OCULUS VISIONTECH INC. - Quarter Report: 2006 September (Form 10-Q)

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 quarterly period ended September 30, 2006

Commission file number: 0-29651

USA VIDEO INTERACTIVE CORP.

(Exact name of registrant as specified in its charter)

WYOMING                                                                  06-1576391

(State or Other Jurisdiction of                               (I.R.S. Employer Identification No.)

Incorporation or Organization)

8 West Main Street, Niantic, Connecticut                            06357

           (Address of principal executive offices)                             (ZIP code)

(860) 739-8030

(Registrant's Telephone Number, including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  [ X ]       No  [   ]|

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [   ]

Accelerated filer [   ]

Non-accelerated filer [ X ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   [   ]       No [ X ]

At November 8, 2006, there were 156,323,088 shares of the registrant's common stock outstanding.

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

USA VIDEO INTERACTIVE CORP.

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(Unaudited)

(Stated in US Dollars)

SEE ACCOMPANYING NOTES

SEE ACCOMPANYING NOTES

SEE ACCOMPANYING NOTES

SEE ACCOMPANYING NOTES

USA VIDEO INTERACTIVE CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006

(Unaudited)

(Stated in US Dollars)

NOTE A – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01(a)(5) of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of the management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included.  The results for the interim periods are not necessarily indicative of the results that may be attained for an entire year or any future periods.  For further information, refer to the Financial Statements and footnotes thereto in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2005.

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.  As shown in the financial statements, the Company has incurred losses of $620,454 for the nine month period ended September 30, 2006 and, in addition the Company incurred losses of $958,250 and $1,403,838 for the years ended December 31, 2005 and 2004, respectively. As of September 30, 2006, the Company had an accumulated deficit of $34,856,395 and a working capital deficit of $324,407. These conditions raise doubt about the Company's ability to continue as a going concern.  The Company's ability to continue as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations as they come due which management believes it will be able to do.  To date, the Company has funded operations primarily through the issuance of common stock and warrants to outside investors and the Company's management.  The Company believes that its operations will generate additional funds and that additional funding from outside investors and the Company's management will continue to be available to the Company when needed.  The Company also has certain lawsuits pending which could result in additional liabilities.  The financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classifications of liabilities that might be necessary in the event the Company cannot continue as a going concern.

Basic loss per common share (“EPS”) is computed as net loss divided by the weighted-average number of common shares outstanding during the period. Diluted EPS includes the impact of common stock potentially issuable upon the exercise of options and warrants. Potential common stock has been excluded from the computation of diluted net loss per share as their inclusion would be antidilutive.

The assets and liabilities of the Company’s foreign subsidiaries are translated into U.S. dollars at current exchange rates, and revenue and expenses are translated at average rates of exchange prevailing during the period. The aggregate effect of translation adjustments is immaterial at September 30, 2006 and 2005.

In September 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently reviewing this new standard to determine its effects, if any, on our results of operations or financial position.

NOTE C – COMMON STOCK

In April 2006, the Company issued 3,825,000 units to investors at a price of $0.060 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.087 per share.

In April 2006, the Company issued 675,000 units to employees at a price of $0.060 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.087 per share.  The Company charged operations approximately $22,275 representing the differential between the fair value and the purchase price of the common stock and for any differential between the fair value of the common stock underlying the warrants and the exercise price of the warrants.

In August 2006, the Company issued 3,100,000 units to investors at a price of $0.0575 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.089 per share.

In August 2006, the Company issued 1,050,000 units to employees at a price of $0.0575 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.089 per share.  The Company charged operations approximately $13,125 representing the differential between the fair value and the purchase price of the common stock and for any differential between the fair value of the common stock underlying the warrants and the exercise price of the warrants.

From January 1, 2006 to September 30, 2006, the Company issued 100,000 shares of common stock upon the exercising of stock options with an exercise price of $.10.

NOTE D – COMMITMENTS AND CONTINGENT LIABILITY

The Company is party to a default judgement entered against one of the Company’s subsidiaries.  During the year ended December 31, 1995, a claim was made to the Company for the total amount payable under the terms of the lease with the Company’s subsidiaries for office space in Dallas, Texas through 2002.  The Company’s management is of the opinion that the amount payable under the terms of this judgement is not estimable or determinable at this time and may be substantially mitigated by the landlord renting the property to another party.  The range of possible loss is from $-0- to approximately $500,000.  Any settlement resulting from the resolution of this contingency will be accounted for in the period of settlement when such amounts are estimable or determinable.

On April 10, 2003, the Company announced that a subsidiary had filed a lawsuit in U.S. District Court for the District of Delaware against Movielink LLC.  The Company alleged that Movielink infringed on the Company’s patented online video delivery system. On January 28, 2005, that court issued an opinion and order granting summary judgment in favor of Movielink, based on the court’s conclusion that the record contained insufficient evidence that the Movielink system “initiates connections” (a requirement for infringement of the Company’s patent) in light of the Court’s construction of the term “initiates,” and on May 27, 2005, denied the Company's motion for reconsideration. The Company appealed the district court's adverse rulings to the U. S. Court of Appeals for the Federal Circuit, and on September 8, 2006, the appellate court affirmed the rulings of the court below, effectively ending the substantive litigation between the Company and Movielink. On September 16, 2006, Movielink filed in district court a Bill of Costs seeking $20,526 in litigation costs allegedly taxable to the Company; the Company subsequently filed objections with the court asserting that only $108 of the costs sought by Movielink is permissible under applicable provisions of law. The court has not determined the amount of costs finally taxable to the Company, and consequently a contingent liability exists, which is estimated to be in a range approximately between $108 and $20,526.

On September 13, 2006, USA Video Technology Corp., a wholly-owned subsidiary of the Company, filed suit in the U.S. District Court for the Eastern District of Texas, alleging that its U.S. Patent No. 5,130,792 is infringed by Time Warner, Inc. (NYSE: TWX), Cox Communications, Inc., Charter Communications, Inc. (NasdaqNM: CHTR), Comcast Cable Communications LLC (NasdaqNM: CMCSA), Comcast of Richardson, LP, Comcast of Plano, LP, and Comcast of Dallas, LP, and seeking statutory compensation and a court injunction against further infringement. The defendant companies cited in the lawsuit operate digital cable systems in which they provide allegedly infringing video-on-demand services to their subscribers. The defendant companies subsequently filed lawsuits in the U.S. District Court for the District of Delaware, primarily seeking declaratory judgments that the first-filed allegations of patent infringement against them are without merit, and also seeking damages, etc., related to the filing of the lawsuits. At present, proceedings in both courts are ongoing. Consequently, a contingent liability exists to the extent that the outcome of these proceedings is uncertain.

The Company leases its Canadian office space under a non-cancelable operating lease, expiring in March 2009. The minimum rental commitment of this lease is approximately $20,000 annually. The Company leases its United States office under a non-cancelable operating lease, expiring in July 2008.  The minimum rental commitment of this lease is approximately $13,200 annually.  Rent expense amounted to $34,265 and $31,758 for the nine months ended September 30, 2006 and 2005, respectively.

NOTE E – STOCK BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board  (‘‘FASB’’) issued Statement of Financial Accounting Standards No. 123R (revised 2004), ‘‘Share-Based Payment’’ which revised Statement of Financial Accounting Standards No. 123, ‘‘Accounting for Stock-Based Compensation’’. This statement supersedes Opinion No. 25, ‘‘Accounting for Stock Issued to Employees.’’ The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the statement of operations. The revised statement has been implemented by the Company effective January 1, 2006.

The implementation of FAS No. 123R had no impact on the statement of operations for the nine-month period ended September 30, 2006.  There is no impact on the basic or diluted earning per share reported on the statement of operations.

For the 2005 year the Company has elected to apply APB Opinion No. 25, and related interpretations in accounting for its stock options and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123.  If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date as prescribed by SFAS No. 123, the Company’s net loss and net loss per common share for the nine month period ended September 30, 2005 would have been as follows:

Effective January 1, 2006, the Company adopted FAS No. 123R utilizing the modified prospective method. FAS No.123R requires the recognition of stock-based compensation expense in the financial statements.

Under the modified prospective method, the provisions of FAS No. 123R apply to all awards granted or modified after the date of adoption. In addition, the unrecognized expense of awards not yet vested at the date of adoption, determined under the original provisions of FAS 123, shall be recognized in net earnings in the periods after the date of adoption. Stock based compensation consists primarily of stock options. Stock options are granted to employees at exercise prices equal to the fair market value of the Company’s stock at the dates of grant. Stock options generally vest over three years and have a term of seven years. Compensation expense for stock options is recognized over the period for each separately vesting portion of the stock option award.

The fair value for options issued prior to January 1, 2006 was estimated at the date of grant using a Black-Scholes option-pricing model. The risk free rate was derived from the U.S. Treasury yield curve in effect at the time of the grant. The volatility factor was determined based historical and other factors. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

A summary of the status of the Company's options and changes for the nine months ended September 30 2006 is presented below:

As of September 30, 2006, there was no unrecognized compensation cost related to non-vested stock option awards.  All options are fully vested as of September 30, 2006.

 In February 2006, the Company adopted a new Stock Options Plan (the “2005 Plan”).  The 2005 Plan authorizes the issuance of up to 13,900,000 of the Company's common shares, subject to adjustment under certain circumstances. The Company is listed on the TSX Venture Exchange ("TSX") and is subject to a limitation on the number of options a company may have. The 2005 Plan provides for the issuance of both incentive stock options and nonqualified options as those terms are defined in the Internal Revenue Code of 1986, as amended (the "Code").  The Company's previous option plan will remain in effect until all granted stock options are exercised, expired or canceled.  

NOTE F– SUBSEQUENT EVENTS

In October 2006, the Company issued 1,900,000 units to investors at a price of $0.045 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.089 per share.

In October 2006, the Company issued 600,000 units to an employee at a price of $0.045 per unit. Each unit consisted of one share of common stock and one warrant to purchase an additional share of common stock at $0.089 per share.  The Company will charge operations for any differential between the fair value and the purchase price of the common stock and for any differential between the fair value of the common stock underlying the warrants and the exercise price of the warrants.

Item 2.

Management's Discussion and Analysis of Financial Condition and

Results of Operations

CAUTIONARY STATEMENT

This document includes statements that may constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution readers regarding certain forward-looking statements in this document, press releases, securities filings, and all other documents and communications.  All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q ("Report") are forward looking.  The words "believes," "anticipates," "estimates," "expects," and words of similar import, constitute "forward-looking statements."  While we believe in the veracity of all statements made herein, forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by us, are inherently subject to significant business, economic and competitive uncertainties and contingencies and known and unknown risks.  As a result of such risks, our actual results could differ materially from those expressed in any forward-looking statements made by, or on behalf of, the company.  We will not necessarily update information if any forward-looking statement later turns out to be inaccurate.  Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including risks and uncertainties set forth in our Annual Report on Form 10-K, as well as in other documents we file with the Securities and Exchange Commission ("SEC").

The following information has not been audited.  You should read this information in conjunction with the unaudited financial statements and related notes to the financial statements included in this report.

OVERVIEW OF THE COMPANY

USA Video Interactive Corp. designs and markets to business customers streaming video and video-on-demand systems, services and source-to-destination digital media delivery solutions that allow live or recorded digitized and compressed video to be transmitted through Internet, intranet, satellite or wireless connectivity.  Our systems, services and delivery solutions include video content production, content encoding, media asset management, media and application hosting, multi-mode content distribution, transaction data capture and reporting, e-commerce, specialized engineering services, and Internet streaming hardware.

Although we have not generated any significant sales for the year to date, we continue to explore opportunities that will result in new products for new revenue streams, but there can be no assurances that such efforts will be successful.

We hold the patent for Store-and-Forward Video-on-Demand (#5,130,792), filed in 1990 and issued by the United States Patent and Trademark Office on July 14, 1992.  It has been cited in at least 200 subsequent U.S. patent documents.  We hold similar patents in England, France, Spain, Italy, Germany, Canada, and Japan.  We anticipate actively engaging in licensing this patent.

Our Store and Forward Video-on-Demand ("VoD") intellectual property potentially reaches several significant segments of the VoD market.  Our patented technique covers the transmission of video content over networks faster than "real time."  VoD is the mechanism by which the delivery of compressed video is managed and, together with compression technology, facilitates the delivery of video to an end user in a timely and interactive fashion.

We have developed a number of specific products and services based on these technologies. These include StreamHQ™, a collection of source-to-destination media delivery services marketed to businesses; EncodeHQ™, a service that digitizes and compresses analog-source video; hardware server and encoder system applications under the brand name Hurricane Mediacaster™ ZMail™, a service that delivers web and rich media content to targeted audiences; mediaClix™, a service that delivers content similar to Zmail but originating from an existing web presence; and MediaSentinel™, a patent-pending digital watermarking technology to deter digital video piracy.

In September 2005 we entered into a formal sales and marketing agreement with First Serve International, LLC ("First Serve"), pursuant to which we will jointly market the MediaSentinel Workstation to companies throughout Asia (including Bollywood in India), Europe, and the United States.  In support of these efforts, we will collaborate with sales support, marketing and educational programs and materials that make clear the benefits of watermarking to potential customers.  Through these efforts, we intend to attract new business and break ground on enforcement of copyright holders.  In September 2006, the agreement was assigned to Ethnic Communications, LLC.

We were incorporated on April 18, 1986, as First Commercial Financial Group Inc. in the Province of Alberta, Canada.  In 1989, our name was changed to Micron Metals Canada Corp., which purchased 100% of the outstanding shares of USA Video Inc., a Texas corporation, in order to focus on the digital media business.  In 1995, we changed our name to USA Video Interactive Corp. and continued our corporate existence to the State of Wyoming.  We have five wholly-owned subsidiaries:  USA Video (California) Corp., USA Video Corp., Old Lyme Productions Inc., USA Video Technologies, Inc., and USVO, Inc.  Our executive and corporate offices are located in Old Lyme, Connecticut, and our Canadian offices are located in Vancouver, British Columbia.

BUSINESS OBJECTIVES:

We have established the following near-term business objectives:

1.

Leverage our digital VoD patent for licensing fees and partnerships in the United States and internationally;

2.

Patent and license new technology developed within the corporate research and development program;

3.

Attain industry recognition for the superior architectural, functional, and business differentiators of our MediaSentinel™ architecture;

4.

Demonstrate proof of concept on a commercial project with MediaSentinel™ architecture;

5.

Establish StreamHQ™ as the industry standard in the streaming video and rich media marketplace;

6.

Expand StreamHQ™ functionality to provide enhanced support for corporate training and education markets.

CRITICAL ACCOUNTING POLICIES (AND ESTIMATES)

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  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 ongoing basis, we evaluate these estimates, including those related to customer programs and incentives, bad debts, inventories, investments, intangible assets, income taxes, warranty obligations, impairment or disposal of long-lived assets, contingencies and litigation.  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 consider the following accounting policies to be both those most important to the portrayal of our financial condition and that require the most subjective judgment:

•

Revenue recognition;

•

Impairment or disposal of long-lived assets; and

•

Deferred taxes.

REVENUE RECOGNITION.  Software revenue and other services are recognized in accordance with the terms of the specific agreement, which is generally upon delivery and when accepted by customer.  Maintenance, support and service revenue are recognized ratably over the term of the related agreement.

IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS.  Long-lived assets are reviewed in accordance with Statement of Financial Accounting Standard (“SFAS”) 144.  Impairment or disposal of long-lived assets losses are recognized in the period the impairment or disposal occurs.  

DEFERRED TAXES.  We record a valuation allowance to reduce deferred tax assets when it is more likely than not that some portion of the amount may not be realized.  

RESULTS OF OPERATIONS

Sales

Sales for the nine-month period ended September 30, 2006 were $-0-, compared to revenue of $18,800 for the nine-month period ended September 30, 2005.  Sales for the three-month period ended September 30, 2006 and September 30, 2005 were $-0-.  We discontinued the sale of select services from our prototype StreamHQ™ after customers' satisfaction and proof of concept.  We no longer sell the individual functions of StreamHQ™.  We intend to continue to develop and expand our StreamHQ™ services business, while pursuing opportunities to sell replicated StreamHQ™ systems to corporations and organizations that prefer systems solutions to services.  

Cost of Sales

The cost of sales for the nine months ended September 30, 2006 was $-0- as compared to $5,000 for the comparable period in 2005.  For the three-month period ended September 30, 2006 and September 30, 2005, the cost of sales were $-0-.  The decrease in cost of sales during the nine months ended September 30, 2006 is directly attributable to the decrease in sales.  

Selling, General and Administrative Expenses

Selling, general and administrative expenses consisted of product marketing expenses, consulting fees, office, professional fees, annual meeting and other expenses to execute the business plan and for our day-to-day operations.  Administrative expenses decreased in the three months ending September 30, 2006 due to the annual meeting being held earlier in 2006 compared to 2005 and non-cash compensation

Selling, general and administrative expenses for the three months ended September 30, 2006 decreased by $37,334 to $195,700 from $233,034 for the three months ended September 30, 2005.  The decrease was due to the date of the annual meeting and, as a result the costs, being earlier than last year and non-cash compensation.   For the nine months ended September 30, 2006 the costs decreased by $88,986 to $568,753 from $657,739 for the comparable period in 2005.  The decrease was the result of expenses incurred related to the decrease in our operations.  

Expenses for the annual meeting for the three months ended September 30, 2006, decreased to $-0- from $15,930 for the comparable period of 2005.  The 2006 Annual Meeting was held June 26, 2006 compared to the 2005 Annual Meeting, which was held September 7, 2005.

Product marketing expense for the three months ended September 30, 2006, decreased to $31,005 from $43,387 for the comparable period in 2005.  For the nine months ended September 30, 2006 these costs decreased to $106,570 from $127,833 for the comparable period in 2005.  The decrease was due to direct marketing to selective possible customers for MediaSentinel™.  

Professional expense for the three months ended September 30, 2006, increased to $68,533 from $37,063 for the comparable period of 2005.  For the nine months ended September 30, 2006 these costs decreased to $113,939 from $195,087 for the comparable period in 2005.  We incurred increased costs in the third quarter of 2006 due to the patent infringement suit filed in Texas and decreased costs in the first quarter of 2006 as a result of the appeal of the patent infringement suit incurred during fiscal 2005.  

We have arranged for additional staff and consultants to engage in marketing activities in an effort to identify and assess appropriate market segments, develop business arrangements with prospective partners, create awareness of new products and services, and communicate to the industry and potential customers.  Other components of selling, general and administrative expense did not change significantly.

Research and Development Expenses

Research and development expenses consisted primarily of contractors, compensation, hardware, software, licensing fees, and new product applications for our proprietary MediaSentinel™.  Research and development expenses increased to $121,762 for the nine months ended September 30, 2006, from $67,000 for the comparable period in 2005 and to $51,112 for the three months ended September 30, 2006 from $-0- for the comparable period in 2005.  The increase was the result of maintaining research and development efforts of MediaSentinel™.

Non-Cash Compensation Charges

Non-cash compensation charges for the nine months ended September 30, 2006 was $35,400, compared to $41,000 for the comparable period in 2005.  The decreased amount for the nine months ended September 30, 2006 was due to the issuance of common shares and share purchase warrants to our officers, directors and employees at a price and exercise price, respectively, below the market price of the common shares at the time of issuance of the common shares and share purchase warrants.  Because the rules of the TSX Venture Exchange require that the offering price for privately placed securities of listed companies be set when the private placement offering is first announced, rather than upon closing, and the market price of the common shares increased between announcement of the offering and closing, the sale price of the common shares and the exercise price of the warrants were below the market price of the common shares on the date of issuance.

Other Income

During the nine months ended September 30, 2006 we recorded a gain on settlement of accounts payable due to the statute of limitation expiring on $61,852 of payroll taxes and settlement of payables.  We also sold property and equipment and recorded a gain on sale of $10,000.  

Net Losses

To date, we have not achieved profitability and, we expect to incur substantial net losses for at least the remainder of 2006.  Our net loss for the nine months ended September 30, 2006 was $620,454, compared with a net loss of $713,323 for the nine months ended September 30, 2005.  The decrease in losses is directly related to the reduced professional fees and the gain on settlement of accounts payable and sale of property and equipment.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2006, we had a cash position of $3,858, compared to $25,253 at December 31, 2005.  We anticipate capital requirements of $500,000 for the continued development of our MediaSentinel™ products, $500,000 for commercialization of our MediaSentinel™ products and $750,000 for costs associated with the infringement lawsuit.

We will require additional financing to fund current operations through fiscal 2006.  We have historically satisfied our capital needs primarily by issuing equity securities.  We will require an additional $1.25 million to $2.00 million to finance operations through fiscal 2007 and we intend to seek such financing through sales of our equity securities.  Subsequent to the nine months ended September 30, 2006, we raised an aggregate of $112,500 through a private placement of 2,500,000 units at a price of $0.045 unit.

Assuming the aforementioned $1.25 million to $2.00 million in financing is obtained, we believe that continuing operations for the longer term will be supported through anticipated licensing revenues and through additional sales of our securities.  We have no binding commitments or arrangements for additional financing, and there is no assurance that we will be able to obtain any additional financing on terms acceptable to us, if at all.

OFF-BALANCE SHEET ARRANGEMENTS

We do not maintain any off-balance sheet transactions, arrangements, or obligations that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity, or capital resources.  

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

Certain risks and uncertainties could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Report.  Risks and uncertainties have been set forth in our Annual Report on Form 10-K, as well as in other documents we file with the SEC.  These risk factors include the following:

OUR ABILITY TO CONTINUE AS A GOING CONCERN: WE HAVE INCURRED SUBSTANTIAL LOSSES; WE EXPECT TO INCUR LOSSES IN THE FUTURE, AND MAY NEVER ACHIEVE PROFITABILITY.

To date, we have not been profitable, have not generated significant revenue from operations, and have incurred substantial losses. For the nine months ended September 30, 2006, we had a net loss of $620,454.  As of September 30, 2006, we had an accumulated deficit of $34,856,395 and a working capital deficit of $324,407.  We intend to continue to expend significant financial and management resources on the development of our proposed products and services, and other aspects of our business.  As a result, we expect operating losses and negative cash flows to increase for the foreseeable future.  Consequently, we will need to generate significant revenues to achieve and maintain profitability.  We may be unable to do so.  If our revenues grow more slowly than anticipated or if operating expenses increase more than expected, or are not reduced sufficiently, we may never achieve profitability.  

OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS AND PROSPECTS.

Our business and prospects must be considered in light of the many risks, uncertainties, expenses, delays and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets such as streaming media.  We cannot be certain that our business strategy will be successful or that we will successfully address these risks.

IF WE ARE UNABLE TO OBTAIN SUBSTANTIAL ADDITIONAL FINANCING IN THE NEXT FEW MONTHS WE MAY NOT BE ABLE TO MAINTAIN OPERATIONS AT CURRENT LEVELS.

We require substantial additional financing to maintain operations at current levels for fiscal 2007.  Financing may not be available when needed on terms favorable to us, or at all.  If adequate funds are not available or are not available on acceptable terms, we may be unable to further develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures, or ultimately, to continue in business.

CONTINUATION OF THE CURRENT SLUMP IN THE TECHNOLOGY SECTOR WILL ADVERSELY AFFECT DEMAND FOR OUR PRODUCTS AND SERVICES.

Our sales have been adversely affected by the ongoing slump in the technology industry segment and the continuation of these market conditions can be expected to result in depressed demand for our products and services.

OUR OPERATING RESULTS IN FUTURE PERIODS ARE EXPECTED TO BE SUBJECT TO SIGNIFICANT FLUCTUATIONS, WHICH WOULD LIKELY AFFECT THE TRADING PRICE OF OUR COMMON SHARES.

Factors that could cause such fluctuations include our ability to attract and retain customers; the introduction of new video transmission services or products by others; price competition; the continued development of and changes in the streaming media market; our ability to remain competitive in our product and service offerings; our ability to attract new personnel; and potential U.S. and foreign regulation of the Internet.  These factors could cause the price of our stock to fall, which may make it difficult for us to raise funds in the future, which funds are essential for us to continue to carry on business.

WE ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, WHICH COULD RENDER OUR PRODUCTS AND SERVICES OBSOLETE.

Keeping pace with the technological advances may require substantial expenditures and lead-time, particularly with respect to acquiring updated hardware and infrastructure components of its systems.  We may require additional financing to fund such acquisitions.  Any such financing may not be available on commercially reasonably terms, if at all, when needed.

IF WE DO NOT CONTINUOUSLY IMPROVE OUR TECHNOLOGY IN A TIMELY MANNER, OUR PRODUCTS COULD BE RENDERED OBSOLETE.

These changes and developments may render our products and technologies obsolete in the future.  As a result, our success depends on our ability to develop or adapt products and services or to acquire new products and services that can compete successfully. If we are unable to continuously upgrade our technology to keep pace with the industry then our products could become obsolete, which would cause our business to fail.  

WE INTEND TO ISSUE ADDITIONAL EQUITY SECURITIES, WHICH MAY DILUTE THE INTERESTS OF CURRENT SHAREHOLDERS OR CARRY RIGHTS OR PREFERENCES SENIOR TO THE COMMON SHARES.

Accordingly, existing shareholders may experience additional dilution of their percentage ownership interest.  In addition, the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common shares.

COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC DISLCOSURE MAY RESULT IN ADDITIONAL EXPENSES.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are creating uncertainty for companies such ours.  These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matter and higher costs necessitated by ongoing revisions to disclosure and governance practices.  We are committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

OUR STOCK PRICE IS EXTREMELY VOLATILE.

The trading price of our common stock has been subject to very wide fluctuations which may continue in the future in response to, among other things, the following:

•

signing or not signing new licensees;

•

new litigation or developments in current litigation;

•

announcements of technological innovations or new products, our licensees or our competitors;

•

positive or negative reports by securities analysts as to our expected financial results; and

•

developments with respect to patents or proprietary rights and other events or factors.

In addition, the equity markets have experienced volatility that has particularly affected the market prices of equity securities of many high technology companies and that often has been unrelated or disproportionate to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of our common stock.

OUR BUSINESS MAY SUFFER IF WE CANNOT PROTECT OUR INTELLECTUAL PROPERTY.

We seeks to protect our proprietary rights through a combination of patents, trade secret and trademark laws, confidentiality procedures and contractual provisions with employees and third parties.  Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we consider as proprietary.  Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of the proprietary rights of others.  Any litigation could result in substantial costs and diversion of management and other resources with no assurance of success and could seriously harm our business and operating results.

THERE IS NO ASSURANCE THAT OUR PATENTS WON’T BE CHALLENGED, INVALIDATED OR CIRCUMVENTED

There can be no assurance that our current or future patents, if any, will not be challenged, invalidated, or circumvented, or that any rights granted thereunder will provide competitive advantages to us.  In addition, there can be no assurance that patents will be issued from pending applications, or that claims allowed on any future patents will be sufficiently broad to protect our technology.  In addition, the laws of some foreign countries may not permit the protection of our proprietary rights to the same extent as do the laws of the United States.  We intend to enforce our proprietary rights through the use of licensing agreements and, when necessary, litigation.  Although we believe the protection afforded by our patents, patent applications, and trademarks has value, the rapidly changing technology in the video transmission industry makes our future success dependent primarily on the innovative skills, technological expertise, and management abilities of our employees rather than on patent and trademark protection.

OUR PRODUCTS MAY INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, CAUSING US TO INCUR SIGNIFICANT COSTS OR PREVENT US FROM LICENSING OUR PRODUCTS.

Other companies, including our competitors, may have or obtain patents or other proprietary rights that would prevent, limit or interfere with our ability to make, use or license our products.  We cannot be certain that our products do not and will not infringe patents or other proprietary rights of others.  We may be subject to legal proceedings, including claims of alleged infringement by us of the intellectual property rights of third parties.  If a successful claim of infringement is brought against us and we fail to or are unable to license the infringed technology on commercially reasonable terms, our business and operating results could be significantly harmed.  Companies in the technology market are increasingly bringing suits alleging infringement of their proprietary rights, particularly patent rights.  Although we are not currently subject to any litigation or claims, any future claims, whether or not valid, could result in substantial costs and diversion of resources with no assurance of success.  Intellectual property litigation or claims could force us to do one or more of the following:

•

cease selling, incorporating or using products or services that incorporate the challenged intellectual property;

•

obtain a license from the holder of the infringed intellectual property right, which license may not be available on commercially reasonable terms, or at all; or

•

redesign our products or services.

If we are forced to take any of these actions, our business could be substantially harmed.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

We believe our exposure to overall foreign currency risk is not material.  We do not manage or maintain market risk sensitive instruments for trading or other purposes and are not exposed to the effects of interest rate fluctuations as we do not carry any long-term debt.

We report our operations in US dollars and our currency exposure, although considered by us as immaterial, is primarily between US and Canadian dollars.  Exposure to other currency risks is also not material as international transactions are settled in US dollars.  Any future financing undertaken by us will be denominated in US dollars.  As we increase our marketing efforts, the related expenses will be primarily in US dollars.  In addition, 90% of our bank deposits are in US dollars.

Item 4.

Controls and Procedures

Based on their evaluation of the effectiveness of our disclosure controls and procedures as of September 30, 2006, the date of this quarterly report, our undersigned officers have concluded that such disclosure controls and procedures are adequate.  There were no significant changes in internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses, subsequent to the date of the most recent evaluation by our undersigned officers of the design and operation of internal controls which could adversely affect our ability to record, process, summarize and report financial data.

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

On April 10, 2003, the Company announced that a subsidiary had filed a lawsuit in U.S. District Court for the District of Delaware against Movielink LLC.  The Company alleged that Movielink infringed on the Company’s patented online video delivery system. On January 28, 2005, that court issued an opinion and order granting summary judgment in favor of Movielink, based on the court’s conclusion that the record contained insufficient evidence that the Movielink system “initiates connections” (a requirement for infringement of the Company’s patent) in light of the Court’s construction of the term “initiates,” and on May 27, 2005, denied the Company's motion for reconsideration. The Company appealed the district court's adverse rulings to the U. S. Court of Appeals for the Federal Circuit, and on September 8, 2006, the appellate court aff irmed the rulings of the court below, effectively ending the substantive litigation between the Company and Movielink. On September 16, 2006, Movielink filed in district court a Bill of Costs seeking $20,526 in litigation costs allegedly taxable to the Company; the Company subsequently filed objections with the court asserting that only $108 of the costs sought by Movielink is permissible under applicable provisions of law. The court has not determined the amount of costs finally taxable to the Company, and consequently a contingent liability exists, which is estimated to be in a range approximately between $108 and $20,526.

On September 13, 2006, USA Video Technology Corp., a wholly-owned subsidiary of the Company, filed suit in the U.S. District Court for the Eastern District of Texas, alleging that its U.S. Patent No. 5,130,792 is infringed by Time Warner, Inc. (NYSE: TWX), Cox Communications, Inc., Charter Communications, Inc. (NasdaqNM: CHTR), Comcast Cable Communications LLC (NasdaqNM: CMCSA), Comcast of Richardson, LP, Comcast of Plano, LP, and Comcast of Dallas, LP, and seeking statutory compensation and a court injunction against further infringement. The defendant companies cited in the lawsuit operate digital cable systems in which they provide allegedly infringing video-on-demand services to their subscribers. The defend ant companies subsequently filed lawsuits in the U.S. District Court for the District of Delaware, primarily seeking declaratory judgments that the first-filed allegations of patent infringement against them are without merit, and also seeking damages, etc., related to the filing of the lawsuits. At present, proceedings in both courts are ongoing. Consequently, a contingent liability exists to the extent that the outcome of these proceedings is uncertain.

Item 2.

Changes in Securities and Use of Proceeds

During the quarter ended September 30, 2006, we completed an offering of 4,150,000 at prices of $0.0575 per unit for total proceeds of $238,625.  Each unit consisted of one share of common stock and one warrant to acquire one additional share at $0.089 per share, exercisable on or before August 11, 2008.  

The offer and sale of the units were exempt from registration pursuant to section 4(2) of the Securities Act, Rule 701 and Rule 506 of Regulation D promulgated thereunder.  We limited the manner of the offering and provided disclosure regarding the offering and our company to the investors.  Two of our officers and directors, one employee, one additional unaffiliated non-accredited investor, and four additional unaffiliated accredited investors purchased the securities.   We believe that a portion of these sales were also exempt under Regulation S under the Securities Act, as such sales were made in offshore transactions to non-U.S. persons.

Item 3.

Defaults Upon Senior Securities.  

None.

Item 4.

Submission of Matters to a Vote of Security Holders.

None.

Item 5.

Other Information.  

None.

Item 6.

Exhibits and Reports on Form 8-K

(a)

Exhibit(s)

31.1

Certification of the Chief Executive Officer Pursuant To Rule 13a-14 Or 15d-14 of the Securities Exchange Act Of 1934,as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of the Chief Financial Officer Pursuant To Rule 13a-14 Or 15d-14 of the Securities Exchange Act of 1934,as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C.  Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)

Reports on Form 8-K

(1)

On September 28th, 2006 we announced that First Serve Entertainment, Inc. ("FSE") has assigned their MediaSentinel marketing agreement with USA Video Interactive Corp. to Munish Gupta, former Chief Operating Officer at FSE.  Consequently, the marketing agreement with FSE has been terminated by mutual consent and USVO has now signed a new marketing agreement with Munish Gupta and his company, Ethnic Communications LLC, on the same terms as the FSE agreement.

SIGNATURE

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.

USA VIDEO INTERACTIVE CORP.

Dated:  November 8th, 2006

By:  /s/  Anton J. Drescher

--------------------------------

Name: Anton J. Drescher

Title:  Chief Financial Officer