or the Secured Term Note based on noncompliance with covenants related to the Company’s delisting from AMEX and allow the Company to get listed on the OTC.BB no later than December 31, 2006, and (iv) authorize the sale of certain of the Company’s patents so that the Company can use the proceeds of the sale for operating capital. In connection with the Financing, the Company’s Chief Executive Officer, Thomas L. Tullie and the Company’s Board of Directors waived cash compensation of $40,500 and $96,000, respectively.

In April 2006 we successfully closed a bridge financing with Laurus, in which we received a $1 million revolving line of credit which we continued to utilize during the quarter. Upon closing of the RLOC we immediately drew down $916,000 and during the nine months ended September 30, 2006 we drew down an additional $924,000.

We are currently pursuing efforts to raise long term additional capital, and urgently need to do so by December 31, 2006. We cannot ensure that financing would be available to us on acceptable terms, if at all. We may not be able to successfully find any financing or other strategic opportunities for us. Our inability to raise capital when needed would seriously harm our business. In addition, additional equity may dramatically dilute our stockholders’ interest, and debt financing, if available, may involve restrictive covenants and could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on debt. If adequate funds are not available, we would need to curtail our operations significantly and might not be able to continue.

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

Our future capital requirements will depend upon many factors, including the size and timing of gross profits, the timing of research and product development efforts, the possible need to acquire new technology, the expansion of our sales and marketing efforts, and our expansion internationally. We expect to continue to expend significant amounts in all areas of our operations.

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


	Nine months ended September 30, 2006			Nine months ended September 30, 2005			Change Between Periods
	(unaudited)			(unaudited)
Net cash (used in) operating activities	$	(2,470	)	$	(4,978	)	$	2,508
Net cash provided by (used in) investing activities		—			(209	)		209
Net cash provided by (used in) financing activities		1,223			5,620			(4,397	)

Net increase (decrease) in cash and cash equivalents	$	(1,247	)	$	433		$	(1,680	)

Operating Activities

Net cash used for operating activities decreased approximately $2.5 million in the nine months ended September 30, 2006, compared to the same period of the previous year. The decrease in cash usage was due primarily to cost reductions implemented while we pursue long term capital. We have reduced our development costs significantly due to the termination of a product development in the previous year. We have also reduced our outside consulting expenses along with personnel and related benefits costs. In addition, approximately $1.5 million of our net loss was composed of non-cash amortization of debt discount and accretion of preferred stock discount related to multiple preferred stock financings and debt financings completed in the last two years.

Investing Activities

Net cash used for investing activities was $0 for the nine months ended September 30, 2006 as compared to $209,000 used for investing activities used in the nine months ended September 30, 2005. In the previous year, we capitalized engineering costs of $113,000 and acquired engineering equipment for $96,000.

Financing Activities

Net cash provided by financing activities was $1.2 million, for the nine months ended September 30, 2006, consisting of approximately $1.8 million in borrowing from the Laurus revolving line of credit which was partially offset by repayments on the line of credit of approximately $1.0 million and approximately $405,000 in net proceeds from sales of our Common Stock through a private placement with accredited investors. Net cash provided by financing activities was approximately $5.6 million for the nine months ended September 30, 2005, consisting primarily of approximately $5.4 million in net proceeds from the issuance of convertible preferred stock and $251,000 in proceeds from the exercise of stock options.

At September 30, 2006, we had material commitments related to our obligations under our 2005 preferred stock financings which could require us to repurchase all our convertible preferred stock for at least $5.0 million in the first quarter of 2009. The Laurus term note matures in December 2008 and the Laurus revolving line of credit matures in April 2008. Our future capital requirements will depend on many factors, including the timing of research and product development efforts, the possible need to acquire new technology, the expansion of our sales and marketing efforts, and our expansion internationally. We expect to continue to expend significant amounts in all areas of our operations.

RESULTS OF OPERATIONS

Revenues

Revenues

(in thousands)


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
Product Revenue	$	870		$	384		127	%	$	2,134		$	2,352		-9	%
Percentage of total revenue		93	%		95	%				90	%		98	%

Service/Other Revenue	$	61		$	20		205	%	$	236		$	57		314	%
Percentage of total revenue		7	%		5	%				10	%		2	%

Total Revenue	$	931		$	404		130	%	$	2,370		$	2,409		-2	%

For the three months ended September 30, 2006, product revenues increased by $486,000, or 127%, to $870,000 from $384,000 during the three months ended September 30, 2005. The increase was due primarily to the deployment of a Digital Terrestrial Transmission by TDF in response to a regulatory requirement by the French government which requires nationwide digital “over-the-air” broadcast. In addition the increase in product revenue was partially attributable to the continued expansion of the Vyvx HD Venue Net which enables increased broadcasts of live sporting events, and the continued expansion of video on demand (“VOD”) and digital simulcast by our cable customers. The service and other revenue increased $41,000, or 205%, to $61,000 during the three months ended September 30, 2006 from $20,000 for the same period in 2005. The increase was due to higher service revenue of $20,000 primarily from a larger number of our units purchased with extended service and warranty contracts and $9,000 in higher royalty revenue related to sales of our licensees’ products based on our DotCAM ^® technology.

Product revenues for the nine months ended September 30, 2006, decreased approximately $200,000, or 9% to $2.1 million from $2.3 million for the same period in 2005. The decrease in product revenue is due primarily to reduced sales of long haul gateway products of approximately $646,000 which was partially offset by an increase in sales of our cable products of approximately $428,000. Service and other revenue increased by $179,000, or 314%, from $57,000 during the nine months ended September 30, 2005 to $236,000 during the same period ended September 30, 2006. The increase was comprised primarily of $137,000 in higher service revenue due to a larger portion of our units purchased with extended service and warranty contracts and $43,000 in higher royalty revenue related to sales of our licensee’s products based on DotCAM ^® technology.

Our revenues can fluctuate from quarter to quarter, based on timing of customer orders and mix of our product sales. Currently, we do not foresee any dramatic improvement of our customer orders in the next couple of quarters.

Cost of Revenues

Cost of Revenues

(in thousands)


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
Cost of Revenue	$	355		$	369		-4	%	$	1,026		$	1,142		-10	%
Percentage of total revenue		38	%		91	%				43	%		47	%

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

Cost of revenues decreased by $14,000, or 4%, to $355,000 in the three months ended September 30, 2006 as compared to $369,000 in the three months ended September 30, 2005. The decrease in cost of revenue was due primarily to a reduction in personnel-related costs due to reassignment of headcount used in allocating overhead costs. The 4% decrease in cost of revenues combined with the 130% increase in product revenues resulted in an increase in gross profit percentage to 62% for the three months ended September 30, 2006 as compared to 9% for the same period ended in 2005.

Cost of revenues decreased by $116,000, or 10%, to $1.0 million in the nine months ended September 30, 2006 as compared to $1.1 million in the nine months ended September 30, 2005. The decrease was due primarily to lower personnel related expenses related to the reassignment of headcount to research and development and a decrease in material costs. The decrease in cost of revenues resulted in an increase in gross profit percentage to 57% for the nine months ended September 30, 2006 as compared to 53% for the same period ended in 2005.

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

Operating Expenses

Engineering, research and development

(in thousands)


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
Engineering, research and development	$	413		$	1,175		-65	%	$	1,453		$	3,296		-56	%
Percentage of total revenue		44	%		291	%				61	%		137	%

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

Engineering, research and development expenses decreased $762,000, or 65% from $1.2 million for the three months ended September 30, 2005 to $413,000 for the same period in 2006. The decrease was due primarily to the reduction of $200,000 in outside consulting and prototype development costs incurred related to product development in the prior year and the reduction of $200,000 in personnel and personnel related expenses due a reduction in headcount and a $313,000 reduction in the allocation of overhead as a result of the reduction in overall operating expenses. In addition, stock based compensation expense decreased by $55,000 due to a reduction in expenses related to direct stock grants to staff executives.

Engineering, research and development expense decreased $1.8 million, or 56%, from $3.3 million to $1.5 million for the nine months ended September 30, 2006 as compared to the same period in 2005. The decrease is due primarily to the reduction of $1.1 million in consulting expenses and prototype expenses associated with product development incurred in the prior year and the reduction of $429,000 in personnel and personnel related expenses due a reduction in personnel and a $266,000 reduction in the allocation of overhead as a result of the reduction in overall operating expenses. In addition, stock based compensation expense decreased by $113,000 due to expenses related to direct stock grants to staff executives.

Sales and marketing

(in thousands)


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
Sales and marketing	$	392		$	949		-59	%	$	1,900		$	2,521		-25	%
Percentage of total revenue		42	%		235	%				80	%		105	%

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

Sales and marketing expenses decreased $557,000, or 59%, to $392,000 from $949,000 for the three months ended September 30, 2006 as compared to the same period in 2005. The decrease was due primarily to a $253,000 reduction in personnel-related costs, a $229,000 reduction in the allocation of overhead as a result of the reduction in overall operating expenses and reduced stock based compensation of $42,000 due to less expense related to direct stock grants to staff executives.

Sales and marketing expenses decreased $621,000, or 25%, to $1.9 million from $2.5 million for the nine months ended September 30, 2006 as compared to the same period in 2005. The decrease was due primarily to the reduction of $372,000 in personnel related costs, a $101,000 reduction in the allocation of overhead as a result of the reduction in overall operating expenses, $62,000 in reduced stock based compensation as a result of less expenses related to direct stock grants to staff executives and a $35,000 reduction in consulting expenses.

General and Administrative

(in thousands)


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
General and administrative	$	482		$	711		-32	%	$	1,424		$	2,114		-33	%
Percentage of total revenue		52	%		176	%				60	%		88	%

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

General and administrative expenses decreased $229,000, or 32%, to $482,000 from $711,000 for the three months ended September 30, 2006 as compared to the same period in 2005. The decrease is due primarily to the reduction of $263,000 in personnel related costs, a $333,000 reduction in legal costs, a $228,000 reduction in consultants and outside services and a $16,000 reduction in board of director fees. The decreases were partially offset by an increase of $590,000 in overhead costs related to the reassignment of headcount used in the allocation.

General and administrative expenses decreased $690,000, or 33%, to $1.4 million from $2.1 million for the nine months ended September 30, 2006, as compared to the same period in 2005. The decrease is due primarily to the $540,000 decrease in stock compensation expenses due to lower expenses related to direct stock grants to staff executives, a $379,000 reduction in consultants and outside services related to decreased audit fees and consultants required in the previous year due to the employee embezzlement and turnover in the finance department. In addition personnel related costs decreased $206,000 and board of director fees decreased $16,000. The decreases were partially offset by an increase of $532,000 in overhead costs related to the reassignment of headcount used in the allocation.

Interest Expense, net


	Three Months Ended September 30,						Percent Change		Nine Months Ended September 30,						Percent Change
	2006			2005			Percent Change		2006			2005			Percent Change
Net interest expense	$	505		$	217		133	%	$	1,475		$	470		214	%
Percentage of total revenue		54	%		54	%				62	%		20	%

Net interest expense consists primarily of interest obligations on our outstanding debt and equity instruments. Interest expense was $505,000 and $1.5 million for the three and nine months ended September 30, 2006, respectively, as compared to $217,000 and $471,000, respectively for the comparable periods in 2005. The increase is due primarily to non-cash charges, characterized as “interest” for accounting purposes, related to the issuance of mandatorily-redeemable convertible preferred shares during the first six months of 2005 and related to the issuance of secured debt and warrants in December 2005 and April 2006. Our Series A Preferred Stock was issued during the first quarter of 2005 and our Series B Preferred Stock was issued in the second quarter of 2005. Thus we had a full nine months of amortization in 2006. We paid actual cash interest of approximately $85,000 and $212,000 in the three and nine months ended September 30, 2006, respectively, versus $0 and $3,000, respectively, in the corresponding 2005 periods due primarily to higher debt balances outstanding during the current year.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

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

Revenue Recognition

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

Product Revenue

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

Research and Development Expenses

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

Share-Based Compensation

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

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Share-based compensation expense recognized in our consolidated statement of operations for the first and second quarters of fiscal 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with SFAS 123(R). For share awards granted in fiscal 2006, expenses are amortized under the straight-line attribution method. For share awards granted prior to fiscal 2006, expenses are amortized under the straight-line single option method prescribed by SFAS 123. As share-based compensation expense recognized in the consolidated statement of operations for the three and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be approximately 20% for both officers and directors and 20% for employees in the three and nine months ended September 30, 2006 based on our historical experience. In our pro forma information required under SFAS 123 for the periods prior to fiscal 2006, we accounted for forfeitures as they occurred. For the nine months ended September 30, 2006, we recorded $413,000 in stock-based compensation expense related to FAS123(R).

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We would be exposed to changes in interest rates primarily from any marketable securities and investments in certain available-for-sale securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. At September 30, 2006, we did not have any marketable securities or investments in available-for-sale securities, nor did we have any sales denominated in a currency other than the United States dollar. Our cash equivalents’ principal would not be materially changed by changes in interest rates, but our $2.1 million term loan and $1.0 million revolving line of credit from Laurus have a floating interest rate and we would have to pay more on interest on the outstanding balance if the interest rates hike again. An immediate increase of two percentage points in the prime interest rate would result in us having to pay additional interest of approximately $60,000 over the next 12 months under these two notes.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports to the SEC is recorded, processed, summarized and reports to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. For example, a company’s operations may change over time, such as the result of new or discontinued lines of business, and management must periodically modify a company’s internal controls and procedures to timely match these changes in its business. Further, all controls and procedures are necessarily subject to the judgment of management in evaluating the design and cost benefit relationship of possible controls and procedures, and the judgment of company personnel in their application.

As of September 30, 2006, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including Tom Tullie, our Chief Executive Officer and Jeremy Ferrell our Interim Chief Financial Officer, of the effectiveness of the design an operation of our disclosure controls and procedures. Based upon the foregoing, our Chief Executive Officer and Interim Chief Financial Officer concluded that, as of September 30, 2006, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting.

There have been no changes in our internal control over financial reporting identified in connection with the evaluation referenced above that occurred during our last fiscal quarter that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

Please see the disclosures in our annual report on Form 10-K for the year ended December 31, 2005 under the caption “Legal Proceedings” regarding the ongoing lawsuit by Gryphon and GSSF Master Fund, LP, and the settled lawsuit which had been brought by Castle Creek, which are incorporated herein by reference. There have been no material developments in those matters since the filing of our Form 10-K.

ITEM 1A.

RISK FACTORS

You should carefully consider the following risks and uncertainties before you invest in our Common Stock. Investing in our Common Stock involves risk. If any of the following risks or uncertainties actually occurs, our business, financial condition or results of operations could be materially adversely affected. The following are not the only risks and uncertainties we face. Additional risks and uncertainties of which we are unaware or which we currently believe are immaterial could also materially adversely affect our business, financial condition or results of operations. In any case, the trading price of our Common Stock could decline, and you could lose all or part of your investment. See also, “Forward-Looking Statements” In Part I, Item 2.

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

Our cash position was approximately $389,000 at September 30, 2006 and approximately $336,000 as of November 9, 2006. Also, our current ratio of current assets to current liabilities has declined significantly, and we have been taking on secured debt. Despite our two private placements in 2005 (in which we raised aggregate proceeds of approximately $5.4 million), our secured convertible term note financing in December 2005 (in which we borrowed $2,100,000), our revolving line of credit financing in April 2006 (in which we borrowed a net of $1.3 million ), and our Common Stock financing in which we raised $405,000 in August 2006, given our projected monthly gross cash burn rate (without contribution from our gross margin on sales of products and without litigation expenses) of approximately $350,000, we need to raise additional capital or sell the assets of the Company to sustain our operations. Without significant revenue, the sale of assets or additional financing we will not be able to fund operations through the fourth quarter of 2006. Financing may not be available to us on acceptable terms, if at all. Our inability to raise capital when needed will severely harm our business. The report of Swenson Advisors LLP, our previous auditors, on our 2005 financial statements includes a “going-concern” qualification, which means that our auditors expressed substantial doubt as to our ability to continue as a going concern. In addition, additional equity financing may dilute our stockholders’ interest massively, and additional debt financing, if available, may involve restrictive covenants and could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on debt. If adequate funds are not available, we might not be able to continue our operations.

One of our possible alternatives in our pursuit of additional financing is the winding down of operations if we do not secure sufficient financing.

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

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

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

Our stock has been delisted from the American Stock Exchange.

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

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

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

Our window of opportunity may be shrinking.

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

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

We have incurred losses since inception and will likely not be profitable at least for the next several quarters.

We have incurred operating losses since our inception in January 1998. As of September 30, 2006, our accumulated deficit was approximately $60.0 million. We have never been profitable. We expect to continue to incur significant operating, sales, marketing, research and development and general and administrative expenses and, as a result, we will need to generate significant revenues to achieve profitability. Even if we do achieve profitability, we cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future.

Changes in senior management may result in difficulties.

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

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

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

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

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

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

In connection with the Laurus line of credit, we entered into a Consent and Waiver agreement dated April 22, 2006 with Castle Creek. In consideration of the consent and waiver given by Castle Creek, we agreed to provisions which have the economic effect of reducing the conversion price of Castle Creek’s Series B Preferred Stock from $2.6316 per share to $1.51 per share. In the Consent and Waiver agreement, we also agreed to offer each of the respective minority holders of the Series B Preferred Stock the same benefits and the same burdens of the Consent and Waiver agreement, as if such minority holder was “Castle Creek” for such purposes. We did so, and all of the minority holders accepted this offer.

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

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

On April 25, 2006, we entered into a $1 million non-convertible secured revolving line of credit with Laurus. The revolving line of credit bears an annual interest rate equal to prime plus 200 basis points per annum, payable monthly in cash. In connection with the financing, we issued to Laurus a seven year warrant to purchase up to 662,251 shares of Common Stock at an exercise price of $1.51 per share. Additionally, Laurus agreed to postpone five months of principal payments totaling $303,000 related to the $2.1 million convertible note issued in December 2005. Monthly principal payments will resume in January 2007. This revolving line of credit is secured by all our assets pursuant to a Security Agreement dated April 25, 2006. We have the ability to draw down advances under the revolving line of credit subject to limits based on our accounts receivable balances and inventory levels.

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

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

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

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

We face competition from established and developing companies, many of which have significantly greater resources, than we do, and we expect such competition to grow.

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

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

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

~~Our~~34 ~~product line is relatively narrow, whereas many of our competitors can offer customers a complete solution. Our limited product portfolio represents a significant competitive disadvantage for us.~~

WeTable mayof need to raise additional capital in the near future. Contents

~~Our~~ that ~~cash~~are ~~position~~competitive atin ~~March~~terms ~~31,~~of ~~2005,~~price ~~was~~or $1performance.8 ~~million.~~If ~~Despite~~ our ~~recent~~competitors ~~private~~develop ~~placements,~~products inor ~~which~~services wethat ~~raised~~offer ~~aggregate~~significant ~~proceeds~~price ofor ~~approximately~~performance ~~$5.4~~advantages ~~million~~as ~~($2.6~~compared ~~million of which is expected~~ to beour ~~received~~current byand ~~the~~proposed ~~end~~products ofand ~~the second quarter of 2005)~~services, ~~given~~or ~~our~~if ~~projected cash burn rate~~ we ~~anticipate~~are weunable ~~may need~~ to ~~raise~~improve ~~additional capital in order to sustain~~ our ~~operations~~technology ator ~~current~~develop ~~levels.~~or ~~We cannot~~acquire ~~ensure~~more ~~that~~competitive ~~financing~~technology, ~~will~~we bemay ~~available~~find toourselves ~~us on acceptable terms, if~~ at ~~all.~~a ~~Our~~competitive ~~inability~~disadvantage toand ~~raise~~our ~~capital~~business ~~when~~could ~~needed~~be ~~would harm our business~~adversely affected. In addition, ~~additional~~competitors ~~equity~~with ~~financing~~greater ~~may dilute our stockholders’ interest~~financial, ~~and debt financing~~marketing, ifdistribution ~~available, may involve restrictive covenants~~ and ~~could~~other ~~result~~resources inthan awe ~~substantial~~have ~~portion~~may ofbe ~~our~~able ~~operating~~to ~~cash~~leverage ~~flow~~such ~~being~~resources ~~dedicated~~ to ~~the~~gain ~~payment~~wide acceptance of ~~principal~~products ~~and~~inferior ~~interest on debt. If adequate funds are not available, we would need~~ to ~~curtail~~ ~~our operations significantly~~ours.

Our product line is relatively narrow, whereas many of our competitors can offer customers a complete solution that includes products that we do not manufacture or technologies which we have not developed. Our limited product line represents a significant competitive disadvantage for us.

We need to develop and introduce new and enhanced products in a timely manner to remain competitive.

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

•

are not cost effective,

•

are not brought to market in a timely manner,

•

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

•

fail to achieve market acceptance.

~~Our~~Technologies ~~future~~are ~~success~~changing rapidly, and we will ~~depend~~be required to spend significant sums on ~~our~~research ~~ability~~and todevelopment ~~develop~~– particularly for new ~~products~~hardware ~~that~~designs ~~will~~and ~~use~~software development – to produce these next generation ~~Intel~~products. ~~IXP~~Our ~~processors~~existing ~~and~~products ~~other~~may ~~key~~soon become difficult to produce because of end-of-life components., ~~These~~because ~~technologies~~of ~~are changing~~emerging ~~rapidly~~governmental restrictions on the manufacture and sale of electronic products containing lead parts and components, and webecause ~~will~~of beincreasing ~~required~~demand toin the market for new standards-based products.

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

In order to develop and market successfully certain of our planned products for digital applications, we may be required to enter into technology development or licensing agreements with third parties. We cannot assure you that we will be able to enter into any necessary technology development or licensing agreement on terms acceptable to us, or at all. The failure to enter into technology development or licensing agreements when necessary could limit our ability to develop and market new products and, accordingly, could materially and adversely affect our business and operating results.

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

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

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

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

Delivery of real-time, broadcast-quality video via IP networks is a new market and subject to evolving standards.

Delivery of real-time, broadcast-quality video over IP networks is novel and evolving, and it is possible that communication service providers or their suppliers will adopt alternative architectures and technologies for delivering real-time, broadcast-quality video over IP networks or other types of networks that are incompatible with our current or future products. In addition to competing with video over IP vendors, we compete with existing or incumbent alternative technologies and architectures for transporting live broadcast video that have existed for many years such as satellite, circuit switched networks and ATM, and our customers may not be willing to move to using an IP network for transporting live video.

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

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

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

Our quarterly financial results are likely to fluctuate significantly.

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

• decreased spending on new products ~~such as ours~~ by ~~communication~~our ~~service providers or their suppliers~~customers,

•

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

23• the timing of new product offerings, acquisitions, licenses or other significant events by us or our competitors,

~~Table~~• problems in our execution of ~~Contents~~key functions such as engineering, manufacturing, marketing and/or sales,

• problems in our execution of key functions such as manufacturing, marketing and/or sales,

•

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

•

demand and pricing of the products we offer,

•

purchases of our products by communication service providers in large, infrequent amounts consistent with past practice,

• ~~consumer~~customer acceptance of the services our products enable,

•

interruption in the manufacturing or distribution of our products,

•

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

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

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

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

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

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

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

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

• the length or total dollar amount of our prospective customers’ planned purchasing programs contemplating our products;,

• changes in prospective customers’ capital equipment budgets or purchasing priorities;,

• prospective customers’ internal acceptance reviews;, and

•

the complexity of prospective customers’ technical needs.

These uncertainties, combined with many potential customers’ measured approaches to corporate spending on technology generally as well as new technologies such as ours, substantially complicate our planning and may reduce prospects for sales of our products. If our prospective customers curtail or eliminate their purchasing programs, decrease their budgets or reduce their purchasing priority, our results of operations could be adversely affected.

reduce prospects for sales of our products. If our prospective customers curtail or eliminate their purchasing programs, decrease their budgets or reduce their purchasing priority, our results of operations could be adversely affected.

Changes in senior management may result in difficulties

On March 29, 2004, Frederick Cary resigned as our chief executive officer and president and was replaced by John Zavoli. On April 26, 2004, Patrick Bohana accepted early retirement from his position as Vice President, Sales and General Manager; on September 1, 2004 we hired Jeff Hale to replace him as Vice President, Sales. On January 24, 2005, we hired Dan McCrary as our new Vice President, Marketing. Changes in senior management of small companies are inherently disruptive, and efforts to implement any new strategic or operating goals may also prove to be disruptive. In addition, until we hire new senior executives to assist him, there is a risk that Mr. Zavoli’s many responsibilities (he is also serving as our chief financial officer, general counsel and secretary) will overwhelm him to the point that he will not be able to devote sufficient attention to one or more of his important roles. We are seeking, but may not be able to successfully hire, a new chief financial officer.

Our customer base is concentrated and the loss of one or more of our key customers would harm our business.

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

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

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

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

We37 ~~may not be able to profit from growth if we are unable to manage effectively the growth.~~

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

~~especially~~We ~~customers~~may ~~that~~not ~~purchase~~be ~~novel~~able ~~and~~to ~~technologically~~profit ~~sophisticated~~from ~~products~~growth ~~such~~if aswe ~~ours,~~are ~~generally~~unable ~~require~~to ~~significant~~manage ~~engineering support. Therefore, adoption of our platforms and products by customers would increase~~ the ~~strain~~growth ~~on our resources~~effectively.

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

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

We will depend on broadcasting, cable and satellite industry spending for a substantial portion of our revenue and any decrease or delay in spending in these industries would negatively impact our resources, operating results and financial condition.

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

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

• overall demand for communication services and the acceptance of new video, voice and data services;,

• annual budget cycles;,

• the status of federal, local and foreign government regulation of telecommunications and television broadcasting;,

• access to financing;,

• evolving industry standards and network architectures;,

• competitive pressures;,

• discretionary customer spending patterns;, and

•

general economic conditions.

~~Recent~~We ~~developments~~believe inthat the capital markets’ more ~~have~~measured approach to providing financing for emerging and even established telecommunications companies, since the bull market that ended in 2000, has reduced access to funding for potential and existing customers causing delays in the timing and scale of deployments of our equipment, as well as the postponement of certain projects by our customers. The timing of deployment of our equipment can be subject to a number of other risks, including the availability of skilled engineering and ~~technical~~ technical personnel.

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

We produce highly complex products that incorporate leading edge technology including hardware, software and embedded firmware. In addition to problems relating to the physical quality of manufacturing, our software and other technology may contain “bugs” that can prevent our products from performing as intended. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects either in individual products or which could affect numerous shipments that, in turn, could create customer dissatisfaction, reduce sales opportunities, or affect gross margins if the cost of remedying the problems exceed our reserves established for this purpose. Our inability to cure a product defect may result in the failure of a product line, serious damage to our reputation, and increased engineering and product re-engineering costs that individually or collectively would have a material adverse impact on our revenues and operating results.

2638

In 2004, we had to focus some of our engineering personnel away from their research and development efforts in favor of sustaining engineering efforts to satisfy our customers’ needs relative to existing products. This use of engineering resources could harm our development of new products.

We rely on several key suppliers of components, sub-assemblies and modules that we use to manufacture our products, and we are subject to manufacturing and product supply chain risks.

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

Our existing products may be subject to growing “lead-free” legislative efforts in the United States and abroad which restrict or prohibit the manufacture and/or sale of electronic products that contain lead. Our current products do contain various lead-based components. We will be required to redesign our products to eliminate lead components by 2006, and we may face difficulty in procuring lead-free parts and components and reengineering our products resulting in our inability to successfully complete such product re-designs which, in turn, could have a material negative impact on our results of operations.

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

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

We may not be able to hire and assimilate key employees.

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

We are dependent on our key employees for our future success.

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

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

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

product is sold, applicable sales discounts, licensed product feature sets, whether we sell our products as an OEM, and whether the sale is a direct sale or an indirect channel sale through our VARs and resellers. Any change in any of these variables could result in a material adverse impact on our gross sales, gross margins and operating results.

We may be unable to obtain full patent protection for our core technology and there is a risk of infringement.

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

In addition to seeking patent protection for our products, we intend to rely upon a combination of trade secret, copyright and trademark laws and contractual provisions to protect our proprietary rights in our products.

We have to vigorously enforce our rights to, and protect our interests in, our intellectual property, and we may not be successful. For example, in March 2005, we filed suit in California Superior Court against QVidia Technologies, Inc. and Ronald Fellman (who was a founder of Path 1) for alleged misappropriation of our proprietary and confidential information. Discovery has not commenced and the case is now pending. There can be no assurance that these efforts will be adequate or prove successful, or that competitors have not or will not independently develop technologies that are substantially equivalent or superior to ours.

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

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

We are subject to local, state and federal regulation.

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

The market price of our ~~common~~Common ~~stock~~Stock could be volatile and your investment could suffer a decline in value.

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

• quarterly variations in operating results and overall financial condition;,

• ~~economic~~announcements ~~and political developments affecting technology spending generally and adoption~~ of ~~new~~debt ~~technologies~~or ~~and~~equity ~~products such as ours;~~financings,

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

•

economic and political developments affecting technology spending generally and adoption of new technologies and products such as ours,

•

customer demand or acceptance of our products and solutions,

•

short-selling programs,

•

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

•

changes in IT spending patterns and the rate of consumer acceptance of video-on-demand,

•

product sales progress, both positive and negative,

•

the stock market’s perception of the telecommunications equipment industry as a whole,

•

technological innovations by others,

•

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

•

the introduction of new products or changes in product pricing policies by us or our competitors,

•

proprietary rights disputes or litigation,

•

other litigation,

•

initiation of or changes in earnings estimates by analysts,

•

additions or departures of key personnel, and

•

sales of substantial numbers of shares of our Common Stock or securities convertible into or exercisable for our Common Stock.

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

In addition, if the average daily trading volume in our Common Stock is low, the resulting illiquidity could magnify the effect.

•Compliance ~~customer~~with ~~demand~~changing orregulation ~~acceptance~~ of ~~our~~corporate ~~products~~governance and ~~solutions;~~public disclosure may result in additional expenses.

•Changing ~~short~~laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-~~selling~~Oxley ~~programs;~~Act of 2002 and new SEC regulations, continue to create uncertainty for many companies, including ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies or in legal interpretations rendered in judicial opinions, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention form revenue or profit generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards do not meet the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

•Any ~~stock~~changes ~~selling~~to byexisting ~~persons~~accounting topronouncements ~~whom~~or taxation rules or practices may cause adverse fluctuations in our reported results of operations or affect how we conduct ~~sold~~our ~~securities~~business; Newly adopted accounting regulations requiring companies to expense stock options will result in ~~one~~a decrease in our earnings, or ~~more~~an ~~private~~increase ~~placements~~in atour ~~below-market~~losses, ~~prices;~~and our stock price may decline.

•A ~~changes~~change in ITaccounting ~~spending~~pronouncements ~~patterns~~or taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the ~~rate~~change is effective. Other new accounting pronouncements or taxation rules and varying interpretations of ~~consumer~~accounting ~~acceptance~~pronouncements or taxation practices have occurred and may occur in the future. The change to existing rules, future changes, if any, or the questioning of ~~video-on-demand;~~current practices may adversely affect our reported financial results or the way we conduct business.

•The ~~product~~FASB ~~sales~~recently ~~progress~~adopted an accounting standard that eliminates the ability to account for share-based compensation transactions using the intrinsic method that we used through 2005. SFAS No. 123(R) generally requires for us that, beginning ~~both~~in ~~positive~~2006, such transactions be accounted for using a fair-value-based method and ~~negative;~~recognized as an expense in our consolidated statement of operations. We have expensed stock options vested after December 31, 2005, and recorded stock-based compensation amounting to $413,000 for the nine months ended September 30, 2006. Through 2005, we generally only disclosed such expenses on a pro forma basis in the notes to our consolidated financial statements in accordance with accounting principles generally accepted in the United States.

•The ~~the~~stock options and bonus stock ~~market’s~~we ~~perception~~offer ofto ~~the~~our ~~telecommunications~~employees, ~~equipment~~non-employee ~~industry~~directors, consultants asand aadvisors ~~whole;~~could result in ongoing dilution to all stockholders.

•We ~~technological~~maintain ~~innovations~~three byequity ~~others~~compensation plans: (i) the 2000 Plan, pursuant to which we may issue an aggregate of 710,000 options and shares of Common Stock to employees, officers, directors, consultants and advisors, (ii) the Purchase Plan, pursuant to which our employees are provided the opportunity to purchase our stock through payroll deductions, and (iii) the 2004 Plan, pursuant to which we may issue a total of 900,000 options and shares of Common Stock to employees, officers, directors, consultants and advisors. As of September 30, 2006, 475,000 shares of stock had been granted directly to current and former executives of the Company and there were options outstanding to purchase 50,153 shares of Common Stock under our 2000 Plan; 599,847 shares of Common Stock remained available for issuance under the 2000 Plan. A maximum of 41,667 shares of Common Stock have been authorized for issuance under the Purchase Plan. As of September 30, 2006, there were options outstanding to purchase 281,249 shares of Common Stock and 318,000 shares of stock had been granted directly to current executives of the Company under our 2004 Plan; 355,751 shares of Common Stock remained available for issuance under the 2004 Plan.

•In ~~cost~~addition, oras ~~availability~~of September 30, 2006, there were 115,000 shares of ~~components~~Common Stock subject to outstanding options granted other than under the 2004 Plan, ~~sub-assemblies~~the ~~and~~2000 Plan ~~modules~~or ~~used~~the inPurchase Plan. These options were granted as inducement stock options to Thomas Tullie, our ~~products;~~new CEO, in 2005.

•We plan to continue to provide our employees opportunities to participate in the ~~introduction~~Purchase Plan. We also plan to issue options to purchase sizable numbers of shares of Common Stock to new ~~products~~and existing employees, officers, directors, advisors, consultants or ~~changes~~other individuals as we deem appropriate and in ~~product~~our ~~pricing~~best ~~policies~~interests. byThis uscould orresult ~~our~~in ~~competitors;~~substantial dilution to all stockholders and increased control by management.

•41 ~~proprietary rights disputes or litigation;~~

• initiation of or changes in earnings estimates by analysts;

• additions or departures of key personnel; and

• sales of substantial numbers of shares of our common stock or securities convertible into or exercisable for our common stock.

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

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

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

The Financial Accounting Standards Board recently adopted the previously proposed regulations that will eliminate the ability to account for share-based compensation transactions using the intrinsic method that we currently use and generally would require that such transactions be accounted for using a fair-value-based method and recognized as an expense in our consolidated statement of operations. We will be required to expense stock options granted after December 31, 2005. Currently, we generally only disclose such expenses on a pro forma basis in the notes to our consolidated financial statements in accordance with accounting principles generally accepted in the United States. The adoption of this new accounting regulation will have a significant impact on our results of operations when or if we issue stock options after December 31, 2005, and our stock price could decline accordingly.

Our outstanding convertible preferred stock and warrants and the stock options and bonus stock we offer to our employees, non-employee directors, consultants and advisors could result in ongoing dilution to all stockholders.

We maintain three equity compensation plans: (i) the 2000 Stock Option/Stock Issuance Plan (the “2000 Plan”), pursuant to which we may issue an aggregate of 710,000 options and shares of common stock to employees, officers, directors, consultants and advisors, (ii) the 2001 Employee Stock Purchase Plan (the “Purchase Plan”), pursuant to which our employees are provided the opportunity to purchase our stock through payroll deductions, and (iii) the 2004 Equity Incentive Plan (the “2004 Plan”), pursuant to which we may issue a total of 900,000 options and shares of common stock to employees, officers, directors, consultants and advisors. As of March 31, 2005, 405,000 shares of stock had been granted directly to current and former executives of the

~~Company~~The ~~and~~conversion ~~there~~or ~~were~~exercise, ~~options~~as ~~outstanding to purchase 282~~applicable,~~350~~ ~~shares~~ of ~~common stock under~~ our ~~2000~~outstanding ~~Plan;~~convertible ~~19,403~~preferred ~~shares of common~~ stock ~~remained available for issuance under the 2000 Plan. A maximum of 41~~,~~667~~ ~~shares~~secured ofconvertible ~~common~~term note ~~stock have been authorized for issuance under the Purchase Plan. As of March 31, 2005, there were options outstanding to purchase 435,231 shares of common stock~~ and ~~20,000~~warrants ~~shares of~~could ~~stock~~result ~~had~~in ~~been~~significant ~~granted~~ongoing ~~directly~~dilution to ~~current~~all ~~executives of the Company under our 2004 Plan; 443,019 shares of common stock remained available for issuance under the 2004 Plan~~stockholders.

InAs ~~addition~~of September 30, 2006, there were outstanding warrants to purchase up to 5,406,072 shares of our Common Stock with a weighted average exercise price of $4.41 per share. The weighted average remaining life for all of the outstanding warrants as of ~~March~~September 30, 312006 was 3.00 years. In addition, ~~2005~~at September 30, 2006, there were 59811,~~840~~921 shares of ~~common~~Series ~~stock~~A ~~subject~~Preferred toStock and 731,157 shares of Series B Preferred Stock outstanding. ~~options~~These ~~granted~~shares ~~other than~~are ~~under~~convertible ~~the~~into ~~2004~~shares ~~Plan~~of Common Stock. Also, ~~the~~we ~~2000~~issued ~~Plan~~a orsecured ~~the~~convertible ~~Purchase~~term ~~Plan.~~note ~~These~~in the ~~non-plan~~principal ~~options~~amount ~~were~~of ~~granted~~$2,100,000 in ~~prior~~December ~~years~~2005 towhich ~~various~~is ~~employees~~convertible into 775,412 ~~directors~~shares of Common Stock. As indicated below, ~~consultants~~this note is convertible into shares of our Common Stock, and ~~advisors~~we ~~before~~are ~~the~~required ~~creation~~in certain circumstances to make scheduled principal and interest payments in shares of ~~any~~our ~~stock~~Common ~~option~~Stock ~~plan~~rather than in cash.

WeThe ~~plan~~issuance toof ~~continue~~any toshares ~~provide~~of our ~~employees~~Common ~~opportunities~~Stock pursuant to the ~~participate~~conversion or exercise of the above securities could significantly dilute your ownership in the ~~Purchase~~Company, ~~Plan.~~and Wethe ~~also~~sale ~~plan~~of such shares of Common Stock in the market could cause the market price of our Common Stock to ~~issue~~decline ~~options~~as a result of the increased supply of shares, which could in turn cause you to ~~purchase~~lose ~~sizable~~a ~~numbers~~portion of your investment. The significant downward pressure on the market price of our Common Stock that would result from the sale of a significant amount of such shares of Common ~~common~~Stock ~~stock~~could also encourage “short sales” by holders of our securities or others. These “short sales” occur when an investor commits to ~~new~~sell ~~and~~a ~~existing~~security ~~employees,~~that ~~officers,~~he ~~directors,~~or ~~advisors~~she does not own at the time such commitment is made, ~~consultants~~but that orthe ~~other~~investor ~~individuals~~hopes asto webuy ~~deem~~in ~~appropriate~~earnest ~~and~~at a lower price in ~~our~~the ~~best~~future ~~interests~~before he or she must deliver the security to the counterparty on the original sale. Investors typically engage in short selling when they believe that the price of the ~~This~~underlying ~~could~~security ~~result~~will decline before the time of settlement. In the event of a significant increase in ~~substantial~~short ~~dilution~~selling toof ~~all~~our ~~stockholders~~Common ~~and~~Stock, ~~increased~~other ~~control~~investors bymay ~~management~~interpret such increase as a sign that the market price of our Common Stock will decline, causing further downward pressure on the market price.

AsLaurus is contractually prevented (subject to default by us or waiver by the holder upon 75 days’ notice to us) from converting its secured convertible term note and/or exercising its warrants if such conversion or exercise would result in such holder owning more than 4.99% of ~~March~~our ~~31,~~issued ~~2005,~~and ~~there~~outstanding ~~were~~shares of Common Stock. Laurus is also further prevented from owning more than 19.99% of our issued and outstanding ~~warrants~~Common toStock ~~purchase~~under upany tocircumstances. 3Laurus could,~~610~~ however,~~843~~ effectively avoid these limitations by selling some of the shares of ~~our~~Common ~~common~~Stock ~~stock~~that ~~with~~it acquires aupon ~~weighted~~partial ~~average~~conversion ~~exercise~~of ~~price~~the secured convertible term note or partial exercise of ~~$5.40~~ ~~per~~the ~~share.~~warrants ~~The~~and ~~weighted~~then ~~average~~receiving ~~remaining~~additional ~~life~~shares ~~for~~upon ~~all~~further conversion of the ~~currently~~note ~~outstanding~~or further exercise of the warrants. isIn 3this way, Laurus could sell more shares of our Common Stock than these contractual limits while never holding more than such limits.6 ~~years~~The ~~from~~issuance ~~March~~of ~~31,~~such ~~2005~~shares of Common Stock could result in significant ongoing dilution to all stockholders.

InThe ~~addition,~~principal atand ~~March~~interest ~~31,~~payable ~~2005,~~on ~~there~~the ~~were~~Laurus ~~864,229~~secured ~~shares~~convertible ofterm 7%note ~~Convertible~~is ~~Preferred Stock outstanding. These shares are~~ convertible into shares of ~~common~~ ~~stock.~~our ~~And~~Common Stock, weand ~~expect~~under tocertain ~~issue~~circumstances ~~792,306~~this conversion ~~shares~~is ofmandated. ~~Series~~The Bnumber 7%of ~~Convertible~~shares ~~Preferred~~of our Common Stock inthat ~~the~~are ~~second~~issuable ~~quarter~~upon conversion of ~~2005;~~the ~~these~~note ~~shares~~is ~~would~~equal ~~also~~to bethe ~~convertible~~aggregate ~~into~~amount ~~shares~~ of ~~common~~the ~~stock.~~principal, Ininterest ~~connection~~and ~~with~~fees ~~the~~then ~~issuance~~due ofand ~~the~~payable ~~Series~~with Brespect ~~7% Convertible~~to ~~Preferred~~the ~~Stock,~~note wedivided ~~would~~by ~~also~~the ~~issue~~fixed conversion ~~435,771~~price ~~common~~then ~~stock~~in ~~warrants~~effect. ~~(with~~The anfixed ~~exercise~~conversion price ofis ~~$3.25~~subject ~~per~~to ~~share)~~potential future adjustment, ~~and~~which would ~~reduce~~result in the ~~exercise~~note ~~price~~becoming ofconvertible ~~432,115~~into ~~outstanding~~a ~~warrants~~greater ~~from~~or ~~$4.20~~lesser ~~per~~number ~~share~~of toshares ~~$3.25~~of ~~per~~our ~~share~~Common Stock.

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

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

WeIn ~~intend to issue, in a private placement in~~ the second quarter of 2005, upwe toissued 792,306 shares of Series B ~~7% Convertible~~ Preferred Stock., ~~Its~~with rights and preferences ~~would be~~ substantially similar to those ~~just~~of ~~stated as to~~ the 7%Series ~~Convertible~~A Preferred Stock.

WeAs doof ~~not~~September 30, ~~intend~~2006, tothere ~~pay~~remain ~~cash~~outstanding ~~dividends.~~811,921 shares of Series A Preferred Stock and 731,157 shares of Series B Preferred Stock.

WeThe ~~have~~agreements ~~never~~governing ~~paid~~our ~~cash~~outstanding ~~dividends~~secured onconvertible ~~our~~term ~~capital~~note ~~stock~~ and dosecured ~~not~~non-convertible ~~anticipate~~revolving ~~paying~~note ~~any~~contain ~~cash~~various ~~dividends~~covenants inwhich ~~the~~may limit ~~foreseeable~~our ~~future~~ability to operate our business.

~~ITEM~~The 3.agreements ~~QUANTITATIVE~~governing ~~AND~~our ~~QUALITATIVE~~outstanding ~~DISCLOSURES~~secured ~~ABOUT~~convertible ~~MARKET~~term ~~RISK~~note and secured non-convertible revolving note contain various provisions that limit our ability to, among other things: declare or pay dividends on our Common Stock, issue mandatorily

We42 would be exposed to changes in interest rates primarily from any marketable securities and investments in certain available-for-sale securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. At March 31, 2005, we did not have any marketable securities or investments in available-for-sale securities, nor did we have any sales denominated in a currency

~~other~~redeemable ~~than~~preferred ~~the~~stock, ~~United~~redeem ~~States~~any ~~dollar.~~preferred ~~Our~~stock, ~~cash~~effect ~~equivalents’~~certain ~~principal~~mergers ~~would~~or ~~not~~other becorporate transactions, materially ~~changed~~alter byor ~~changes~~change inthe ~~interest~~scope ~~rates~~of our business, ~~but~~sell asor ~~the~~lease ~~short~~assets, ~~term instruments~~or ~~mature~~create ~~and~~or ~~roll~~incur ~~over,~~additional weindebtedness. ~~would~~These berestrictions ~~able~~could tolimit ~~earn~~our ~~more~~ability ~~interest~~to inplan ~~the~~for ~~future~~or ifreact ~~interest~~to ~~rates~~market ~~rise.~~conditions Aor ~~one~~meet ~~percentage~~extraordinary ~~point~~capital ~~(100~~needs ~~basis~~or ~~point)~~otherwise ~~increase~~restrict incorporate ~~interest~~activities, ~~rates~~any ~~would~~of which ~~result~~could inhave ~~approximately~~ a ~~$17,000~~material ~~annual~~adverse ~~increase~~impact inon our ~~income from~~business. ~~cash equivalents~~Also, ~~assuming~~upon our ~~cash~~failure ~~equivalents~~to ~~principal~~comply ~~balance~~with ~~remained~~any atof ~~its~~the ~~March~~covenants ~~31,~~contained ~~2005~~in ~~level.~~the ~~Our~~agreements $1governing ~~million~~the secured convertible term note and secured non-convertible revolving ~~line~~note, ofthe ~~credit~~holder thereof ~~from~~may ~~Laurus~~accelerate ~~(which~~the indebtedness outstanding thereunder, and currently ~~has~~we awould ~~zero~~not ~~balance~~have ~~outstanding)~~sufficient ~~has~~funds aavailable ~~floating~~to ~~interest~~make ~~rate~~the required accelerated payments.

~~ITEM~~We 4.do ~~CONTROLS~~not ~~AND~~intend ~~PROCEDURES~~to pay cash dividends.

~~John~~We ~~Zavoli,~~have ~~who~~never ispaid ~~both~~cash ~~our~~dividends ~~principal~~on ~~executive~~our ~~officer~~Common Stock and ~~principal~~do ~~financial~~not ~~officer, after evaluating the effectiveness of our “disclosure~~anticipate ~~controls~~paying ~~and~~any ~~procedures”~~cash ~~(as~~dividends ~~defined~~ in ~~Securities~~the ~~Exchange~~foreseeable ~~Act of 1934 Rule 13a–15(e)), concluded that as of March 31, 2005, our disclosure controls and procedures were effective~~future.

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not a defendant in any material legal proceedings.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

OnPreviously ~~July~~disclosed ~~30,~~in ~~2003,~~our ~~the~~Current ~~SEC~~Reports ~~declared~~on ~~effective~~Form ~~the~~8-K ~~registration~~filed ~~statement~~with (the SEC ~~file~~on ~~no.~~September 1, ~~333-105638)~~2006, September 5, ~~for~~2006 ~~our~~and ~~initial~~September 7, ~~public~~2006, ~~offering~~each of ~~units~~which ~~through~~are ~~underwriters~~incorporated ~~led~~herein by ~~Paulson Investment Company, Inc~~reference.

We have now completed our use of the $13,055,136 net proceeds of the offering. We used $1,380,000 to pay accrued accounts payable, $1,382,000 to repurchase $1,180,000 principal amount of our 7% convertible debentures, $92,997 to repurchase 27,777 shares of common stock from Ronald Fellman, a total of $100,000 to pay cash bonuses to Frederick Cary and John Zavoli, $9,463,000 to fund negative cash flows from operations and approximately $637,000 to fund negative cash flows from investing activities. Except as discussed in the previous sentence, none of these payments went directly or indirectly to our directors, officers, general partners, affiliates, 10% owners, or any of their associates.

We previously reported on Form 8-K the required information regarding issuance of unregistered equity securities in the first quarter of 2005.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

~~Not~~As ~~applicable~~of November 14, 2006, we have an accumulated dividend accrual on our outstanding Series A Preferred Stock of approximately $305,000.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

ITEM 5.

OTHER INFORMATION

None.

3143

ITEM 6.

EXHIBITS

The following exhibits are included as part of this report. References to “Path 1” or “us” in this Item 6 mean Path 1 Network Technologies Inc., a Delaware corporation.


Exhibit Number		Description
3.1		Certificate of Incorporation, as amended. (1)

3.2		Certificate of Amendment of Certificate of Incorporation, as filed with the Delaware Secretary of State on February 28, 2002. (2)

3.3		Certificate of Amendment to Certificate of Incorporation, as filed with the Delaware Secretary of State on July 22, 2003. (3)

3.4		Certificate of Designations of Preferred Stock to be Designated 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on January 27, 2005. (4)

3.5		Amended and Restated Certificate of Designations. (5)

3.6		Certificate of Designations of Preferred Stock to be Designated Series B 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on May 31, 2005. (5)

3.7		Amended and Restated Bylaws. (1)

4.1		Warrant to Purchase Common Stock dated August 30, 2006 by and among the Company and Laurus Master Fund, Ltd. (6)

10.1		Purchase Agreement dated August 30, 2006 by and between the Company and the investors whose names appear on the signatures pages thereof. (6)

10.2		Officer Waiver of Cash Compensation dated August 30, 2006. (6)

10.3		Form of Board of Directors Waiver of Cash Compensation dated August 30, 2006. (6)

10.4*		Patent Purchase Agreement dated November 13, 2006 between the Company and Great Links G.B. LLC.

31.1*		Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).

31.2*		Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).

32.1*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).

32.2*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).

ExhibitNumber		Description
3.3		Certificate of Designations of Preferred Stock to be Designated 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on January 27, 2005. (1)
10.74		Securities Purchase Agreement, dated January 26, 2005. (1)
10.75		Registration Rights Agreement, dated January 26, 2005. (1)
10.76		Form of Warrant to Purchase Shares of Common Stock (January 27, 2005/February 18, 2005). (1)
10.77		Form of Warrant to Purchase Shares of Common Stock, dated February 18, 2005. The warrants were issued to Jonathan Hodson-Walker (21,606 warrants), John C. Bowen (10,606 warrants) and Nicolas A. McCoy (10,606 warrants). (2)
10.78		Second Amendment to Restricted Stock Award between us and John R. Zavoli, dated March 8, 2005. (3)
10.79		Lease Agreement Between Pointe Camino Windell LLC and us dated January 26, 2005. (4)
10.89*#		Daniel S. McCrary employment letter agreement.
10.90*#		Restricted Stock Award Agreement between us and Daniel S. McCrary, dated January 26, 2005.
31*		Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a–14(a)
32*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b)

*	Filed Herewith

#(1) ~~Indicates~~This ~~management~~exhibit ~~contract~~was orpreviously ~~compensatory~~filed ~~plan~~as orpart ~~arrangement.~~of, and is hereby incorporated by reference to, our Current Report on Form 8-K filed with the SEC on December 16, 2005.

(12) This exhibit was previously filed as part of, and is hereby incorporated by reference to, our Annual Report on Form 810-K for the year ended December 31, 2001, filed with the ~~Commission~~SEC on ~~January~~April 3115, ~~2005~~2002.

(23) This exhibit was previously filed as part of, and is hereby incorporated by reference to, ~~our~~Current Report on Form 8-K filed with the ~~Commission~~SEC on ~~February~~July 2223, ~~2005~~2003.

(34) This exhibit was previously filed as part of, and is hereby incorporated by reference to, ~~our~~Current Report on Form 8-K filed with the ~~Commission~~SEC on ~~March~~January 931, 2005.

(45) This exhibit was previously filed as part of, and is hereby incorporated by reference to, ~~our~~Current Report on Form 108-K filed with the ~~Commission~~SEC on ~~March~~June 295, 2005.

32(6) This exhibit was previously filed as part of, and is hereby incorporated by reference to, Current Report on Form 8-K filed with the SEC on September 1, 2006

SIGNATURES

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

Path 1 Network Technologies Inc.

By:		/S/ JOHN R. ZAVOLI
		John R. Zavoli
		President and Chief Executive Officer,
		Chief Financial Officer, General Counsel and Secretary
Date: May 13, 2005


By:		/s/ Thomas L. Tullie
		Thomas L. Tullie
		President and Chief Executive Officer

33Date: November 13, 2006

~~Exhibit~~INDEX ~~List~~OF EXHIBITS

References to “us” or “Path 1” in this Exhibit List mean Path 1 Network Technologies Inc., a Delaware corporation


Exhibit Number		Description
3.1		Certificate of Incorporation, as amended. (1)

3.2		Certificate of Amendment of Certificate of Incorporation, as filed with the Delaware Secretary of State on February 28, 2002. (2)

3.3		Certificate of Amendment to Certificate of Incorporation, as filed with the Delaware Secretary of State on July 22, 2003. (3)

3.4		Certificate of Designations of Preferred Stock to be Designated 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on January 27, 2005. (4)

3.5		Amended and Restated Certificate of Designations. (5)

3.6		Certificate of Designations of Preferred Stock to be Designated Series B 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on May 31, 2005. (5)

3.7		Amended and Restated Bylaws. (1)

4.1		Warrant to Purchase Common Stock dated August 30, 2006 by and among the Company and Laurus Master Fund, Ltd. (6)

10.1		Purchase Agreement dated August 30, 2006 by and between the Company and the investors whose names appear on the signatures pages thereof. (6)

10.2		Officer Waiver of Cash Compensation dated August 30, 2006. (6)

10.3		Form of Board of Directors Waiver of Cash Compensation dated August 30, 2006. (6)

10.4*		Patent Purchase Agreement dated November 13, 2006 between the Company and Great Links G.B. LLC.

31.1*		Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).

31.2*		Certification under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a-14(a).

32.1*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).

32.2*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b).

ExhibitNumber		Description
3.3		Certificate of Designations of Preferred Stock to be Designated 7% Convertible Preferred Stock, as filed with the Delaware Secretary of State on January 27, 2005. (1)
10.74		Securities Purchase Agreement, dated January 26, 2005. (1)
10.75		Registration Rights Agreement, dated January 26, 2005. (1)
10.76		Form of Warrant to Purchase Shares of Common Stock (January 27, 2005/February 18, 2005). (1)
10.77		Form of Warrant to Purchase Shares of Common Stock, dated February 18, 2005. The warrants were issued to Jonathan Hodson-Walker (21,606 warrants), John C. Bowen (10,606 warrants) and Nicolas A. McCoy (10,606 warrants). (2)
10.78		Second Amendment to Restricted Stock Award between us and John R. Zavoli, dated March 8, 2005. (3)
10.79		Lease Agreement Between Pointe Camino Windell LLC and us dated January 26, 2005. (4)
10.89*#		Daniel S. McCrary employment letter agreement.
10.90*#		Restricted Stock Award Agreement between us and Daniel S. McCrary, dated January 26, 2005.
31*		Certifications under Section 302 of the Sarbanes-Oxley Act of 2002 / SEC Rule 13a–14(a)
32*		Certification under Section 906 of the Sarbanes-Oxley Act of 2002 / 18 U.S.C. Section 1350/ SEC Rule 13a-14(b)

*	Filed Herewith

(34) This exhibit was previously filed as part of, and is hereby incorporated by reference to, ~~our~~Current Report on Form 8-K filed with the ~~Commission~~SEC on ~~March~~January 931, 2005.

(45) This exhibit was previously filed as part of, and is hereby incorporated by reference to, ~~our~~Current Report on Form 108-K filed with the ~~Commission~~SEC on ~~March~~June 295, 2005.

34(6) This exhibit was previously filed as part of, and is hereby incorporated by reference to, Current Report on Form 8-K filed with the SEC on September 1, 2006

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

WeTable mayof need to raise additional capital in the near future. Contents

Table of Contents

Table of Contents

Table of Contents

Filing Compare · PATH 1 NETWORK TECHNOLOGIES INC