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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended March 31, 2005.

or

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)

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 an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

As of April 30, 2005, 6,882,221 shares of the registrant’s common stock were outstanding.

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PATH 1 NETWORK TECHNOLOGIES INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2005

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Path 1 Network Technologies Inc.

Consolidated Balance Sheets

(in thousands, except shares data)

See accompanying notes to these consolidated financial statements.

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Path 1 Network Technologies Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

See accompanying notes to these consolidated financial statements.

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Path 1 Network Technologies Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

See accompanying notes to these consolidated financial statements.

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Path 1 Network Technologies Inc.

Notes to the Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

The accompanying consolidated balance sheet at March 31, 2005, the consolidated statements of operations for the three-month periods ended March 31, 2005 and 2004, and the consolidated statements of cash flows for the three-month periods ended March 31, 2005 and 2004, have been prepared by Path 1 Network Technologies Inc. (the “Company”) and have not been audited. The consolidated balance sheet at December 31, 2004 has been audited. These consolidated quarterly financial statements, in the opinion of management, include all adjustments, consisting only of normal and recurring adjustments, necessary to state fairly the financial information set forth therein, in accordance with accounting principles generally accepted in the United States. These quarterly consolidated financial statements should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2004. The interim consolidated financial information contained in this filing is not necessarily indicative of the results to be expected for any other interim period or for the full year ending December 31, 2005.

Reclassifications

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

Recently Issued Accounting Standards

In March 2005, the FASB issued Interpretation No.47 (FIN 47), Accounting for Conditional Asset Retirement Obligations. FIN 47 clarifies that an entity must record a liability for a “conditional” asset retirement obligation if the fair value of the obligation can be reasonably estimated. The provision is effective no later than the end of fiscal years ending after December 15,2005. We have not determined what effect, if any, FIN 47 will have on our financial condition or results of operations.

On December 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.

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, Inventory Costs, an Amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and requires the allocation of fixed production overhead to inventory based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Adoption of SFAS 151 is not expected to have a material impact on the Company’s financial condition, results of operations or cash flows.

In November 2004, the 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

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exchanged 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 2 – Stock-based Compensation

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

The Company accounts for equity instruments issued to non-employees using the fair value method in accordance with the provisions of SFAS 123 and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (SFAS 48), Accounting for Stock-Based Compensation—Transition and Disclosure. This statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company makes the following required disclosure under SFAS 148. The table below provides, on a pro forma basis, the effect employee stock-based compensation would have had on our operating results had the Company used the fair value method of accounting for stock-based compensation arrangements in conformity with SFAS 123 (in thousands, except per share amounts):

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

During the three-month periods ended March 31, 2005 and 2004, 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.

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Note 3 – 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 Company follows specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, the Company assesses a number of factors including specific contract and purchase order

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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 is reasonably assured.

Allowances for Doubtful Accounts, Returns and Discounts

The Company performs credit evaluations on all prospective customers, and historically has not required collateral or deposits. 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. If there were to be a deterioration of a major customer’s creditworthiness, or if actual defaults were higher than our historical experience, our operating results and financial position could be adversely affected.

Note 7 – Warranty Reserves, Indemnification Arrangements and Guarantees

In 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.

The Company 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 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:

The Company also undertakes indemnification obligations in the ordinary course of business related to its products, the licensing of its software, and the issuance of securities. Under these arrangements, the Company may indemnify other parties such as business partners, customers, and underwriters, for certain losses suffered,

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

Note 8 – Capitalized Software Development Costs

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.

The costs 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 capitalization of costs under SFAS 86 to date, and for the development of a particular software product to be sold, has been recorded under the working model provisions, SFAS 86 also provides for capitalization of costs incurred once a product has achieved technological feasibility under a more structured detail program design model. The Company plans to use the detail program design methodology in the future for software development efforts.

At March 31, 2005, the Company had net software capitalizations totaling $110,000. The capitalized amount will be amortized over an expected twenty-four month period beginning in the second quarter of 2005. The amount of annual expense to be recognized will be the greater of the amount that would be amortized using the straight-line method over the remaining economic life of the product including the period being reported and the amount that would be amortized by the ratio actual period sales of the product bear to the total of current and anticipated future sales of the product. The following table summarizes activity within the capitalized software and related amortization accounts during the three months ended March 31, 2005:

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Note 9 – Off Balance Sheet Arrangements

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

Note 10 – Reportable Operating Segments

We do not have more than one reportable operating segment.

Note 11 – Long-Term Liabilities

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:

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:

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.

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If all of the convertible preferred shares had been converted into the Company’s common stock on March 31, 2005, The Company would have been required to issue 864,229 common shares with a total fair value of approximately $5.1 million.

Total interest expense for the three months ended March 31, 2005, includes coupon interest on notes payable of approximately $1,700; non-cash interest expense of approximately $17,300 pertaining to discounts related to warrants; and non-cash interest expense of approximately $76,000 pertaining to discounts related to the beneficial conversion features.

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

Note 12 – Subsequent Events

On April 26, 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 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

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

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

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

OVERVIEW

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

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Our principal executive offices are 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 BACKGROUND

Current technologies for transmitting real-time, high-quality video over long distances require an established and fully dedicated circuit for the duration of a transmission, regardless of whether the circuit is being used by the end-user. The concept is similar to a traditional telephone network—a call is placed, a circuit between two (or multiple) points is established and thereafter remains open for the duration of the call (regardless of whether anyone is speaking). These technologies typically require that the network be designed to be able to handle twice the expected average 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. Dedicated bandwidth is often priced on a monthly basis, requiring significant cost regardless of usage.

Cable and satellite companies have historically used technologies that typically require all available packages of programs be broadcast to every subscriber. As a result, limited bandwidth remains available for video on demand and similar interactive services requiring two-way communication. As a result, such services are currently available only on a limited basis and in select markets.

The rise of IP and packet-based networks

IP networks have been predominantly used to carry data traffic 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 of IP and packet-based networks has resulted in a dramatic increase in the transmission and exchange of data, information and ideas. IP networks chop data into small packets that are addressed to and received by designated addresses. These packets are capable of being transmitted over networks independent of one another. Divided and reassembled by switches and directed from source to destination by routers, 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. 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 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.

The impact of late or missing packets on a transmission depends in large part on the form of communication. With respect to written text, for instance, delay in the arrival of packets will likely not be noticed by the recipient. For this reason, email is an ideal form of communication for IP networks. But in the case 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. 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.

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THE PATH 1 SOLUTION

We have developed the technologies and products that have overcome the above mentioned inherent limitations of IP networks for transporting live, broadcast quality 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, higher reliability 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 follows:

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

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

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used by video carriers to 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 Providers

Satellite providers broadcast signals to earth from satellites nearly 22,000 miles above sea level. Because of the coverage area (or “footprint”) from that altitude, satellite broadcasts are capable of reaching vast areas. Uplinking content to the satellite for subsequent broadcast back to Earth, however, must be done at earth stations located in areas with characteristics favorable for uplinking. Currently, many satellite providers collect content at these uplink earth stations. As a result, content often “hops” from its source to and from the Earth via interim earth stations and interim satellites until its reaches the uplink earth station positioned to deliver the content up to the intended satellite for broadcast to satellite subscribers. Moreover, satellites have a maximum 15-year useful life, requiring satellite providers to periodically revisit the extreme expense of launching and maintaining a satellite in orbit.

Our Cx1000 product line allows satellite providers to gather content at uplink earth stations without the need to hop the content through interim satellites, reducing the strain on, and cost of, satellite networks and their maintenance. In addition to the cost-savings, collecting information at uplink earth stations via IP networks, as opposed to satellite hops, increases the speed by which information moves from source to consumer. Use of our products enables satellite providers to avoid some of the delay associated with “live” satellite feeds. Each satellite hop introduces a half-second delay whereas an existing terrestrial fiber international circuit has less than a quarter-second delay. PanAmSat is an example of a satellite provider using our Cx1000 product over terrestrial fiber to interconnect earth stations for video routing with the least delay.

As cable operators expand the number of channels offered and introduce services such as VOD and HDTV, satellite providers are seeking to protect and expand their subscriber base in a number of ways. Satellite operators now have the right to provide local channels to local markets in the United States and have made available local channels in most of the largest metropolitan markets. Recent advances in digital compression technology and terrestrial transport now allow satellite operators to cost-effectively add new high definition channels to their line-up to further expand their video entertainment offerings.

Mobile Video

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

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bandwidth (both into the home and within the network) allows cable companies to increase the volume of content (whether movies, television or live events) available for delivery whenever requested by the cable subscriber, or to increase the number of subscribers served with existing content volume.

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.

Enterprise

Certain industries require delivery of 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.

To attain the level of resolution required by studios and for government applications requires data to be delivered uncompressed. Compression, a common means for transporting high-resolution data, is designed to eliminate what would typically be redundant or unnecessary information, or to allow data to fit on satellites’ limited bandwidth. Because of the unerring detail required by these industries, what is generally acceptable TV-quality degradation becomes unacceptable. The opposing requirements of exceptionally high resolution and high bit-rate make most delivery methods (such as satellite) unusable. Our Cx1000 product enables the delivery of exceptionally high resolution, high bit-rate, and real-time video.

OUR SALES AND MARKETING STRATEGY

In the United States, we 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.

We sell to international customers through independent distributors and integrators. International distributors are generally responsible for importing the products and providing certain installation, technical support and other services to customers in their territory. Our direct sales force and distributors are supported by a highly trained technical staff including sales engineers who work closely with operators to develop technical proposals and design systems to optimize system performance and economic benefits to operators.

An element of our strategy is to aggressively pursue (within our financial and other means) opportunities to introduce our products into the market and that create demand for our products. As such, we have entered into selling arrangements with major equipment providers and system integrators, both domestically and abroad, to enable greater market penetration of our products. We intend to continue our pursuit of those strategic relationships where we believe we are capable of expanding our sales opportunities within the markets we currently serve as well as those markets that may emerge in the future.

Our marketing organization develops strategies for product lines and, in conjunction with our sales force, identifies evolving technical and application needs of customers so that our product development resources can be most effectively and efficiently deployed to meet anticipated product requirements. Our marketing organization is also responsible for setting price levels, demand forecasting and general support of the sales force, particularly at major accounts.

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OUR TECHNOLOGY

Flexible Product Architecture

In a market that is largely comprised of equipment based on fixed hardware designs, Path 1 has chosen to utilize designs based on high-powered network processors with specialized applications software (firmware) to implement a wide variety of products without requiring an equally large number of unique hardware platforms. Our common hardware platform is scalable, and helps to control product cost and reduce inventory risk while also minimizing time to market for new features and functions.

Path 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 video over IP 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.

As network changes take place, either on a planned or an emergency basis, Path 1 boxes can be upgraded to meet the new needs with minimal impact to the networks. For example, a customer may begin with a 4 port software-enabled version of our Chameleon products. At any point the same equipment can be field-upgraded to add input or output ports or increase video stream counts or rates—through network-downloaded licensing changes. In the case of our Cx1000 and Ax100 products, these products can be upgraded with our RepliCaster^™ upgrade to provide for video stream replication.

Product Technology – Long Haul

Path 1 products are designed to overcome the inherent limitations in IP networks that would otherwise make it difficult if not impossible to transport live, broadcast quality video over these networks. IP networks, in general, are not perfect in their timing and in their ability to prevent packet loss. Through the use of proprietary technologies, however, our long-haul products restore timing that may have been skewed as the packets traveled through the networks. Our products also have the ability to restore lost or out of order packets through the use of 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 restore losses of thousands of consecutive packets, which is extremely valuable in networks that are particularly “bursty” in nature. This resiliency has allowed some of our customers to transport high quality video over the public Internet. Moreover, our customers can send live video over MPLS networks without concern for the impact of network fast re-routing.

Even in the case of the emerging international standards for transporting live video over IP networks, Path 1 provides a unique differentiated solution. In contrast to most of our competitors, our implementation of Pro-MPEG standard forward error correction in the Vx8000, our first standards-based transport gateway, enables handling the maximum allowed number of consecutive lost packets. This is possible due to the large memory buffers and processor-driven implementation in our products.

Our Cx1000 is one of the few products in the market that is capable of SDI data rates. With advanced features, such as the ability to replicate a single SDI stream into three streams, a Cx1000 can transmit a full 1 Gigabit/second stream of video into the network. The RepliCaster^™ feature has been especially useful when MPLS networks are not appropriate.

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Product Technology – Multiplexing, De-multiplexing, and Pass-thru

A large amount of legacy equipment used in video transport networks has been designed to output or input in video ASI format. Our Chameleon vidX products can convert multiple ASI video streams to Ethernet-based Internet Protocol and can also take Ethernet-based Internet Protocol streams containing MPEG 2 video and convert to ASI video. Doing so allows legacy equipment to be used in today’s IP networks. The flexibility provided by the Path 1 technology provides multiplexing, de-multiplexing and pass-thru of ASI streams utilizing a Chameleon vidX unit at both ends of the IP network.

Product Development

Our product development efforts are continuous, and are based on customer requirements for increased performance, flexibility and functionality. These efforts include upgrades and functional enhancements to current products and ultimately the development of a new generation of products.

Our most recent new product is the Vx8000, a multi port ASI and IP product capable of handling up to 8 ports of ASI video for long haul IP transport. This product makes use of the latest Pro-MPEG Code of Practice #3 forward error correction and RTP transport.

Our next generation products will make use of higher performance network processors developed by Intel and FPGAs by Xilinx and Altera. The use of higher performance electronics will increase flexibility of our products and also increase capacity to handle uncompressed High Definition video as well as an increased number of High Definition and Standard Definition streams.

COMPETITION

We face competition in each of the target markets for our products, services and products in development. Our competition includes vendors that produce products for legacy video transport networks such as satellite, circuit switch, Radio Frequency (RF), ATM and other transport platforms. We also compete with vendors that produce products that enable the transport of video over IP networks including, but not limited to, companies such as Scientific-Atlanta, Tandberg Television, Thomson, Harris and Aastra. A number of established and development-stage or start-up companies in these markets offer similar or alternative technological solutions for convergence of real-time data, such as audio and video over IP networks, as well as real-time, high-quality transition of video over IP networks. We anticipate that we will face increased competition in the future as adoption rates for video over IP transport increase, and as competitors offering video over IP products and solutions enhance their product offerings and new competitors emerge. Our competitors have significantly greater resources and industry clout and, therefore, could threaten the viability of our business.

Many of our competitors have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the industry than we do. As a result, certain of these competitors may be able to develop products that directly compete with ours and may be able to succeed with inferior product offerings. These 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 sale of their 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

Since our inception on January 30, 1998, we have financed our operations primarily through the sale of common equity securities to investors (including our public offering in July/August 2003) and strategic partners, as well as from the issuance of convertible notes.

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From January 30, 1998 through March 31, 2005, we incurred losses totaling $47.1 million. We have not yet achieved profitability, and we remain a risky enterprise. We believe that our existing capital resources will enable us to fund operations for at least the next twelve months. At March 31, 2005, we had working capital of $2.4 million. Cash and cash equivalents at March 31, 2005 totaled $1.8 million.

In addition to the $2,808,750 we raised in the 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 a 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 $2,808,750 private placement is reflected on our balance sheet as a long-term liability at its net carrying value. The 7% convertible preferred stock is treated as a liability, rather than equity, for accounting purposes because of its mandatory redemption feature. As a result of the transaction, we recorded a liability equal to the aggregate redemption price and a discount totaling approximately $2,122,000 that was booked to additional paid-in capital. The discount results from an embedded beneficial conversion feature and detachable warrants to purchase common stock with fair values of $1,748,000 and $374,000, respectively. These deferred interest charges will be amortized on an effective yield basis over four years, or sooner if any preferred stock is previously redeemed or converted, resulting in non-cash interest expense each quarter. At March 31, 2005, the net carrying value of the liability for our mandatorily-redeemable 7% preferred stock was $745,000. The remaining unamortized discount related to beneficial conversion feature and detachable warrants was $1,684,000 and $380,000, respectively.

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

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

At March 31, 2005, we had material commitments related to our 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, our operating leases, and a convertible note with a face amount of $102,000 which is due in May 2005. Our future capital requirements will depend upon many factors, including the timing of research and product development efforts, the possible need to acquire new technology, the expansion of our sales and marketing efforts, and our expansion internationally. We expect to continue to expend significant amounts in all areas of our operations.

Cash used in operations was approximately $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.

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Cash used in investing activities for the three months ended March 31, 2005, was $136,000, compared to $111,000 for the same period ended March 31, 2004. In the 2005 period, we capitalized $99,000 of engineering costs and acquired $37,000 of engineering equipment. In the 2004 quarter, we purchased $120,000 of equipment for use in our engineering lab and for sales and marketing display equipment.

Cash provided by financing activities for the three-month period ended March 31, 2005, was $2.9 million compared to cash provided of $235,000 for the same period ended March 31, 2004. The cash provided by financing activities in 2005 resulted primarily from the sale of 7% convertible preferred stock while the 2004 provision resulted primarily from the exercise of warrants issued in 2003 in our 7% convertible notes offering.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2005 vs. Three Months Ended March 31, 2004

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. A majority of our sales in the first quarter of 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.

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. The decrease in cost of sales results primarily from a 39% reduction in total units shipped along with a 10% decrease in direct cost per unit produced during the current period versus the prior year period. Cost of products sold consists primarily of raw material costs, warranty costs and labor associated with manufacturing.

Gross profit totaled $598,000 for the quarter ended March 31, 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 mix from being heavily weighted towards cable (including shipment of cable products sold at particularly unfavorable prices to a single customer) in 2004 to being heavily weighted towards our long-haul products in 2005.

Engineering, research and development expenses for the quarter ended March 31, 2005, increased 43% to $940,000 from $656,000 in the quarter ended March 31, 2004. The increase is due primarily to higher costs related to contract employees for engineering efforts related to new product development. We continue to spend heavily on engineering expenses for new product development and other sustaining engineering efforts; thus, engineering, research and development expenses are expected to be higher in future quarters as we work to expand our product offerings.

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.

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General and administrative expenses for the quarter ended March 31, 2005, decreased 55% to $346,000 from $775,000 in the same quarter of the prior year. The $429,000 decrease results principally from a one-time charge of $260,000 in the 2004 period for our former CEO’s severance arrangement as provided for in his employment agreement with us, along with 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.

Net interest expense for the quarter ended March 31, 2005 was $88,000 versus $30,000 of expense in the same quarter ended March 31, 2004. 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 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, “Special Note Regarding Forward-Looking Statements.”

Our limited sales history and limited revenues to date make it difficult to evaluate our prospects.

We were founded in January 1998 and have only been selling our products commercially since 2002, which makes an evaluation of our prospects difficult. Because of our limited sales history, 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.

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, 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

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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 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.

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

Our cash position at March 31, 2005, was $1.8 million. Despite our recent private placements, in which we raised aggregate proceeds of approximately $5.4 million ($2.6 million of which is expected to be received by the end of the second quarter of 2005), given our projected cash burn rate we anticipate we may need to raise additional capital in order to sustain our operations at current levels. We cannot ensure that financing will be available to us on acceptable terms, if at all. Our inability to raise capital when needed would harm our business. In addition, additional equity financing may dilute our stockholders’ interest, and debt financing, if available, may involve restrictive covenants and could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on debt. If adequate funds are not available, we would need to curtail our operations significantly.

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

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

Our future success will depend on our ability to develop new products that will use next generation Intel IXP processors and other key components. These technologies are changing rapidly, and we will be required to

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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.

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-MPEG Code of Practice. Our Vx8000 is the first product we are launching that will be Pro-MPEG standards-based. This move towards offering standards-based products for transporting video over IP networks may result in increased competition, and may also have a negative impact on our ability to offer differentiated products incorporating our proprietary technology, thereby causing 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:

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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 customer trials, of our products as well as competing products prior to making a purchasing decision. 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 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, as well the rate of market adoption of applications enhanced by our products such as video-on-demand. Accordingly, we have limited visibility into when we might realize substantial revenue from product sales. 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:

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

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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.

We 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,

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especially customers that purchase novel and technologically sophisticated products such as ours, generally require significant engineering support. Therefore, adoption of our platforms and products by customers would increase the strain on our resources.

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

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

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

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

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

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

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.

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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

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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 stock could be volatile and your investment could suffer a decline in value.

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

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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

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Company and there were options outstanding to purchase 282,350 shares of common stock under our 2000 Plan; 19,403 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 March 31, 2005, there were options outstanding to purchase 435,231 shares of common stock and 20,000 shares of stock had been granted directly to current executives of the Company under our 2004 Plan; 443,019 shares of common stock remained available for issuance under the 2004 Plan.

In addition, as of March 31, 2005, there were 59,840 shares of common stock subject to outstanding options granted other than under the 2004 Plan, the 2000 Plan or the Purchase Plan. These non-plan options were granted in prior years to various employees, directors, consultants and advisors before the creation of any stock option plan.

We plan to continue to provide our employees opportunities to participate in the Purchase Plan. We also plan to issue options to purchase sizable numbers of shares of common stock to new and existing employees, officers, directors, advisors, consultants or other individuals as we deem appropriate and in our best interests. This could result in substantial dilution to all stockholders and increased control by management.

As of March 31, 2005, there were outstanding warrants to purchase up to 3,610,843 shares of our common stock with a weighted average exercise price of $5.40 per share. The weighted average remaining life for all of the currently outstanding warrants is 3.6 years from March 31, 2005.

In addition, at March 31, 2005, there were 864,229 shares of 7% Convertible Preferred Stock outstanding. These shares are convertible into shares of common stock. And, we expect to issue 792,306 shares of Series B 7% Convertible Preferred Stock in the second quarter of 2005; these shares would also be convertible into shares of common stock. In connection with the issuance of the Series B 7% Convertible Preferred Stock, we would also issue 435,771 common stock warrants (with an exercise price of $3.25 per share), and would reduce the exercise price of 432,115 outstanding warrants from $4.20 per share to $3.25 per share.

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

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

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

We do not intend to pay cash dividends.

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

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 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

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other than the United States dollar. Our cash equivalents’ principal would not be materially changed by changes in interest rates, but as the short term instruments mature and roll over, we would be able to earn more interest in the future if interest rates rise. A one percentage point (100 basis point) increase in interest rates would result in approximately a $17,000 annual increase in our income from cash equivalents, assuming our cash equivalents principal balance remained at its March 31, 2005 level. Our $1 million revolving line of credit from Laurus (which currently has a zero balance outstanding) has a floating interest rate.

John Zavoli, who is both our principal executive officer and principal financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Securities Exchange Act of 1934 Rule 13a–15(e)), concluded that as of March 31, 2005, our disclosure controls and procedures were effective.

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

On July 30, 2003, the SEC declared effective the registration statement (SEC file no. 333-105638) for our initial public offering of units through underwriters led by Paulson Investment Company, Inc.

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 applicable.

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

Not applicable.

ITEM 5. OTHER INFORMATION

None.

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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.

* Filed Herewith

# Indicates management contract or compensatory plan or arrangement.

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SIGNATURES

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

Path 1 Network Technologies Inc.

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Exhibit List

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

* Filed Herewith

# Indicates management contract or compensatory plan or arrangement.

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