Edgar Filing: IPIX CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2004 Commission File No. 000-26363

IPIX Corporation
(Exact name of registrant as specified in its charter)

Delaware 52-2213841
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

3160 Crow Canyon Road
San Ramon, California 94583
(Address of principal executive offices, zip code)

Registrant's telephone number, including area code: (925) 242-4002

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 Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

18,018,622 shares of $0.001 par value common stock outstanding as of July 16,
2004.

IPIX CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2004
INDEX

PART I - FINANCIAL INFORMATION........................................... 3

Item 1. Condensed Consolidated Financial Statements (unaudited)..... 3

Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12

Item 3. Quantitative and Qualitative Disclosures About Market Risk... 20

Item 4. Controls and Procedures..................................... 20

PART II - OTHER INFORMATION............................................ 20

Item 1. Legal Proceedings........................................... 20

Item 2. Changes In Securities And Use Of Proceeds................... 21

Item 3. Defaults Upon Senior Securities............................. 21

Item 4. Submission Of Matters To A Vote Of Security Holders......... 21

Item 5. Other Information........................................... 21

Item 6. Exhibits And Reports On Form 8-K............................ 21

Signatures............................................................. 22

Exhibit Index.......................................................... 23

PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

IPIX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

December 31, June 30,
2003 2004
---------------- -------------
(1) (unaudited)
(In thousands)

ASSETS
Cash and cash equivalents......................................................................... $ 10,241 $ 13,453
Restricted short term investments................................................................. 1,100 800
Short term investments............................................................................
331 645
Accounts receivable, net.......................................................................... 261 629
Inventory, net.................................................................................... 398 436
Prepaid expenses and other current assets......................................................... 1,523 1,571
------------ -----------
Total current assets........................................................................ 13,854 17,534
Computer hardware, software and other, net........................................................ 1,578 1,134
Restricted cash and other long term assets........................................................ 852 718
------------ -----------
Total assets................................................................................ $ 16,284 $ 19,386
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................................................................. $ 612 $ 434
Accrued liabilities............................................................................... 3,342 3,456
Deferred revenue.................................................................................. 76 8
Current portion of obligations under capital leases............................................... 608 279
------------ -----------
Total current liabilities................................................................... 4,638 4,177
Other long term liabilities....................................................................... 181 22
------------ -----------
Total liabilities........................................................................ 4,819 4,199
------------ -----------
STOCKHOLDERS' EQUITY:
Preferred stock (Aggregate liquidation value: $23,716 in 2003 and $9,533 in 2004)................. 1 -
Common stock...................................................................................... 9 18
Class B common stock.............................................................................. - -
Additional paid-in capital........................................................................ 515,186 525,513
Accumulated deficit............................................................................... (503,731) (510,344)
------------ -----------
Total stockholders' equity.................................................................. 11,465 15,187
------------ -----------

Total liabilities and stockholders' equity.................................................. $ 16,284 $ 19,386
============ ===========

______________________

(1) The December 31, 2003 balances were derived from the audited financial
statements.

See accompanying notes to the unaudited condensed consolidated
financial statements.

IPIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three months ended Six months ended
June 30, June 30,
--------------------- -------------------------
2003 2004 2003 2004
---------- --------- ----------- ------------
(In thousands, except per share data) (unaudited) (unaudited)

Revenue:
Security......................................................... $ 86 $ 404 $ 91 $ 406
AdMission........................................................ 6,058 288 11,660 534
InfoMedia........................................................ 408 609 1,192 1,083
--------- --------- -------- ---------
Total revenue................................................. 6,552 1,301 12,943 2,023
--------- --------- -------- ---------
Cost of revenue:
Security......................................................... 82 288 86 289
AdMission........................................................ 1,768 560 3,550 1,238
InfoMedia........................................................ 287 297 625 594
--------- --------- -------- ---------
Total cost of revenue......................................... 2,137 1,145 4,261 2,121
--------- --------- -------- ---------
Gross profit (loss)........................................... 4,415 156 8,682 (98)
--------- --------- -------- ---------
Operating expenses:
Sales and marketing.............................................. 2,044 1,653 3,805 2,995
Research and development......................................... 1,168 997 2,428 1,922
General and administrative....................................... 834 925 1,663 1,618
--------- --------- -------- ---------
Total operating expenses...................................... 4,046 3,575 7,896 6,535
--------- --------- -------- ---------
Income (loss) from operations.................................... 369 (3,419) 786 (6,633)
Other............................................................ (34) 16 (83) 20
--------- --------- -------- ---------
Net income (loss)................................................ 335 (3,403) 703 (6,613)
Preferred stock dividends........................................ (453) (224) (891) (624)
--------- --------- -------- ---------
Net loss available to common stockholders........................ $ (118) $ (3,627) $ (188) $ (7,237)
========= ========= ======== =========
Loss per common share, basic and diluted ........................ $ (0.02) $ (0.23) $ (0.03) $ (0.58)
Weighted average common shares, basic and diluted................ 7,004 15,894 6,910 12,398

See accompanying notes to the unaudited condensed consolidated financial
statements.

IPIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six months ended
June 30,
---------------------
2003 2004
--------- ----------
(In thousands) (unaudited)

Cash flows from operating activities:
Net income (loss)............................................................................................ $ 703 $ (6,613)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation................................................................................................. 1,868 519
Provision for doubtful accounts receivable................................................................... 28 3
Changes in operating assets and liabilities:
Accounts receivable....................................................................................... 1,461 (371)
Inventory................................................................................................. 1 (38)
Prepaid expenses and other current assets................................................................. (866) (48)
Other long term assets.................................................................................... 50 134
Accounts payable.......................................................................................... 531 (178)
Accrued liabilities and other............................................................................. (24) (45)
Deferred revenue.......................................................................................... 2,993 (68)
--------- ----------
Net cash provided by (used in) operating activities.................................................... 6,745 (6,705)
--------- ----------
Cash flows from investing activities:
Purchases of computer hardware, software and other........................................................... (808) (75)
Maturity of short term investments...........................................................................
-- 1,431
Purchase of short term investments........................................................................... -- (1,445)
--------- ----------
Net cash used in investing activities.................................................................. (808) (89)
--------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock....................................................................... 1,036 4,901
Proceeds from issuance of common stock (PIPE), net........................................................... -- 4,897
Proceeds from issuance of common stock (AIR)................................................................. -- 537
Repayments of capital lease obligations...................................................................... (1,316) (329)
--------- ----------
Net cash provided by (used in) financing activities.................................................... (280) 10,006
--------- ----------
Effect of exchange rate changes on cash...................................................................... 3 --
--------- ----------
Net increase in cash and cash equivalents.................................................................... 5,660 3,212
Cash and cash equivalents, beginning of period............................................................... 3,020 10,241
--------- ----------
Cash and cash equivalents, end of period..................................................................... $ 8,680 $ 13,453
========= ==========

See accompanying notes to the unaudited condensed consolidated financial
statements

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

IPIX Corporation, formerly Internet Pictures Corporation, offers mission
critical imaging where visual content is required for the protection of life and
property and eCommerce. IPIX conducts its business through three business units
that share IPIX's patented technology: IPIX Security, IPIX AdMission and IPIX
InfoMedia. The Company's solutions create, process and manage a rich variety of
media including still images, Full-360 degree immersive images and video. IPIX
Security is a supplier of Full-360 video surveillance technology for critical
government and commercial security applications that provide complete and
continuous situational awareness. IPIX AdMission offers services that visually
enhance online auctions and real estate listings. IPIX InfoMedia supports the
creation of Full-360 degree panoramic photography and movies content.

IPIX's extensive intellectual property covers patents for Full-360 imaging,
video and surveillance applications and image management.

The accompanying unaudited condensed consolidated financial statements include
the accounts of IPIX Corporation and its wholly-owned subsidiaries, Interactive
Pictures Corporation, Interactive Pictures UK Limited, Internet Pictures
(Canada), Inc. and PW Technology, Inc. The consolidation of these entities will
collectively be referred to as the Company or IPIX. All significant intercompany
balances and transactions have been eliminated. The Company has ceased
operations in its Canadian and United Kingdom subsidiaries and is in the process
of liquidation of those subsidiaries.

We have prepared these financial statements, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United State of America have been omitted. The unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in our audited financial
statements as of and for the year ended December 31, 2003.

The information furnished reflects all adjustments which management believes are
necessary for a fair presentation of our financial position as of June 30, 2004
and the results of our operations for the three and six month periods ended June
30, 2003 and 2004 and our cash flows for the six month periods ended June 30,
2003 and 2004. All such adjustments are of a normal recurring nature. The
results of operations for the three and six month periods ended June 30, 2003
and 2004 are not necessarily indicative of the results to be expected for the
respective full years.

2. GOING CONCERN CONSIDERATIONS

The accompanying financial statements have been presented in accordance with
generally accepted accounting principles, which assume the continuity of the
Company as a going concern. During the quarter ended June 30, 2004 and in the
prior fiscal years, the Company experienced and continues to experience, certain
going concern issues related to cash flow and profitability.

During 2003, the Company changed its relationship with its largest customer,
eBay, which represented 87% of revenue for the year ended December 31, 2003.
eBay licensed technology from the Company that had previously been used by the
Company to provide eBay with recurring services. After 2003, the Company no
longer provides any services to eBay. As a result, the Company has a limited
operating history as it is operating in 2004 and upon which an evaluation of its
business and prospects may be made. In addition, the Company is subject to
generally prevailing economic conditions and, as such, the Company's operating
results in 2004 will be dependent upon its ability to provide quality products
and services, the success of its customers and the appropriations processes of
various commercial and governmental entities.

Management believes, however, that the Company has sufficient cash resources to
meet its funding needs through at least the next twelve months. The Company
finished the second quarter of 2004 with approximately $15.5 million in cash
reserves (cash and cash equivalents of $13.5 million, short-term restricted
investments of $0.8 million, long-term restricted cash of $0.6 million and
short-term investments of $0.6 million). The Company has three business units
all at different stages in their development. Management expects to continue to
make significant investments in the development, sale and marketing of new
products for the security market and in the image management business, which may
consume some of the Company's cash reserves.

3. CASH, CASH EQUIVALENTS AND RESTRICTED SHORT TERM INVESTMENTS

We consider all highly liquid debt instruments with a remaining maturity at date
of purchase of three months or less to be cash equivalents.

At June 30, 2004, we had a $1.4 million short term investment which matures on
June 19, 2005, $0.8 million of which has been provided as collateral for certain
capital lease obligations and, accordingly, classified as restricted short term
investments. We will renew the investment for successive short term periods
until the capital lease obligation restrictions are removed.

4. EQUITY

On April 5, 2004, we completed the sale of 909,090 shares of our common stock,
resulting in net proceeds received of approximately $4.9 million, and additional
investment rights ("AIR") to purchase another 888,180 shares of our unregistered
common stock in a private offering to accredited institutional investors
("PIPE"). The shares of common stock were sold at $5.50 per share and the
shares of common stock underlying the AIR are purchasable at $6.05 per share.
The AIR is exercisable until September 28, 2004. During the quarter ended June
30, 2004, we issued 88,818 shares of common stock upon exercise of a portion of
the AIR. The proceeds to the Company from the AIR exercise were $0.5 million.
The common stock and the common stock underlying the AIR have been registered
under the Securities Act of 1933, as amended, and may be offered or sold in the
United States. The Company's Form S-3 filed on May 5, 2004 provides a
description of this transaction and copies of the executed documents.

During the three months ended March 31, 2004, we issued 442,144 shares of common
stock upon exercise of stock options. The total proceeds to the Company from
the first quarter option exercises were $0.6 million, $0.3 million of which was
collected on April 1, 2004. During the quarter ended June 30, 2004, we issued
1,511,680 shares of common stock upon exercise of stock options. The proceeds to
the Company from the option exercises were $4.2 million. During the quarter
ended June 30, 2004, we sold 91,140 shares of common stock to employees under
the IPIX Employee Stock Purchase Plan ("ESPP"). The proceeds to the Company
from the ESPP purchases were $0.1 million.

5. INCOME (LOSS) PER COMMON SHARE

Basic income (loss) per common share is computed by dividing net income (loss)
available to common stockholders for the period by the weighted average number
of shares of common stock outstanding. Net income (loss) available to common
stockholders is calculated as the net income (loss) less cumulative preferred
stock dividends for the period. If dilutive, the participation right of the
preferred stock is reflected in the calculation of basic income (loss) per share
using the "if converted" method or the "two class method," if more dilutive.
Diluted income (loss) per common share is computed by dividing net income (loss)
for the period by the weighted average number of shares of common stock
outstanding plus, if dilutive, potential common stock outstanding during the
period.

The following table sets forth the computation of basic and dilutive loss per
common share for the periods indicated:

Three months ended Six months ended
June 30, June 30,
------------------------ ------------------------
(In thousands, except per share) 2003 2004 2003 2004
------------------------ ------------------------
(unaudited) (unaudited)
NUMERATOR:
Net income (loss).................................................... $ 335 $ (3,403) $ 703 $ (6,613)
Preferred stock dividends............................................ (453) (224) (891) (624)
----------- --------- --------- ---------
Net loss available to common stockholders............................ $ (118) $ (3,627) $ (188) $ (7,237)
=========== ========== ========= =========
DENOMINATOR:
Weighted average shares outstanding - Basic and diluted........... 7,004 15,894 6,910 12,398
=========== ========== ========= =========
LOSS PER COMMON SHARE, BASIC AND DILUTED............................. $ (0.02) $ (0.23) $ (0.03) $ (0.58)
=========== ========== ========= =========

The following table sets forth potential common shares that are not included in
the diluted net loss per common share calculation because to do so would be
antidilutive for the three months ended June 30, 2003 and 2004 as a result of
the net loss available to common stockholders:

(Shares in thousands) Three months ended
June 30,
------------------------
2003 2004
------------------------

Stock options........................................... 1,248 1,967
Convertible preferred stock............................. 12,893 4,225
Warrants................................................. 337 1,917

Not included in the table above, were the following rights to purchase common
stock where the average exercise price was greater than the average common share
price during the period and, accordingly, they were excluded from diluted net
earnings per common share for the three month periods ended June 30, 2003 and
2004:

(Shares in thousands) Three months ended
June 30,
----------------------
2003 2004
---------- ----------

Average share price of IPIX common stock................................... $ 2.76 $ 10.17
Stock options:
Average exercise price of options....................................... $ 21.68 $ 85.34
Shares excluded......................................................... 929 94
Common Warrants (average exercise price $165.33)........................... 137 137

6. RESTRUCTURING AND OTHER

During the six months ended June 30, 2004, $0.2 million of payments were made
against the Company's restructuring accrual. No additions were made to the
accrual during the six months ended June 30, 2004. At June 30, 2004 the
remaining balance in the restructuring accrual was $0.2 million.

7. STOCK-BASED COMPENSATION - FAIR VALUE DISCLOSURES

We comply with the disclosure provisions of Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 123 "Accounting for Stock-based
Compensation" ("FAS 123"). We have elected, however, to continue accounting for
stock-based compensation issued to employees using Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
Under APB 25, compensation expense is based on the difference, if any, on the
date of grant, between the fair value of our stock and the exercise price of the
option. Stock and other equity instruments issued to non-employees have been
accounted for in accordance with FAS 123 and Emerging Issues Task Force Issue
No. 96-18, "Accounting for Equity Instruments Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods, or Services," and have been
valued using the Black-Scholes model.

Pro forma information regarding our net income (loss) is required by FAS 123 and
FAS 148 "Accounting for Stock-Based Compensation, Transition and Disclosure",
and has been determined as if we had accounted for the stock options under the
fair value method of FAS 123.

The computations for pro forma basic and diluted loss per share follow:

Three months ended Six months ended
June 30, June 30,
------------------------- -------------------------
(In thousands, except per share data) 2003 2004 2003 2004
------------ ---------- ----------- -----------
(unaudited) (unaudited)
------------------------- -------------------------
Net loss available to common stockholders............................ $ (118) $ (3,627) $ (188) $ (7,237)
Less total stock-based employee compensation expense
determined under fair value based methods for all awards.........
(431) (940) (867) (1,281)
---------- ---------- --------- ------------
Adjusted net loss available to common stockholders................... $ (549) $ (4,567) $ (1,055) $ (8,518)
========== ========== ========= ============

Basic and diluted loss per common share:
Net loss available to common stockholders before pro forma charges.. $ (0.02) $ (0.23) $ (0.03) $ (0.58)
Net effect of pro forma charges..................................... (0.06) (0.06) (0.12) (0.10)
---------- ---------- ---------- ------------
Adjusted net loss per common share available to common stockholders.... $ (0.08) $ (0.29) $ (0.15) $ (0.68)
========== ========== ========== ============

Grants under the ESPP have a look-back feature and a 15% discount and
accordingly under FAS 123 would have had compensation expense calculated as a
result. The fair value disclosure associated with the ESPP grants is included in
the fair value pro-forma information above.

8. COMMITMENTS AND CONTINGENCIES

Commitments

The table below shows our contractual obligations as of June 30, 2004:

(In thousands) Payments Due by Period
-------------------------------------------------------
Remainder
Total of 2004 2005 2006 2007
-------- --------- --------- ------- --------
Capital leases...................................................... $ 279 $ 279 $ - $ - $ -
Operating leases.................................................... 2,728 495 1,398 771 64
-------- -------- -------- ------ -------
Total............................................................... $ 3,007 $ 774 $ 1,398 $ 771 $ 64

At June 30, 2004, the Company had $0.6 million of its cash deposits restricted
as collateral on a letter of credit for certain co-location facility leases
expiring in 2005 and, accordingly, classified as long term restricted cash. In
addition, as of June 30, 2004, the Company has prepaid $0.5 million of its
obligations to the co-location facility.

Contingencies

On November 15, 2002, a First Amended Consolidated Complaint for violation of
federal securities laws was filed against Homestore.com, Inc. ("Homestore") by
the California Teachers' Retirement System ("CalSTRS"). The Complaint is a
class action lawsuit filed on behalf of stockholders of Homestore which flows
from alleged misstatements and omissions made by Homestore and the other named
defendants, which include us. The Complaint alleges that during 2001, Homestore
and IPIX entered into fraudulent reciprocal transactions intended to
artificially bolster and maintain Homestore's and our respective stock prices.
The Complaint alleges that Homestore's public statements with respect to these
transactions are attributable to us and violate Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. We joined with other co-defendants and filed a
joint motion to dismiss, alleging that the Complaint fails to state a claim upon
which relief may be granted, among other things. On March 7, 2003, the United
States District Court for the District of Central California granted our motion
to dismiss, with prejudice. On April 7, 2004, the California Teachers'
Retirement System filed a notice of appeal with the United States Court of
Appeals for the Ninth Circuit appealing the dismissal of the First Amended
Consolidated Complaint for violation of federal securities laws filed against
Homestore.com, Inc, us and the other named defendants. On July 22, 2004, CalSTRS
and IPIX filed a Stipulation of Dismissal with the Court of Appeals pursuant to
which the appeal was dismissed, with prejudice, against IPIX.

In June 2003, we filed a lawsuit against Ford Oxaal and Minds-Eye-View, Inc. in
the United States District Court for the Eastern District of Tennessee alleging
patent infringement of certain patents and other causes of action. The
defendants in the lawsuit have filed counterclaims against the Company in their
response to our action. The litigation is in the pre-trial motion stage at the
current time.

We are not currently a party to any other legal proceedings the adverse
outcome of which, individually or in the aggregate, we believe could have a
material adverse effect on our business, financial condition, results of
operations or cash flows.
Indemnification Provisions

During the ordinary course of business, in certain limited circumstances, the
Company has included indemnification provisions within certain of its contracts.
Pursuant to these agreements, the Company will indemnify, hold harmless and
agree to reimburse the indemnified party for losses suffered or incurred by the
indemnified party, generally parties with which the Company has commercial
relations, in connection with certain intellectual property infringement claims
by any third party with respect to the Company's products and services. To date,
the Company has not incurred any costs in connection with such indemnification
clauses.

9. SEGMENTS

We currently have three reportable segments. The accounting policies of the
segments are the same as those of the Company. Management evaluates the
performance of the segments and allocates resources to them based on evaluations
of the segment's revenues and gross profit. There are no inter-segment revenues.
We do not make allocations of corporate costs to the individual segments and do
not identify separate assets of the segments in making decisions regarding the
performance or the allocation of resources to them.

Information about the reported segments is as follows:

Three months ended Six months ended
June 30, June 30,
---------------------- -----------------------
(In thousands) 2003 2004 2003 2004
-------- --------- -------- ---------

Revenue:
Security.................................................... $ 86 $ 404 $ 91 $ 406
AdMission................................................... 6,058 288 11,660 534
InfoMedia................................................... 408 609 1,192 1,083
-------- -------- -------- ---------
Total.......................................................... $ 6,552 $ 1,301 $ 12,943 $ 2,023
======== ======== ======== =========

Gross profit (loss):
Security.................................................... $ 4 $ 116 $ 5 $ 117
AdMission................................................... 4,290 (272) 8,110 (704)
InfoMedia................................................... 121 312 567 489
-------- -------- -------- ---------
Total.......................................................... $ 4,415 $ 156 $ 8,682 $ (98)
======== ======== ======== =========

10. CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject us to a concentration of credit
risk consist of cash, cash equivalents, short term investments and accounts
receivable. Cash, cash equivalents and short term investments are deposited with
high quality financial institutions. Our accounts receivable are derived from
revenue earned from customers located in the U.S. and abroad. We perform ongoing
credit evaluations of our customers' financial condition and we do not require
collateral from our customers.

The following table summarizes the revenue from customers in excess of 10% of
total revenues:

Three months ended Six months ended
June 30, June 30,
----------------------- ----------------------
2003 2004 2003 2004
---------- --------- --------- ----------

Homestore............................................................... 3% 9% 3% 10%
eBay.................................................................... 87% --% 85% --%
UK Distributor.......................................................... --% 35% --% 22%

At June 30, 2004, Homestore represented 13% of accounts receivable and our UK
distributor represented 48% of accounts receivable. There are no amounts due
from eBay as of June 30, 2004. At December 31, 2003, Homestore represented 22%
and our UK Distributor represented 3% of accounts receivable. There were no
amounts due from eBay as of December 31, 2003.

11. LIQUIDATION PREFERENCE AND PREFERRED STOCK DIVIDENDS

On September 26, 2001, Image Investor Portfolio, a separate series of Memphis
Angels, LLC ("Image") and certain strategic investors completed the purchase of
1,115,080 shares of the Series B Preferred Stock for total consideration of
$22.3 million. Each share of the Series B Preferred Stock is convertible into
approximately 9.2 shares of our Common Stock and is entitled to vote on matters
submitted to holders of Common Stock on an as-converted basis. At any time that
the holders of the Series B Preferred Stock hold more than 50% of our voting
stock, a voluntary liquidation, dissolution or winding up of the Company must be
approved by at least five of the seven members of our board of directors.

Holders of Series B Preferred Stock, in preference to holders of any other
series of Preferred Stock and in preference to the holders of Common Stock
(collectively, "Junior Securities"), accrue dividends at the rate of eight
percent (8%) of the price paid per annum on each outstanding share of Series B
Preferred Stock ("Series B Dividends"). The Series B Dividends are cumulative,
accrue daily and shall be payable, when and if declared by the Board, upon
conversion or as an accretion to the Liquidation Preference, as defined below.
Accrued Series B Dividends may be paid in cash or common stock, at the election
of the Series B Preferred stockholder. Holders of Series B Preferred Stock
participate on an as-if converted basis in any common stock dividends.

Upon any liquidation event, before any distribution or payment shall be made to
the holders of any Junior Securities, the holders of Series B Preferred Stock
shall be entitled to be paid out of the assets of the Company legally available
for distribution, or the consideration received in such Transaction, an amount
per share of Series B Preferred Stock equal to the price paid plus all accrued
and unpaid Series B Dividends for each share of Series B Preferred Stock held by
them (the "Liquidation Preference"). If, upon any such liquidation event, the
assets of the Company are insufficient to make payment in full to all holders of
Series B Preferred Stock of the Liquidation Preference, then such assets shall
be distributed among the holders of Series B Preferred Stock at the time
outstanding, ratably in proportion to the full amounts to which they would
otherwise be respectively entitled.

During the second quarter, 613,483 shares of Series B Preferred stock plus
accumulated dividends were converted into 6,261,574 shares of the Company's
Common Stock. The Company did not receive any proceeds from the conversions.
As of June 30, 2004, 390,347 shares of Series B Preferred Stock remain
outstanding and the Liquidation Preference was $9.5 million, which includes
$1.7 million in accrued dividends in arrears on the Series B Preferred Stock
which have not been declared to be paid. During the second quarter, 791 shares
of Series B Preferred stock, issued by the exercise of 1,000 shares of the
Series B Warrants, were converted into 7,286 shares of the Company's Common
Stock. The Company did not receive any proceeds from the Warrant exercise.

12. RELATED PARTY TRANSACTIONS

Transactions with eBay, Inc.

In September 2001, eBay acquired Series B Preferred Stock from the Company and
as a result beneficially owned more than 10% of the Company's common stock
through April 2004. Pursuant to an agreement dated April 19, 2000, as amended,
the Company provided to eBay, Inc. image management services to eBay's online
auction Web sites. Pursuant to that agreement, the Company issued eBay a
warrant to purchase 60,000 shares of Common Stock at an exercise price of
$203.80 per share. The warrant expires on April 19, 2010. Under this
agreement, as amended, the Company generated revenue of $5.7 million and
$11.1 million for the quarter and six months ended June 30, 2003, respectively.
As announced in June 2003, the Company amended the then current commercial
agreement with eBay to include a one-time $8.0 million license fee from eBay for
IPIX technology and other services. The license fee was recognized by the
Company in the fourth quarter of 2003 and the Company no longer provides any
products or services to eBay.

The Company's visual content services agreement with eBay required the Company
to pay marketing fees to eBay of $16.0 million over a two-year period. As of
September 26, 2001, the Company had paid $9.5 million of the $16.0 million
commitment and agreed to extend the additional $6.5 million of payments through
September 2003. The commitment has been paid in full. In accordance with EITF
01-09, during the quarter and six months ended June 30, 2003, $0.5 million and
$1.0 million, respectively, of these fees was offset against revenue which
amount represented the excess over the fair value of the benefit received.

In 2001 and 2002, the Company sold to eBay, and eBay leased back to the Company,
certain computer equipment utilized to provide image management services to eBay
and other customers. The purchase price for the equipment was approximately
$5.3 million. The transactions resulted in no gain or loss to the Company. In
the six months ended June 30, 2003, we paid eBay $1.0 million pursuant to

these lease schedules. In the fourth quarter of 2003, the Company returned the
underlying equipment, with a net carrying amount of $0.9 million, associated
with these lease obligations and eBay forgave the remaining balances due of $1.1
million.

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

The following discussion is intended to assist in the understanding and
assessment of significant changes and trends related to our results of
operations and our financial condition together with our consolidated
subsidiaries. This discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K. Historical results and percentage relationships set forth
in the statement of operations, including trends which might appear, are not
necessarily indicative of future operations.

OVERVIEW

Our Business

Over the past few years, we have restructured the Company around our higher
gross margin businesses. We are now organized into three market focused
business units: IPIX Security, IPIX AdMission and IPIX InfoMedia.

IPIX Security: Supplies Full-360 video surveillance technology for critical
government and commercial security applications. Patent protected technology
used in digital video systems that provide complete and continuous situational
awareness.

IPIX AdMission: Enables local advertisers with the means to create rich,
visual ads showcasing their businesses, products and services. The AdMission
platform is implemented on a large scale for managing media across the Internet.
It allows advertisers and consumers to successfully conclude commercial
transactions by communicating the value of advertised goods and services through
accompanying media.

IPIX InfoMedia: Provides for creation of Full-360 degree panoramic photography
and movies content. Markets are professional photographers, ad and creative
media agencies, Web developers and visual documentation.

Products

CommandView - Two, multi-mega-pixel network cameras, with fisheye lens, patented
Full-360 viewing technology and camera management software to provide a unique
award-winning 'see everything' video surveillance and security camera system
that can see in all directions, simultaneously with no moving parts and no blind
spots.

AdMission - A hosted media platform enabling local advertisers to create rich,
visual ads showcasing their businesses, products and services. AdMission
enhanced ads are an upsell to print classified and display ads. They include
logos, photos, fast facts, printable coupons and information about the
advertiser's business, products and services. Consumers are rewarded with a
convenient informative presentation that appears directly within their search
results. AdMission ads communicate product and service offerings effectively and
result in better-qualified leads to advertisers.

Interactive Studio - A single integrated solution for panorama photographers
that can automate a wide variety of tasks previously requiring separate tools.
Makes creating multiple Full-360 degree images as simple as a drag-and-drop of
fisheye source images into the application, selecting the output file formats
desired and hitting the save button. Features include image editors, image
format converter tools and high dynamic range image compositors.

Target Markets

CommandView - Commercial facilities such as banks and retail outlets. Homeland
security infrastructure protection related to ports, harbors, waterways, dams,
conventional and nuclear power stations, utilities, airports and mass transit
rail systems. In the military, perimeter force protection, unmanned vehicles and
special operations.

AdMission - Newspaper classified and display advertising (online and print);
yellow page directories (online); and local search platforms (online).

Interactive Studio - Visual documentation markets such as facilities management;
private and government infrastructure management and service departments; and
vertical market data-warehouse solutions providers such as insurance and
mapping.

Business Models
IPIX Security: Sell camera systems via world-wide network of distributors.
Camera systems will retail from $1,000 to $25,000, depending upon configuration.
Traditional distributor discounts will apply (25 to 35%).

IPIX AdMission: Partner with publishers and software vendors of the publishing
industry. Recurring revenue share on premiums charged for visually enhanced
ads. Fixed infrastructure support costs, with very low marginal cost as volumes
grow.

IPIX InfoMedia: Market software platform and supporting hardware products
primarily over the internet.

Business Trends and Conditions

On March 31, 2004, our Security business unit launched a new family of Full-360
degree real-time video camera systems. Shipment of these products to
distributors began in late June 2004. These new camera systems will generate
revenues from their sale primarily to distributors. We continue to develop
additional products for the security and surveillance market.

Substantially all of our recurring revenue in the past was derived from
transaction fees generated by our AdMission business unit. In particular, eBay
represented approximately 87% and 85% of total revenue for the quarter and six
months ended June 30, 2003, respectively. We no longer provide any products or
services to eBay as of November 1, 2003. Since April 1, 2004, we have continued
to diversify and add additional AdMission customers and have launched two new
products: AdMission Classifieds and AdMission Directories which are currently
targeted at newspaper and yellow page publishers for online and in-print
classified advertising and other business opportunities.

Our Full-360 degree technology used by the InfoMedia business unit primarily
generates revenues in two ways: licenses of software and the resale of camera
equipment. In the past, we utilized "keys" to license our InfoMedia technology
to capture and save a single immersive image. With the launch of Interactive
Studios in the first quarter of 2004, we now offer time-based seat or user
licenses which permit an unlimited number of immersive images to be captured and
saved within a specific time period, usually a year. We sell our Full-360
products primarily into the real estate, travel and hospitality and visual
documentation markets. The cost of sales for our licenses is low in proportion
to the related revenue. The cost of sales for the sale of camera equipment has
generally been 50% to 75% of related revenues.

We also provide professional services to customers that request specific
customizations or integrations of our products and services. Providing
professional services is labor intensive and our cost of sales for professional
service tends to be 40% to 60% of revenues.

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations
is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to revenue recognition, uncollectible receivables and other long-lived
assets and contingencies. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements: revenue recognition; valuation allowances, specifically
the allowance for doubtful accounts; and other long-lived assets; and
significant accruals. We believe that full consideration has been given to all
relevant circumstances that we may be subject to, and our financial statements
accurately reflect management's best estimate of the results of operations,
financial position and cash flows for the periods presented.

Management has discussed the development and selection of the following critical
accounting policies, estimates and assumptions with the Audit Committee of our
Board of Directors and the Audit Committee has reviewed these disclosures. We
believe the following represent our critical accounting policies:

Revenue Recognition

We recognize revenue in accordance with SOP 97-2, "Software Revenue Recognition"
and Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial
Statements." We derive revenue from product sales and services we provide to
customers. Product revenue includes InfoMedia hardware and licenses, IPIX
Security hardware and licenses, as well as AdMission license revenue. Service
revenues are primarily from transactions where a seller uses IPIX image
management products to enhance their on-line offering.

Product revenue is recognized upon shipment or delivery provided there are no
uncertainties surrounding product acceptance, persuasive evidence of an
arrangement exists, there are no significant vendor obligations, the fees are
fixed or determinable and collection is reasonably assured. Initial license
fees are recognized when a contract exists, the fee is fixed or determinable,
software delivery has occurred and collection of the receivable is reasonably
assured. If there are continuing obligations, then license fees are recognized
ratably over the life of the contract. Revenue from product sales to
distributors is recognized upon shipment ("sell-in") if the distributor
relationship does not create substantial uncertainty regarding fixed or
determinable fees and collectibility. If at the outset of an arrangement we
determine the arrangement fee is not, or is presumed to not be, fixed
and determinable, revenue is deferred and subsequently recognized as amounts
become due and payable.

Transaction hosting revenues are recognized ratably as transactions are
performed provided there was persuasive evidence of an arrangement, the fee was
fixed or determinable and collection of the resulting receivable was reasonably
assured. Revenues generated from professional services are recognized as the
related services are performed. When such professional services are combined
with on-going transaction services or are deemed to be essential to the
functionality of the delivered software product, revenue from the entire
arrangement is recognized while the transaction services are performed, on a
percentage of completion method or not until the contract is completed in
accordance with SOP 81-1, "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts," and ARB No. 45, "Long-Term Construction-Type
Contracts." Reimbursements received for out-of-pocket expenses incurred are
characterized as revenue in the statement of operations.

Where multiple elements exist in an arrangement, the arrangement fee is
allocated to the different elements based upon verifiable objective evidence of
the fair value of the elements, as governed under EITF 00-21, which is codified
in SEC Staff Accounting Bulletin No. 104 "SAB 104." Multiple element
arrangements primarily involve an arrangement with professional services and
transaction hosting. Revenue is recognized as each element is earned, namely
upon completion of the services, provided that the fair value of the undelivered
element(s) has been determined, the delivered element has stand-alone value,
there is no right of return on delivered element(s), and we are in control of
delivery of the undelivered element(s).

Royalties derived from desktop imaging products were recognized as revenues upon
receipt of the royalty sell-through reports from customers, which are generally
in the quarter following the quarter in which the sale by the customer took
place.

Payments received in advance are initially recorded as deferred revenue and
recognized as obligations are fulfilled.

Allowances for Doubtful Accounts

Significant management judgments and estimates must be made and used in
connection with establishing the doubtful account allowances in any accounting
period. Management specifically analyzes accounts receivable and historical bad
debts, customer concentrations, customer credit-worthiness, current economic
trends and changes in our customer payment terms when evaluating the adequacy of
the allowance for doubtful accounts. Material differences could result in the
amount and timing of expense recorded if management had different judgment or
utilized different estimates.

Goodwill

During the fourth quarter of 2003, certain events, including the end of the
agreement with eBay, led the Company to perform an impairment review of
goodwill. The eBay agreement ended in November 2003 and was the primary source
of cash flows for the technology associated with goodwill in the AdMission
business unit. This review indicated that goodwill was being carried at

amounts in excess of the fair value based on estimated discounted future cash
flows of the AdMission business unit. As a result, an impairment charge was
recorded to expense in the year ended December 31, 2003. No balance remains in
goodwill.

Significant Accruals, including Restructuring Charges and Sales Tax

We recorded restructuring charges associated with vacated facilities. The key
assumptions associated with these charges include the timing and amount of
sub-lease income. In addition, in establishing and providing for sales tax
accruals, we make judgments based on the actual tax laws and guidance. While
management believes that its judgments and interpretations regarding tax
liabilities are appropriate, significant differences in actual experience may
materially affect our future financial results.

RESTRUCTURING ACTIONS

During the years ended December 31, 2000 thru December 31, 2003, the Company
executed several restructuring actions and recorded related charges during each
of those fiscal years. During the three and six months ended June 30, 2004,
$0.1 million and $0.2 million, respectively, of payments were made against the
Company's restructuring accrual. No additions were made to the accrual during
the three or six months ended June 30, 2004. At June 30, 2004, the remaining
balance in the restructuring accrual was $0.2 million.

RESULTS OF OPERATIONS

Financial results from prior periods are not useful in comparison to 2004
results because of the previously announced amendment of the Company's service
agreements with eBay to a one-time 2003 license fee and since the Company
launched its security business products in the second quarter of 2004. The
following table presents, for the periods indicated, the percent relationship to
total revenues of select items in our statements of operations.

Three months ended Six months ended
June 30, June 30,
---------------------- --------------------
2003 2004 2003 2004
--------- --------- -------- --------
Revenue:
Security.......................................................... 1.3% 31.1% 0.7% 20.1%
AdMission......................................................... 92.5 22.1 90.1 26.4
InfoMedia......................................................... 6.2 46.8 9.2 53.5
----- ----- ----- -----
Total revenue........................................................ 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenue:
Security.......................................................... 1.2 22.1 0.7 14.3
AdMission......................................................... 27.0 43.1 27.4 61.2
InfoMedia......................................................... 4.4 22.8 4.8 29.3
----- ----- ----- -----
Total cost of revenue................................................ 32.6 88.0 32.9 104.8
----- ----- ----- -----
Gross profit......................................................... 67.4 12.0 67.1 (4.8)
----- ----- ----- ------
Operating expenses:
Sales and marketing............................................... 31.2 127.1 29.4 148.1
Research and development.......................................... 17.9 76.6 18.8 95.0
General and administrative........................................ 12.7 71.1 12.8 80.0
----- ----- ----- -----
Total operating expenses............................................. 61.8 274.8 61.0 323.1
----- ----- ----- -----
Income (loss) from operations........................................... 5.6 (262.8) 6.1 (327.9)
Other................................................................... (0.5) 1.2 (0.6) 1.0
----- ----- ----- -----
Net income (loss)....................................................... 5.1% (261.6)% 5.5.% (326.9)%
===== ======== ====== ========

Quarter Ended June 30, 2003 Compared to the Quarter Ended June 30, 2004

Three months ended
June 30,
----------------------
Percent
(Dollars in thousands) 2003 2004 Difference Change
---------- --------- ------------ ---------

Revenue:
Security................................................................. $ 86 $ 404 $ 318 370%
AdMission................................................................ 6,058 288 (5,770) (95)
InfoMedia................................................................ 408 609 201 49
-------- ------- -------- --------
Total revenue............................................................... 6,552 1,301 (5,251) (80)
-------- ------- -------- --------

Cost of revenue:
Security................................................................. 82 288 206 251
AdMission................................................................ 1,768 560 (1,208) (68)
InfoMedia................................................................ 287 297 10 3
------- ------- ------- --------
Total cost of revenue....................................................... 2,137 1,145 (992) (46)
------- ------- ------- --------
Gross profit................................................................ 4,415 156 (4,259) (96)
------- ------- ------- --------

Operating expenses:
Sales and marketing...................................................... 2,044 1,653 (391) (19)
Research and development................................................. 1,168 997 (171) (15)
General and administrative............................................... 834 925 91 11
------- ------- ------- --------

Total operating expenses.................................................... 4,046 3,575 (471) (12)
------- ------- ------- --------
Income (loss) from operations.................................................. 369 (3,419) (3,788) (1,027)
Other.......................................................................... (34) 16 50 156
-------- -------- -------- ---------

Net income (loss).............................................................. $ 335 $(3,403) $(3,738) (1,116)%
========= ======== ======== ========

Revenue.
Security: On March 31, 2004, the Security business unit launched its new
family of Full-360 degree security cameras. Prior to this launch, the
Security business unit had primarily been developing the products and
testing them in field beta trials. The first finished products were
shipped during late June, 2004.
AdMission: Decreased in the quarter ended June 30, 2004 over the quarter
ended June 30, 2003 due to decreased volumes of images processed,
primarily related to the change in relationship with eBay as of
November 2003.
InfoMedia: Increased in the quarter ended June 30, 2004 over the quarter
ended June 30, 2003 primarily due to the increased sales of the new
software platform launched in the first quarter of 2004.

Cost of Revenue.
Security: Cost of revenues consists of the costs to purchase and assemble
the components of the video cameras sold during the quarter. In
second quarter 2003, the business unit recognized virtually no revenues
or cost of revenues.
AdMission: Cost of revenue consists of our direct expenses associated
with the processing, hosting and distribution of digital content.
With the reduced volumes of images to process during the second quarter
of 2004 relative to the second quarter of 2003, the AdMission business
unit decreased depreciation expense by reducing the capital committed
to image processing ($0.7 million), lowered its purchase of bandwidth
and managed care services from third party co-location facilities
($0.4 million) and reduced the number of personnel and other expenses
incurred in the management of the network ($0.1 million). Gross
profit in the second quarter of 2004 was negative because of fixed
costs associated with the running and management of the network.
InfoMedia: Cost of revenues consists of the costs of the digital camera
and related components included in an InfoMedia kit. Cost of revenue in
the second quarter of 2004 was approximately unchanged relative to
2003. Cost of revenue as a percent of revenue decreased from 71% in
the second quarter of 2003 to 49% in the second quarter of 2004
primarily because of the increase in software sales due to the launch
of its new software platform in the first quarter of 2004.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries
for marketing, sales and business development personnel. Sales and marketing
expenses also include commissions and related benefits for sales personnel and
consultants, traditional advertising and promotional expenses. Sales and
marketing expenses decreased in the quarter ended June 30, 2004 over the quarter
ended June 30, 2003, primarily due to the changed relationship with eBay
($0.7 million) offset by an increase in growth of sales and marketing activities
in our Security business unit ($0.3 million).

Research and Development. Research and development expenses consist primarily of
personnel costs related to building and enhancing our digital media
infrastructure and immersive imaging technology. Research and development
expenses decreased in the quarter ended June 30, 2004 over the quarter ended
June 30, 2003, due to the changed relationship with eBay ($0.4 million), offset
by an increase in growth of research and development for our new family of
Full-360 degree security cameras ($0.2 million).

General and Administrative. General and administrative expenses consist
primarily of salaries and related benefits for administrative and executive
staff, fees for outside professional services and other costs associated with
being a public company. General and administrative expenses increased in the
quarter ended June 30, 2004 over the quarter ended June 30, 2003 primarily as a
result of additional expenses incurred in association with compliance with
public company regulations, including Sarbanes-Oxley.

Six Months Ended June 30, 2003 Compared to the Six Months Ended June 30, 2004

Six months ended
June 30,
---------------------
Percent
(Dollars in thousands) 2003 2004 Difference Change
--------- --------- ---------- --------

Revenue:
Security................................................................. $ 91 $ 406 $ 315 346%
AdMission................................................................ 11,660 534 (11,126) (95)
InfoMedia................................................................ 1,192 1,083 (109) (9)
--------- -------- ---------- ------
Total revenue............................................................... 12,943 2,023 (10,920) (84)
--------- -------- ---------- ------

Cost of revenue:
Security................................................................. 86 289 203 236
AdMission................................................................ 3,550 1,238 (2,312) (65)
InfoMedia................................................................ 625 594 (31) (5)
--------- -------- ---------- ------
Total cost of revenue....................................................... 4,261 2,121 (2,140) (50)
--------- -------- ---------- ------
Gross profit................................................................ 8,682 (98) (8,780) (101)
--------- -------- ---------- ------

Operating expenses:
Sales and marketing...................................................... 3,805 2,995 (810) (21)
Research and development................................................. 2,428 1,922 (506) (21)
General and administrative............................................... 1,663 1,618 (45) (3)
--------- -------- ---------- ------
Total operating expenses.................................................... 7,896 6,535 (1,361) (17)
--------- -------- ---------- ------
Income (loss) from operations.................................................. 786 (6,633) (7,419) (944)
Other.......................................................................... (83) 20 103 124
--------- -------- ---------- ------

Net income (loss).............................................................. $ 703 $ (6,613) $ (7,316) (1,041)%
========= ========= ========== ========

Revenue.
Security: On March 31, 2004, the Security business unit launched its new
family of Full-360 degree security cameras. Prior to this launch, the
Security business unit had primarily been developing the products and
testing them in field beta trials. The first finished products were
shipped during late June, 2004.
AdMission: Decreased in the six months ended June 30, 2004 over the six
months ended June 30, 2003 due to decreased volumes of images
processed, primarily related to the change in relationship with eBay as
of November 2003.
InfoMedia: During the first six months of 2003, InfoMedia recognized $0.3
million in royalties while in the first six months of 2004 the group
recognized virtually no royalty revenues. In February 2004, InfoMedia
launched Interactive Studios to eventually replace the sale of one-use
keys, which generated royalty income in 2003. This decrease in
revenues in 2004 was offset by sales of the new products launched in
the first quarter of 2004.

Cost of Revenue.
Security: Cost of revenues consists of the costs to purchase and assemble
the components of the video cameras sold during the period. In 2003,
the business unit recognized virtually no revenues or cost of revenues.
AdMission: Cost of revenue consists of our direct expenses associated
with the processing, hosting and distribution of digital content. With
the reduced volumes of images to process during the first six months of
2004 relative to the first six months of 2003, the AdMission business
unit decreased depreciation expense by reducing the capital committed
to image processing ($1.3 million), lowered its purchase of bandwidth
and managed care services from third party co-location facilities ($0.7
million) and reduced the number of personnel and other expenses
incurred in the management of the network ($0.3 million). Gross
profit in the first six months of 2004 was negative because of fixed
costs associated with the running and management of the network.
InfoMedia: Cost of revenues consists of the costs of the digital camera
and related components included in an InfoMedia kit. Cost of revenue
declined in the first six months of 2004 relative to 2003, primarily
due to fewer kit sales and change in product mix between hardware and
software. Cost of revenue as a percent of revenue increased from 53%
in the first six months of 2003 to 55% in the first six months of 2004
primarily because in the first six months of 2003 the group recognized
$0.3 million of royalties, which have no cost of revenues, where as in
the first six months of 2004 the group recognized virtually no royalty
revenues. The remaining difference in cost of revenues between the
first six months is related to product mix of the types of camera kits
sold.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries
for marketing, sales and business development personnel. Sales and marketing
expenses also include commissions and related benefits for sales personnel and
consultants, traditional advertising and promotional expenses. Sales and
marketing expenses decreased in the six months ended June 30, 2004 over the six
months ended June 30, 2003, primarily due to the changed relationship with eBay
($1.3 million) offset by an increase in growth of sales and marketing activities
in our Security business unit ($0.5 million).

Research and Development. Research and development expenses consist primarily of
personnel costs related to building and enhancing our digital media
infrastructure and immersive imaging technology. Research and development
expenses decreased in the six months ended June 30, 2004 over the six months
ended June 30, 2003, due to the result of the changed relationship with eBay
($0.8 million), offset by an increase in growth of research and development for
our new family of Full-360 degree security cameras ($0.3 million).

General and Administrative. General and administrative expenses consist
primarily of salaries and related benefits for administrative and executive
staff, fees for outside professional services and other costs associated with
being a public company. General and administrative expenses decreased in the six
months ended June 30, 2004 over the six months ended June 30, 2003, due to the
decrease in personnel costs and outside professional services ($0.2 million),
partially offset by increased costs of being a public company ($0.1 million).

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations through our registered public
offerings, the private placements of capital stock, a convertible debenture, a
convertible promissory note and warrant and option exercises. At June 30, 2004,
we had $15.5 million of cash, restricted cash and short term investments, of
which $1.4 million was restricted.

Summary Consolidated Cash Flow Data

Three months ended Six months ended
June 30, June 30,
------------------------- -----------------------
(In thousands) 2003 2004 2003 2004
------------ ----------- ---------- ----------

Net cash provided by (used in) operating activities............... $ 3,636 $ (3,339) $ 6,745 $ (6,705)
Net cash used in investing activities............................. (90) (37) (808) (89)
Net cash provided by (used in) financing activities............... 406 9,862 (280) 10,006
Effect of exchange rate changes on cash........................... (1) -- 3 --
---------- ---------- --------- ---------
Net increase (decrease) in cash and cash equivalents.............. 3,951 6,472 5,660 3,212
Cash and cash equivalents, beginning of period.................... 4,729 6,981 3,020 10,241
---------- ---------- --------- ---------

Cash and cash equivalents, end of period.......................... $ 8,680 $ 13,453 $ 8,680 $ 13,453
========== ========== ========= =========

Cash flows from operating activities in the second quarter of 2004, reflects a
net loss of $3.4 million, compared to net income of $0.3 million in the second
quarter of 2003. Our net income for the three months ended June 30, 2003
included $0.9 million of non-cash depreciation charges, whereas the three months
ended June 30, 2004 included $0.2 million of such charges. During the second
quarter of 2003, the Company had positive net cash flows from working capital of
$3.6 million, primarily as a result of $3.0 million for the collection of
deferred revenue in the second quarter. During the second quarter of 2004, the
Company invested $0.1 million in additional working capital for its three
business units.

Net cash used in investing activities in the second quarter of 2004 and 2003 was
primarily related to the acquisition of computer software and hardware.

Net cash provided by financing activities in the second quarter of 2004 was
primarily related to $4.9 million of net proceeds from the private placement of
common stock in April 2004, $0.5 million of proceeds from an AIR exercise, $4.5
million of proceeds from the exercise of stock options, $0.1 million of proceeds
from the sale of common stock to employees under the Company's ESPP, net of $0.1
million of payments made on capital lease obligations. Net cash provided by
financing activities in the second quarter of 2003 related to $1.0 million of
proceeds from the exercise of stock options, net of $0.6 million of payments on
capital lease obligations. The capital lease payments in 2003 were larger than
in 2004 because in the fourth quarter of 2003, the Company returned equipment
under lease from eBay in exchange for the retirement of the remaining
obligations under the leases.

Cash flows from operating activities in the six months of 2004, reflects net
loss of $6.6 million, compared to a net income of $0.7 million the six months of
2003. Our net income for the six months ended June 30, 2003 included $1.9
million of non-cash depreciation charges, whereas the six months ended June 30,
2004 included $0.5 million of such charges. During the six months of 2003, the
Company had positive net cash flows from working capital of $4.1 million,
primarily as a result of $3.0 million for the collection of deferred revenue in
the second quarter. During the six months of 2004, the Company invested $0.6
million in additional working capital for its three business units.

Net cash used in investing activities in the six months of 2004 and 2003 was
primarily related to the acquisition of computer software and hardware.

Net cash provided by financing activities in the six months of 2004 was
primarily related to $4.9 million of net proceeds from the private placement of
common stock in April 2004, $0.5 million of proceeds from AIR exercise, $4.8
million of proceeds from the exercise of stock options, $0.1 million of proceeds
from the sale of common stock to employees under the Company's ESPP, net of $0.3
million of payments made on capital lease obligations. Net cash used in
financing activities in the six months of 2003 related to $1.0 million of
proceeds from the exercise of stock options, net of $1.3 million payments on
capital lease obligations. The capital lease payments in 2003 were larger than
in 2004 because in the fourth quarter of 2003, the Company returned equipment
under lease from eBay in exchange for the retirement of the remaining
obligations under the leases.

During the quarter ended June 30, 2004 and in the prior fiscal periods, the
Company experienced certain going concern issues related to cash flow and
profitability. During the first six months of 2004, the Company has generated
approximately $10 million in cash from the sale of its common stock. In
addition, the Company believes that it will improve its operating cash flows
through the sale of new products launched in the first six months of 2004.

During 2003, the Company changed its relationship with its largest customer,
eBay, which represented 87% of revenue for the year ended December 31, 2003.
eBay licensed technology from the Company that had previously been used by the
Company to provide eBay with recurring services. After 2003, the Company no
longer provides any services to eBay. As a result, the Company has a limited
operating history as it will operate in 2004 and upon which an evaluation of its
business and prospects may be made. In addition, the Company is subject to
generally prevailing economic conditions and, as such, the Company's operating
results in 2004 will be dependent upon its ability to provide quality products
and services, the success of its customers and the appropriations processes of
various commercial and governmental entities.

Management's focus is to manage our cash requirements and focus our operations
on revenue generation and controlled spending. Our long-term strategy remains
unchanged. We will continue to invest in research and development for our
Security and image management products and in the expansion of our distribution
channels for security and the offline publications and online classified
advertising businesses.

INFLATION

Inflation has not had a significant impact on our operations to date.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of June 30, 2004, we had $15.5 million of cash, cash equivalents, short-term
and long-term restricted cash and short-term investments. Our interest income is
sensitive to changes in the general level of United States interest rates,
particularly since the majority of our investments are in short-term
instruments. Due to the nature of our short-term investments, we concluded that
we do not have material market risk exposure.

Item 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Our chief executive
officer and chief financial officer have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a-14(c)) as of the end of the period covered by this
quarterly report. Based on that evaluation, the chief executive officer and
chief financial officer have concluded that our disclosure controls and
procedures are effective to ensure that material information relating to the
Company and our consolidated subsidiaries is made known to such officers by
others within these entities, particularly during the period for which this
quarterly report was prepared, in order to allow timely decisions regarding
required disclosure.

(b) Changes in Internal Controls. There have not been any significant changes
in our internal controls or in other factors during the period covered by this
quarterly report that materially affected or are reasonably likely to materially
affect our internal controls over financial reporting.

FORWARD-LOOKING STATEMENTS

This quarterly report contains statements about future events and expectations
which are characterized as forward-looking statements. Forward-looking
statements are based on our management's beliefs, assumptions and expectations
of our future economic performance, taking into account the information
currently available to them. These statements are not statements of historical
fact. Forward-looking statements involve risks and uncertainties that may cause
our actual results, performance or financial condition to be materially
different from the expectations of future results, performance or financial
condition we express or imply in any forward-looking statements. Factors that
could contribute to these differences include those discussed in "Risk Factors"
of our annual report on Form 10-K filed with the SEC on March 31, 2004.

The words "believe", "may", "will", "should", "anticipate", "estimate",
"expect", "intends", "objective" or similar words or the negatives of these
words are intended to identify forward-looking statements. We qualify any
forward-looking statements entirely by these cautionary factors.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

See Item 3, Legal Proceedings in our Annual Report on Form 10-K. On April 7,
2004, the California Teachers' Retirement System ("CalSTRS") filed a notice of
appeal with the United States Court of Appeals for the Ninth Circuit appealing
the dismissal of the First Amended Consolidated Complaint for violation of
federal securities laws filed against Homestore.com, Inc, us and the other
named defendants. On July 22, 2004, CalSTRS and IPIX filed a Stipulation of
Dismissal with the Court of Appeals pursuant to which the appeal was dismissed,
with prejudice, against IPIX.

Item 2. Changes In Securities And Use Of Proceeds

On April 5, 2004, we completed the sale of 909,090 shares of our common stock,
resulting in net proceeds received of approximately $4.9 million, and additional
investment rights ("AIR") to purchase another 888,180 shares of our unregistered
common stock in a private offering to accredited institutional investors
("PIPE"). The shares of common stock were sold at $5.50 per share and the shares
of common stock underlying the AIR are purchasable at $6.05 per share. The AIR
is exercisable until September 28, 2004. During the quarter ended June 30,
2004, we issued 88,818 shares of common stock upon exercise of the part of the
AIR. The proceeds to the Company from the AIR exercise were $0.5 million. The
common stock and the common stock underlying the AIR have been registered under
the Securities Act of 1933, as amended, and may be offered or sold in the United
States. The Company's Form S-3 provides a description of this transaction and
copies of the executed documents.

During the three months ended March 31, 2004, we issued 442,144 shares of common
stock upon exercise of stock options. The total proceeds to the Company from
the first quarter option exercises were $0.6 million, $0.3 million of which was
collected on April 1, 2004. During the quarter ended June 30, 2004, we issued
1,511,680 shares of common stock upon exercise of stock options. The proceeds to
the Company from the option exercises were $4.3 million. During the quarter
ended June 30, 2004, we sold 91,140 shares of common stock to employees under
the IPIX Employee Stock Purchase Plan ("ESPP"). The proceeds to the Company
from the ESPP purchases were $0.1 million.

During the second quarter, 613,483 shares of Series B Preferred stock plus
accumulated dividends were converted into 6,261,574 shares of the Company's
Common Stock. The Company did not receive any proceeds from the conversions.
As of June 30, 2004, 390,347 shares of Series B Preferred Stock remain
outstanding. During the second quarter, 791 shares of Series B Preferred stock,
issued by the exercise of 1,000 shares of the Series B Warrants, were converted
into 7,286 shares of the Company's Common Stock. The Company did not receive
any proceeds from the Warrant exercise.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission Of Matters To A Vote Of Security Holders

On May 4, 2004, we held the annual meeting of our stockholders to vote upon the
election of directors. The common stockholders voted to elect two directors to
serve until the 2007 annual meeting of stockholders. Our common stockholders
elected Laban P. Jackson to the Board of Directors by a vote of 6,575,379 for,
12,383 against, and 0 abstentions and broker non-votes. Our common stockholders
also elected Donald W. Strickland to the Board of Directors by a vote of
6,575,166 for, 12,597 against, and 0 abstentions and broker non-votes. Andrew P.
Seamons was elected to the Board of Directors by the holders of our Series B
Preferred Stock by a vote of 8,331,053 as-converted common shares for, 0 against
and 0 abstentions and broker non-votes.

David M. Wilds and Michael D. Easterly continue to serve as members of the board
of directors until their terms expire at the annual meeting of stockholders in
2005.

Item 5. Other Information

None.

Item 6. Exhibits And Reports On Form 8-K

Exhibit Exhibit Description
------- -------------------
Number
------

31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32 Section 1350 Certification of Chief Executive Officer and Chief
Financial Officer

Reports On Form 8-K

The Company filed the following Current Reports on Form 8-K during the quarter
ended June 30, 2004:

Date Filed Event Reported

April 7, 2004.......... Item 5. Announcing IPIX agreed to sell 909,090 shares of its unregistered common stock.

April 16, 2004......... Items 7 and 12. Earnings release regarding financial results for the quarter ended March 31, 2004.

June 18, 2004.......... Item 4. Announcing dismissal by our Audit Committee of PricewaterhouseCoopers LLP as our accountants
and the engagement of Armanino McKenna LLP to serve as our accountants for the year ending December 31,
2004.

IPIX CORPORATION
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.

DATE: July 23, 2004 IPIX CORPORATION
(Registrant)

/s/ Paul Farmer
----------------------------
Paul Farmer
Authorized Officer
Chief Financial Officer and
Chief Accounting Officer

IPIX CORPORATION
INDEX TO EXHIBITS FOR FORM 10-Q
FOR QUARTER ENDED JUNE 30, 2004

EXHIBIT NO. EXHIBIT DESCRIPTION
----------- -------------------

31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer

31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer

32 Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer