**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**




**Washington,
      D.C. 20549**





**Form
      10-K**





R
            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  **SECURITIES
                  EXCHANGE ACT OF 1934****For the fiscal year ended December
                31, 2006****or**£
            **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934**





**Commission
      file number 001-15751**





**eMAGIN
      CORPORATION**


*(Exact
      name of registrant as specified in its charter* *)*





**Delaware**
            **56-1764501***(State
                or other jurisdiction of*
            *(I.R.S.
                Employer**incorporation
                or organization)*
            *Identification
                No.)*





**10500
      NE 8** **th** **Street, Suite 1400, Bellevue, Washington 98004**


*(Address
      of principal executive offices)*





**(425)
      749-3600**


**(** *Registrant’s
      telephone number, including area code* **)**





**Securities
      registered pursuant to Section 12(b) of the Act: None**





**Securities
      registered pursuant to Section 12(g) of the Act: Common Stock, $.001 Par Value
      Per Share**





Indicate
      by check mark whether the registrant is a well-known seasoned issuer as defined
      in Rule 405 of the Securities Act. Yes £ No R





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes £ No R





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 R No £





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. £





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 R





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





As
      of
      June 30, 2006, the aggregate market value of the issued and outstanding common
      stock held by non-affiliates of the registrant, based upon the closing price
      of
      the common stock as quoted on the American Stock Exchange of $2.90 was
      approximately $27.6 million. For purposes of the above statement only, all
      directors, executive officers and 10% shareholders are assumed to be affiliates.
      This determination of affiliate status is not necessarily a conclusive
      determination for any other purpose.





Number
      of
      shares of common stock outstanding as of March 16, 2007 was
      11,049,164.





**DOCUMENTS
      INCORPORATED BY REFERENCE** -
      None ****











**FORM
      10-K**





**FOR
      THE FISCAL YEAR ENDED DECEMBER 31, 2006**





**INDEX**





**Page****PART
                I**Item
                1
            Business
            4Item
                1A
            Risk
                Factors
            16Item
                1B
            Unresolved
                Staff Comments
            20Item
                2
            Properties
            20Item
                3
            Legal
                Proceedings
            21Item
                4
            Submission
                of Matters to a Vote of Security Holders
            21**PART
                II**Item
                5
            Market
                for Registrant’s Common Equity, Related Shareholder Matters and Issuer
                Purchases of Equity Securities
            21Item
                6
            Selected
                Financial Data
            22Item
                7
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            23Item
                7A
            Quantitative
                and Qualitative Disclosures About Market Risk
            28Item
                8
            Financial
                Statements and Supplementary Data
            29Item
                9
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            53Item
                9A
            Controls
                and Procedures
            53Item
                9B
            Other
                Information
            53**PART
                III**Item
                10
            Directors,
                Executive Officers, and Corporate Governance
            53Item
                11
            Executive
                Compensation
            53Item
                12
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            53Item
                13
            Certain
                Relationships and Related Transactions
            53Item
                14
            Principal
                Accounting Fees and Services
            53**PART
                IV**Item
                15
            Exhibits
                and Financial Statement Schedules
            54Signatures








2





**STATEMENT
      REGARDING FORWARD-LOOKING STATEMENTS**





In
      this
      annual report, references to "eMagin Corporation," "eMagin," "Virtual Vision,"
      "the Company," "we," "us," and "our" refer to eMagin Corporation and its wholly
      owned subsidiary, Virtual Vision, Inc.





Except
      for the historical information contained herein, some of the statements in
      this
      Report contain forward-looking statements that involve risks and uncertainties.
      These statements are found in the sections entitled "Business," "Management's
      Discussion and Analysis or Plan Operations," and "Risk Factors." They include
      statements concerning: our business strategy; expectations of market and
      customer response; liquidity and capital expenditures; future sources of
      revenues; expansion of our proposed product line; and trends in industry
      activity generally. In some cases, you can identify forward-looking statements
      by words such as "may," "will," "should," "expect," "plan," "could,"
      "anticipate," "intend," "believe," "estimate," "predict," "potential," "goal,"
      or "continue" or similar terminology. These statements are only predictions
      and
      involve known and unknown risks, uncertainties and other factors, including,
      but
      not limited to, the risks outlined under "Risk Factors," that may cause our
      or
      our industry's actual results, levels of activity, performance or achievements
      to be materially different from any future results, levels of activity,
      performance or achievements expressed or implied by such forward-looking
      statements. For example, assumptions that could cause actual results to vary
      materially from future results include, but are not limited to: our ability
      to
      successfully develop and market our products to customers; our ability to
      generate customer demand for our products in our target markets; the development
      of our target markets and market opportunities; our ability to manufacture
      suitable products at competitive cost; market pricing for our products and
      for
      competing products; the extent of increasing competition; technological
      developments in our target markets and the development of alternate, competing
      technologies in them; and sales of shares by existing shareholders. Although
      we
      believe that the expectations reflected in the forward looking statements are
      reasonable, we cannot guarantee future results, levels of activity, performance
      or achievements. Unless we are required to do so under federal securities laws
      or other applicable laws, we do not intend to update or revise any
      forward-looking statements.





3


**PART
      I**





**ITEM
      1. BUSINESS**





**Introduction**





eMagin
      Corporation designs, develops, manufactures, and markets virtual imaging
      products which utilize OLEDs, or organic light emitting diodes, OLED-on-silicon
      microdisplays and related information technology solutions. We integrate OLED
      technology with silicon chips to produce high-resolution microdisplays smaller
      than one-inch diagonally which, when viewed through a magnifier, create virtual
      images that appear comparable in size to that of a computer monitor or a
      large-screen television. Our products enable our original equipment
      manufacturer, or OEM, customers to develop and market improved or new electronic
      products. We believe that virtual imaging will become an important way for
      increasingly mobile people to have quick access to high resolution data, work,
      and experience new more immersive forms of communications and entertainment.





Our
      first
      commercial product, the SVGA+ (Super Video Graphics Array of 800x600 picture
      elements plus 52 added columns of data) OLED microdisplay was initially offered
      for sampling in 2001, and our first SVGA-3D (Super Video Graphics Array plus
      built-in stereovision capability) OLED microdisplay was shipped in early 2002.
      These products are being applied or considered for near-eye and headset
      applications in products such as entertainment and gaming headsets, handheld
      Internet and telecommunication appliances, viewfinders, and wearable computers
      to be manufactured by OEM customers for military, medical, industrial, and
      consumer applications. We market our products globally.





In
      2006
      we introduced our OLED-XL technology, which provides longer luminance half
      life
      and enhanced efficiency of eMagin's SVGA+ and SVGA-3D product lines. We are
      in
      the process of completing development of 2 additional OLED microdisplays, namely
      the SVGA 3DS (SVGA 3D shrink, a smaller format SVGA display with a new cell
      architecture with embedded features) and an SXGA (1280 x 1024 picture elements).





In
      January 2005 we announced the world's first personal display system to combine
      OLED technology with head-tracking and 3D stereovision, the Z800 3DVisor(tm),
      which was first shipped in mid-2005. This product was recognized as a Digital
      Living Class of 2005 Innovators, and received the Consumer Electronics
      Association’s coveted Consumer Electronics Show (CES) 2006 Best of Innovation
      Awards for the entire display category as well as a Design and Innovations
      Award
      for the electronic gaming category. In February 2007 the Z800 3DVisor, as
      integrated in Chatten Associates’ head-aimed remote viewer, was recognized
      as one
      of
      Advanced Imaging's Solutions of the Year.





We
      believe that our OLED-on-silicon microdisplays offer a number of advantages
      over
      current liquid crystal microdisplays, including greatly increased system level
      power efficiency, less weight and wider viewing angles. Using our active matrix
      OLED technology, many computer and video electronic system functions can be
      built directly into the OLED-on-silicon microdisplay, resulting in compact
      systems with expected lower overall system costs relative to alternative
      microdisplay technologies. We have developed our own technology to create high
      performance OLED-on-silicon microdisplays and related optical systems and we
      have licensed certain fundamental OLED and display technology from Eastman
      Kodak.





As
      the
      first to exploit OLED technology for microdisplays, and with the support of
      our
      partners and the development of our intellectual property, we believe that
      we
      enjoy a significant advantage in the commercialization of this display
      technology for virtual imaging. We believe we are the only company to sell
      full-color active matrix small molecule OLED-on-silicon
      microdisplays.





eMagin
      Corporation was created through the merger of Fashion Dynamics Corporation
      ("FDC"), which was organized on January 23, 1996 under the laws of the State
      of
      Nevada and FED Corporation ("FED"), a developer and manufacturer of optical
      systems and microdisplays for use in the electronics industry. FDC had no active
      business operations other than to acquire an interest in a business. On March
      16, 2000, FDC acquired FED. The merged company changed its name to eMagin
      Corporation. Following the merger, the business conducted by eMagin is the
      business conducted by FED prior to the merger.





Our
      website is located at www.emagin.com and our
      e-commerce site is www.3dvisor.com .
      We make
      available on our website, free of charge, our annual report on Forms 10K, our
      proxy statement, our quarterly reports on Forms 10Q, our current reports on
      Form
      8K, and all amendments to such reports filed under the Securities and Exchange
      Act, earnings press releases, and other business-related press releases. We
      also
      post on our website the charters of our Audit, Compensation, and Governance
      and
      Nominating committees, our Codes of Ethics and any amendments of or waiver
      to
      those codes of ethics, and other corporate governance materials recommended
      by
      the Securities and Exchange Commission as they occur.





**Industry
      Overview**





A
      recent
      (February 2007) study by NanoMarkets predicts the overall OLED market will
      approach $10.9 billion in 2010 and grow to $15.5 billion by 2014. These markets
      include various sizes devices for a range of applications from cell phone size
      to viewfinder displays to televisions to lighting. Displays in general are
      sold
      as independent products (such as TV monitors) or as components of other systems
      (such as laptop computers). Our products target one segment of the display
      industry, the near-eye, personal display, which is viewed through a lens rather
      than directly, in comparison to desktop computer screens which are known as
      direct view displays. As an off-shoot of our work in microdisplays, we are
      also
      participating in government-funded development studies for OLED-based
      lighting.





4


Personal
      displays, that is, near-eye systems based on microdisplays and optics, include
      video headsets, camcorders, viewfinders and other portable devices.
      Microdisplays are typically of such high resolution that they can be practically
      viewed only with magnifying optics. Although microdisplays are typically
      physically smaller than a postage stamp, they can provide a magnified viewing
      area similar to that of a full-size computer screen. For example, when magnified
      through a lens, a high-resolution 0.6-inch diagonal display can appear
      comparable to a 19- to 21-inch computer screen at about 2 feet from the viewer
      or a 60-inch TV screen at about 6 feet. The wearable display market, according
      to DisplaySearch, is expected to grow to at least $153 million in 2010.
      McLaughlin Consulting, in a report published December 2006, projects that,
      with
      effective marketing, the Personal Viewer market could reach nearly $1 billion
      in
      2010.





We
      believe that the most significant driver of the longer term near-eye virtual
      imaging microdisplay market is growing consumer demand for mobile access to
      larger volumes of information and entertainment in smaller packages. This desire
      for mobility has resulted in the development of near-eye microdisplay products
      in two general categories: (i) an established market for electronic viewers
      incorporated in products such as viewfinders for digital cameras and video
      cameras which may potentially also be developed as personal viewers for cell
      phones and (ii) an emerging market for headset-application platforms which
      include accessories for mobile devices such as notebook and sub-notebook
      computers, portable DVD systems, electronic games, and other entertainment,
      and
      wearable computers.





Until
      now, near-eye virtual imaging microdisplay technologies have not simultaneously
      met all of the requirements for high resolution, full color, low power
      consumption, brightness, lifetime, size and cost which are required for
      successful commercialization in OEM consumer products. We believe that our
      new
      OLED-on-silicon microdisplay product line meets these requirements better than
      alternative products and will help to enable virtual imaging to emerge as an
      important display industry segment.





**Our
      Approach: OLED-on-Silicon Microdisplays and Optics**





There
      are
      two basic classes of organic light emitting diode, or OLED, technology, dubbed
      single molecule or small molecule (monomer) and polymer. Our microdisplays
      are
      currently based upon active matrix molecular OLED technology, which we call
      OLED-on-silicon because we build the displays directly on silicon chips. Our
      OLED-on-silicon technology uniquely permits millions of individual low-voltage
      light sources to be built on low-cost, silicon computer chips to produce single
      color, white or full-color display arrays. OLED-on-silicon microdisplays offer
      a
      number of advantages over current liquid crystal microdisplays, including
      increased brightness, lower power requirements, less weight and wider viewing
      angles. Using our OLED technology, many computer and video electronic system
      functions can be built directly into the silicon chip, under the OLED film,
      resulting in very compact, integrated systems with lowered overall system costs
      relative to alternative technologies.





We
      have
      developed our own proprietary and patented technology to create high performance
      OLED-on-silicon microdisplays and related optical systems, and we license
      fundamental OLED technology from Eastman Kodak. (See "Intellectual Property"
      and
      "Strategic Relationships"). We expect that the integration of our
      OLED-on-silicon microdisplays into mobile electronic products will result in
      lower overall system costs to our OEM customers.





We
      believe that our OLED-on-silicon microdisplays will initiate a new generation
      of
      virtual imaging products that could have a profound impact on many industries.
      Headsets providing virtual screens surrounding the user in a sphere of data
      become a practical reality with our displays and a low cost head tracker.
      Because our microdisplays generate and emit light, they have a wider viewing
      angle than competing liquid crystal microdisplays, and because they have the
      same high brightness at all forward viewing angles, our microdisplays permit
      a
      large field-of-view and superior optical image.





The
      wider
      viewing angle of our display results in the following superior optical
      characteristics in comparison with LCDs and other near-eye display technologies:





·
            the
                user does not need to accurately position the head-wearable display
                to the
                eye;





·
            the
                image will change minimally with eye movement and appear more natural;
                and





·
            the
                display can be placed further from the eye and not cut off part of
                the
                image.





In
      addition, our OLED-on-silicon microdisplays offer faster response times and
      use
      much less power than competitive liquid crystal microdisplay systems. Our
      subsystem-level power consumption is so low that two SVGA, full color, full
      speed motion video computer displays can easily be run in stereovision off
      the
      power from a single USB port on a portable computer. Battery life is extended
      and weight is greatly reduced in systems using our products.






5





Our
      SVGA+
      OLED microdisplay stores all the color and luminance value information at each
      of the more than 1.5 million picture elements, or pixels, between refresh cycles
      in the display array, eliminating the flicker or color breakup seen by most
      other high-resolution microdisplay technologies. Even power efficient frame
      rates as low as 30 Hz can usually be used effectively. Power consumption at
      the
      system level is expected to be the lowest of any full-color, full-video SVGA
      resolution range, large view microdisplay on the market. The OLED's ability
      to
      emit light at wide angles allows customers to create large field of view
      (approx. 40 degrees), wide image capture range images from very compact,
      low-cost, one-piece optical systems. The display contains the majority of the
      electronics required for connection to the RGB (red, green, blue signal) port
      of
      a portable computer imbedded in its silicon chip backplane, thereby eliminating
      many other components required by other display technologies such as
      digital-analog converters, application-specific integrated circuits (ASICs),
      light sources, multiple optical elements, and other components. We believe
      that
      these features will enable our new class of microdisplay to potentially be
      the
      most compact, highest image quality, and lowest cost solution for high
      resolution near-eye applications, once they are in full production.





We
      have
      also developed advanced lens technology which permits our OLED-on-silicon
      microdisplays to provide large field of view images that can be viewed for
      extended periods with reduced eye-fatigue. Molded plastic prism lenses have
      been
      developed to help our OEM customers obtain better quality, large area virtual
      images using our displays at relatively low cost in comparison to alternate
      approaches.





**Our
      Products**





Our
      first
      commercial microdisplay products are based on our "SVGA series" OLED
      microdisplays. We offer products utilizing both our proprietary “OLED” or
“OLED-XL” technologies, applied to the same integrated circuit base. We offer
      our products to OEMs and other large volume buyers as both separate components,
      integrated bundles coupled with our own optics, or full systems. We also offer
      engineering support to enable customers to quickly integrate our products into
      their own product development programs.





***(1)
      OLED Microdisplay Component Products***





***SVGA+
      OLED Microdisplay (Super Video Graphics Array of 800x600 plus 52 added columns
      of data).*** Our 0.62
      inch diagonal SVGA+ OLED microdisplays have a resolution of 852x600 triad pixels
      (1.53 million picture elements). The product was dubbed "SVGA+" because it
      has
      52 more display columns than a standard SVGA display, permitting users to run
      either (1) standard SVGA (800 x 600 pixels) to interface to the analog output
      of
      many portable computers or (2) 852 x 480, using all the data available from
      a
      DVD player in a 16:9 wide screen entertainment format. The display also has
      an
      internal NTSC monochrome video decoder for low power night vision systems.





***SVGA-3D
      OLED Microdisplay (Super Video Graphics Array plus built-in stereovision
      capability).*** Our 0.59
      inch diagonal SVGA-3D OLED microdisplays have a resolution of 800x600 triad
      pixels (1.44 million picture elements). A built-in circuit provides
      compatibility with single channel frame sequential stereoscopic vision without
      additional external components.





***Microdisplays
      Under Development.*** We are
      developing two additional display products, a smaller format (“shrink”) version
      of our SVGA display, which will have 800 x 600 triad pixels and be 0.44 inch
      diagonal and an SXGA OLED microdisplay with resolution of 1280x 1024 triad
      pixels with diagonal size to be determined. The new products will include a
      number of embedded features such as luminance and dimming ranges.





***Lens
      and Design Reference Kit*** *s* .
      We
      offer a WF05 prism optic, with mounting brackets or combined with OLED
      microdisplays to form an optic-display module. We provide Design Reference
      Kits,
      which include a microdisplay and associated electronics to help OEMs evaluate
      our microdisplay products and to assist their efforts to build and test new
      products incorporating our microdisplays.





***Integrated
      Modules.*** We
      provide near-eye virtual imaging modules that incorporate our OLED-on-silicon
      microdisplays with our lenses and electronic interfaces for integration into
      OEM
      products. We have shipped customized modules to several customers, some of
      which
      have incorporated our products into their own commercial products.





***(2)
      Personal Display Systems (Head-Wearable and Headset Systems)***





Our
      Z800
      3DVisors(tm) give users the ability to work with their hands while
      simultaneously viewing information or video on the display. The Z800 3DVisor
      enables more versatile portable computing, using a 0.59-inch diagonal
      microdisplay (SVGA-3D capable of delivering an image that appears comparable
      to
      that of a 19-inch monitor at 22 to 24 inches from the eye, or a 105 inch movie
      screen at 12 foot distance. Our systems are currently being used for personal
      entertainment, electronic gaming, and military training and simulation, among
      other applications. We believe that personal display systems will fill the
      increasing demand for instant data accessibility and privacy in mobile
      workplaces. We sell the personal display systems to OEM systems and equipment
      customers, through distributors, and through our e-commerce website,
      www.3dvisor.com.






6





**Our
      Market Opportunity - Personal Display Systems Platforms, including Head-wearable
      Displays**





The
      growth potential of our selected target market segments have been investigated
      using information gathered from key industry market research firms, including
      DisplaySearch, Frost and Sullivan, Fuji-Chimera, International Data Corporation,
      Nikkei, SEMI, Stanford Resources-iSuppli and others. Such data was obtained
      using published reports and data obtained at industry symposia. We have also
      relied substantially on market projections obtained privately from industry
      leaders, industry analysts, and potential customers.





The
      virtual-imaging markets we are targeting include industrial, medical, military,
      arcade games, 3-D CAD/Virtual Reality, and wearable computers. Within each
      of
      these market sectors, we believe that our microdisplays, when combined with
      compact optic lenses, will become a key component for a number of mobile
      electronic products. Applications we are targeting the following:





Head-wearable
      displays incorporate microdisplays mounted in or on eyeglasses, goggles, simple
      headbands, helmets, or hardhats, and are often referred to as head-mounted
      displays (HMDs) or headsets. Head-wearable displays may block out surroundings
      for a fully immersive experience, or be designed as "see-through" or
      "see-around" to the user's surroundings. They may contain one (monocular) or
      two
      (binocular) displays. Some of the increased current interest is due to
      accelerating the timetable to adapt such systems to military applications such
      as night vision and fire and rescue applications. These have military,
      commercial, and consumer applications.





**Military**





Military
      demand for head-wearable displays is currently being met with microdisplay
      technologies that we believe to be inferior to our OLED-on-silicon products.
      The
      new generation of soldiers will be highly mobile, and will often need to carry
      highly computerized communications and surveillance equipment. To enable
      interaction with the digital battlespace, rugged, yet lightweight and energy
      efficient technology is required. Currently available microdisplay technologies
      do not meet the requirements for low power, hands-free, day and night-viewable
      displays. Our OLED microdisplays demonstrate performance characteristics
      important to military and other demanding commercial and industrial applications
      including high brightness and resolution, wide dimming range, wider temperature
      operating ranges, shock and vibration resistance and insensitivity to high
      G-forces. The image does not suffer from flicker or color breakup in vibrating
      environments, and the microdisplay's wide viewing angle allows ease of viewing
      for long periods of time. The OLED's very low power consumption reduces battery
      weight and increases allowed mission length. Properly implemented, we believe
      that head-mounted systems incorporating our microdisplays will increase
      effectiveness by allowing hands-free operation and increasing situational
      awareness with enough brightness to be used in daylight, yet controllable for
      nighttime light security. The OLED's wide temperature range is especially of
      interest for military applications because the display can turn on instantly
      at
      temperatures far below freezing and can operate at very high temperatures in
      desert conditions.





Our
      OLED
      microdisplays have been selected for a range of defense-security applications,
      including a situational awareness HMD for the US Army Land Warrior programs,
      a
      handheld thermal imager for border patrol and training, and simulation virtual
      monitors for Quantum 3D. The Land Warrior, a core program in the Army's drive
      to
      digitize the battlefield, is an integrated digital system that incorporates
      computerized communication, navigation, targeting and protection systems for
      use
      by the twenty-first century infantry soldier. Rockwell Collins, the principal
      contractor for the US Army's Land Warrior HMD system, and eMagin applied their
      respective expertise in HMD and imaging technology to develop rugged, yet
      lightweight and energy efficient products meeting the requirements of tomorrow's
      soldier. The US Army expects to initially equip more than 40,000 soldiers with
      the Land Warrior system. The current overall redesign of the Land Warrior system
      by General Dynamics and Rockwell Collins has delayed increased volume use of
      displays beyond small quantities for that program until a future date to be
      determined. Our display is also used in Rockwell Collins’ commercially available
      ProView S035 Monocular HMD. Night Vision Equipment Corporation's
      HelmetIR-50(TM), a lightweight, military helmet mounted thermal imager, which
      provides hands-free operation and allows viewers to see through total darkness,
      battlefield obscurants, and even foliage, is the first OLED-equipped product
      to
      be listed on the US Government's GSA schedule. Virtually Better Inc. has
      incorporated our Z800 3DVisor into its “Virtual Iraq” treatment for
      post-traumatic stress disorders. In addition, our displays have been
      commercialized, or planned to be commercialized, by military systems integrators
      including Insight Technologies, Elbit, Thales, Sagem, and Nivisys, among others.
      We cannot assure that Government projects will remain on schedule, or be fully
      implemented. Similar systems are of interest for other military applications
      as
      well as for related operations such as fire and rescue.





**Commercial,
      Industrial, and Medical**





We
      believe that a wide variety of commercial and industrial markets offer
      significant opportunities due to increasing demand for instant data
      accessibility in mobile workplaces. Some examples of microdisplay applications
      include: immediate access to inventory such as parts, tools and equipment
      availability; instant accessibility to maintenance or construction manuals;
      routine quality assurance inspection; endoscopic surgery; and real-time viewing
      of images and data for a variety of applications. As one potential example,
      a
      user wearing a HMD while using test equipment, such as oscilloscopes, can view
      technical data while simultaneously probing printed circuit boards. Commercial
      products in these sectors include Sage Technologies, Ltd.'s Helmet Vue (TM)
      Thermal Imaging System and Liteye's 500, which incorporates IBM's wearable
      PC
      technology. VRmagic GmbH, a leading developer of virtual reality simulators,
      is
      using our OLED microdisplays in their EYESI(TM) Virtual Reality Surgical
      Simulator, which provides real-time simulation of ophthalmic surgery, high
      performance biomechanical tissue simulation, precision tracking, and realistic
      stereo imaging. Sensics has incorporated our OLED displays in their immersive
      SkyVizor (TM) virtual reality headset to serve as the "eyes" of the Robonaut,
      a
      humanoid robot being developed by NASA and Department of Defense agencies.
      The
      Robonaut system can work side by side with humans, or alone in high-risk
      situations. Telepresence uses virtual reality display technology to visually
      immerse the operator into the robot's workspace, facilitating operation and
      interaction with the Robonaut, and potentially reducing the number of dangerous
      space walks required of real astronauts.





7


**Consumer**





We
      believe that our head-wearable display products will enhance the following
      consumer products:





·
            Entertainment
                and gaming video headset systems, which permit individuals to view
                television, including HDTV, video CDs, DVDs and video games on virtual
                large screens or stereovision in private without disturbing others.
                We
                believe that these new headset game systems can provide a game or
                telepresence experience not otherwise practical using conventional
                direct
                view display technology. The advent of video iPods and the rapidly
                increasing amount of downloadable content have accelerated the movement
                toward portable video technology. At the same time, the desire for
                larger
                screen sizes while retaining the iPod portability has been referenced
                in
                many publications. Virtual imaging uniquely provides a large, high
                resolution view in a small portable package, and we believe that
                our OLED
                on silicon technology is a best fit to help open this market.





·
            Notebook
                computers, which can use head-wearable devices to reduce power
                requirements as well as expand the apparent screen size and increase
                privacy. Current notebook computers do not use microdisplays. Our
                products
                can apply not only to new models of notebook computers, but also
                as
                aftermarket attachments to older notebooks still in use. The display
                can
                be easily used as a second monitor on notebook computers for ease
                of
                editing multiple documents to provide multiple screens or for data
                privacy
                while traveling. It can also be used to provide larger screen capability
                for viewing spreadsheets or complex computer aided design (CAD) files.
                We
                expect to market our head-wearable displays to be used as plug-in
                peripherals to be compatible with most notebook computers. We believe
                that
                the SVGA-3D microdisplay is well suited for most portable PC headsets.
                Our
                microdisplays can be operated using the USB power source of most
                portable
                computers. This eliminates added power supplies, batteries, and rechargers
                and reduces system complexity and cost.





·
            Handheld
                personal computers, whose small, direct view screens are often
                limitations, but which are now capable of running software applications
                that would benefit from a larger display. Microdisplays can be built
                into
                handheld computers to display more information content on virtual
                screens
                without forfeiting portability or adding the cost a larger direct
                view
                screen. Microdisplays are not currently used in this market. We believe
                that GPS viewers and other novel products are likely to develop as
                our
                displays become more available.





The
      combination of power efficiency, high resolution, low systems cost, brightness
      and compact size offered by our OLED-on-silicon microdisplays has not been
      made
      available to makers and integrators of existing entertainment and gaming video
      headset systems, notebook computers and handheld computers. We believe that
      our
      microdisplays will propel the growth of new products and applications such
      as
      lightweight wearable computer systems.




**Our
      Strategy**





Our
      strategy is to establish and maintain a leadership position as a worldwide
      supplier of microdisplays and virtual imaging technology solutions for
      applications in high growth segments of the electronics industry by capitalizing
      on our leadership in both OLED-on-silicon technology and microdisplay lens
      technology. We aim to provide microdisplay and complimentary accessories to
      enable OEM customers to develop and manufacture new and enhanced electronic
      products. Some key elements of our strategy to achieve these objectives include
      the following:





·
            Leverage
                our superior technology to establish a leading market position. As
                the
                first to exploit OLED-on-silicon microdisplays, we believe that we
                enjoy a
                significant advantage in bringing this technology to market.





·
            Optimize
                manufacturing efficiencies by outsourcing while protecting proprietary
                processes. We outsource certain portions of microdisplay production,
                such
                as chip fabrication, to minimize both our costs and time to market.
                We
                intend to retain the OLED application and OLED sealing processes
                in-house.
                We believe that these areas are where we have a core competency and
                manufacturing expertise. We also believe that by keeping these processes
                under tight control we can better protect our proprietary technology
                and
                process know-how. This strategy will also enhance our ability to
                continue
                to optimize and customize processes and devices to meet customer
                needs. By
                performing the processes in-house we can continue to directly make
                improvements in the processes, which will improve device performance.
                We
                also retain the ability to customize certain aspects such as color
                balance, which is known as chromaticity, as well as specialized boards
                or
                interfaces, and to adjust other parameters at the customer's request.
                In
                the area of lenses and head-wearable displays, we intend to focus
                on
                design and development, while working with third parties for the
                manufacture and distribution of finished products. We intend to prototype
                new optical systems, provide customization of optical systems, and
                manufacture limited volumes, but we intend to outsource high volume
                manufacturing operations. There are numerous companies that provide
                these
                outsource services.






8





·
            Build
                and maintain strong internal design capabilities. As more circuitry
                is
                added to OLED-on-silicon devices, the cost of the end product using
                the
                display can be decreased; therefore integrated circuit design capability
                will become increasingly important to us. To meet these requirements,
                we
                utilize in-house design capabilities supplemented by outsourced design
                services. Building and maintaining this capacity will allow us to
                reduce
                engineering costs, accelerate the design process and enhance design
                accuracy to respond to our customers' needs as new markets develop.
                In
                addition, we intend to maintain a product design staff capable of
                rapidly
                developing prototype products for our customers and strategic partners.
                Contracting third party design support to meet demand and for specialized
                design skills will also remain a part of our overall long term strategy.





**Our
      Strategic Relationships**





Strategic
      relationships have been an important part of our research and development
      efforts to date and are an integral part of our plans for commercial product
      launch. We have forged strategic relationships with major OEMs and strategic
      suppliers. We believe that strategic relationships allow us to better determine
      the demands of the marketplace and, as a result, allow us to focus our future
      research and development activities to better meet our customer's requirements.
      Moreover, we expect to provide microdisplays and Microviewers(TM) to some of
      these partners, thereby taking advantage of established distribution channels
      for our products.





Eastman
      Kodak is a technology partner in OLED development, OLED materials, and a
      potential future customer for both specialty market display systems and consumer
      market microdisplays. We license Eastman Kodak's OLED and optics technology
      portfolio. We have a nonexclusive; perpetual, worldwide license to use Eastman
      Kodak patented OLED technology and associated intellectual property in the
      development, use, manufacture, import and sale of microdisplays. The license
      covers emissive active matrix microdisplays with a diagonal size of less than
      2
      inches for all OLED display technology previously developed by Kodak. An annual
      minimum royalty is paid at the beginning of each calendar year and is fully
      creditable against the royalties we are obligated to pay based on net sales
      throughout the year. Eastman Kodak and eMagin have engaged in numerous
      discussions regarding potential product applications for eMagin's microdisplays
      by Eastman Kodak.





We
      are
      working cooperatively with the US Army, US Navy, and with several military
      system integrators to further characterize operation of our displays in rugged
      military environments.





We
      are a
      member of the United States Display Consortium, a cooperative agency of display
      and related technology manufacturers whose charter is to support continued
      progress of the display industry. We are currently partnering with the
      University of Michigan to develop advanced display process via a
      government-sponsored research program. We intend to continue to establish
      additional strategic relationships in the future.





**Our
      Technology Platforms**





***OLED-on-Silicon
      Technology***





Scientists
      working at Eastman Kodak invented OLEDs in the early 1980s. OLEDs are thin
      films
      of stable organic materials that emit light of various colors when a voltage
      is
      impressed across them. OLEDs are emissive devices, which mean they create their
      own light, as opposed to liquid crystal displays, which require a separate
      light
      source. As a result, OLED devices use less power and can be capable of higher
      brightness and fuller color than liquid crystal microdisplays. Because the
      light
      they emit is Lambertian, which means that it appears equally bright from most
      forward directions, a moderate movement in the eye does not change the image
      brightness or color as it does in existing technologies. OLED films may be
      coated on computer chips, permitting millions of individual low-voltage light
      sources to be built on silicon integrated circuits to produce single color,
      white or full-color display arrays. Many computer and video electronic system
      functions can be built directly into a silicon integrated circuit as part of
      the
      OLED display, resulting in an ultra-compact system. We believe these features,
      together with the well-established silicon integrated circuit fabrication
      technology of the semiconductor industry, make our OLED-on-silicon microdisplays
      attractive for numerous applications.





We
      believe our technology licensing agreement with Eastman Kodak, coupled with
      our
      own intellectual property portfolio, gives us a leadership position in OLED
      and
      OLED-on-silicon microdisplay technology. Eastman Kodak provides OLED technology
      and we provide additional technology advancements that have enabled us to coat
      the silicon integrated circuits with OLEDs.





9


We
      have
      developed numerous and significant enhancements to OLED technology as well
      as
      key silicon circuit designs to effectively incorporate the OLED film on a
      silicon integrated circuit. For example, we have developed a unique,
      top-emitting structure for our OLED-on-silicon devices that enables OLED
      displays to be built on opaque silicon integrated circuits rather than only
      on
      glass. Our OLED devices can emit full visible spectrum light that can be
      isolated with color filters to create full color images. Our microdisplay
      prototypes have a brightness that can be greater than that of a typical notebook
      computer and can have a potential useful life of over 50,000 operating hours,
      in
      certain applications. New materials and device improvements in development
      offer
      future potential for even better performance for brightness, efficiency, and
      lifespan. Additionally, we have invested considerable work over several years
      to
      develop unique electronics control and drive designs for OLED-on-silicon
      microdisplays.





In
      addition to our OLED-on-silicon technology, we have developed compact optic
      and
      lens enhancements which, when coupled with the microdisplay, provide the high
      quality large screen appearance that we believe a large proportion of the
      marketplace demands.





***Advantages
      of OLED Technology***





We
      believe that our OLED-on-silicon technology provides significant advantages
      over
      existing solutions in our targeted microdisplay markets. We believe these key
      advantages will include:





·
            Low
                manufacturing cost;





·
            Low
                cost system solutions;





·
            Wide
                angle light emission resulting in large apparent screen size;





·
            Low
                power consumption for improved battery life and longer system life;





·
            High
                brightness for improved viewing;





·
            High-speed
                performance resulting in clear video images;





·
            Wide
                operating temperature range; and





·
            Good
                environmental stability (vibration and humidity).





***Low
      manufacturing cost.*** Many
      OLED-on-silicon microdisplays can be built on an 8-inch silicon wafer using
      existing automated OLED and color filter processing tools. The level of
      automation used lowers labor costs. Only a minute amount of OLED material is
      used in each OLED-on-silicon microdisplay so that material costs, other than
      the
      integrated circuit itself, are small. The number of displays per silicon wafer
      may be higher on OLEDs than on liquid crystal displays, or LCDs, because OLEDs
      do not require a space-wasting perimeter seal band. Expensive transparent wafers
      with CMOS silicon laminated onto quartz are not required for OLED microdisplays,
      as standard CMOS chips may be used as backplanes.





***Low
      cost systems solutions.*** In
      general, an OEM using OLED-on-silicon microdisplays will not need to purchase
      and incorporate lighting assemblies, color converter related Applications
      Specific Integrated Circuits, or ASICs, or beam splitter lenses as is the case
      in liquid crystal microdisplays, which also require illumination. Many important
      display-related system functions can be incorporated into an OLED-on-silicon
      microdisplay, reducing the size and cost of the system. Non-polarized light
      from
      OLEDs permit lenses for many OLED-on-silicon applications that are made of
      a
      single piece of molded plastic, which reduces size, weight and assembly cost
      when compared to the multipiece lens systems used for liquid crystal
      microdisplays. System cost relative to liquid crystal and liquid crystal on
      silicon, or LCOS, competitive products is thus reduced. Because our displays
      are
      power efficient, they typically require less power at the system level than
      other display technologies at a given display size and brightness.





***Wide-angle
      light emission simplifies optics for large apparent screen size.*** OLEDs
      emit light at most forward directions from each pixel. This permits the display
      to be placed close to the lens in compact optical systems. It also provides
      the
      added benefit of less angular dependence on the image quality relative to pupil
      and eye position when showing a large field of view, unlike reflective LCOS
      microdisplays. This results in less eye fatigue and makes it relatively easy
      to
      low power consumption for improved battery life and longer system life. OLEDs
      emit light rather than transmitting it, so no power-consuming backlight or
      front
      light, as required for liquid crystal displays, is required. OLEDs can be energy
      efficient because of their high efficiency light generation. Furthermore, OLEDs
      conserve power by powering only those pixels that are on while liquid crystal
      on
      silicon requires light at all pixels all the time. Most optical systems used
      for
      our OLEDs are highly efficient, permitting over 80% of the light to reach the
      eye, whereas reflective technologies such as liquid crystal on silicon require
      multiple beam splitters to get light to the display, and then into the optical
      system. This results in typically less than 25% light throughput efficiency
      in
      reflective microdisplay systems. Most important, we do not need a power-hungry
      video frame buffer, as required in liquid crystal frame-sequential color
      systems. Battery life can therefore be extended.






10





***High
      brightness for improved viewing.*** This
      feature can be of great value to military applications, where there is a need
      to
      see the computer image overlaid onto brightly lit real-life backgrounds such
      as
      desert sand, water reflections or sunlit clouds. The OLED can be operated over
      a
      large luminance range without loss of gray level control, permitting the
      displays to be used in a range of dark environments to very bright ambient
      applications. Since military simulation and situation awareness applications,
      including night vision, typically require large fields of view, the OLED's
      Lambertian optical characteristics make it an excellent choice.





***High-speed
      performance resulting in clear video image.*** OLEDs
      switch much more rapidly than liquid crystals or most cathode ray tubes, or
      CRTs. This results in smear-free video rate imagery and provides improved image
      quality for DVD playback applications. This eliminates visible image smear
      and
      makes practicable three-dimensional stereo imaging using a split frame rate.
      This advantage of our OLED-on-silicon is very important for 3-D stereovision
      gaming applications.





***Flicker-free
      and no color breakup.*** Because
      the OLED-on-silicon stores brightness and color information at each pixel,
      the
      display can be run with no noticeable flicker and no color sequential breakup,
      even at low refresh rates. A lower refresh rate not only helps reduce power,
      but
      it also facilitates system integration. Color sequential breakup occurs in
      systems such as liquid crystal on silicon and some liquid crystal display
      microdisplays when red, green and blue frames are sequentially imaged in time
      for the eye to combine. Since the different color screens occur at different
      times, movement of the eye due to vibration or just fast pupil movement can
      create color bands at each dark-light edge, making the image unpleasant to
      view
      and making text difficult to read. For example, the liquid crystal on silicon
      display needs to run at least three times the "normal" frame rate or speed
      to
      produce color sequential images, which wastes power and makes for a difficult
      technological challenge as display resolutions increase.





***Wide
      operating temperature range.*** Our
      OLEDs offer much less temperature sensitivity at both high and low temperatures
      than LCDs. LCDs are sluggish or non-operative much below freezing unless heaters
      are added and lose contrast above 50 degrees Celsius, while our OLEDs turn
      on
      instantly and can operate between -55 degrees Celsius and 130 degrees Celsius.
      We specify a smaller temperature range on most consumer products to accommodate
      lower cost packaging. This is an important characteristic for many portable
      products that may be used outdoors in many varying environmental conditions.
      It
      is especially important for military customers. Insensitivity to vibration,
      shock, and pressure are also important environmental control attributes.





**Complementary
      lens and system technologies.** We have
      developed a wide range of technologies which complement our core OLED and lens
      technologies and which will enhance our competitive position in the microdisplay
      and head-wearable display markets. These include:





*Lens
      technology* .
      High
      quality, large view lenses with a wide range for eye positioning are essential
      for using our displays in near-eye systems. We have developed advanced lens
      technology for microdisplays and personal head-wearable display systems and
      hold
      key patents in these areas. Our lens technology permits our OLED-on-silicon
      microdisplays to provide large field of view images that can be viewed for
      extended periods with reduced eye-fatigue. We have engaged a firm to manufacture
      our lenses in order to provide them in larger quantities to our customers and
      are using them in our own personal display systems.





We
      believe that the key advantages of our lens technology include:





·
            Can
                be very low cost, with minimal assembly. A one piece, molded plastic
                optic
                attached to the microdisplay has been introduced and may potentially
                serve
                consumer end-product markets. Since our process is plastic molding,
                our
                per unit production costs are low;




·
            Allows
                a compact and lightweight lens system that can greatly magnify a
                microdisplay to produce a large field of view. For example, our WF05
                prism
                lens, in combination with our SVGA OLED microdisplay, provides a
                virtual
                view equivalent to that of a 105-inch diagonal display viewed at
                12 feet;





·
            Can
                use single-piece molded microdisplay lenses to permit high light
                throughput making the display image brighter or permitting the use
                of less
                power for an acceptable brightness;





·
            Can
                be designed to provide focusing to enable users with various eyesight
                qualities to view images clearly; and





·
            Can
                optionally provide focal plane adjustment for simultaneous focusing
                of
                computer images and real world objects. For example, this characteristic
                is beneficial for word processing or spreadsheet applications where
                a
                person is typing data in from reference material. This feature can
                make it
                easier for people with moderately poor accommodation to use a
                head-wearable display as a portable computer-viewing accessory.






11





*Personal
      display system technology* .
      We have
      developed ergonomic technologies that make head-wearable displays easier to
      use
      in a wide variety of applications. For example, the use of our patented
      rotatable Eyeblocker(TM) provides a sharp image without requiring most users
      to
      squint. The Eyeblocker can also be moved to create an effective see-through
      appearance. To our knowledge, we have made the lightest weight, high-resolution
      head-wearable display with an over 35 degree diagonal field of view ever
      publicly demonstrated. We have also incorporated low cost, small size, high
      speed headtrackers to further enhance game and telepresence applications.





**Sales
      and Marketing**





We
      primarily provide display components for OEMs to incorporate into their branded
      products and sell through their own well-established distribution channels.
      In
      addition, we market head-wearable displays directly to various vertical market
      channels, such as medical, industrial, and government customers. A typical
      buyer
      is a manufacturer of a product requiring a specific resolution of visual display
      or viewfinder for insertion into a product such as a portable DVD headset,
      a
      PC-gaming headset, or an instrument.





We
      market
      our services in North America, Asia, and Europe primarily through direct
      technical sales from our headquarters. Regular purchase orders are processed
      by
      our customer service coordinators and technical questions related to product
      purchases or product applications are processed by our technical support team.
      As a market-driven company, we assess customer needs both quantitatively and
      qualitatively, through market research and direct communications. Because our
      microdisplays are the main functional component that defines many of our
      customers' end products, we work closely with potential customers to define
      our
      products to optimize the final design, typically on a senior
      engineer-to-engineer basis. Our personal display systems are sold through select
      resellers and on-line through our e-commerce site, www.3dvisor.com ,
      and via
      www.amazon.com, www.pcmall.com, and www.skymall.com.





We
      identify companies with end products and applications for which we believe
      that
      our products will provide a system level solution and for which our products
      can
      be a key differentiator. We target both market leaders and select early adopter
      companies; their acceptance validates our technology and approach in the market.
      We believe successful marketing will require relationships with recognized
      consumer brand companies.





Near
      term
      sales efforts for OLED microdisplays have been focused on our military,
      industrial, and medical customers. We have received production orders and design
      wins for both the SVGA+ and SVGA 3D displays. To date, we have shipped products
      and evaluation kits to more than 200 OEM customers. An OEM design cycle
      typically requires between 6 and 36 months, depending on the uniqueness of
      the
      market and the complexity of the end product. New product development may
      require several design iterations prior to commercialization. Some of our
      initial customers have completed their initial evaluation cycle and we are
      now
      receiving follow-on orders and notification of product purchase decisions.
      We
      have also received notification that our microdisplays will be used as
      components in versions 1.0 and 2.0 of the US Army Land Warrior program and
      in
      the French FELIN program, among others. (See "Our Market Opportunity: Military;
      Commercial, Industrial, and Medical; and Consumer")





**Customers**





Customers
      for our products include both large multinational and smaller OEMs. We maintain
      relationships with OEMs in a diverse range of industries encompassing the
      military, industrial, medical, and consumer market sectors. During 2006, 59%
      of
      our net revenue was to firms based in the United States and 41% was to
      international firms, compared to 49% domestic revenue and 51% international
      revenue during 2005. In 2006, we had 5 customers that accounted for more than
      68% of our total revenue. In 2006, we had one customer that accounted for 13%
      of
      its total revenues as compared to 2005, where we had no customers that accounted
      for more than 10% of our total revenue.





**Backlog**





As
      of
      March 15, 2007, we had a backlog of approximately $ 6.1 million for purchases
      through December 31, 2007. This backlog consists of purchase orders and purchase
      agreements but does not include expected revenue from our 2 military government
      R&D contracts of approximately $2 million in 2007, expected NRE
      (non-recurring engineering) programs under development, or regular run rate
      orders from new or existing OEM customer orders.





The
      majority of our backlog consists of purchase agreements for delivery over the
      next 12 months. Most purchase orders are subject to rescheduling or cancellation
      by the customer with no or limited penalties. Because of the possibility of
      customer changes in delivery schedules or cancellations and potential delays
      in
      product shipments, our backlog as of a particular date may not be indicative
      of
      net sales for any succeeding period. Some customers have experienced delays
      in
      their expected product launch schedules due to their own product development
      delays not directly related to our microdisplays, such as development of custom
      optics or other aspects of their end product, or by delays in government
      programs contracted to them.











12


Research
      and
      Development


Near-to-the-eye
      virtual imaging and OLED technology are relatively new technologies that have
      considerable room for substantial improvements in luminance, life, power
      efficiency, voltage swing, design compactness, field of view, optical range
      of
      visibility, headtracking options, wireless control and many other parameters.
      We
      also anticipate that achieving reductions in manufacturing costs will require
      new technology developments. We anticipate that improving the performance,
      capability and cost of our products will provide an important competitive
      advantage in our fast moving, high technology marketplace. Past and current
      research activities include development of improved OLED and display device
      structures, developing and/or evaluating new materials (including the synthesis
      of new organic molecules), manufacturing equipment and process development,
      electronics design methodologies and new circuits and the development of new
      lenses and related systems. In 2006, we spent approximately $4.4 million on
      research and development. In 2006 we continued to research more efficient
      materials and processes. We also completed the primary development of our new
      smaller display the SVGA 3D shrink and our new visor products the X800 3DVisor
      and the Eyebud 800, for which continued development efforts have been
      discontinued until additional financial resources for these programs are
      available.





External
      relationships play an important role in our research and development efforts.
      Suppliers, equipment vendors, government organizations, contract research
      groups, external design companies, customer and corporate partners, consortia,
      and university relationships all enhance the overall research and development
      effort and bring us new ideas (See "Strategic Relationships").





The
      FY
      2007 Department of Defense Appropriations Bill provided funding for two
      development programs managed by the US Army. The first aims to improve the
      power-efficiency of OLED microdisplays for U.S. Army thermal imaging
      applications, in cooperation with US Army NVESD (Night Vision and Electronic
      Sensors Directorate). The second will result in a very high-resolution,
      HD-compatible display for U.S. Army medical applications, in cooperation with
      US
      Army TATRC (Telemedicine and Advanced Technologies Research Center). The awards
      totaled approximately $2.75 million to support the two projects for fiscal
      year
      2007, and provide resources for development of higher performance OLED
      technology and higher resolution devices.





**Manufacturing
      Facilities**





We
      are
      located at IBM's Microelectronics Division facility, known as the Hudson Valley
      Research Park, located about 70 miles north of New York City in Hopewell
      Junction, New York. We lease approximately 40,000 square feet of space housing
      our own equipment for OLED microdisplay fabrication and for research and
      development plus additional space for assembly and administrative offices.
      We
      also entered into lease agreement with IBM for a 16,300 square foot class 10
      clean room space, along with additional, lower level clean room space.





Facilities
      services provided by IBM include our clean room, pure gases, high purity
      de-ionized water, compressed air, chilled water systems, and waste disposal
      support. This infrastructure provided by our lease with IBM provides us with
      many of the resources of a larger corporation without the added overhead costs.
      It further allows us to focus our resources more efficiently on our product
      development and manufacturing goals.





We
      lease
      additional non-clean room facilities for chemical mixing, cleaning, chemical
      systems, and glass/silicon cutting. OLED chemicals can be purified in our
      facility with our own equipment, permitting the company to evaluate new
      chemicals in pilot production that are not yet available in suitable purity
      for
      OLED applications on the market.





Our
      display fabrication process starts with the silicon wafer, which is manufactured
      by a semiconductor foundry using conventional CMOS process. After a device
      is
      designed by a combination of internal and external designers with customer
      participation, we outsource wafer fabrication.





Our
      manufacturing process for OLED-on-silicon microdisplays has three main
      components: organic film deposition, organic film encapsulation (also known
      as
      sealing), and color filter processing. All steps are performed in
      semi-automated, hands-free environment suitable for high volume throughput.
      An
      automated cluster tool provides all OLED deposition steps in a highly controlled
      environment that is the centerpiece of our OLED fabrication. After wafer
      processing, each part is inspected using an automated inspection system, prior
      to shipment. We have electrical and optical instrumentation required to
      characterize the performance of our displays including photometric and color
      coordinate analysis. We are also equipped for integrated circuit and electronics
      design and display testing.





We
      also
      lease a facility in Bellevue, Washington where we operate our system development
      effort and business development activities. The lease for this facility expires
      in August of 2009. The facilities are well suited for designing and building
      limited volume prototypes and small quantity industrial or government products.
      Cables and electronic interfaces have recently been produced to permit our
      OEM
      customers to more rapidly create products and shorten their time-to-market.
      We
      plan to outsource medium to high volume subsystem production to low cost
      plastics, lenses, and assembly manufacturers. We are currently using domestic
      and international outside manufacturers and we are investigating new outsource
      opportunities.





We
      believe that manufacturing efficiency is an important factor for success in
      the
      consumer markets. We believe that high yield and maximum utilization of our
      equipment set will be key for profitability. The equipment required for initial
      profitable production is in place. Some equipment will be added when our
      production volume increases or as needed.






13





**Intellectual
      Property**





We
      have
      developed a significant intellectual property portfolio of patents, trade
      secrets and know-how, supported by our license from Eastman Kodak and our
      current patent portfolio.





Our
      license from Eastman Kodak gives us the right to use in miniature displays
      a
      portfolio in organic light emitting diode and optics technology, some of which
      are fundamental. Our agreement with Eastman Kodak provides for perpetual access
      to the OLED technology for our OLED-on-silicon applications, provided we remain
      active in the field and meet our contractual requirements to Eastman Kodak.
      We
      also generate intellectual property as a result of our internal research and
      development activities.





Our
      patents and patent applications cover a wide range of materials, device
      structures, processes, and fabrication techniques, such as methods of
      fabricating full color OLEDs. We believe that our patent applications relating
      to up-emitting structures on opaque substrates such as silicon wafers, which
      are
      critical for OLED microdisplays, and applications relating to the hermetic
      sealing of such structures are particularly important.





Our
      patents are concentrated in the following areas:





·
            OLED
                Materials, Structures, and Processes;





·
            Display
                Color Processing and Sealing;





·
            Active
                Matrix Circuit Methodologies and Designs;





·
            Field
                Emission and General Display Technologies;





·
            Lenses
                and Tracking (Eye and Head);





·
            Ergonomics
                and Industrial Design; and





·
            Wearable
                Computer Interface Methodology





We
      also
      rely on proprietary technology, trade secrets, and know-how, which are not
      patented. To protect our rights in these areas, we require all employees, and
      where appropriate, contractors, consultants, advisors and collaborators to
      enter
      into confidentiality and non-competition agreements. There can be no assurance,
      however, that these agreements will provide meaningful protection for our trade
      secrets, know-how or other proprietary information in the event of any
      unauthorized use, misappropriation or disclosure of such trade secrets, know-how
      or other proprietary information.





We
      believe that our intellectual property portfolio, coupled with our strategic
      relationships and accumulated experience in the OLED field, gives us an
      advantage over potential competitors.





**Competition**





We
      may
      face competition in the OLED and microdisplay industry from a variety of
      companies and technologies. We believe that our key competition will come from
      liquid crystal on silicon microdisplays, or LCOS, also known as reflective
      liquid crystal displays. While we believe that OLED-on-silicon provides
      comparatively lower optics cost, larger apparent image size, reduced electronics
      cost and complexity, enhanced color, and improved power efficiency advantages
      over liquid crystal on silicon microdisplays, there is no assurance that these
      benefits will be realized or that liquid crystal on silicon manufacturers will
      not suitably improve these parameters. Companies pursuing liquid crystal on
      silicon technology include Microdisplay Corporation and Syntax/Brillian
      Corporation, among others, although most of the companies are primarily focusing
      on projection microdisplays, which do not compete directly with us. In certain
      markets, we may also face competition from developers of transmissive liquid
      crystal displays, such as those developed by Kopin, or laser scanning systems,
      such as those developed by Microvision Corporation.





To
      our
      knowledge, the only other company that has publicly stated plans to develop
      OLED
      microdisplays for near-eye applications is MicroEmissive Displays in Britain.
      We
      may also compete with potential licensees of Universal Display Corporation
      and
      Cambridge Display Corporation, each of which license OLED technology portfolios.
      Even though we could potentially license technology from these developers,
      potential competitors could also obtain such licenses and may do so at more
      favorable royalty rates. However, should they decide to embark on developing
      microdisplays on silicon, we believe that our progress to date in this area
      gives us a substantial head start.








14


**Employees**





As
      of
      March 16, 2007, we had a total of 67 full time and part time staff. None of
      our
      employees are represented by a labor union. We have not experienced any work
      stoppages and consider our relations with our employees to be good.





**Executive
      Officers**





The
      following table sets forth certain information with respect to our directors
      and
      executive officers as of March 9, 2007.





**Name**
            **Age**
            **Position**K.C.
                Park
            70
            Interim
                Chief Executive Officer, PresidentJohn
                Atherly
            47
            Chief
                Financial OfficerSusan
                K. Jones
            55
            Chief
                Marketing and Strategy Officer,
                Secretary







Dr.
      K.C.
      Park was appointed Interim CEO and President in January 2007. He served as
      executive vice president of International Operations since 1998 and as president
      of eMagin's subsidiary, Virtual Vision, Inc., from 2002 to 2004. Earlier, with
      LG Electronics as an executive vice president and member of the Board, he built
      up LG's business in LCDs and PDPs, solidifying their world leadership position
      in flat-panel display products. At IBM, he managed flat panel display and
      semiconductor programs at the Watson Research Center; then served as director
      of
      Display Technology with worldwide responsibility at the IBM Corporate
      Headquarters, setting up technical operations in Korea as senior managing
      director. Dr. Park holds his Ph.D. in Solid-State Chemistry from the University
      of Minnesota and an MBA from New York University .




John
      Atherly has served as Chief Financial Officer since June of 2004. Before joining
      eMagin Corporation, Mr. Atherly worked for Click2learn, Inc., a NASDAQ listed
      enterprise Software Company from 1990 to 2004. He held the positions of Vice
      President of Finance and CFO for approximately 8 years and prior to that held
      the positions of Director of Finance and Controller. During his 14 years with
      Click2learn Mr. Atherly managed the firm's finance and administration, human
      resources, IT and manufacturing organizations. From 1987 to 1990, Mr. Atherly
      was a Finance and Operations Manager at MicroDisk Services, a manufacturing
      firm
      serving the software industry. Mr. Atherly holds a BA in Business Administration
      from the University of Washington.





Susan
      K.
      Jones has served as Executive Vice President and Secretary since 1992, and
      assumed responsibility of Chief Marketing and Strategy Officer in 2001. Ms.
      Jones has 25 years of industrial experience, including senior research,
      management, and marketing assignments at Texas Instruments and Merck, Sharp,
      & Dohme Pharmaceuticals. Ms. Jones serves on the boards or chairs committees
      for industry organizations including IEEE, SPIE, and SID. Ms. Jones served
      as a
      director of eMagin Corporation from 1993 to 2000 and was a director of Virtual
      Vision, Inc. Ms. Jones graduated from Lamar University with a B.S. in chemistry
      and biology, holds more than a dozen patents, and has authored more than 100
      papers and talks.




15


**ITEM
      1A. RISK FACTORS**





You
      should carefully consider the following risk factors and the other information
      included herein as well as the information included in other reports and filings
      made with the SEC before investing in our common stock. If any of the following
      risks actually occurs, our business, financial condition or results of
      operations could be harmed. The trading price of our common stock could decline
      due to any of these risks, and you may lose part or all of your investment.





**RISKS
      RELATED TO OUR FINANCIAL RESULTS**





***We
      have a history of losses since our inception and may incur losses for the
      foreseeable future*** **.**





Our
      accumulated losses are $181million as of December 31, 2006. We have not yet
      achieved profitability and we can give no assurances that we will achieve
      profitability within the foreseeable future as we fund operating and capital
      expenditures in areas such as establishment and expansion of markets, sales
      and
      marketing, operating equipment and research and development. We cannot assure
      investors that we will ever achieve or sustain profitability or that our
      operating losses will not increase in the future.





***We
      may not be able to execute our business plan and may not generate cash from
      operations.***





As
      we
      have reported, our business is currently experiencing significant revenue growth
      during the year ended December 31, 2006. We anticipate that our cash
      requirements to fund these requirements as well as other operating or investing
      cash requirements over the next twelve months will be greater than our current
      cash on hand.  In
      the
      event that cash flow from operations is less than anticipated and we are unable
      to secure additional funding to cover our expenses, in order to preserve cash,
      we would be required to reduce expenditures and effect reductions in our
      corporate infrastructure, either of which could have a material adverse effect
      on our ability to continue our current level of operations. We
      do not
      currently have any financing commitments and no assurance can be given that
      additional financing will be available, or if available, will be on acceptable
      terms.  If
      we are
      unable to obtain sufficient funds during the next twelve months we will further
      reduce the size of our organization and may be forced to reduce and/or curtail
      our production and operations, all of which could have a material adverse impact
      on our business prospects .





***Our
      independent registered public accounting firm has expressed doubt about our
      ability to continue as a going concern, which may hinder our ability to obtain
      future financing.***




Our
      consolidated financial statements as of December 31, 2006 have been prepared
      under the assumption that we will continue as a going concern for the year
      ending December 31, 2007. Our independent registered public accounting firm
      has
      issued a report dated March 27, 2007 that included an explanatory paragraph
      expressing substantial doubt in our ability to continue as a going concern
      without additional capital becoming available. Our
      ability to continue as a going concern ultimately is dependent on our ability
      to
      generate a profit which is likely dependant upon our ability to obtain
      additional equity or debt financing, attain further operating efficiencies
      and,
      ultimately, to achieve profitable operations. The financial statements do not
      include any adjustments that might result from the outcome of this
      uncertainty.







***RISKS
      RELATED TO MANUFACTURING***







***The
      manufacture of*** **OLED** ***-on-silicon
      is new and*** **OLED** ***microdisplays have not been produced in significant quantities.***





If
      we are
      unable to produce our products in sufficient quantity, we will be unable to
      maintain and attract new customers. In addition, we cannot assure you that
      once
      we commence volume production we will attain yields at high throughput that
      will
      result in profitable gross margins or that we will not experience manufacturing
      problems which could result in delays in delivery of orders or product
      introductions.





***We
      are dependent on a single manufacturing line.***





We
      currently manufacture our products on a single manufacturing line. If we
      experience any significant disruption in the operation of our manufacturing
      facility or a serious failure of a critical piece of equipment, we may be unable
      to supply microdisplays to our customers. For this reason, some OEMs may also
      be
      reluctant to commit a broad line of products to our microdisplays without a
      second production facility in place. However, we try to maintain product
      inventory to fill the requirements under such circumstances. Interruptions
      in
      our manufacturing could be caused by manufacturing equipment problems, the
      introduction of new equipment into the manufacturing process or delays in the
      delivery of new manufacturing equipment. Lead-time for delivery of manufacturing
      equipment can be extensive. No assurance can be given that we will not lose
      potential sales or be unable to meet production orders due to production
      interruptions in our manufacturing line. In order to meet the requirements
      of
      certain OEMs for multiple manufacturing sites, we will have to expend capital
      to
      secure additional sites and may not be able to manage multiple sites
      successfully.




16





***We
      could experience manufacturing interruptions, delays, or inefficiencies if
      we
      are unable to timely and reliably procure components from single-sourced
      suppliers.***





We
      maintain several single-source supplier relationships, either because
      alternative sources are not available or the relationship is advantageous due
      to
      performance, quality, support, delivery, capacity, or price considerations.
      If
      the supply of a critical single-source material or component is delayed or
      curtailed, we may not be able to ship the related product in desired quantities
      and in a timely manner. Even where alternative sources of supply are available,
      qualification of the alternative suppliers and establishment of reliable
      supplies could result in delays and a possible loss of sales, which could harm
      operating results.





***We
      expect to depend on semiconductor contract manufacturers to supply our silicon
      integrated circuits and other suppliers of key components, materials and
      services.***





We
      do not
      manufacture the silicon integrated circuits on which we incorporate our OLED
      technology. Instead, we expect to provide the design layouts to semiconductor
      contract manufacturers who will manufacture the integrated circuits on silicon
      wafers. We also expect to depend on suppliers of a variety of other components
      and services, including circuit boards, graphic integrated circuits, passive
      components, materials and chemicals, and equipment support. Our inability to
      obtain sufficient quantities of high quality silicon integrated circuits or
      other necessary components, materials or services on a timely basis could result
      in manufacturing delays, increased costs and ultimately in reduced or delayed
      sales or lost orders which could materially and adversely affect our operating
      results.





**RISKS
      RELATED TO OUR INTELLECTUAL PROPERTY**





***We
      rely on our license agreement with Eastman Kodak for the development of our
      products.***





We
      rely
      on our license agreement with Eastman Kodak for the development of our products,
      and the termination of this license, Eastman Kodak's licensing of its OLED
      technology to others for microdisplay applications, or the sublicensing by
      Eastman Kodak of our OLED technology to third parties, could have a material
      adverse impact on our business.





Our
      principal products under development utilize OLED technology that we license
      from Eastman Kodak. We rely upon Eastman Kodak to protect and enforce key
      patents held by Eastman Kodak, relating to OLED display technology. Eastman
      Kodak's patents expire at various times in the future. Our license with Eastman
      Kodak could terminate if we fail to perform any material term or covenant under
      the license agreement. Since our license from Eastman Kodak is non-exclusive,
      Eastman Kodak could also elect to become a competitor itself or to license
      OLED
      technology for microdisplay applications to others who have the potential to
      compete with us. The occurrence of any of these events could have a material
      adverse impact on our business.





***We
      may not be successful in protecting our intellectual property and proprietary
      rights.***





We
      rely
      on a combination of patents, trade secret protection, licensing agreements
      and
      other arrangements to establish and protect our proprietary technologies. If
      we
      fail to successfully enforce our intellectual property rights, our competitive
      position could suffer, which could harm our operating results. Patents may
      not
      be issued for our current patent applications, third parties may challenge,
      invalidate or circumvent any patent issued to us, unauthorized parties could
      obtain and use information that we regard as proprietary despite our efforts
      to
      protect our proprietary rights, rights granted under patents issued to us may
      not afford us any competitive advantage, others may independently develop
      similar technology or design around our patents, our technology may be available
      to licensees of Eastman Kodak, and protection of our intellectual property
      rights may be limited in certain foreign countries. We may be required to expend
      significant resources to monitor and police our intellectual property rights.
      Any future infringement or other claims or prosecutions related to our
      intellectual property could have a material adverse effect on our business.
      Any
      such claims, with or without merit, could be time consuming to defend, result
      in
      costly litigation, divert management's attention and resources, or require
      us to
      enter into royalty or licensing agreements. Such royalty or licensing
      agreements, if required, may not be available on terms acceptable to us, if
      at
      all. Protection of intellectual property has historically been a large yearly
      expense for eMagin. We have not been in a financial position to properly protect
      all of our intellectual property, and may not be in a position to properly
      protect our position or stay ahead of competition in new research and the
      protecting of the resulting intellectual property.




**RISKS
      RELATED TO THE MICRODISPLAY INDUSTRY**







***The
      commercial success of the microdisplay industry depends on the widespread market
      acceptance of microdisplay systems products.***





The
      market for microdisplays is emerging. Our success will depend on consumer
      acceptance of microdisplays as well as the success of the commercialization
      of
      the microdisplay market. As an OEM supplier, our customer's products must also
      be well accepted. At present, it is difficult to assess or predict with any
      assurance the potential size, timing and viability of market opportunities
      for
      our technology in this market. The viewfinder microdisplay market sector is
      well
      established with entrenched competitors with whom we must compete.




17





***The
      microdisplay systems business is intensely competitive.***





We
      do
      business in intensely competitive markets that are characterized by rapid
      technological change, changes in market requirements and competition from both
      other suppliers and our potential OEM customers. Such markets are typically
      characterized by price erosion. This intense competition could result in pricing
      pressures, lower sales, reduced margins, and lower market share. Our ability
      to
      compete successfully will depend on a number of factors, both within and outside
      our control. We expect these factors to include the following:





·
            our
                success in designing, manufacturing and delivering expected new products,
                including those implementing new technologies on a timely basis;





·
            our
                ability to address the needs of our customers and the quality of
                our
                customer services;





·
            the
                quality, performance, reliability, features, ease of use and pricing
                of
                our products;





·
            successful
                expansion of our manufacturing capabilities;





·
            our
                efficiency of production, and ability to manufacture and ship products
                on
                time;





·
            the
                rate at which original equipment manufacturing customers incorporate
                our
                product solutions into their own products;





·
            the
                market acceptance of our customers' products; and





·
            product
                or technology introductions by our competitors.





Our
      competitive position could be damaged if one or more potential OEM customers
      decide to manufacture their own microdisplays, using OLED or alternate
      technologies. In addition, our customers may be reluctant to rely on a
      relatively small company such as eMagin for a critical component. We cannot
      assure you that we will be able to compete successfully against current and
      future competition, and the failure to do so would have a materially adverse
      effect upon our business, operating results and financial condition.





***The
      display industry is cyclical*** *.*





The
      display industry is characterized by fabrication facilities that require large
      capital expenditures and long lead times for supplies and the subsequent
      processing time, leading to frequent mismatches between supply and demand.
      The
      OLED microdisplay sector may experience overcapacity if and when all of the
      facilities presently in the planning stage come on line leading to a difficult
      market in which to sell our products.





***Competing
      products may get to market sooner than ours.***





Our
      competitors are investing substantial resources in the development and
      manufacture of microdisplay systems using alternative technologies such as
      reflective liquid crystal displays (LCDs), LCD-on-Silicon ("LCOS")
      microdisplays, active matrix electroluminescence and scanning image systems,
      and
      transmissive active matrix LCDs. Our competitive position could be damaged
      if
      one or more of our competitors’ products get to the market sooner than our
      products. We cannot assure you that our product will get to market ahead of
      our
      competitors or that we will be able to compete successfully against current
      and
      future competition. The failure to do so would have a materially adverse effect
      upon our business, operating results and financial condition.





***Our
      competitors have many advantages over us.***





As
      the
      microdisplay market develops, we expect to experience intense competition from
      numerous domestic and foreign companies including well-established corporations
      possessing worldwide manufacturing and production facilities, greater name
      recognition, larger retail bases and significantly greater financial, technical,
      and marketing resources than us, as well as from emerging companies attempting
      to obtain a share of the various markets in which our microdisplay products
      have
      the potential to compete. We cannot assure you that we will be able to compete
      successfully against current and future competition, and the failure to do
      so
      would have a materially adverse effect upon our business, operating results
      and
      financial condition.





18





***Our
      products are subject to lengthy OEM development periods.***





We
      plan
      to sell most of our microdisplays to OEMs who will incorporate them into
      products they sell. OEMs determine during their product development phase
      whether they will incorporate our products. The time elapsed between initial
      sampling of our products by OEMs, the custom design of our products to meet
      specific OEM product requirements, and the ultimate incorporation of our
      products into OEM consumer products is significant. If our products fail to
      meet
      our OEM customers' cost, performance or technical requirements or if unexpected
      technical challenges arise in the integration of our products into OEM consumer
      products, our operating results could be significantly and adversely affected.
      Long delays in achieving customer qualification and incorporation of our
      products could adversely affect our business.





***Our
      products will likely experience rapidly declining unit prices.***





In
      the
      markets in which we expect to compete, prices of established products tend
      to
      decline significantly over time. In order to maintain our profit margins over
      the long term, we believe that we will need to continuously develop product
      enhancements and new technologies that will either slow price declines of our
      products or reduce the cost of producing and delivering our products. While
      we
      anticipate many opportunities to reduce production costs over time, there can
      be
      no assurance that these cost reduction plans will be successful nor is there
      any
      assurance that our costs can be reduced as quickly as any reduction in unit
      prices. We may also attempt to offset the anticipated decrease in our average
      selling price by introducing new products, increasing our sales volumes or
      adjusting our product mix. If we fail to do so, our results of operations would
      be materially and adversely affected.





**RISKS
      RELATED TO OUR BUSINESS**





***Our
      success depends on attracting and retaining highly skilled and qualified
      technical and consulting personnel.***





We
      must
      hire highly skilled technical personnel as employees and as independent
      contractors in order to develop our products. The competition for skilled
      technical employees is intense and we may not be able to retain or recruit
      such
      personnel. We must compete with companies that possess greater financial and
      other resources than we do, and that may be more attractive to potential
      employees and contractors. To be competitive, we may have to increase the
      compensation, bonuses, stock options and other fringe benefits offered to
      employees in order to attract and retain such personnel. The costs of retaining
      or attracting new personnel may have a materially adverse affect on our business
      and our operating results. In addition, difficulties in hiring and retaining
      technical personnel could delay the implementation of our business plan.





***Our
      success depends in a large part on the continuing service of key personnel.***





Changes
      in management could have an adverse effect on our business. We are dependent
      upon the active participation of several key management personnel and will
      also
      need to recruit additional management in order to expand according to our
      business plan. The failure to attract and retain additional management or
      personnel could have a material adverse effect on our operating results and
      financial performance.





***Our
      business depends on new products and technologies.***





The
      market for our products is characterized by rapid changes in product, design
      and
      manufacturing process technologies. Our success depends to a large extent on
      our
      ability to develop and manufacture new products and technologies to match the
      varying requirements of different customers in order to establish a competitive
      position and become profitable. Furthermore, we must adopt our products and
      processes to technological changes and emerging industry standards and practices
      on a cost-effective and timely basis. Our failure to accomplish any of the
      above
      could harm our business and operating results.





***We
      generally do not have long-term contracts with our customers.***





Our
      business has primarily operated on the basis of short-term purchase orders.
      We
      are now receiving longer term purchase agreements, such as those which comprise
      our approximately $6.1 million backlog, and procurement contracts, but we cannot
      guarantee that we will continue to do so. Our current purchase agreements can
      be
      cancelled or revised without penalty, depending on the circumstances. We plan
      production on the basis of internally generated forecasts of demand, which
      makes
      it difficult to accurately forecast revenues. If we fail to accurately forecast
      operating results, our business may suffer and the value of your investment
      in
      eMagin may decline.





***Our
      business strategy may fail if we cannot continue to form strategic relationships
      with companies that manufacture and use products that could incorporate our
      OLED-on-silicon technology.***





Our
      prospects will be significantly affected by our ability to develop strategic
      alliances with OEMs for incorporation of our OLED-on-silicon technology into
      their products. While we intend to continue to establish strategic relationships
      with manufacturers of electronic consumer products, personal computers,
      chipmakers, lens makers, equipment makers, material suppliers and/or systems
      assemblers, there is no assurance that we will be able to continue to establish
      and maintain strategic relationships on commercially acceptable terms, or that
      the alliances we do enter in to will realize their objectives. Failure to do
      so
      would have a material adverse effect on our business.






19





***Our
      business depends to some extent on international transactions.***





We
      purchase needed materials from companies located abroad and may be adversely
      affected by political and currency risk, as well as the additional costs of
      doing business with a foreign entity. Some customers in other countries have
      longer receivable periods or warranty periods. In addition, many of the OEMs
      that are the most likely long-term purchasers of our microdisplays are located
      abroad exposing us to additional political and currency risk. We may find it
      necessary to locate manufacturing facilities abroad to be closer to our
      customers which could expose us to various risks, including management of a
      multi-national organization, the complexities of complying with foreign laws
      and
      customs, political instability and the complexities of taxation in multiple
      jurisdictions.





***Our
      business may expose us to product liability claims.***





Our
      business may expose us to potential product liability claims. Although no such
      claims have been brought against us to date, and to our knowledge no such claim
      is threatened or likely, we may face liability to product users for damages
      resulting from the faulty design or manufacture of our products. While we plan
      to maintain product liability insurance coverage, there can be no assurance
      that
      product liability claims will not exceed coverage limits, fall outside the
      scope
      of such coverage, or that such insurance will continue to be available at
      commercially reasonable rates, if at all.





***Our
      business is subject to environmental regulations and possible liability arising
      from potential employee claims of exposure to harmful substances used in the
      development and manufacture of our products.***





We
      are
      subject to various governmental regulations related to toxic, volatile,
      experimental and other hazardous chemicals used in our design and manufacturing
      process. Our failure to comply with these regulations could result in the
      imposition of fines or in the suspension or cessation of our operations.
      Compliance with these regulations could require us to acquire costly equipment
      or to incur other significant expenses. We develop, evaluate and utilize new
      chemical compounds in the manufacture of our products. While we attempt to
      ensure that our employees are protected from exposure to hazardous materials,
      we
      cannot assure you that potentially harmful exposure will not occur or that
      we
      will not be liable to employees as a result.




**RISKS
      RELATED TO OUR STOCK**







***The
      substantial number of shares that are or will be eligible for sale could cause
      our common stock price to decline even if eMagin is successful.***





Sales
      of
      significant amounts of common stock in the public market, or the perception
      that
      such sales may occur, could materially affect the market price of our common
      stock. These sales might also make it more difficult for us to sell equity
      or
      equity-related securities in the future at a time and price that we deem
      appropriate. As of March 16, 2007, we have outstanding (i) options to purchase
      1,065,745 shares and (ii) warrants to purchase 3,548,174 shares of common stock.





***We
      have a staggered board of directors and other anti-takeover provisions, which
      could inhibit potential investors or delay or prevent a change of control that
      may favor you.***





Our
      Board
      of Directors is divided into three classes and our Board members are elected
      for
      terms that are staggered. This could discourage the efforts by others to obtain
      control of eMagin. Some of the provisions of our certificate of incorporation,
      our bylaws and Delaware law could, together or separately, discourage potential
      acquisition proposals or delay or prevent a change in control. In particular,
      our board of directors is authorized to issue up to 10,000,000 shares of
      preferred stock (less any outstanding shares of preferred stock) with rights
      and
      privileges that might be senior to our common stock, without the consent of
      the
      holders of the common stock.





**ITEM
      1B. UNRESOLVED STAFF COMMENTS**





None.





**ITEM
      2. PROPERTIES**





Our
      corporate offices are located in Bellevue, Washington. Our Washington location
      includes administrative, finance, operations, research and development and
      sales
      and marketing functions and consists of leased space of approximately 19,000
      square feet. The lease expires in 2009. Our manufacturing facility is located
      in
      Hopewell Junction, New York, where we lease approximately 40,000 square feet
      from IBM. The NY facility houses our equipment for OLED microdisplay
      fabrication, assembly operations, research and development, and administrative
      functions. The lease expires in 2009. We believe our facilities are adequate
      for
      our current and near-term needs. See Note 12 to our Consolidated Financial
      Statement for more information about our lease commitments.






20





**ITEM
      3. LEGAL PROCEEDINGS**





On
      December 6, 2005, New York State Urban Development Corporation commenced action
      against eMagin in the Supreme Court of the State of New York, County of New
      York
      against eMagin, asserting breach of contract and seeking to recover a $150,000
      grant which was made to eMagin based on goals set forth in the agreement for
      recruitment of employees. On July 13, 2006, eMagin agreed to a settlement with
      the New York State Urban Development Corporation to repay $112,200 of the
      $150,000 grant. The settlement requires that repayments be made on a monthly
      basis in the amount of $3,116.67 per month commencing August 1, 2006 and ending
      on July 1, 2009.





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**





Our
      Annual Meeting of Stockholders was held on October 20, 2006 in Bellevue,
      Washington at 2 P.M. local time.





There
      were present in person or by proxy 8,042,735 shares of Common Stock, of a total
      of 10,113,162 shares of Common Stock entitled to vote.





The
      number of shares voted in favor of the election of the following nominees for
      director is set forth opposite each nominee’s name:





**Nominee**
            
            **Number
                of Shares**Paul
                C. Cronson
            
            7,716,533Rear
                Admiral Thomas Paulsen, USN (Ret.)
            
            7,800,344Brigadier
                Gen. Stephen Seay, US Army (Ret.)
            
            7,814,189





Five
      proposals were presented and adopted.





The
      proposal to  amend
      the
      Company's certificate of incorporation to increase the maximum number of
      directors which may be appointed to the Company's Board of Directors from 9
      to
      10 persons received 7,633,895 votes  in  favor.





The
      proposal to
      authorize the Company's Board of Directors, in its discretion, to amend the
      Company's certificate of incorporation to effect a reverse stock split of the
      outstanding shares of the Company's common stock received 7,244,636 votes  in  favor .





The
      proposal to
      authorize the Company's Board of Directors for the potential issuance of shares
      of our common stock underlying our 6% Senior Secured Convertible Notes and
      warrants to purchase shares of our common stock at a price below fair market
      value received 2,976,481 votes  in  favor .





The
      proposal to
      increase the number of authorized shares of common stock issuable pursuant
      to
      the 2004 Non-Employee Stock Compensation Plan from
      200,000 to 950,000 shares received 2,817,761 votes  in  favor.





The
      proposal to appoint Eisner LLP as the Company's independent auditors received 7,822,205 votes  in  favor.








**PART
      II**





**ITEM
      5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STAREHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES**





Our
      common stock is traded on the American Stock Exchange under the symbol "EMA".
      The following table sets forth the range of high and low prices per share of
      our
      common stock for each period indicated.





**2005**
            
            **2006****High**
            
            **Low**
            
            **High**
            
            **Low**First
                quarter
            $13.00
            
            $8.40
            
            $7.10
            
            $4.60Second
                quarter
            $10.40
            
            $7.00
            
            $5.70
            
            $2.50Third
                quarter
            $10.30
            
            $5.30
            
            $3.80
            
            $1.80Fourth
                quarter
            $
                9.00
            
            $5.40
            
            $2.50
            
            $1.01






21





As
      of
      March 16, 2007, there were 491 holders of record of our common stock. Because
      brokers and other institutions hold many of the shares on behalf of
      shareholders, we are unable to determine the actual number of shareholders
      represented by these record holders.





***Dividends***





We
      have
      never declared or paid cash dividends on our common stock. We currently
      anticipate that we will retain all future earnings to fund the operation of
      our
      business and do not anticipate paying dividends on our common stock in the
      foreseeable future.





***Recent
      Issuances of Unregistered Stock***





None.








**ITEM
      6. SELECTED FINANCIAL DATA**





The
      following selected consolidated financial data should be read in conjunction
      with our consolidated financial statements and related notes and “Management’s
      Discussion and Analysis of Financial Condition and Results of Operations”. The
      statements of operations data for the years ended December 31, 2006, 2005,
      and
      2004 and the balance sheet data at December 31, 2006 and 2005 are derived from
      our audited financial statements which are included elsewhere in this Form
      10-K.
      The statement of operations data for the year ended December 31, 2003 and 2002
      and the balance sheet data at December 31, 2004, 2003 and 2002 are derived
      from
      our audited financial statements which are not included in this Form 10-K.
      The
      historical results are not necessarily indicative of results to be expected
      for
      future periods. The following information is presented in thousands, except
      per
      share data.





**Consolidated
      Statements of Operations Data:**





**For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(In
                thousands, except per share data)**Revenue
            
            $
            8,169
            
            $
            3,745
            
            $
            3,593
            
            $
            2,578
            
            $
            2,128Cost
                of goods sold
            
            
            11,359
            
            
            10,219
            
            
            5,966
            
            
            5,141
            
            
            —Gross
                (loss) profit
            
            
            (3,190
            )
            
            (6,474
            )
            
            (2,373
            )
            
            (2,563
            )
            
            2,128Operating
                expenses:Research
                and development
            
            
            4,406
            
            
            4,020
            
            
            898
            
            
            19
            
            
            7,255Stock
                based compensation (1)
            
            
            —
            
            
            —
            
            
            88
            
            
            2,183
            
            
            1,647Selling,
                general and administrative
            
            
            8,860
            
            
            6,316
            
            
            4,340
            
            
            3,529
            
            
            5,832Total
                operating expenses
            
            
            13,266
            
            
            10,336
            
            
            5,326
            
            
            5,731
            
            
            14,734Loss
                from operations
            
            
            (16,456
            )
            
            (16,810
            )
            
            (7,699
            )
            
            (8,294
            )
            
            (12,606
            )Other
                income (expense), net
            
            
            1,190
            
            
            282
            
            
            (5,012
            )
            
            3,571
            
            
            (2,306
            )Net
                loss
            
            $
            (15,266
            )
            $
            (16,528
            )
            $
            (12,711
            )
            $
            (4,723
            )
            $
            (14,912
            )Basic
                and diluted loss per share
            
            $
            (1.52
            )
            $
            (1.94
            )
            $
            (1.98
            )
            $
            (1.31
            )
            $
            (5.07
            )Shares
                used in calculation of loss per share:Basic
                and diluted
            
            
            10,058
            
            
            8,541
            
            
            6,428
            
            
            3,599
            
            
            2,941





**Consolidated
      Balance Sheet Data:**





**December
                31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Cash,
                cash equivalents
            
            $
            1,415
            
            $
            6,727
            
            $
            13,457
            
            $
            1,054
            
            $
            83Working
                capital (deficit)
            
            $
            (305
            )
            $
            8,868
            
            $
            14,925
            
            $
            106
            
            $
            (13,602
            )Total
                assets
            
            $
            7,005
            
            $
            14,142
            
            $
            18,436
            
            $
            3,749
            
            $
            1,834Long-term
                obligations
            
            $
            2,229
            
            $
            56
            
            $
            22
            
            $
            6,161
            
            $
            228Total
                Shareholders’ equity (capital deficit)
            
            $
            (1,164
            )
            $
            10,401
            
            $
            16,447
            
            $
            (4,767
            )
            $
            (12,808
            )


(1)
      Represents amounts reported under FAS 123.







22





**ITEM
      7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF
      OPERATION**





**Introduction**





The
      following discussion should be read in conjunction with the Financial Statements
      and Notes thereto. Our fiscal year ends December 31. This document contains
      certain forward-looking statements including, among others, anticipated trends
      in our financial condition and results of operations and our business strategy.
      (See Part I, Item 1A, "Risk Factors "). These forward-looking statements are
      based largely on our current expectations and are subject to a number of risks
      and uncertainties. Actual results could differ materially from these
      forward-looking statements. Important factors to consider in evaluating such
      forward-looking statements include (i) changes in external factors or in our
      internal budgeting process which might impact trends in our results of
      operations; (ii) unanticipated working capital or other cash requirements;
      (iii)
      changes in our business strategy or an inability to execute our strategy due
      to
      unanticipated changes in the industries in which we operate; and (iv) various
      competitive market factors that may prevent us from competing successfully
      in
      the marketplace.





***Overview***





We
      design
      and manufacture miniature displays, which we refer to as
      OLED-on-silicon-microdisplays, and microdisplay modules for virtual imaging,
      primarily for incorporation into the products of other manufacturers.
      Microdisplays are typically smaller than many postage stamps, but when viewed
      through a magnifier they can contain all of the information appearing on a
      high-resolution personal computer screen. Our microdisplays use organic light
      emitting diodes, or OLEDs, which emit light themselves when a current is passed
      through the device. Our technology permits OLEDs to be coated onto silicon
      chips
      to produce high resolution OLED-on-silicon microdisplays.





We
      believe that our OLED-on-silicon microdisplays offer a number of advantages
      in
      near to the eye applications over other current microdisplay technologies,
      including lower power requirements, less weight, fast video speed without
      flicker, and wider viewing angles. In addition, many computer and video
      electronic system functions can be built directly into the OLED-on-silicon
      microdisplay, resulting in compact systems with lower expected overall system
      costs relative to alternate microdisplay technologies.





Since
      our
      inception in 1996 through 2004, we derived the majority of our revenues from
      fees paid to us under research and development contracts, primarily with the
      U.S. federal government. We have devoted significant resources to the
      development and commercial launch of our products. We commenced limited initial
      sales of our SVGA+ microdisplay in May 2001 and commenced shipping samples
      of
      our SVGA-3D microdisplay in February 2002. From inception to December 31, 2006,
      we have recognized an aggregate of approximately $19.5 million from sales of
      our
      products, and as of December 31, 2006, we have a backlog of approximately $6.1
      million in products ordered for delivery through December 31, 2007. These
      products are being applied or considered for near-eye and headset applications
      in products such as entertainment and gaming headsets, handheld Internet and
      telecommunication appliances, viewfinders, and wearable computers to be
      manufactured by original equipment manufacturer (OEM) customers. We have also
      shipped a limited number of our Z800 3DVisor personal display systems. In
      addition to marketing OLED-on-silicon microdisplays as components, we also
      offer
      microdisplays as an integrated package, which we call Microviewer that includes
      a compact lens for viewing the microdisplay and electronic interfaces to convert
      the signal from our customer's product into a viewable image on the
      microdisplay. Through our operations in Washington State we are also developing
      head-wearable displays that incorporate our Microviewer.





We
      license our core OLED technology from Eastman Kodak and we have developed our
      own technology to create high performance OLED-on-silicon microdisplays and
      related optical systems. We believe our technology licensing agreement with
      Eastman Kodak, coupled with our own intellectual property portfolio, gives
      us a
      leadership position in OLED and OLED-on-silicon microdisplay technology. We
      believe that we are the only company to demonstrate publicly and market
      full-color small molecule OLED-on-silicon microdisplays.





***Company
      History***





Historically,
      we have been a developmental stage company. As of January 1, 2003, we were
      no
      longer classified as a development stage company. We have transitioned to
      manufacturing our product and intend to significantly increase our marketing,
      sales, and research and development efforts, and expand our operating
      infrastructure. Currently, most of our operating expenses are fixed. If we
      are
      unable to generate significant revenues, our net losses in any given period
      could be greater than expected.





23


**Critical
      Accounting Policies**





The
      Securities and Exchange Commission ("SEC") defines "critical accounting
      policies" as those that require application of management's most difficult,
      subjective or complex judgments, often as a result of the need to make estimates
      about the effect of matters that are inherently uncertain and may change in
      subsequent periods. Not all of the accounting policies require management to
      make difficult, subjective or complex judgments or estimates. However, the
      following policies could be deemed to be critical within the SEC definition.





***Revenue
      and Cost Recognition***





Revenue
      on product sales is recognized when persuasive evidence of an arrangement
      exists, such as when a purchase order or contract is received from the customer,
      the price is fixed, title and risk of loss to the goods has changed and there
      is
      a reasonable assurance of collection of the sales proceeds. We obtain written
      purchase authorizations from our customers for a specified amount of product
      at
      a specified price and consider delivery to have occurred at the time of
      shipment. We record a reserve for estimated sales returns, which is reflected
      as
      a reduction of revenue at the time of revenue recognition. Products sold
      directly to consumers have a fifteen day right of return. Revenue on consumer
      products is deferred until the right of return has expired.





Revenues
      from research and development activities relating to firm fixed-price contracts
      are generally recognized on the percentage-of-completion method of accounting
      as
      costs are incurred (cost-to-cost basis). Revenues from research and development
      activities relating to cost-plus-fee contracts include costs incurred plus
      a
      portion of estimated fees or profits based on the relationship of costs incurred
      to total estimated costs. Contract costs include all direct material and labor
      costs and an allocation of allowable indirect costs as defined by each contract,
      as periodically adjusted to reflect revised agreed upon rates. These rates
      are
      subject to audit by the other party.





***Use
      of estimates***





The
      preparation of financial statements in conformity with generally accepted
      accounting principles in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      the disclosure of contingent assets and liabilities at the date of the financial
      statements as well as the reported amounts of revenues and expenses during
      the
      reporting period. Actual results could differ from those estimates. These
      estimates and assumptions relate to recording net revenue, collectibility of
      accounts receivable, useful lives and impairment of tangible and intangible
      assets, accruals, income taxes, inventory realization and other factors.
      Management has exercised reasonable judgment in deriving these estimates.
      Consequently, a change in conditions could affect these estimates.





***Fair
      value of financial instruments***





eMagin’s
      cash, cash equivalents, accounts receivable, short-term investments and accounts
      payable are stated at cost which appropriates fair value due to the short-term
      nature of these instruments.





***Stock-based
      Compensation***





eMagin
      maintains several stock equity incentive plans. The 2005 Employee Stock Purchase
      Plan (the “ESPP”) provides our employees with the opportunity to purchase common
      stock through payroll deductions. Employees purchase stock semi-annually at
      a
      price that is 85% of the fair market value at certain plan-defined dates. As
      of
      December 31, 2006, the number of shares of common stock available for issuance
      was 150,000. As of December 31, 2006, the plan had not been
      implemented.





The
      2003
      Stock Option Plan (the”2003 Plan”) provides for grants of shares of common stock
      and options to purchase shares of common stock to employees, officers, directors
      and consultants. Under the 2003 plan, an ISO grant is granted at the market
      value of our common stock at the date of the grant and a non-ISO is granted
      at a
      price not to be less than 85% of the market value of the common stock. These
      options have a term of up to 10 years and vest over a schedule determined by
      the
      Board of Directors, generally over a five year period. The amended 2003 Plan
      provides for an annual increase of 3% of the diluted shares outstanding on
      January 1 of each year for a period of 9 years which commenced January 1, 2005.





On
      January 1, 2006, we adopted the provisions of Financial Accounting Standards
      Board (“FASB”) Statement No. 123(R), “Share-Based Payment”, and (“SFAS No.
      123R”), which requires us to recognize expense related to the fair value of our
      share-based compensation issued to employees and directors. Prior to the January
      1, 2006, we accounted for share-based compensation under the recognition and
      measurement provisions of Accounting Principles Board Opinion No. 25
      ("APB No. 25"), “Accounting for Stock Issued to Employees”,
      and related interpretations, as permitted by FASB Statement No. 123, "Accounting
      for Stock-Based Compensation" (“SFAS No. 123”). In accordance with APB No. 25,
      no compensation cost was required to be recognized for options granted that
      had
      an exercise price equal to the market value of the underlying common stock
      on
      the date of grant.







24


We
      adopted SFAS No. 123R using the modified prospective transition method and
      consequently have not retroactively adjusted results for prior periods. Under
      this transition method, compensation cost associated with stock options
      includes: a) compensation cost for all share-based compensation granted prior
      to, but not vested as of January 1, 2006, based on the grant-date fair value
      estimated in accordance with the provisions of SFAS No.123 and b) compensation
      cost for all share-based compensation granted beginning January 1, 2006, based
      on the grant-date fair value estimated in accordance with the original
      provisions of SFAS No.123R. We use the straight-line method for recognizing
      compensation expense. Compensation expense for awards under SFAS 123R includes
      an estimate for forfeitures.





**Results
      of Operations**





The
      following table presents certain financial data as a percentage of total revenue
      for the periods indicated. Our historical operating results are not necessarily
      indicative of the results for any future period.





**As
                a Percentage of Total**
              **Revenue**
              **Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004****Consolidated
                Statements of Operations Data:**Revenue
            
            
            100
            %
            
            100
            %
            
            100
            %Cost
                of goods sold
            
            
            139
            
            
            273
            
            
            166Gross loss
            
            
            (39
            )
            
            (173
            )
            
            (66
            )Operating
                expenses:Research
                and development
            
            
            54
            
            
            107
            
            
            25Stock
                based compensation
            
            
            ----
            
            
            ----
            
            
            2Selling,
                general and administrative
            
            
            109
            
            
            169
            
            
            121Total operating expenses
            
            
            163
            
            
            276
            
            
            148Loss
                from operations
            
            
            (202
            )
            
            (449
            )
            
            (214
            )Other
                income (expense)
            
            
            15
            
            
            8
            
            
            (140
            )Net
                loss
            
            
            (187
            )%
            
            (441
            )%
            
            (354
            )%




**Year
      Ended December 31, 2006 Compared to Year Ended December 31,
      2005**





**Revenues**





Revenues
      increased by approximately $4.5 million to a total of approximately $8.2 million
      for the year ended December 31, 2006 from approximately $3.7 million for the
      year ended December 31, 2005, representing an increase of 118%. This increase
      was due to increased microdisplay demand and the broadening of our product
      revenue through the sales of the Z800 3D Visor. Our contract revenue increased
      approximately $150 thousand while our product revenue increased approximately
      $4.3 million. Average price per unit for microdisplays was $386 in 2006 and
      $372
      in 2005. Our current expectation is that revenue will continue to grow in 2007
      if we successfully execute our business plan.





**Cost
      of Goods Sold**





Cost
      of
      goods sold includes direct and indirect costs associated with production of
      our
      products. Cost of goods sold for the years ended December 31, 2006 and 2005
      was
      approximately $11.4 million and approximately $10.2, respectively, an increase
      of $1.2 million. The gross loss was approximately ($3.2) million and
      approximately ($6.5) million, respectively, for the years ended December 31,
      2006 and 2005, respectively. The gross loss was (39%) for the year ended
      December 31, 2006 as compared to (173%) for the year ended December 31, 2005.
      The increase in cost of goods sold for the year ended December 31, 2006 was
      attributed to higher materials usage to support increased production as well
      as
      approximately $343 thousand of stock compensation expense reflected in
      accordance with SFAS No. 123R in 2006.  The
      decrease in gross loss was attributed to fuller utilization of our fixed
      production overhead due to higher unit volume. We
      expect that gross margins will improve in 2007 as a result of continued leverage
      of our production overhead as volumes and revenue increase.





***Research
      and Development Expenses***





Research
      and development expenses included salaries, development materials and other
      costs specifically allocated to the development of new microdisplay products,
      OLED materials and subsystems. Research and development expenses for the year
      ended December 31, 2006 were approximately $4.4 million as compared to
      approximately $4.0 million for the year ended December 31, 2005. The increase
      was primarily due to the stock-based compensation expense of approximately
      $435
      thousand in 2006.






25





***Selling,
      General and Administrative Expenses***





Selling,
      general and administrative expenses consist primarily of salaries and fees
      for
      professional services, legal fees incurred in connection with patent filings
      and
      related matters, as well as other marketing and administrative expenses. General
      and administrative expenses increased by approximately $2.9 million to a total
      of approximately $8.9 million for the year ended December 31, 2006 from $6.3
      million for the year ended December 31, 2005. The increase in selling, general
      and administrative expenses was due primarily to stock-based compensation
      expense of approximately $2.9 million and an increase in marketing expenses
      related to our Z800 3DVisor.





***Other
      Income (Expense*** )





Other
      income, net consists primarily of interest income earned on investments,
      interest expense related to the secured debentures, and gain from the change
      in
      the derivative liability. For the year ended December 31, 2006, interest income
      was approximately $92 thousand as compared to approximately $210 thousand for
      the year ended December 31, 2005. The decrease in interest income was primarily
      a result of lower cash balances available for investment. For the year ended
      December 31, 2006, interest expense was approximately $1.3 million as compared
      to approximately $4 thousand for the year ended December 31, 2005. The increase
      in the interest expense was a result of interest associated with our notes
      payable of approximately $124 thousand, the amortization of the deferred costs
      associated with the notes payable of approximately $221 thousand, and the
      amortization of the debt discount of approximately $956 thousand. For the year
      ended December 31, 2006, income from the change in the derivative liability
      was
      approximately $2.4 million as compared to $0 for the year ended December 31,
      2005.





***Off-Balance
      Sheet Arrangements***





We
      do not
      have any off balance sheet arrangements that are reasonably likely to have
      a
      current or future effect on our financial condition, revenues, results of
      operations, liquidity or capital expenditures.





**Year
      Ended December 31, 2005 Compared to Year Ended December 31,
      2004**





***Revenues***





Revenues
      increased by approximately $152 thousand to a total of approximately $3.7
      million for the year ended December 31, 2005 from approximately $3.6 million
      for
      the year ended December 31, 2004, representing an increase of 4%. This increase
      was due primarily to the broadening of our product offerings with the Z800
      product and incremental revenue generated by these sales. Our contract revenue
      decreased approximately $72 thousand while our product revenue increased
      approximately $217 thousand. Average price per unit for microdisplays was $372
      in 2005 and 2004.





***Cost
      of Goods Sold***





Cost
      of
      goods sold includes direct and indirect costs associated with production of
      our
      products. In the year ended December 31, 2005 we recorded approximately $10.2
      million in cost of goods sold which resulted in a gross loss of approximately
      $6.5 million as compared to approximately $6.0 million in costs of goods sold
      resulting in a gross loss of $2.4 million in the year ended December 31, 2004.
      The production
      expenses for 2005 include labor costs related to operating two full eight hour
      shifts and a partial third shift as compared to a single shift in
      2004.  To accommodate longer operating hours and expected higher
      product output in 2005 we initiated modifications to our production process
      that resulted in less than 10% of our expected capacity while underway. 
Stabilization of these modifications initially was expected to be completed
      early in 2005, but took until the first quarter of 2006 to
      achieve.  As a result gross margins in 2005 declined as compared to
      2004 due to the higher labor costs.




***Research
      and Development Expenses***




Gross
      research and development expenses increased by approximately $3.1 million to
      a
      total of $4.0 million for the year ended December 31, 2005 from approximately
      $0.9 million for the year ended December 31, 2004. The approximately $3.1
      million increase in R&D expenses for the year ended December 31, 2005
      reflects efforts to develop two new microdisplays and three visor products.





***Selling,
      General and Administrative Expenses***





Selling,
      general and administrative expenses increased by approximately $2.0 million
      to a
      total of approximately $6.3 million for the year ended December 31, 2005 from
      approximately $4.3 million for the year ended December 31, 2004. The increase
      in
      selling, general and administrative expenses was due primarily to an increase
      in
      staff and personnel costs.





26


***Other
      Income (Expense*** )





Other
      income, net, for 2005 was approximately $282 thousand and was comprised of
      net
      interest income of approximately $207 thousand; a gain on miscellaneous
      equipment sales of approximately $38 thousand; and a gain on foreign exchange
      of
      approximately $37 thousand. Other expense, net, for 2004 was approximately
      $5.0
      million and was comprised of approximately $3.2 million of charges related
      to
      the value of the warrants issued to induce the holders of the approximately
      $7.8
      million in notes to agree to an early conversion of the notes into common stock;
      approximately $1.6 million in charges related to the remaining unamortized
      debt
      discount and beneficial conversion feature associated with aforementioned notes;
      and approximately $75 thousand in charges related to the write-off of the
      remaining unamortized deferred financing costs.





***Off-Balance
      Sheet Arrangements***





We
      do not
      have any off balance sheet arrangements that are reasonably likely to have
      a
      current or future effect on our financial condition, revenues, results of
      operations, liquidity or capital expenditures.





**Liquidity
      and Capital Resources**





At
      December 31, 2006, our principal source of liquidity was cash of $1.4 million.





For
      the
      year ended December 31, 2006, net cash used by operating activities was
      approximately $10.4 million, primarily attributable to our net loss of
      approximately $15.3 million. For the year ended December 31, 2005, net cash
      used
      by operating activities was approximately $15.7 million, primarily attributable
      to our net loss of approximately $16.5 million.





For
      the
      year ended December 31, 2006, net cash used by investing activities was
      approximately $257 thousand primarily related to purchases of equipment. Net
      cash used by investing activities for the year ended December 31, 2005 was
      approximately $1.1 million primarily related to equipment purchases..





Net
      cash
      provided by financing activities the year ended December 31, 2006 was
      approximately $5.3 million and was comprised primarily of approximately $5.4
      million in proceeds from debt issuance and offset by payments on long-term
      debt
      and capitalized lease obligations of approximately $55 thousand. Net cash
      provided by financing activities during the year ended December 31, 2005 was
      approximately $10.1 million and was comprised primarily of approximately $8.4
      million in proceeds from the sale of common stock and approximately 1.6 million
      from the exercise of stock options and warrants.





Our
      consolidated financial statements as of December 31, 2006 have been prepared
      under the assumption that we will continue as a going concern for the year
      ending December 31, 2007. Our independent registered public accounting firm
      has
      issued a report dated March 27 , 2007
      that included an explanatory paragraph expressing substantial doubt in our
      ability to continue as a going concern without additional capital becoming
      available. Our
      ability to continue as a going concern ultimately is dependent on our ability
      to
      generate a profit which is likely dependant upon our ability to obtain
      additional equity or debt financing, attain further operating efficiencies
      and,
      ultimately, to achieve profitable operations. The financial statements do not
      include any adjustments that might result from the outcome of this
      uncertainty.





As
      we
      have reported our business is currently experiencing significant revenue growth
      during the year ended December 31, 2006. This trend, if it continues, may result
      in higher accounts receivable levels and may require increased production and/or
      higher inventory levels. In addition, in July 2007, we areresponsible
      for repaying $2.9 million to the noteholders. If the funds are not available,
      we
      will negotiate with the noteholders to defer the payment but no assurances
      can
      be made that they will agree.We
      anticipate that our cash requirements to fund these requirements as well as
      other operating or investing cash requirements over the next twelve months
      will
      be greater than our current cash on hand. While we received approximately $5.4
      million, net, from the sale of senior secured debentures pursuant to theNote
      Purchase agreements that we entered into on July 21, 2006, and such agreements
      provide for the investors to purchase an additional $0.5 million, nevertheless
      we anticipate that we will still require additional fundsover the
      next twelve months.
      We do
      not currently have commitments for these funds and no assurance can be given
      that additional financing will be available, or if available, will be on
      acceptable terms.If we
      are unable to obtain sufficient funds during the next twelve months we will
      further reduce the size of our organization and may be forced to reduce and/or
      curtail our production and operations, all of which could have a material
      adverse impact on our business prospects.





In
      addition to the foregoing, as previously reported, we have retained CIBC World
      Markets Corporation and Larkspur Capital Corporation to assist us in
      investigating and evaluating various strategic alternatives, ranging from
      investment to acquisition, in response to inquiries that we have
      received.







27





**Contractual
      Obligations**





The
      following chart describes the outstanding contractual obligations of eMagin
      as
      of December 31, 2006 (in thousands):








**Payments
                due by period****Total**
            
            **1
                Year**
            
            **2-3
                Years**
            
            **4-5
                Years**Capital
                lease obligations
            
            $
            6
            
            $
            6
            
            $
            —
            
            $
            —Operating
                lease obligations
            
            
            3,387
            
            
            1,405
            
            
            1,982
            
            
            —Purchase
                obligations (a)
            
            
            1,476
            
            
            1,476
            
            
            —
            
            
            —Other
                long-term liabilities (b)
            
            
            787
            
            
            183
            
            
            354
            
            
            250Total
            
            $
            5,656
            
            $
            3,070
            
            $
            2,336
            
            $
            250





(a)
      The
      majority of purchase orders outstanding contain no cancellation fees except
      for
      minor re-stocking fees.


(b)
      This
      amount represents the obligation for royalty payments, capitalized software
      and
      the New York Urban Development settlement.





**Effect
      of Recently Issued Accounting Pronouncements**





See
      Note
      11 of the Consolidated Financial Statements in Item 8 for a full description
      of
      recent accounting pronouncements, including the expected dates of adoption
      and
      estimated effects on results of operations and financial condition.





**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**





***Market
      rate risk***





We
      are
      exposed to market risk related to changes in interest rates and foreign currency
      exchanges rates.





***Interest
      rate risk***





We
      hold
      our assets in cash and cash equivalents. We do not hold derivative financial
      instruments or equity securities.





***Foreign
      currency exchange rate risk***





Our
      revenue and expenses are denominated in U.S. dollars. We have conducted some
      transactions in foreign currencies and expect to continue to do so; we do not
      anticipate that foreign exchange gains or losses will be significant. We have
      not engaged in foreign currency hedging to date.





Our
      international business is subject to risks typical of international activity,
      including, but not limited to, differing economic conditions; change in
      political climates; differing tax structures; and other regulations and
      restrictions. Accordingly, our future results could be impacted by changes
      in
      these or other factors.







28





**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





**Financial
      Statement Index**








**Page**Report
                of Independent Registered Public Accounting Firm
            30Consolidated
                Balance Sheets as of December 31, 2006 and 2005
            31Consolidated
                Statements of Operations for the years ended December 31, 2006, 2005
                and
                2004
            32Consolidated
                Statements of Changes in Shareholders’ Equity (Deficit) for the years
                ended December 31, 2006, 2005 and 2004
            33Consolidated
                Statements of Cash Flows for the years ended December 31, 2006, 2005
                and
                2004
            34Notes
                to the Consolidated Financial Statements
            35








29


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





Board
      of
      Directors and Stockholders


eMagin
      Corporation





We
      have
      audited the accompanying consolidated balance sheets of eMagin Corporation
      and
      subsidiary (the "Company") as of December 31, 2006 and 2005, and the related
      consolidated statements of operations, shareholders' equity (deficit) and cash
      flows for each of the three years in the period ended December 31, 2006. These
      financial statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of eMagin Corporation
      and
      subsidiary as of December 31, 2006 and 2005 and the consolidated results of
      their operations and their consolidated cash flows for each of the three years
      in the period ended December 31, 2006 in conformity with accounting principles
      generally accepted in the United States of America.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 2 to the consolidated
      financial statements, the Company has had recurring losses from operations
      which
      it believes will continue, has working capital and capital deficits at December
      31, 2006. These factors raise substantial doubt about the Company’s ability to
      continue as a going concern. Management’s plans in regard to these matters are
      also discussed in Note 2. The consolidated financial statements do not include
      any adjustments that might result from the outcome of this uncertainty.




As
      discussed in Note 2 to the consolidated financial
      statements, the Company changed its method of accounting for stock-based
      compensation effective January 1, 2006








/s/
      Eisner LLP





Eisner
      LLP


New
      York,
      New York


March
      27,
      2007








30


**eMAGIN
      CORPORATION**


**CONSOLIDATED
      BALANCE SHEETS**





**December
                31,****2006**
            
            **2005**(In
                thousands, except share
                and per share amounts)**ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            1,415
            
            $
            6,727Investments
                - held to maturity
            
            
            171
            
            
            120Accounts
                receivable, net
            
            
            908
            
            
            822Inventory
            
            
            2,485
            
            
            3,839Prepaid
                expenses and other current assets
            
            
            656
            
            
            1,045Total
                current assets
            
            
            5,635
            
            
            12,553Equipment,
                furniture and leasehold improvements, net
            
            
            666
            
            
            1,299Intangible
                assets, net
            
            
            55
            
            
            57Other
                assets
            
            
            233
            
            
            233Deferred
                financing costs, net
            
            
            416
            
            
            —Total
                assets
            
            $
            7,005
            
            $
            14,142**LIABILITIES
                AND SHAREHOLDERS’ (DEFICIT) EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            1,192
            
            $
            562Accrued
                compensation
            
            
            959
            
            
            1,010Other
                accrued expenses
            
            
            749
            
            
            1,894Advanced
                payments
            
            
            444
            
            
            60Deferred
                revenue
            
            
            126
            
            
            96Current
                portion of capitalized lease obligations
            
            
            6
            
            
            16Current
                portion of debt
            
            
            1,217
            
            
            —Derivative
                liability - warrants
            
            
            1,195
            
            
            —Other
                current liabilities
            
            
            52
            
            
            47Total
                current liabilities
            
            
            5,940
            
            
            3,685Capitalized
                lease obligations
            
            
            —
            
            
            6Other
                long-term liabilities
            
            
            2,229
            
            
            50Total
                liabilities
            
            
            8,169
            
            
            3,741Commitments
                and contingenciesShareholders’
                (deficit) equity:Preferred
                stock, $.001 par value: authorized 10,000,000 shares; no shares issued
                and
                outstanding
            
            
            —
            
            
            —Common
                stock, $.001 par value: authorized 200,000,000 shares, issued and
                outstanding, 10,341,029 shares in 2006 and 9,997,246 shares in
                2005
            
            
            10
            
            
            10Additional
                paid in capital
            
            
            179,651
            
            
            175,950Accumulated
                deficit
            
            
            (180,825
            )
            
            (165,559
            )Total
                shareholders’ (deficit) equity
            
            
            (
                1,164
            )
            
            10,401Total
                liabilities and shareholders’ (deficit) equity
            
            $
            7,005
            
            $
            14,142








See
      notes
      to Consolidated Financial Statements .






31


**eMAGIN
      CORPORATION**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





**For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004**(In
                thousands, except per share data)Revenue:Product
                revenue
            
            $
            7,983
            
            $
            3,719
            
            $
            3,502Contract
                revenue
            
            
            186
            
            
            36
            
            
            108Sales
                returns and allowance
            
            
            —
            
            
            (10
            )
            
            (17
            )Total
                revenue, net
            
            
            8,169
            
            
            3,745
            
            
            3,593Cost
                of goods sold
            
            
            11,359
            
            
            10,219
            
            
            5,966Gross
                loss
            
            
            (3,190
            )
            
            (6,474
            )
            
            (2,373
            )Operating
                expenses:Research
                and development
            
            
            4,406
            
            
            4,020
            
            
            898Selling,
                general and administrative
            
            
            8,860
            
            
            6,316
            
            
            4,428Total
                operating expenses
            
            
            13,266
            
            
            10,336
            
            
            5,326Loss
                from operations
            
            
            (16,456
            )
            
            (16,810
            )
            
            (7,699
            )Other
                income (expense):Interest
                expense
            
            
            (1,306
            )
            
            (4
            )
            
            (5,087
            )Gain
                on warrant derivative liability
            
            
            2,405
            
            
            —
            
            
            —Other
                income, net
            
            
            91
            
            
            286
            
            
            75Total other income (expense), net
            
            
            1,190
            
            
            282
            
            
            (5,012
            )Net
                loss
            
            $
            (15,266
            )
            $
            (16,528
            )
            $
            (12,711
            )Loss
                per share, basic and diluted
            
            $
            (1.52
            )
            $
            (1.94
            )
            $
            (1.98
            )Weighted
                average number of shares outstanding:Basic
                and diluted
            
            
            10,058
            
            
            8,541
            
            
            6,428










See
      notes
      to Consolidated Financial Statements .





32


**eMAGIN
      CORPORATION**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (DEFICIT)**





**Additional**
            
            
            
            **Total****Common
                Stock**
            
            **Deferred**
            
            **Paid-In**
            
            **Accumulated**
            
            **Shareholders’****Shares**
            
            **Amount**
            
            **Compensation**
            
            **Capital**
            
            **Deficit**
            
            **Equity**(In
                thousands, except share amounts)Balance,
                December 31, 2003
            
            
            4,270
            
            $
            4
            
            $
            (88
            )
            $
            131,638
            
            $
            (136,320
            )
            $
            (4,766
            )Sale
                of common stock, net of issuance costs
            
            
            1,641
            
            
            2
            
            
            —
            
            
            16,383
            
            
            —
            
            
            16,385Debt
                to equity conversion
            
            
            1,139
            
            
            1
            
            
            —
            
            
            8,566
            
            
            —
            
            
            8,567Issuance
                of warrants for early conversion of debt to equity
            
            
            
            
            
            
            
            
            —
            
            
            3,180
            
            
            —
            
            
            3,180Exercise
                of common stock warrants
            
            
            353
            
            
            —
            
            
            —
            
            
            3,790
            
            
            —
            
            
            3,790Stock
                options exercised
            
            
            522
            
            
            1
            
            
            —
            
            
            1,383
            
            
            —
            
            
            1,384Issuance
                of common stock for services
            
            
            39
            
            
            —
            
            
            —
            
            
            531
            
            
            —
            
            
            531Amortization
                of deferred stock compensation
            
            
            —
            
            
            —
            
            
            88
            
            
            —
            
            
            —
            
            
            88Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (12,711
            )
            
            (12,711
            )Balance,
                December 31, 2004
            
            
            7,964
            
            $
            8
            
            $
            —
            
            $
            165,471
            
            $
            (149,031
            )
            $
            16,448Sale
                of common stock, net of issuance costs
            
            
            1,662
            
            
            2
            
            
            —
            
            
            8,398
            
            
            —
            
            
            8,400Stock
                options exercised
            
            
            11
            
            
            —
            
            
            —
            
            
            37
            
            
            —
            
            
            37Exercise
                of common stock warrants
            
            
            306
            
            
            —
            
            
            —
            
            
            1,584
            
            
            —
            
            
            1,584Issuance
                of common stock for services
            
            
            54
            
            
            —
            
            
            —
            
            
            461
            
            
            —
            
            
            460Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (16,528
            )
            
            (16,528
            )Balance,
                December 31, 2005
            
            
            9,997
            
            $
            10
            
            $
            —
            
            $
            175,950
            
            $
            (165,559
            )
            $
            10,401Debt
                to equity conversion
            
            
            85
            
            
            —
            
            
            —
            
            
            220
            
            
            —
            
            
            220Issuance
                of common stock for services
            
            
            254
            
            
            —
            
            
            —
            
            
            580
            
            
            —
            
            
            580Stock-based
                compensation
            
            
            —
            
            
            —
            
            
            —
            
            
            2,891
            
            
            —
            
            
            2,891Stock
                options exercised
            
            
            5
            
            
            —
            
            
            —
            
            
            10
            
            
            —
            
            
            10Net
                loss
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (15,266
            )
            
            (15,266
            )Balance,
                December 31, 2006
            
            
            10,341
            
            $
            10
            
            $
            —
            
            $
            179,651
            
            $
            (180,825
            )
            $
            (
                1,164
            )







See
      notes
      to Consolidated Financial Statements.





33







**eMAGIN
      CORPORATION**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004**(In
                thousands)Cash
                flows from operating activities:Net
                loss
            
            $
            (15,266
            )
            $
            (16,528
            )
            $
            (12,711
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            841
            
            
            908
            
            
            620Amortization
                of deferred financing fees
            
            
            221
            
            
            ---
            
            
            8Increase
                (reduction) of provision for sales returns and doubtful
                accounts
            
            
            (39
            )
            
            (284
            )
            
            467Stock
                based compensation
            
            
            2,891
            
            
            ---
            
            
            88Non-cash
                interest related charges
            
            
            ---
            
            
            ---
            
            
            5,094Issuance
                of common stock for services, net
            
            
            553
            
            
            470
            
            
            531Amortization
                of discount on notes payable
            
            
            956
            
            
            ---
            
            
            ---Gain
                on warrant derivative liability
            
            
            (2,405
            )
            
            ---
            
            
            ---Loss
                on other asset
            
            
            157Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (42
            )
            
            (2
            )
            
            (235
            )Unbilled
                costs and estimated profits on contracts in progress
            
            
            ---
            
            
            ---
            
            
            75Inventory
            
            
            1,354
            
            
            (1,821
            )
            
            (1,742
            )Prepaid
                expenses and other current assets
            
            
            389
            
            
            (175
            )
            
            (400
            )Advance
                Payments
            
            
            384
            
            
            (4
            )
            
            (58
            )Deferred
                revenue
            
            
            30
            
            
            96
            
            
            ---Accounts
                payable, accrued compensation, and accrued expenses
            
            
            (566
            )
            
            1,613
            
            
            (51
            )Other
                current liabilities
            
            
            153
            
            
            14
            
            
            17Net
                cash used in operating activities
            
            
            (10,389
            )
            
            (15,713
            )
            
            (8,297
            )Cash
                flows from investing activities:Purchase
                of equipment
            
            
            (204
            )
            
            (898
            )
            
            (721
            )Purchase
                of investments - held to maturity
            
            
            (51
            )
            
            (120
            )Purchase
                of intangibles and other assets
            
            
            (2
            )
            
            (54
            )
            
            (99
            )Net
                cash used by investing activities
            
            
            (257
            )
            
            (1,072
            )
            
            (820
            )Cash
                flows from financing activities:Proceeds
                from sale of common stock, net of issuance costs
            
            
            ---
            
            
            8,400
            
            
            16,385Proceeds
                from exercise of stock options and warrants
            
            
            10
            
            
            1,621
            
            
            5,173Proceeds
                from long-term debt
            
            
            5,970
            
            
            50
            
            
            ---Payments
                related to deferred financing costs
            
            
            (591
            )
            
            ---
            
            
            ---Payments
                of long-term debt and capitalized lease obligations
            
            
            (55
            )
            
            (16
            )
            
            (38
            )Net
                cash provided by financing activities
            
            
            5,334
            
            
            10,055
            
            
            21,520Net
                (decrease) increase in cash and cash equivalents
            
            
            (5,312
            )
            
            (6,730
            )
            
            12,403Cash
                and cash equivalents, beginning of year
            
            
            6,727
            
            
            13,457
            
            
            1,054Cash
                and cash equivalents, end of year
            
            $
            1,415
            
            $
            6,727
            
            $
            13,457Cash
                paid for interest
            
            $
            128
            
            $
            4
            
            $
            8Cash
                paid for taxes
            
            $
            40
            
            $
            15
            
            $
            -----Supplemental
                non-cash transactions:Conversion
                of debt to equity
            
            $
            220
            
            $
            ---
            
            $
            8,567During
                the year ended December 31, 2006, the Company


·
              entered
                  into several Note Purchase Agreements with investors and issued
                  warrants
                  that are exercisable at $3.60 per share into approximately 1.6
                  million
                  shares of common stock valued at $3.4
                  million; ·
              issued
                10,000 shares of common stock in lieu of cash payment of $26,000
                as
                compensation for services performed and recorded as deferred costs;
                and ·
              issued
                approximately 85,000 shares for the conversion of Notes totaling
                $220,000.








See
      notes
      to Consolidated Financial Statements .




34










**eMAGIN
      CORPORATION**


**NOTES
      TO THE CONSOLIDATED FINANCIAL STATMENTS**





**Note
      1 - NATURE OF BUSINESS**





eMagin
      Corporation and its wholly owned subsidiary (the “Company”) designs, develops,
      manufactures, and markets virtual imaging products for consumer, commercial,
      industrial and military applications. The Company’s products are sold mainly in
      North America, Asia, and Europe,





**Note
      2 - SIGNIFICANT ACCOUNTING POLICIES**





***Principles
      of consolidation***





The
      accompanying audited consolidated financial statements include the accounts
      of
      eMagin Corporation and its wholly owned subsidiary. All intercompany
      transactions have been eliminated in consolidation.





***Basis
      of presentation***





The
      consolidated financial statements have been prepared assuming that the Company
      will continue as a going concern.  The Company has had recurring losses
      from operations which it believes will continue through in a foreseeable
      future.  The Company’s cash requirements over the next twelve months are
      greater than the Company’s current cash on hand. At December 31, 2006, the
      Company’s has working capital and shareholders’ deficits. These factors raise
      substantial doubt regarding the Company’s ability to continue as a going concern
      without continuing to obtain additional funding. The
      Company does not have commitments for such financing and no assurance can be
      given that additional financing will be available, or if available, will be
      on
      acceptable terms. If the
      Company is unable to obtain sufficient funds during the next twelve months,
      the
      Company will further reduce the size of its organization and/or curtail
      operations which will have a material adverse impact on the Company’s business
      prospects. The consolidated financial statements do not include any adjustments
      that might result from the outcome of this uncertainty.




On
      November 3, 2006, the Company effected a one-for-ten (1-for-10) reverse stock
      split of its issued and outstanding common stock. See Note 9 to the Consolidated
      Financial Statements for a further discussion. All common share amounts and
      per
      share amounts in the accompanying financial statements and this Form 10-K have
      been adjusted to reflect the 1-for-10 reverse stock split. The Company has
      adjusted its shareholders’ equity accounts by reducing its stated capital and
      increasing its additional paid-in capital by approximately $91 thousand as
      of
      December 31, 2006, 2005 and 2004 to reflect the reduction in outstanding shares
      as a result of the reverse stock split.





***Use
      of estimates***





In
      accordance with accounting principles generally accepted in the United States
      of
      America, management utilizes certain estimates and assumptions that affect
      the
      reported amounts of assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. On an on-going basis, management evaluates its estimates
      and
      judgments. Management bases its estimates and judgments 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 could differ from those estimates.





***Revenue
      and cost recognition*** **





Revenue
      is recognized when products are shipped to customers, net of allowances for
      anticipated returns.  The Company’s revenue-earning
      activities generally involve delivering products and revenues
      are considered to be earned when the Company has completed the process
      by which it is entitled to such revenues.
      Revenue is recognized when persuasive evidence of
      an arrangement exists, delivery has occurred, selling price is
      fixed or determinable and collection is reasonably assured. The Company defers
      revenue recognition on products sold directly to the consumer with a fifteen
      day
      right of return. Revenue is recognized upon the expiration of the right of
      return.





The
      Company also earns revenues from certain of eMagin's
      R&D activities under
      both firm fixed-price contracts and cost-type
      contracts, including some cost-plus-fee contracts. 
Revenues relating to firm fixed-price contracts are
      generally recognized on the percentage-of-completion method
      of accounting as costs are incurred (cost-to-cost basis). 
Revenues on cost-plus-fee contracts include costs incurred plus a
      portion of estimated fees or profits based on the relationship of costs incurred
      to total estimated costs. Contract costs include all direct material and
      labor costs and an allocation of allowable indirect costs as
      defined by each contract, as periodically adjusted to reflect revised
      agreed upon rates. These rates are subject to audit by the other party. 
Amounts can be billed on a bi-monthly basis.






35





***Research
      and development expenses***





Research
      and development costs are expensed as incurred.





***Cash
      and cash equivalents***





All
      highly liquid instruments with an original maturity of three months or less
      at
      the date of purchase are considered to be cash equivalents.





***Investments-held
      to maturity***





Securities
      that the Company has the positive intent and ability to hold to maturity are
      classified as held-to-maturity and are carried at amortized cost on the
      accompanying balance sheet.





***Accounts
      receivable***





The
      majority of the Company’s commercial accounts receivable is due from Original
      Equipment Manufacturers ("OEM’s”). Credit is extended based on evaluation of a
      customers' financial condition and, generally, collateral is not required.
      Accounts receivable are payable in U.S. dollars, are due within 30-90 days
      and
      are stated at amounts due from customers net of an allowance for doubtful
      accounts. Any account outstanding longer than the contractual payment terms
      is
      considered past due.





***Allowance
      for doubtful account*** **





The
      allowance for doubtful accounts reflects an estimate of probable losses inherent
      in the accounts receivable balance. The allowance is determined based on a
      variety of factors, including the length of time receivables are past due,
      historical experience, the customer's current ability to pay its obligation,
      and
      the condition of the general economy and the industry as a whole. The Company
      will record a specific reserve for individual accounts when the Company becomes
      aware of a customer's inability to meet its financial obligations, such as
      in
      the case of bankruptcy filings or deterioration in the customer's operating
      results or financial position. If circumstances related to customers change,
      the
      Company would further adjust estimates of the recoverability of
      receivables.





***Inventory*** **





Inventory
      is stated at the lower of cost or market. Cost is determined using the first-in
      first-out method. Cost includes materials, labor, and manufacturing overhead
      related to the purchase and production of inventories. The Company regularly
      reviews inventory quantities on hand, future purchase commitments with the
      Company’s suppliers, and the estimated utility of the inventory. If the Company
      review indicates a reduction in utility below carrying value, the inventory
      is
      reduced to a new cost basis.





***Equipment,
      furniture and leasehold improvements***





Equipment,
      furniture and leasehold improvements are stated at cost. Depreciation on
      equipment is calculated using the straight-line method of depreciation over
      its
      estimated useful life. Amortization of leasehold improvements is calculated
      by
      using the straight-line method over the shorter of their estimated useful lives
      or lease terms. Expenditures for maintenance and repairs are charged to expense
      as incurred.





In
      accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
      Long-Lived Assets," the Company performs impairment tests on its long-lived
      assets when circumstances indicate that their carrying amounts may not be
      recoverable. If required, recoverability is tested by comparing the estimated
      future undiscounted cash flows of the asset or asset group to its carrying
      value. Impairment losses, if any, are recognized based on the excess of the
      assets' carrying amounts over their estimated fair values.





***Intangible
      Assets***





The
      Company’s intangible assets consist of patents that are amortized over their
      estimated useful lives of fifteen years using the straight line method. Total
      intangible amortization expense was approximately $4 thousand, $4 thousand,
      and
      $2 thousand for the years ended December 31, 2006, 2005, and 2004,
      respectively.






36





***Advertising***





Costs
      related to advertising and promotion of products is charges to sales and
      marketing expense as incurred. Advertising expense for the years ended December
      31, 2006, 2005 and 2004 were $296 thousand, $108 thousand, and $0,
      respectively.





***Income
      taxes***





The
      Company accounts for income taxes in accordance with the provisions of Statement
      of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS
      No. 109”). SFAS No. 109 requires that the Company recognize deferred tax
      liabilities and assets for the expected future tax consequences of events that
      have been included in the financial statements or tax returns. Under this
      method, deferred tax liabilities and assets are determined on the basis of
      the
      difference between the tax basis of assets and liabilities and their respective
      financial reporting amounts (“temporary differences”) at enacted tax rates in
      effect for the years in which the temporary differences are expected to reverse.
      The Company records an estimated valuation allowance on its deferred income
      tax
      assets if it is not more than likely that these deferred income tax assets
      will
      be realized.





***Loss
      per common share***





In
      accordance with SFAS No. 128, "Basic Earnings Per Share", net loss per common
      share amounts ("basic EPS") is computed by dividing net loss by the weighted
      average number of common shares outstanding and excluding any potential
      dilution. Net loss per common share amounts assuming dilution ("diluted EPS")
      reflects the potential dilution from the exercise of stock options and warrants.
      These common equivalent shares have been excluded from the computation of
      diluted EPS for all periods presented as their effect is antidilutive. The
      years
      ended December 31, 2006, 2005, and 2004 do not include options and warrants
      to
      purchase 4,613,919, 4,424,988 and 3,517,739 respectively, of common equivalent
      shares, as their effect would be antidilutive.





***Comprehensive
      income (loss)***





SFAS
      No.
      130, "Reporting Comprehensive Income", requires companies to report all changes
      in equity during a period, except those resulting from investment by owners
      and
      distributions to owners, for the period in which they are recognized.
      Comprehensive income (loss) is the total of net income (loss) and other
      comprehensive income (loss) items, such as unrealized gains or losses on foreign
      currency translation adjustments. Comprehensive income (loss) must be reported
      on the face of the annual financial statements. The Company's operations did
      not
      give rise to any material items includable in comprehensive income (loss),
      which
      were not already in net loss for the years ended December 31, 2006, 2005, and
      2004. Accordingly, the Company's comprehensive loss is the same as its net
      income (loss) for the periods presented.





***Stock-based
      compensation*** **





On
      January 1, 2006, the Company adopted the provisions of SFAS No. 123R,
“Share-Based Payment”, which requires the Company to recognize expense related
      to the fair value of the Company’s share-based compensation issued to employees
      and directors. Prior to January 1, 2006, the Company accounted for share-based
      compensation under the recognition and measurement provisions of
      APB No. 25 and related interpretations, as permitted by SFAS No. 123.
      We adopted SFAS No. 123R using the modified prospective transition method.
      Accordingly, periods prior to adoption have not been restated. Compensation
      cost
      recognized for the twelve months ended December 31, 2006 includes a)
      compensation cost for all share-based compensation granted prior to, but not
      vested as of January 1, 2006, based on the grant-date fair value estimated
      in
      accordance with the original provisions of SFAS No.123 and b) compensation
      cost
      for all share-based compensation granted beginning January 1, 2006, based on
      the
      grant-date fair value estimated in accordance with the provisions of SFAS
      No.123R. The compensation cost was recognized using the straight-line
      attribution method. See Note 10 for
      a
      further discussion on stock-based compensation .





***Fair
      value of financial instruments*****





At
      December 31, 2006, the Company's cash, cash equivalents, accounts receivable,
      short-term investments and accounts payable are shown at cost which approximates
      fair value due to the short-term nature of these instruments.





**Note
      3- RECEIVABLES**





Receivables
      consisted of the following (in thousands):





**December
                31,****2006**
            
            **2005**Trade
                receivables
            
            $
            1,351
            
            $
            1,309Less
                allowance for doubtful accounts
            
            
            (443
            )
            
            (487
            )Net
                receivables
            
            $
            908
            
            $
            822





37


**Note
      4 - INVENTORY**





The
      components of inventories were as follows (in thousands):





**December
                31,****2006**
            
            **2005**Raw
                materials
            
            $
            1,146
            
            $
            2,353Work
                in process
            
            
            558
            
            
            107Finished
                goods
            
            
            781
            
            
            1,379Total
                Inventory
            
            $
            2,485
            
            $
            3,839





**Note
      5 - EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS**





Equipment,
      furniture and leasehold improvements consist of the following (in thousands):





**December
                31,****2006**
            
            **2005**Computer
                hardware and software
            
            $
            1,017
            
            $
            893Lab
                and factory equipment
            
            
            3,312
            
            
            3,182Furniture,
                fixtures, and office equipment
            
            
            306
            
            
            256Assets
                under capital leases
            
            
            66
            
            
            66Leasehold
                improvements
            
            
            473
            
            
            473Construction
                in progress
            
            
            ---
            
            
            100Total
                equipment, furniture and leasehold improvements
            
            
            5,174
            
            
            4,970Less:
                accumulated depreciation
            
            
            (4,508
            )
            
            (3,671
            )Equipment,
                furniture and leasehold improvements, net
            
            $
            666
            
            $
            1,299





Depreciation
      expense was $837, $904 and $617 for the years ended December 31, 2006, 2005,
      and
      2004, respectively. Assets under capital leases are fully
      amortized.





**Note
      6 - DEBT**





Debt
      is
      as follows (in thousands):





**December
                31,****2006**
            
            **2005****Current
                portion of long-term debt:**Capitalized
                lease obligations
            
            $
            6
            
            $
            16Other
                debt
            
            
            586%
                Senior Secured Convertible Notes
            
            
            2,880
            
            
            —Less:
                Unamortized discount on notes payable
            
            
            (1,721
            )
            
            —Current
                portion of long-term debt, net
            
            
            1,223
            
            
            16**Long-term
                debt:**Capitalized
                lease obligations
            
            
            —
            
            
            6Other
                debt
            
            
            104
            
            
            506%
                Senior Secured Convertible Notes
            
            
            2,890
            
            
            —Less:
                Unamortized discount on notes payable
            
            
            (765
            )
            
            —Long-term
                debt, net
            
            
            2,229
            
            
            56Total
                debt, net
            
            $
            3,452
            
            $
            72





Maturities
      with respect to the capitalized lease obligation, other debt and the 6% Senior
      Secured Convertible Notes as of December 31, 2006 are as follows (in
      thousands):





Years
                Ending December 31,2007
            
            $
            2,9442008
            
            $
            2,9342009
            
            $
            60





On
      July
      21, 2006, the Company entered into several Note Purchase Agreements for the
      sale
      of approximately $5.99 million of senior secured debentures (the “Notes”)
      together with warrants to purchase approximately 1.8 million shares of common
      stock, par value $.001 per share. 50% of the aggregate principal amount matures
      on July 21, 2007 and the remaining 50% matures on January 21, 2008. The Notes
      pay 6% per annum interest quarterly beginning September 1, 2006. Interest of
      approximately $124 thousand was paid to investors in the year ended December
      31,
      2006.







38


The
      Company accounted for the net proceeds from the issuance of the Notes as two
      separate components: a detachable warrant component and a debt component.
 The Company determined the relative fair value of warrants to be $3.4
      million which was recorded


as
      debt
      discount, a reduction of the carrying value of the Notes. The following
      assumptions were used to determine the fair value of the warrants:





Dividend
                yield
            
            
            0
            %Risk
                free interest rates
            
            
            4.99
            %Expected
                volatility
            
            
            122
            %Expected
                term (in years)
            
            
            5.0
                years


The
      discount is being amortized to interest expense using the straight-line method
      as it approximates the effective interest method over the term of the Notes.
      For
      the twelve months ended December 31, 2006, debt discount of $956 thousand was
      amortized to interest expense. See
      Note
      9.





The
      Notes
      have specific terms that the Company must adhere to, i.e. maintaining minimum
      cash and cash equivalent balances and trading its stock on specific Exchanges.
      On March 9, 2007, the terms of the Note were amended to allow the Company to
      trade its common stock on the Over-The-Counter Bulletin Board and also requiring
      the Company to maintain cash and cash equivalent balances of $200,000 from
      February 26, 2007 through March 31, 2007. Subsequent to March 31, 2007, the
      company must maintain cash and cash equivalent balances of $600,000. On March
      12, 2007, the Company was suspended from trading on the AMEX and is currently
      trading the Company’s common stock on the Over-The Counter Bulletin Board. The
      delisting from the AMEX triggered a compliance condition on the notes payable.
      As a result the Company is required to pay the noteholders monthly interest
      at
      1% on the outstanding principal of the notes payable. The Company received
      a
      waiver from the noteholders that allows the Company to accrue the interest
      and
      delay the interest payment until the earliest of the Company (i) completing
      $2
      million of debt or equity financing or (ii) the occurrence of a Repurchase
      Event
      per the note. On March 27, 2007, the cash and cash equivalents balances
      requirement was amended to maintain cash and cash equivalents balances of
      $200,000 from April 1, 2007 through May 15, 2007. Subsequent to May 15, 2007,
      the Company must maintain $600,000 in cash and cash equivalent balances.





**Note
      7 - DEBT SETTLEMENT AND DEBT CONVERSION**





In
      February 2004, eMagin entered into an agreement whereby the holders of eMagin’s
      Secured Convertible Notes (the "Notes"), which were due in November 2005, agreed
      to an early conversion of all of the $7.8 million principal amount of the Notes,
      together with the $.742 million of accrued interest on the Notes, into 1,139,462
      shares of common stock of eMagin. On the date of the conversion the Company
      recorded $1.6 million in interest expense related to the unamortized debt
      discount and beneficial conversion feature and $75 thousand in interest expense
      related to the write-off of deferred financing costs.





In
      consideration of the Noteholders agreeing to the early conversion of the Notes,
      eMagin issued the Noteholders warrants to purchase an aggregate of 250,000
      shares of common stock (the "Warrants"), which Warrants are exercisable at
      a
      price of $27.60 per share. 150,000 of the Warrants, "D warrants", were
      exercisable until December 31, 2005. The remaining 100,000 of the Warrants,
      "E
      warrants", are exercisable until June 10, 2008. Using the Black-Scholes method
      of valuating warrants, an expense totaling $3.18 million was recorded in
      interest expense in the first quarter of 2004 to record an estimated value
      for
      these warrants. The fair value of the warrants was estimated at $23.00 using
      the
      Black-Scholes option-pricing model with the following assumptions for the two
      sets of warrants: (1) average expected volatility of 100%, (2) average risk-free
      interest rates of 3.52%, (3) dividends of 0%, and (4) Average Term (in days)
      of
      670 for the D warrants and 1,460 for the E warrants.





**Note
      8 - INCOME TAXES**





The
      difference between the statutory federal income tax rate on the Company's
      pre-tax income and the Company's effective income tax rate is summarized as
      follows:




**For
                the years ended December 31,****2006**
            
            **2005**
            
            **2004**U.S.
                Federal income tax provision (benefit) at federal statutory
                rate
            
            (34)
                %
            
            (35)
                %
            
            (35)
                %Change
                in valuation allowance
            
            32
                %
            
            35
                %
            
            35
                %Permanent
              difference
            
            2 %
            
            0
                %
            
            0
                %





39


Significant
      components of eMagin's deferred tax assets and liabilities are as follows
      (numbers are in thousands):


**For
                the years ended December 31,****2006**
            
            **2005**
            
            **2004**Net
                operating losses
            
            $
            53,974
            
            $
            54,607
            
            $
            39,262Goodwill
                and other intangibles
            
            
            14,422
            
            
            17,957
            
            
            19,894Allowance
                for doubtful accounts
            
            
            159
            
            
            195
            
            
            274Deferred
                payroll
            
            
            13
            
            
            18
            
            
            25Accrued
                vacation payable
            
            
            132
            
            
            142
            
            
            81Depreciation
            
            
            (44
            )
            
            (120
            )
            
            ----Stock
              compensation
            
            
            279
            
            
            ----
            
            
            ----Total
            
            
            68,935
            
            
            72,799
            
            
            59,536Less
                valuation allowance
            
            
            (68,935
            )
            
            (72,799
            )
            
            (59,536
            )Net
                deferred tax asset
            
            $
            0
            
            $
            0
            
            $
            0





As
      of
      December 31, 2006, eMagin has federal and state net operating loss carryforwards
      of approximately $149.9  million that will be available to offset
      future taxable income, if any, through December 2026. The utilization of net
      operating losses is subject to a substantial limitation due to the change of
      ownership provisions under Section 382 of the Internal Revenue Code and similar
      state provisions. Such limitation may result in the expiration of the net
      operating losses before their utilization. As of December 31, 2006 and 2005,
      the
      Company has gross deferred tax assets of approximately of $68 and $73
      million**,**respectively,
      primarily resulting from the future tax benefit of net operating loss
      carryforwards and temporary differences relating to amortization of intangible
      assets. Such net deferred tax assets are fully offset by a
      federal valuation allowance due to the uncertainty as to their
      realizability. A federal  valuation allowance has been established to
      reserve for the deferred tax assets arising from the net operating losses and
      other temporary differences due to the uncertainty that their benefit will
      be
      realized in the future. The federal valuation allowance decreased
      approximately $3.9 million for the year ended December 31, 2006 and increased
      $13.3 million for the year ended December 31, 2005.





**Note
      9 - SHAREHOLDERS' EQUITY**





***Common
      Stock***





***2006***




At
      the
      Company’s 2006 Annual Meeting of Shareholders held on October 20, 2006, the
      Company’s shareholders approved an amendment to the Company’s certificate of
      incorporation to effect a reverse stock split of the issued and outstanding
      common stock on a ratio of 1-for-10. On November 3, 2006, the reverse stock
      split became effective. The Company has adjusted its shareholders’ equity
      accounts by reducing its stated capital and increasing its additional paid-in
      capital by approximately $91 thousand as of December 31, 2006, 2005 and 2004
      to
      reflect the reduction in outstanding shares as a result of the reverse stock
      split.





On
      July
      21, 2006, the Company entered into several Note Purchase Agreements for the
      sale
      of approximately $5.99 million of senior secured debentures (the “Notes”) and
      warrants to purchase approximately 1.8 million shares of common stock, par
      value
      $.001 per share. The investors purchased $5.99 million principal amount of
      Notes
      with conversion prices of $2.60 per share that may convert into approximately
      2.3 million shares of common stock and 5 year warrants exercisable at $3.60
      per
      share into approximately 1.6 million shares of common stock. If the Notes are
      not converted, 50% of the principal amount will be due on July 21, 2007 and
      the
      remaining 50% will be due on January 21, 2008. Commencing September 1, 2006,
      6%
      interest is payable in quarterly installments on outstanding notes. For the
      year
      ended December 31, 2006, the Company paid approximately $124,000 of interest
      to
      investors. The Company received approximately $5.4 million, net of deferred
      financing costs of approximately $0.6 million which are amortized over the
      life
      of the Notes. The Company amortized approximately $221 thousand of deferred
      financing costs in 2006. For the year ended December 31, 2006, two note holders
      converted their promissory notes valued at approximately $220 thousand and
      were
      issued an aggregate of approximately 85,000 shares.




An
      additional $0.5 million was to be invested through the exercise of a warrant
      to
      purchase approximately 192,000 shares of common stock at $2.60 per share on
      or
      prior to December 14, 2006, or at the election of the Company, by the purchase
      of additional Notes and warrants. The Company determined the relative fair
      value
      of the warrants to be approximately $157,000 which was recorded as an other
      asset. The following assumptions were used to determine the fair value of the
      warrant:





Dividend
                yield
            
            
            0
            %Risk
                free interest rates
            
            
            5.25
            %Expected
                volatility
            
            
            122
            %Expected
                term (in years)
            
            
            0.4
                years


The
      investor elected not to exercise its warrants prior to December 14, 2006. The
      fair value of the warrants which was recorded as an other asset was written
      off
      as a sales, general and administrative expense.






40





Under
      EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to and
      Potentially Settled in, a Company’s Own Stock”, the fair value of the warrants,
      $3.6 million, have been recorded as a liability since the warrant agreement
      requires a potential net-cash settlement in the first year of the warrant
      agreement if the registration statement is not effective. As of December 31,
      2006, the registration statement is effective. The liability will be adjusted
      to
      fair value at each reporting period. The change in the fair value of the
      warrants will be recorded in the Consolidated Statement of Operations as other
      income (expense). For the twelve months ended December 31, 2006, the Company
      recorded approximately $2.4 million of gain from the change in the fair value
      of
      the derivative liability.





In
      connection with the Notes, a registration rights agreement was entered into
      which requires the Company to file a registration statement for the resale
      of
      the common stock underlying the Notes and the warrants. The Company must use
      its
      best efforts to have the registration statement declared effective by the end
      of
      a specified grace period and also maintain the effectiveness of the registration
      statement until all shares of common stock underlying the Notes and the warrants
      have been sold or may be sold without volume restrictions pursuant to Rule
      144(k) of the Securities Act. If the Company fails to have the registration
      statement declared effective within the grace period or fails to maintain the
      effectiveness as set forth in the preceding sentence, the Company is required
      to
      pay each investor cash payments equal to 1.0% of the aggregate purchase price
      monthly until the failure is cured. If the Company fails to pay the liquidated
      damages, interest at 16.0% will accrue until the liquidated damages are paid
      in
      full. The registration statement was filed and declared effective by the
      Securities and Exchange Commission within the specified grace period. As of
      December 31, 2006, the registration statement remains effective.





The
      Company accounts for the registration rights agreement as a separate
      freestanding instrument and accounts for the liquidated damages provision as
      a
      derivative liability subject to SFAS 133. The estimated fair value of the
      derviative liability is based on an estimate of the probability and costs of
      cash penalties being incurred. The Company determined that the fair value of
      the
      liability was immaterial and it is not recorded in accrued liabilities. The
      Company will revalue the potential liability at each balance sheet
      date.





As
      a
      result of the issuance of the Notes, the outstanding 116,576 Series A Common
      Stock Purchase Warrants, that were issued to certain accredited and/or
      institutional investors pursuant to the Securities Purchase Agreement dated
      January 9, 2004, were re-priced from $5.50 to $2.60 and the outstanding 650,001
      Series F Common Stock Purchase Warrants, that were issued to certain accredited
      and/or institutional investors pursuant to the Securities Purchase Agreement
      dated October 25, 2004, were re-priced from $10.90 to $8.60.





For
      the
      year ended December 31, 2006, the Company received approximately $10,000 for
      the
      exercise of 5,000 options and there were no warrants exercised. For year ended
      December 31, 2006, the Company issued approximately 254,000 shares of common
      stock in lieu of cash payments in the amount of approximately $580,000 as
      compensation for services rendered and to be rendered in the future. 
The fair value of the services was measured at market value of the common stock
      at the time of payment. As such, the Company recorded the fair value of the
      services rendered in selling, general and administrative expenses in the
      accompanying audited consolidated statement of operations for the year ended
      December 31, 2006.





The
      2004
      Non-Employee Compensation Plan (the “2004 Plan”) was established to help the
      Company retain consultants, professionals and service providers. The Board
      of
      Directors will select the recipient of the awards, the nature of the awards
      and
      the amount. At the 2006 Annual Shareholder meeting, the shareholders approved
      an
      increase in the number of authorized shares of common stock usable from 200,000
      to 950,000. This number is subject to adjustment in the event of a
      recapitalization, reorganization or similar event.





***2005***





On
      October 20, 2005, the Company entered into a Securities Purchase Agreement,
      pursuant to which the Company sold and issued 1,661,906 shares of common stock,
      par value $0.001 per share, at a price of $5.50 per share and warrants to
      purchase up to 997,143 shares of common stock for an aggregate purchase price
      of
      approximately $9.14 million. The net proceeds received after expenses were
      approximately $8.4 million.





The
      warrants are exercisable at a price of $10.00 per share and expire on April
      20,
      2011. Of the 997,143 warrants, 664,763 of the warrants are exercisable on or
      after May 20, 2006. The remaining 332,381 are exercisable after March 31, 2007,
      however these warrants will be cancelled if the Company’s net revenue for fiscal
      year 2006 exceeds $20 million or if the investor has sold more than 25% of
      the
      shares purchased under the securities purchase agreement prior to December
      31,
      2006.





As
      a
      result of the above transaction, the outstanding 121,335 Series A Common Stock
      Purchase Warrants, that were issued to participants of the Securities Purchase
      Agreement dated January 9, 2004, were re-priced from $10.50 to $5.50 and the
      outstanding 650,001 Series F Common Stock Purchase Warrants, that were issued
      to
      participants of the Securities Purchase Agreement dated October 25, 2004, were
      re-priced from $12.10 to $10.90.





A
      registration rights agreement was entered into in connection with the private
      placement which requires the Company to file a registration statement for the
      resale of the common stock and the shares underlying the warrants. The Company
      must use its best efforts to have the registration statement declared effective
      by the end of a specified grace period and also maintain the effectiveness
      of
      the registration statement until all common stock have been sold or may be
      sold
      without volume restrictions pursuant to Rule 144(k) of the Securities Act.
      If
      the Company fails to have the registration statement declared effective within
      the grace period or fails to maintain the effectiveness, the agreement requires
      the Company to pay each investor cash payments equal to 2.0% of the aggregate
      purchase price monthly until the failure is cured. If the Company fails to
      pay
      the liquidated damages, interest at 15.0% will accrue until the liquidated
      damages are paid in full. The registration statement was filed and declared
      effective within the specified grace period. As of December 31, 2006, the
      registration statement remains effective.






41





The
      Company accounts for the registration rights agreement as a separate
      freestanding instrument and accounts for the liquidated damages provision as
      a
      derivative liability subject to SFAS 133. The estimated fair value of the
      liability is based on an estimate of the probability and costs of cash penalties
      being incurred. The Company determined that the fair value of the liability
      was
      immaterial and it is not recorded in accrued liabilities. The Company will
      revalue the potential liability at each balance sheet date.





In
      2005,
      the Company received approximately $1.6 million for the exercise of
      approximately 11,100 options and 306,000 warrants. The Company also issued
      approximately 54,300 shares of common stock for the payment of $461,000 of
      services rendered and to be rendered in the future. The fair value of the
      services was measured at market value of the common stock at the time of
      payment. As such, the Company recorded the fair value of the services rendered
      in selling, general and administrative expenses in the accompanying audited
      consolidated statement of operations for the year ended December 31, 2005.





***2004***





On
      January 9, 2004, the Company entered into a Securities Purchase Agreement with
      several accredited institutional and private investors whereby such investors
      purchased an aggregate of 333,336 shares of common stock and 431,221 warrant
      shares for an aggregate purchase price of approximately $4.2 million.





The
      shares of common stock were priced at a 20% discount to the average closing
      price of the stock from December 30, 2003 to January 6, 2004, which ranged
      from
      $13.80 to $19.40 per share during the period for an average closing price of
      $12.60 per share. In addition, the investors received warrants to purchase
      an
      aggregate of 200,002 shares of common stock (subject to anti-dilution
      adjustments) exercisable at a price of $17.40 per share for a period of five
      (5)
      years. The warrants were priced at a 10% premium to the average closing price
      of
      the stock for the pricing period.





In
      connection with the Securities Purchase Agreement, eMagin also issued additional
      warrants to the investors to acquire an aggregate of 231,219 shares of common
      stock. 120,691 of such warrants are exercisable, within 6 months from the
      effective date of the registration statement covering these securities, at
      a
      price of $17.40 per share (a 10% premium to the average closing price of the
      stock for the pricing period), and 110,528 of such warrants are exercisable
      within 12 months from the effective date of the registration statement covering
      these securities, at a price of $19.00 per share (a 20% premium to the average
      closing price of the stock for the pricing period).





The
      Company also entered into a registration rights agreement with the
      aforementioned investors with respect to the common stock issued and common
      stock issuable upon the exercise of the warrants. A registration rights
      agreement was entered into in connection with the private placement which
      requires the Company to file a registration statement for the resale of the
      common stock and the shares underlying the warrants. The Company must use its
      best efforts to have the registration statement declared effective by the end
      of
      a specified grace period and also maintain the effectiveness of the registration
      statement until all common stock have been sold or may be sold without volume
      restrictions pursuant to Rule 144(k) of the Securities Act. If the Company
      fails
      to have the registration statement declared effective within the grace period
      or
      fails to maintain the effectiveness, the agreement requires the Company to
      pay
      each investor cash payments equal to 2.0% of the aggregate purchase price
      monthly until the failure is cured. If the Company fails to pay the liquidated
      damages, interest at 15.0% will accrue until the liquidated damages are paid
      in
      full. The registration statement was filed and declared effective within the
      specified grace period. As of December 31, 2006, the registration statement
      remains effective.





The
      Company accounts for the registration rights agreement as a separate
      freestanding instrument and accounts for the liquidated damages provision as
      a
      derivative liability subject o SFAS 133. The estimated fair value of the
      liability is based on an estimate of the probability and costs of cash penalties
      being incurred. The Company determined that the fair value of the liability
      was
      immaterial and it is not recorded in accrued liabilities. The Company will
      revalue the potential liability at each balance sheet date.





In
      February 2004, the Company and all of the holders of the Secured Convertible
      Notes (the "Notes"), which were due in November 2005, entered into an agreement
      whereby the holders agreed to an early conversion of 100% of the principal
      amount of the Notes aggregating $7.825 million, together with all of the accrued
      interest of approximately $742,000 on the Notes, into 1,139,462 shares of the
      Company's common stock. The listing of the shares issuable pursuant to such
      agreement was approved by the American Stock Exchange.





In
      consideration of the Noteholders agreeing to the early conversion of the Notes,
      eMagin agreed to issue the Noteholders warrants to purchase an aggregate of
      250,000 shares of common stock (the "warrants"), which warrants are exercisable
      at a price of $27.60 per share. 150,000 of the warrants (series D warrants)
      are
      exercisable until the later of (i) twelve (12) months from the date upon which
      a
      registration statement covering the shares issuable upon exercise of the
      Warrants is declared effective by the Securities and Exchange Commission, or
      (ii) December 31, 2005. The remaining 100,000 of the warrants (series E
      warrants) are exercisable until June 10, 2008. Using the Black-Scholes method
      of
      valuating warrants, an expense totaling $3.18 million was recorded in interest
      expense during 2004 to record an estimated fair value of these warrants. The
      fair value of the warrants, $3.18 million, was estimated at $23.00 using the
      Black-Scholes option-pricing model with the following assumptions for the two
      sets of warrants: (1) average expected volatility of 100%, (2) average risk-free
      interest rates of 3.52%, (3) dividends of 0%, and (4) Average Term (in days)
      of
      670 for the series D warrants and 1,460 for the series E warrants.






42





In
      connection with the above conversion, eMagin also entered into a Registration
      Rights Agreement with the holders of the Notes providing the holders with
      certain registration rights under the Securities Act of 1933, as amended, with
      respect to the common stock issuable upon exercise of the warrants.





In
      August
      2004, the Company and certain of the holders of its outstanding Class A, B
      and C
      common stock purchase warrants entered into an agreement pursuant to which
      the
      Company and the holders of the warrants agreed to the $9.00 re-pricing and
      exercise of Class A, B and C common stock purchase warrants. As a condition
      to
      the transaction, the holders of the warrants agreed to limit the right of
      participation that they were granted in January 9, 2004. As a result of the
      transaction, the holders agreed to re-price and exercise approximately, 209,989
      Class A, B and/or C common stock purchase warrants for an aggregate of
      $1,889,900.





On
      October 21, 2004, the Company entered into a Securities Purchase Agreement,
      pursuant to which eMagin sold and issued 1,033,453 shares of common stock,
      and
      series F common stock warrants to purchase 512,976 of common stock for an
      aggregate purchase price of $10,772,500. The common
      stock was
      priced at $10.50. The common stock and the shares underlying the warrants were
      drawn-down off of a shelf registration statement which was filed by the Company
      on May 5, 2004, and declared effective by the Securities and Exchange Commission
      on June 10, 2004. Net proceeds received after deducting expenses was
      approximately $9.75 million.





The
      Series F Warrants are exercisable from April 25, 2005 until April 25, 2010
      at an
      exercise price of $12.10 per share, subject to adjustment upon the occurrence
      of
      specific events, including stock dividends, stock splits, combinations or
      reclassifications of the Company’s common stock or distributions of cash or
      other assets. In addition, the Series F Warrants contain provisions protecting
      against dilution resulting from the sale of additional shares of the Company’s
      common stock for less than the exercise price of the Series F Warrants, or
      the
      market price of the common stock, on the date of such issuance or sale.





On
      October 28, 2004, eMagin entered into a Securities Purchase Agreement, pursuant
      to which eMagin sold and issued 274,048 shares of common stock, and series
      F
      common stock purchase warrants to purchase eMagin’s common stock to purchasers
      for an aggregate purchase price of $2,877,500. The common stock was priced
      at
      $10.50. The common stock and the shares underlying the warrants were drawn-down
      off of a shelf registration statement which was filed by us on May 5, 2004,
      and
      declared effective by the Securities and Exchange Commission on June 10, 2004.
      Net proceeds received after deducting expenses was approximately $2.65 million.





The
      Series F Warrants are exercisable from April 25, 2005 until April 25, 2010
      to
      purchase up to 137,024 shares of common stock at an exercise price of $12.10
      per
      share, subject to adjustment upon the occurrence of specific events, including
      stock dividends, stock splits, combinations or reclassifications of eMagin’s
      common stock or distributions of cash or other assets. In addition, the Series
      F
      Warrants contain provisions protecting against dilution resulting from the
      sale
      of additional shares of eMagin’s common stock for less than the exercise price
      of the Series F Warrants, or the market price of the common stock, on the date
      of such issuance or sale.





As
      a
      result of the above transaction, 121.335 outstanding Series A Common Stock
      Purchase Warrants, that were issued to participants of the Securities Purchase
      Agreement dated January 9, 2004, were re-priced from $17.40 to $10.50.





The
      Company paid a Placement Agent $814,000, a fee equal to 6% of the gross proceeds
      of these offerings.





In
      addition, the Company engaged Larkspur Capital Corporation, a Related Party,
      to
      act as an adviser in connection with the sale of these securities. For such
      services, the Company paid Larkspur Capital Corporation a fee of $136,500,
      an
      amount equal to 1% of the gross proceeds of these offerings and 9,326 warrants.





In
      2004,
      the Company received $5,173,945 for the exercise of 552,105 options and 353,335
      warrants.





The
      Company also issued 38,602 shares of common stock for the payment of $531,031
      for services rendered and to be rendered in the future. The fair value of the
      services was measured at market value of the common stock at the time of
      payment. As such, the Company recorded the fair value of the services rendered
      in selling, general and administrative expenses in the accompanying audited
      consolidated statement of operations for the year ended December 31, 2004.





**Note
      10 - STOCK COMPENSATION**





***Employee
      stock purchase plan***





In
      2005,
      the stockholders approved the 2005 Employee Stock Purchase Plan (“ESPP”). The
      ESPP provides the Company’s employees with the opportunity to purchase common
      stock through payroll deductions. Employees purchase stock semi-annually at
      a
      price that is 85% of the fair market value at certain plan-defined dates. At
      December 31, 2006, the number of shares of common stock available for issuance
      was 150,000 and the plan will automatically increase 75,000 shares on January
      1
      of each year for a period of three years starting January 1, 2006. As of
      December 31, 2006, the plan had not been implemented.





43


***Incentive
      compensation plans***





In
      1994,
      the Company established the 1994 Stock Plan (the "1994 Plan"). The plan provided
      for the granting of options to purchase an aggregate of 1,286,000 shares of
      the
      common stock to employees and consultants. This Plan expired in 2004.





In
      2000,
      the Company established the 2000 Stock Option Plan (the "2000 Plan"). The Plan
      permits the granting of options and stock purchase rights to employees and
      consultants of the Company. The 2000 Plan allows for the grant of incentive
      stock options meeting the requirements of Section 422 of the Internal Revenue
      Code of 1986 (the "Code") or non-qualified stock options which are not intended
      to meet such requirements.





In
      2003,
      the Company established the 2003 Stock Option Plan (the "2003 Plan"). The 2003
      Plan provided for the granting of options to purchase an aggregate of 9,200,000
      shares of the common stock to employees and consultants. On July 2, 2003, the
      shareholders approved the plan and the 2003 Plan was subsequently amended by
      the
      Board of Directors on July 2, 2003 to reduce the number of additional shares
      that may be provided for issuance under the "evergreen" provisions of the 2003
      Plan. The amended 2003 Plan provides for an increase of 2,000,000 shares in
      January 2004 and an annual increase on January 1 of each year for a period
      of
      nine (9) years commencing on January 1, 2005 of 3% of the diluted shares
      outstanding. The shareholders approved an amendment to the 2003 Plan to provide
      grants of shares of common stock in addition to options to purchase shares
      of
      common stock. In 2005, approximately 2.4 million shares were added to the plan.





Vesting
      terms of the options range from immediate vesting to a ratable vesting period
      of
      5 years. Option activity for the years ended December 31, 2006, 2005 and 2004
      is
      summarized as follows:




**Number
                of Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Life (In Years)**
            
            **Aggregate
                Intrinsic Value**Balances
                at December 31, 2003
            
            
            1,216,177
            
            $
            5.30Options
                granted
            
            
            677,990
            
            
            16.00Options
                exercised
            
            
            (16,146
            )
            
            2.70Options
                cancelled
            
            
            (522,105
            )
            
            11.20Balances
                at December 31, 2004
            
            
            1,355,916
            
            $
            11.40Options
                granted
            
            
            582,400
            
            
            9.60Options
                exercised
            
            
            (11,059
            )
            
            3.40Options
                cancelled
            
            
            (121,993
            )
            
            13.90Balances
                at December 31, 2005
            
            
            1,805,264
            
            $
            10.90Options
                granted
            
            
            185,744
            
            
            4.30Options
                exercised
            
            
            (5,000
            )
            
            2.10Options
                forfeited
            
            
            (453,115
            )
            
            7.47Options
                cancelled
            
            
            (467,148
            )
            
            11.97Balances
                at December 31, 2006
            
            
            1,065,745
            
            $
            2.94
            
            
            3.75
            
            $
            ------Vested
                or expected to vest at December 31, 2006 (1)
            
            
            991,143
            
            $
            2.94
            
            
            3.75
            
            $
            ------Exercisable
                at December 31, 2006
            
            
            711,310
            
            $
            2.93
            
            
            3.01
            
            $
            ------





At
      December 31, 2006, there were 1,069,423 shares available for grant under the
      2003 Plan and the 2000 Plan.





44


The
      following table summarizes information about stock options outstanding at
      December 31, 2006:





**Options
                Outstanding**
            
            **Options
                Exercisable****Number
                Outstanding**
            
            
            
            
            
            **Weighted
                Average Remaining Contractual Life (In Years**)****
            
            
            **Weighted
                Average Exercise Price**
            
            
            **Number
                Exercisable**
            
            
            **Weighted
                Average Exercisable Price**$2.10
                - $2.70
            
            
            925.689
            
            
            4.04
            
            $
            2.57
            
            
            590,894
            
            $
            2.54$3.40
                - $5.80
            
            
            105,924
            
            
            1.09
            
            
            3.69
            
            
            100,424
            
            
            3.58$6.60
                - $22.5
            
            
            34,132
            
            
            4.31
            
            
            10.59
            
            
            19,992
            
            
            11.161,065,745
            
            
            3.75
            
            $
            2.94
            
            
            711,310
            
            $
            2.93





(1)
      The
      expected to vest options are the result of applying the pre-vesting forfeiture
      rate assumptions to total outstanding options.





The
      aggregate intrinsic value in the table above represents the difference between
      the exercise price of the underlying options and the quoted price of the
      Company’s common stock for the options that were in-the-money. As of December
      31, 2006 there were no options that were in-the-money. The Company’s closing
      stock price was $1.04 as of December 31, 2006. The Company issues new shares
      of
      common stock upon exercise of stock options.





On
      July
      21, 2006, certain employees and Directors of the Company agreed to cancel
      approximately 467,000 shares underlying existing stock options in return for
      the
      re-pricing of approximately 869,000 existing options at $2.60 per share having
      a
      weighted average original exercise price of $11.97. Option grants that have
      not
      been re-priced will remain unchanged. The unvested options which were re-priced
      will continue to vest on original vesting schedules, but in no event vest prior
      to January 19, 2007. Previously vested options which were re-priced will now
      vest on January 19, 2007. Re-priced grants will be forfeited if the individual
      leaves voluntarily. The Company has accounted for the re-pricing and
      cancellation transactions as a modification under SFAS No. 123R. The Company
      will recognize the additional compensation charges over the four months ended
      January 19, 2007 for previously vested options and over the remaining vesting
      period for unvested options. Incremental cost was $171 thousand and the amount
      recognized in 2006 was $118 thousand, net of forfeitures.




At
      the
      Company’s 2006 Annual Meeting of Shareholders held on October 20, 2006, the
      Company’s shareholders approved an amendment to the Company’s Certificate of
      Incorporation to effect a reverse stock split of the Company’s outstanding
      common stock at an exchange ratio of one-for-ten. On November 3, 2006, the
      reverse stock split became effective. Each holder of ten shares of the Company’s
      common stock became the holder of one share of the Company’s common stock. In
      addition, all outstanding options, warrants, and convertible notes were adjusted
      in accordance with their terms and pursuant to the ratio of the reverse split.
      All fractional shares were rounded up to the next whole number of shares.





***Stock
      based compensation***





On
      January 1, 2006, the Company adopted the provisions of SFAS No. 123R, which
      requires the Company to recognize expense related to the fair value of the
      Company’s share-based compensation issued to employees and directors. Prior to
      January 1, 2006, the Company accounted for share-based compensation under the
      recognition and measurement provisions of APB No. 25 and related
      interpretations, as permitted by SFAS No. 123. The Company adopted SFAS No.
      123R
      using the modified prospective transition method. Accordingly, periods prior
      to
      adoption have not been restated. Compensation cost recognized for the twelve
      months ended December 31, 2006 includes a) compensation cost for all share-based
      compensation granted prior to, but not vested as of January 1, 2006, based
      on
      the grant-date fair value estimated in accordance with the original provisions
      of SFAS No.123 and b) compensation cost for all share-based compensation granted
      beginning January 1, 2006, based on the grant-date fair value estimated in
      accordance with the provisions of SFAS No.123R. The compensation cost was
      recognized using the straight-line attribution method.





The
      following table summarizes the allocation of stock-based compensation to expense
      categories for the year ended December 31, 2006 (in thousands):





**For
                the year ended**
              **December
                31, 2006**Cost
                of revenue
            
            $
            343Research
                and development
            
            
            435Selling,
                general and administrative
            
            
            2,113Total
                stock compensation expense
            
            $
            2,891





For
      the
      year ended December 31, 2006, stock compensation was approximately $2.9 million.
      At December 31, 2006, total unrecognized compensation costs related to stock
      options was approximately $3.4 million, net of estimated forfeitures. Total
      unrecognized compensation cost will be adjusted for future changes in estimated
      forfeitures and is expected to be recognized over a weighted average period
      of
      approximately 5.3 years.






45





The
      Company recognizes compensation expense for options granted to non-employees
      in
      accordance with the provision of Emerging Issues Task Force (“EITF”) consensus
      Issue 96-18, “Accounting for Equity Instruments that are Issued to Other Than
      Employees for Acquiring, or in Conjunction with Selling Goods or Services,”
which requires using a fair value options pricing model and re-measuring such
      stock options to the current fair market value at each reporting period as
      the
      underlying options vest and services are rendered.





In
      determining the fair value of stock options granted during the twelve month
      periods ended December 31, 2006, 2005, and 2004, the following key assumptions
      were used in the Black-Scholes option pricing model:





**For
                the years ended December 31,****2006**
            
            **2005**
            
            **2004**Dividend
                yield
            
            0%
            
            0%
            
            0%Risk
                free interest rates
            
            4.59%
                - 4.82%
            
            4.4%
            
            3.6%Expected
                volatility
            
            123%
                - 126%
            
            126%
            
            139%Expected
                term ( in years)
            
            5
                years
            
            5
                years
            
            5
                years





We
      have
      not declared or paid any dividends and do not currently expect to do so in
      the
      near future. The risk-free interest rate used in the Black-Scholes is based
      on
      the implied yield currently available on U.S. Treasury securities with an
      equivalent term. Expected volatility is based on the weighted average historical
      volatility of the Company’s common stock for the most recent five year period.
      The expected term of options represents the period that eMagin’s stock-based
      awards are expected to be outstanding and was determined based on historical
      experience and vesting schedules of similar awards.





The
      following table shows the proforma effect on eMagin’s net loss and net loss per
      share had compensation expense been determined based on the fair value at the
      award grant date in accordance with SFAS No. 123 for the twelve months ended
      December 31, 2005 and 2004 (in thousands, except per share data):





**For
                the years ended**
              **December
                31,****2005**
            
            **2004**Net
                loss applicable to common stockholders, as reported
            
            $
            (16,528
            )
            $
            (12,711
            )Add:
                Stock-based employee compensation expense included in reported net
                loss
            
            
            ----
            
            
            88Deduct: 
                Stock-based employee compensation expense determined under fair value
                method
            
            
            (3,035
            )
            
            (1,743
            )Pro
                forma net loss
            
            $
            (19,563
            )
            $
            (14,366
            )Net
                loss per share:Basic
                and diluted, as reported
            
            $
            (1.94
            )
            $
            (1.98
            )Basic
                and diluted, pro forma
            
            $
            (2.29
            )
            $
            (2.23
            )







46





***Warrants***





At
      December 31, 2006, 3,548,174 warrants to purchase shares of common stock are
      outstanding and exercisable at exercise prices ranging from $2.60 to $27.60
      and
      expiration dates ranging from June 20, 2007 to February 27, 2012.





**Outstanding
                Warrants****Shares**
            
            **Weighted
                Average Exercise Price**Balances
                at December 31, 2003
            
            
            1,233,629
            
            $
            8.00Warrants
                granted
            
            
            1,335,587
            
            
            16.90Warrants
                exercised
            
            
            (353,335
            )
            
            15.20Warrants
                cancelled
            
            
            (54,058
            )
            
            11.20Balances
                at December 31, 2004
            
            
            2,161,823
            
            $
            11.40Warrants
                granted
            
            
            997,143
            
            
            10.00Warrants
                exercised*
            
            
            (370,820
            )
            
            6.10Warrants
                cancelled
            
            
            (168,421
            )
            
            26.70Balances
                at December 31, 2005
            
            
            2,619,725
            
            $
            10.20Warrants
                granted
            
            
            1,805,037
            
            
            3.49Warrants
                exercised
            
            
            —
            
            
            —Warrants
                expired
            
            
            (876,588
            )
            
            6.90Balances
                at December 31, 2006
            
            
            3,548,174
            
            $
            7.05*Cashless
                exercise - 647,619 warrants





**Note
      11 - RECENTLY ISSUED ACCOUNTING STANDARDS**





The
      Financial Accounting Standards Board (“FASB”) has issued interpretation No. 48,
“Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement
      No. 109” (“FIN 48”), regarding accounting for, and disclosure of, uncertain tax
      positions. FIN 48 clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise’s financial statements in accordance with FASB
      Statement 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 also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition. FIN 48 is effective for fiscal years beginning after December 15,
      2006. We do not anticipate that the adoption of this statement will have a
      material effect on the Company’s financial position or results of
      operation.





In
      September 2006, the SEC issued SAB 108. SAB 108 provides guidance on
      the consideration of the effects of prior year misstatements in quantifying
      current year misstatements for the purpose of a materiality assessment. SAB
      108
      establishes an approach that requires quantification of financial statement
      errors based on the effects of each of the Company’s balance sheet and statement
      of operations and the related financial statement disclosures. SAB 108
      permits companies to record the cumulative effect of initial adoption by
      recording the necessary “correcting” adjustments to the carrying values of
      assets and liabilities as of the beginning of that year with the offsetting
      adjustment recorded to the opening balance of retained earnings only if
      material. SAB 108 is effective for fiscal years ending on or after
      November 15, 2006.




In
      November 2004, the FASB issued Statement No. 151 (“SFAS 151”), “Inventory
      Costs, an Amendment of ARB No. 43, Chapter 4.”  SFAS 151 clarifies the
      accounting for abnormal amounts of idle facility expense, freight, handling
      costs and wasted material and requires that these items be recognized as current
      period charges.  SFAS 151 applies only to inventory costs incurred during
      periods beginning after the effective date and also requires that the allocation
      of fixed production overhead to conversion costs be based on the normal capacity
      of the production facilities.  SFAS 151 is effective beginning in fiscal
      2007. The Company does not believe that the adoption of SFAS 151 will have
      a material impact on its financial position or results of
      operations.




In
        June
        2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
        Corrections”, a replacement of APB No. 20, *“* Accounting
        Changes” (“APB No. 20”) and SFAS No. 3, “Reporting Accounting Changes
        in Interim Financial Statements” ** (“SFAS
        No. 3”). SFAS No. 154 changes the requirements for the accounting for
        and reporting of, a change in accounting principle. Previously, most voluntary
        changes in accounting principles required recognition of a cumulative effect
        adjustment within net income of the period of the change. SFAS No. 154
        requires retrospective application to prior periods’ financial statements,
        unless it is impracticable to determine either the period-specific effects
        or
        the cumulative effect of the change. SFAS No. 154 is effective for
        accounting changes made in fiscal years beginning after December 15, 2005;
        however, it does not change the transition provisions of any existing accounting
        pronouncements. The Company adopted the statement as of January 1,
        2006.




In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS
      157”). SFAS 157 provides guidance for using fair value to measure assets and
      liabilities. It also responds to investors’ requests for expanded information
      about the extent to which companies measure assets and liabilities at fair
      value, the information used to measure fair value, and the effect of fair value
      measurements on earnings. SFAS 157 applies whenever other standards require
      (or
      permit) assets or liabilities to be measured at fair value, and does not expand
      the use of fair value in any new circumstances. SFAS 157 is effective for
      financial statements issued for fiscal years beginning after November 15, 2007
      and is required to be adopted by the Company in the first quarter of 2008.
      The
      Company is evaluating the effect that the adoption of SFAS 157 will have on
      its
      consolidated results of operations and financial condition and is not yet in
      a
      position to determine such effects.






47





**Note
      12 - COMMITMENTS AND CONTINGENCIES**





***Royalties***





The
      Company, in accordance with a royalty agreement, is obligated to make minimum
      annual royalty payments to a corporation commencing January 1, 2001. The
      original minimum annual royalty due under this agreement was $32 thousand per
      year and it increased to a $125 thousand in 2005 and beyond. Under this
      agreement, the Company must pay a certain percentage of net sales of certain
      products, which percentages are defined in the agreement. The percentages are
      on
      a sliding scale depending on the amount of sales generated. Any minimum
      royalties paid may be credited against the amounts due based on the percentage
      of sales. The royalty agreement terminates upon the expiration of the
      last-to-expire issued patent.





For
      the
      years ended December 31, 2006, 2005, and 2004, royalty expense of approximately
      $515 thousand, $191 thousand and $194 thousand, respectively, is included in
      cost of goods sold.





***Operating
      leases***





The
      Company leases office facilities and office, lab and factory equipment under
      operating leases expiring through 2009. The Company currently has lease
      commitments for space in Hopewell Junction, New York and Bellevue, Washington.





The
      Company’s manufacturing facilities are leased from IBM in New York. eMagin
      leases approximately 40,000 square feet to house its equipment for OLED
      microdisplay fabrication and for research and development, an assembly area
      and administrative offices. In 2004, eMagin entered into an agreement to
      extend the term of the lease until 2009.





In
      July
      2005, eMagin signed a sub-lease agreement for approximately 19,000 square feet
      in Bellevue Washington. The leased space is used as the Company’s corporate
      headquarters. This lease will expire in 2009. The Company’s lease at the Redmond
      Washington location expired in August 2005 and was not renewed.





The
      future minimum lease payments through 2009 are as follows:





2007
            
            $
            1,4052008
            
            
            1,4442009
            
            
            538$
            3,387


Rent
      expense for the years ended December 31, 2006, 2005, and 2004 was approximately
      $1.3 million, $1.0 million, and $0.8 million, respectively. The Redmond lease
      was paid in common stock valued at $42 thousand and $48 thousand for the 2005
      and 2004 rent periods, respectively.





***Employee
      benefit plans***





eMagin
      has a defined contribution plan (the 401(k) Plan) under Section 401(k) of the
      Internal Revenue Code, which is available to all employees who meet established
      eligibility requirements. Employee contributions are generally limited to 15%
      of
      the employee's compensation. Under the provisions of the 401(k) Plan, eMagin
      may
      match a portion of the participating employees' contributions. There was no
      matching contribution to the 401(k) Plan for the years ended December 31, 2006,
      2005 and 2004.





***Legal
      proceedings***





On
      December 6, 2005, New York State Urban Development Corporation commenced action
      against eMagin in the Supreme Court of the State of New York, County of New
      York
      against eMagin, asserting breach of contract and seeking to recover a $150
      thousand grant which was made to eMagin based on goals set forth in the
      agreement for recruitment of employees. On July 13, 2006, eMagin agreed to
      a
      settlement with the New York State Urban Development Corporation to repay
      approximately $112 thousand of the $150 thousand grant. The settlement requires
      that repayments be made on a monthly basis in the amount of approximately $3
      thousand per month commencing August 1, 2006 and ending on July 1,
      2009.





**Note
      13 - RELATED PARTY TRANSACTIONS**





**2006**





On
      July
      21, 2006, the Company entered into several Note Purchase Agreements for the
      sale
      of approximately $5.99 million of senior secured debentures (the “Notes”) and
      warrants to purchase approximately 1.8 million shares of common stock, par
      value
      $.001 per share. The investors purchased $5.99 million principal amount of
      Notes
      with conversion prices of $2.60 per share that may convert into approximately
      2.3 million shares of common stock and 5 year warrants exercisable at $3.60
      per
      share into approximately 1.6 million shares of common stock. If the Notes are
      not converted, 50% of the principal amount will be due on July 21, 2007 and
      the
      remaining 50% will be due on January 21, 2008. Commencing September 1, 2006,
      6%
      interest is payable in quarterly installments on outstanding notes.






48





In
      the
      Note Purchase transaction, two employees and two board members participated.
      Olivier Prache, Senior VP of Display Operations, purchased a $30 thousand
      promissory note which may be converted into 11,539 shares and received 8,077
      warrants which are exercisable at $3.60 per share. Mr. Prache converted $20
      thousand of his promissory note and received 7,693 shares. John Atherly, CFO,
      purchased a $40 thousand promissory note which may be converted into 15,385
      shares and received 10,770 warrants exercisable at $3.60 per share. David
      Gottfried, board member, purchased a $250 thousand promissory note which may
      be
      converted into 96,154 shares and received 67,308 warrants exercisable at $3.60
      per share. Paul Cronson, board member, through Navacorp III, LLC purchased
      a
      $200 thousand promissory note which may be converted into 76,923 shares and
      received 53,847 warrants exercisable at $3.60 per share.





Stillwater
      is a beneficial owner of more than 5% of the Company’s common stock. Rainbow
      Gate Corporation, a corporation in which its investment manager is the sole
      member of Stillwater LLC and its controlling shareholder is the same as Ginola
      Limited, purchased a $700 thousand promissory note which may be converted into
      269,231 shares and received 188,462 warrants exercisable at $3.60 per share.
      Ginola Limited purchased an $800 thousand promissory note which may be converted
      into 307,693 shares and received 215,385 warrants exercisable at $3.60 per
      share. Stillwater LLC disclaims beneficial ownership of shares owned by Rainbow
      Gate Corporation.





A
      family
      member of an outside director of eMagin is the holder of a Series A warrant
      to
      purchase an aggregate of 4,286 shares of common stock. As a result of the Note
      Purchase transaction, the exercise price of all Series A warrants was reduced
      from $5.50 to $2.60 per share. Family members of an outside director of eMagin
      are holders of Series F warrants to purchase an aggregate of 10 thousand shares
      of common stock. As a result of the Note Purchase transaction, the exercise
      price of all Series F warrants was reduced from $10.90 to $8.60 per
      share.





eMagin
      has entered into a financial advisory agreement with Larkspur Capital
      Corporation. Paul Cronson, a director of eMagin, is a founder and shareholder
      of
      Larkspur Capital Corporation. The Company has agreed to pay a minimum fee of
      $500 thousand to Larkspur Capital Corporation in the event certain transactions
      occur, i.e. sale of the Company’s assets or change of control.





**2005**





On
      October 20, 2005, the Company entered into a Securities Purchase Agreement
      to
      sell to certain qualified institutional buyers and accredited investors an
      aggregate of 1,661,906 shares of eMagin’s common stock, par value $0.001 per
      share (the “Shares”), and warrants to purchase an additional 997,143 shares of
      common stock, for an aggregate purchase price of approximately $9.1 million.
      The
      purchase price of the common stock and corresponding warrant was $5.50 per
      share.





The
      warrants are exercisable at a price of $10.00 per share and expire on October
      20, 2010. Of the 997,143 warrants, 664,762 of the warrants are exercisable
      on or
      after May 20, 2006. The remaining 332,380 are exercisable after March 31, 2007.
      Both Stillwater and Ginola are beneficial owners of more than 5% of the
      Company’s common stock.





Rainbow
      Gate Corporation, a corporation in which its investment manager is the sole
      member of Stillwater LLC and its controlling shareholder is the same as Ginola
      Limited, participated in the sale of equity pursuant to the Securities Purchase
      Agreement by investing $500 thousand. Stillwater LLC disclaims beneficial
      ownership of shares owned by Rainbow Gate Corporation.





Chelsea
      Trust Company, as trustee of a trust with the same directors and/or controlling
      shareholders as Ginola Limited, participated in the sale of equity pursuant
      to
      the Securities Purchase Agreement by investing $250 thousand. Ginola Limited
      disclaims beneficial ownership of shares owned by Chelsea Trust
      Company.





In
      connection with the issuance of the Shares and the warrants pursuant to the
      Securities Purchase Agreement, the Company was required to lower the exercise
      prices of existing Series A and F warrants from $10.50 and $12.10, respectively,
      to $5.50 and $10.90 per share, respectively, pursuant to the anti-dilution
      provisions of the Series A and F warrants.





A
      family
      member of an outside director of eMagin is the holder of a Series A warrant
      to
      purchase an aggregate of 4,286 shares of common stock. Accordingly, the exercise
      price of all Series A warrants was reduced from $10.50 to $5.50 per share.





**2004**





eMagin
      is
      party to a financial advisory and investment banking agreement with Larkspur
      Capital Corporation. Paul Cronson, a director of eMagin, is a founder and
      shareholder of Larkspur Capital Corporation. Larkspur Capital Corporation
      received as compensation for financial advisory and investment banking services
      in connection with the January 2004 private placement a cash fee of 6 3/4%
      of
      the funds raised and warrants to purchase eMagin shares of common stock equal
      to
      2.5% of the cash netted to eMagin. Approximately $284 thousand and 4,365 common
      stock purchase warrants exercisable at $24.10 per share which expire in January
      2009, were paid under the terms of the agreement. Paul Cronson was engaged
      as an
      advisor in connection with the sale of securities sold in October 2004 and
      received a fee of $136 thousand.






49





A
      family
      member of an outside director of eMagin participated in the Securities Purchase
      Agreement in January 2004's private placement in the amount of $90 thousand.





Stillwater
      LLC, a limited liability company and a beneficial owner of more than five
      percent of the outstanding shares of eMagin's common stock, held an aggregate
      of
      $4 million of the notes converted in February 2004. Ginola Limited, a beneficial
      owner of more than five percent of the outstanding shares of eMagin's common
      stock, held an aggregate of $1.3 million of the notes which were converted.
      An
      outside director of eMagin held $250 thousand of the notes converted.





A
      family
      member of an outside director of eMagin participated in the re-pricing of the
      Securities Purchase Agreement in August. 209,989 warrants were re-priced and
      exercised. The family member re-priced and exercised 2,586 B warrants and 2,368
      C warrants.





**Note
      14 - EMPLOYMENT AGREEMENTS**





On
      January 24, 2006, pursuant to actions taken by the Compensation Committee of
      the
      Board of Directors of eMagin Corporation (the “Company”), Gary Jones entered
      into a revised executive employment agreement, to conform to the recently
      established Sarbanes-Oxley requirements, in connection with his service as
      Chief
      Executive Officer and President of the Company. Additionally, Susan Jones
      entered into a revised executive employment agreement, to conform to the
      recently established Sarbanes-Oxley requirements, in connection with her service
      as the Company’s Chief Marketing and Strategy Officer, Executive Vice President
      and Corporate Secretary.





Each
      agreement is effective for an initial term of three years, effective January
      1,
      2006. The agreement provides for an annual salary, benefits made available
      by
      the Company to its employees and eligibility for an incentive bonus pursuant
      to
      one or more incentive compensation plans established by the Company from time
      to
      time. The Company may terminate the employment of Executive at any time with
      or
      without notice and with or without cause (as such term is defined in the
      agreement). If the Executive’s employment is terminated without cause, or
      if Executive resigns with good reason (as such term is defined in the
      agreement), or if Executive’s position is terminated or significantly changed as
      result of change of control (as such term is defined in the agreement),
      Executive shall be entitled to receive salary until the end of the agreement’s
      full term or twelve months, whichever is greater, payment for accrued vacation,
      and bonuses which would have been accrued during the term of the agreement.
      If
      Executive voluntarily terminates employment with the Company, other than for
      good reason or is terminated with cause (as such term is defined in the
      agreement), Executive shall cease to accrue salary, vacation, benefits, and
      other compensation on the date of the voluntary or with cause termination.
      The
      Executive Employment Agreement includes other conventional terms and also
      contains invention assignment, non-competition, non-solicitation and
      non-disclosure provisions.





On
      April
      17, 2006, the parties entered into amendments to the employment agreements
      pursuant to which the parties clarified that t he
      Company has agreed to pay for health benefits equivalent to medical and dental
      benefits provided during the executive’s full time employment until the end of
      the agreement’s full term or twenty-four (24) months, whichever is
      greater.





On
      January 11, 2007, Gary Jones resigned as the President, Chief Executive Officer,
      and as a Director of the Company. Mr. Jones and the Company entered into an
      Executive Separation and Consulting Agreement. See Note 16 - Subsequent Events
      for additional information.





In
      addition, on January 11, 2007, Dr. K.C. Park was appointed Interim Chief
      Executive Office, President, and a Director of the Company. Dr. Park entered
      into a Compensation Agreement with the Company on February 12, 2007. See Note
      16
      - Subsequent Events for additional information.





**Note
      15 - CONCENTRATIONS**





In
      2006
      eMagin had one customer that accounted for 13% of its total revenues. In
      2005
      eMagin had no customers that accounted for more than 10% of its total revenues.
      In 2004 eMagin had two customers that individually accounted for 17% and 15%
      of
      net revenues.





For
      the
      year ended December 31, 2006, approximately 59% of the Company's net revenues
      were made to customers in the United States and approximately 41% of the
      Company's net revenues were made to international customers. For the year ended
      December 31, 2005, approximately 49% of the Company's net revenues were made
      to
      customers in the United States and approximately 51% of the Company's net
      revenues were made to international customers. For the year ended December
      31,
      2004, approximately 78% of the Company's net revenues were made to customers
      in
      the United States and approximately 22% of the Company's net revenues were
      made
      to international customers.




At
      December 31, 2006, there were 5 customers which comprised 69% of the outstanding
      accounts receivable. At December 31, 2005, there
      were 2 customers which comprised 31% of the outstanding accounts
      receivable .
      At
      December 31, 2004, there were 3 customers which comprised 50% of the outstanding
      accounts receivable.






50





The
      Company purchases principally all of its silicon wafers from a single supplier
      located in Taiwan.





**Note
      16 - SUBSEQUENT EVENTS**





***Executive
      Separation and Consulting Agreement***





On
      January 11, 2007, Gary Jones resigned as the President, Chief Executive Officer,
      and as a Director of the Company. Mr. Jones and the Company entered into an
      Executive Separation and Consulting Agreement (“the Agreement”). Under the
      Agreement, the Company made a payment to Mr. Jones in an amount equal to: all
      accrued salary as of the date of the Agreement plus an additional 30 days of
      salary (approximately $47 thousand); 360 hours of unused vacation
      (approximately $55 thousand); advance for legal and accounting fees associated
      with 2004 stock options ($30 thousand); and an advance for future travel
      expenditures ($5 thousand). Mr. Jones also received 500 thousand shares of
      registered shares of common stock of the Company valued at $430 thousand. In
      his
      consulting relationship, Mr. Jones will be paid $460 thousand upon the
      consummation of a strategic transaction. The Company will provide up to $7.5
      thousand for reasonable moving expenses of personal property from the New York
      office. In addition, the Company will pay up to an additional $30 thousand
      to
      Mr. Jones related to personal legal fees.





***Compensation
      Agreement***





On
      January 11, 2007, Dr. K.C. Park was appointed Interim Chief Executive Office,
      President, and a Director of the Company. On February 12, 2007, the Company
      entered in a Compensation Agreement (“the Agreement”) with Dr. Park. Under the
      Agreement, the Company has agreed to pay Dr. Park an annual base salary equal
      to
      $300 thousand plus a quarterly increase in his base salary in the amount of
      $12.5 thousand per fiscal quarter through December 31, 2007. The Company agreed
      to issue Dr. Park an aggregate of 250 thousand restricted shares of common
      stock
      within 10 business days of the completion of a change of control of the Company.
      In addition, if a change of control transaction is completed and Dr. Park is
      not
      offered a senior executive position in the new organization, the Company has
      agreed to pay Dr. Park three month’s salary.





***AMEX
      Delisting***





On
      October 9, 2006, the Company received notice from the American Stock Exchange
      (the “AMEX”) Listing Qualifications Department stating that the Company does not
      meet certain continued listing standards as set forth in Part 10 of the AMEX
      Company Guide (the “Company Guide”). Specifically, pursuant to a review by the
      AMEX of the Company’s 10-Q for the three and six months ended June 30, 2006, the
      AMEX has determined that the Company is not in compliance with Sections
      1003(a)(ii) and 1003(a)(iii) of the Company Guide, respectively, which state,
      in
      relevant part, that the AMEX will normally consider suspending dealings in,
      or
      removing from the list, securities of a company that (a) has stockholders'
      equity of less than $4.0 million if such company has sustained losses from
      continuing operations and/or net losses in three of its four most recent fiscal
      years; or (b) has stockholders' equity of less than $6.0 million if such company
      has sustained losses from continuing operations and/or net losses in its five
      most recent fiscal years, respectively.





On
      November 6, 2006, the Company submitted a plan advising the AMEX of actions
      that
      it will take, which may bring it into compliance with Sections 1003 (a)(ii)
      and
      1003(a)(iii) of the Company Guide within a maximum of 18 months of receipt
      of
      the notice letter. On January 5, 2007, the Company received notice from the
      staff of the AMEX indicating that it intends to strike the Company’s common
      stock from listing on AMEX by filing a delisting application with the Securities
      and Exchange Commission as it has determined that the Company has failed to
      comply with the continued listing standards. The Company requested a verbal
      hearing which was held on February 27, 2007.





On
      March
      1, 2007, the Company received notice from the AMEX indicating that the AMEX
      will
      initiate the delisting process with respect to the Company’s common stock. On
      March 12, 2007, in accordance with Part 12 of the Company Guide, the Company
      was
      suspended from trading on the AMEX. The Company is currently trading the
      Company’s common stock on the Over-the-Counter Bulletin Board under the symbol,
      EMAN.





The
      delisting from the AMEX triggered a compliance condition on the notes payable.
      As a result the Company is required to pay the noteholders monthly interest
      at
      1% on the outstanding principal of the notes payable. The Company received
      a
      waiver from the noteholders that allows the Company to accrue the interest
      and
      delay the interest payment until the earliest of the Company (i) completing
      $2
      million of debt or equity financing or (ii) the occurrence of a Repurchase
      Event
      per the note.






51





**Note
      17 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**





Summarized
      quarterly financial information for 2006 and 2005 are as follows (in thousands
      except per share data):





**Quarters
                Ended****March
                31, 2006**
            
            **June
                30, 2006**
            
            **September
                30, 2006**
            
            **December
                31, 2006**Revenues
            
            $
            1,641
            
            $
            1,674
            
            $
            2,292
            
            $
            2,562Gross
                margin (loss)
            
            $
            (1,388
            )
            $
            (1,291
            )
            $
            (648
            )
            $
            137Net
                loss
            
            $
            (5,160
            )
            $
            (4,838
            )
            $
            (3,769
            )
            $
            (1,499
            )Net
                loss per share - basic and diluted
            
            $
            (0.52
            )
            $
            (0.48
            )
            $
            (0.37
            )
            $
            (0.15
            )Shares
                used in per share calculation - basic and diluted
            
            
            10,004
            
            
            10,011
            
            
            10,077
            
            
            10,196**Quarters
                Ended****March
                31, 2005**
            
            
            **June
                30, 2005**
            
            
            **September
                30, 2005**
            
            
            **December
                31, 2005**Revenues
            
            $
            690
            
            $
            $652
            
            $
            $1,131
            
            $
            $1,272Gross
                loss
            
            $
            (1,267
            )
            $
            (1,737
            )
            $
            (1,555
            )
            $
            (1,915
            )Net
                loss
            
            $
            (3,469
            )
            $
            (4,498
            )
            $
            (3,763
            )
            $
            (4,798
            )Net
                loss per share - basic and diluted
            
            $
            (0.43
            )
            $
            (0.55
            )
            $
            (0.47
            )
            $
            (0.52
            )Shares
                used in per share calculation - basic and diluted
            
            
            8,143
            
            
            8,245
            
            
            8,304
            
            
            9,476










52





**ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE**





None.





**ITEM
      9A. CONTROLS AND PROCEDURES**





(a) ***Evaluation
      of Disclosure Controls and Procedures***





Based
      on
      an evaluation of our disclosure controls and procedures (as defined in
      Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
      1934, as amended) required by paragraph (b) of Rule 13a-15 or
      Rule 15d-15, as of December 31, 2006, our Chief Executive Officer and Chief
      Financial Officer have concluded that our disclosure controls and procedures
      were effective in ensuring that information required to be disclosed by us
      in
      the reports that we file or submit under the Exchange Act is recorded,
      processed, summarized and reported within the time periods specified in the
      Commission’s rules and forms. Our Chief Executive Officer and Chief
      Financial Officer also concluded that, as of December 31, 2006, our disclosure
      controls and procedures were effective in ensuring that information required
      to
      be disclosed by us in the reports that we file or submit under the Exchange
      Act
      is accumulated and communicated to our management, including our Chief Executive
      Officer and Chief Financial Officer, to allow timely decisions regarding
      required disclosure.




(b) ***Changes
      in Internal Controls***





During
      the period ended December 31, 2006, there were no changes in our internal
      control over financial reporting identified in connection with the evaluation
      required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has materially
      affected, or is reasonably likely to materially affect, our internal control
      over financial reporting.




**ITEM
      9B. OTHER INFORMATION**





None.





**PART
      III**




**ITEM
      10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE**




The
      information required by this item is incorporated by reference to eMagin’s Proxy
      Statement for its 2007 Annual Meeting of Stockholders to be filed with the
      SEC
      within 120 days after the end of the fiscal year ended December 31, 2006.




The
      information required by this item concerning our executive officers is set
      forth
      under the heading “Executive Officers” in Part I of this Annual Report on
      Form 10-K.




**ITEM
      11. EXECUTIVE COMPENSATION**




The
      information required by this item is incorporated by reference to eMagin’s Proxy
      Statement for its 2007 Annual Meeting of Stockholders to be filed with the
      SEC
      within 120 days after the end of the fiscal year ended December 31, 2006.





**ITEM
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS**




The
      information required by this item is incorporated by reference to eMagin’s Proxy
      Statement for its 2007 Annual Meeting of Stockholders to be filed with the
      SEC
      within 120 days after the end of the fiscal year ended December 31, 2006.




**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE**




The
      information required by this item is incorporated by reference to eMagin’s Proxy
      Statement for its 2007 Annual Meeting of Stockholders to be filed with the
      SEC
      within 120 days after the end of the fiscal year ended December 31, 2006.





**ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**




The
      information required by this item is incorporated by reference to eMagin’s Proxy
      Statement for its 2007 Annual Meeting of Stockholders to be filed with the
      SEC
      within 120 days after the end of the fiscal year ended December 31, 2006.





53


**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**





**(a)
      Financial Statements and Schedules**





1. ***Financial
      Statements***





The
      following consolidated financial statements are filed as part of this report
      under Item 8 of Part II “Financial Statements and Supplementary
      Data.:





A.
      Consolidated Balance Sheets at December 31, 2006 and 2005.


B.
      Consolidated Statements of Operations for the Years Ended December 31, 2006,
      2005, and 2004.


C.
      Consolidated Statements of Changes in Shareholders’ Equity (Deficit) for the
      Years Ended December 31, 2006, 2005, and 2004.


D.
      Consolidated Statements of Cash Flows for the Years Ended December 31, 2006,
      2005, and 2004.





2 *.* ***Financial
      Statement Schedules***





The
      following financial statement schedule is filed as part of this
      report:





A.
      Schedule II - Valuation and Qualifying Accounts





Financial
      statement schedules not included herein have been omitted because they are
      either not required, not applicable, or the information is otherwise included
      herein.





**(b)
      Exhibits**





The
      exhibits listed in the accompanying Index to Exhibits on pages 57 to 59 are
      filed or incorporated by reference as part of this Annual Report on Form 10-K.








54


**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized on this 2nd day of April, 2007.




**eMAGIN
                CORPORATION**By:
            /s/ 
K.C.
              ParkK.
              C. ParkInterim
              Chief
              Executive Officer










In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on April 2nd, 2007, on behalf of the registrant and in the
      capacities Indicated.








**Signature**
            
            **Title**/s/K.C.
                Park
            
            Interim
                President and Chief Executive Officer, DirectorK.C.
                Park
            
            (Principal
                Executive Officer)/s/
                John Atherly
            
            Chief
                Financial OfficerJohn
                Atherly
            
            (Principal
                Financial and Accounting Officer)/s/
                Adm. Thomas Paulsen
            
            Chairman
                of the Board, DirectorAdm.
                Thomas Paulsen/s/
                Claude Charles
            
            DirectorClaude
                Charles/s/
                Paul Cronson
            
            DirectorPaul
                Cronson/s/
                Irwin Engelman
            
            DirectorIrwin
                Engelman/s/
                Dr. Jacob E. Goldman
            
            DirectorDr.
                Jacob E. Goldman/s/
                David Gottfried
            
            DirectorDavid
                Gottfried/s/
                Brig. Gen. Stephen Seay
            
            DirectorBrig.
                Gen. Stephen Seay





55


**eMAGIN
      CORPORATION**


**SCHEDULE
      II - VALUATION AND QUALIFYING ACCOUNTS**











**Allowance
      for doubtful accounts**





**Year
                Ended**
            
            **Beginning
                Balance**
            
            **Charged
                to Expenses**
            
            **Amounts
                Written Off**
            
            **Ending
                Balance**(In
                thousands)December
                31, 2004
            
            $
            (304
            )
            $
            (488
            )
            $
            21
            
            $
            (771
            )December
                31, 2005
            
            $
            (771
            )
            $
            164
            
            $
            120
            
            $
            (487
            )December
                31, 2006
            
            $
            (487
            )
            $
            —
            
            $
            44
            
            $
            (443
            )










56


**eMAGIN
      CORPORATION**


**INDEX
      TO EXHIBITS**





**Exhibit
                  Number**
              
              **Description**2.1
              
              Agreement
                  and Plan of Merger between Fashion Dynamics Corp., FED Capital
                  Acquisition
                  Corporation and FED Corporation dated March 13, 2000 (incorporated
                  by
                  reference to exhibit 2.1 to the Registrant's Current Report on
                  Form 8-K/A
                  filed on March 17, 2000).****3.1
              
              Amended
                  and Restated Articles of Incorporation (incorporated by reference
                  to
                  exhibit 99.2 to the Registrant's Definitive Proxy Statement filed
                  on June
                  14, 2001).****3.2
              
              Amended
                  Articles of Incorporation (incorporated by reference to exhibit
                  A to the
                  Registrant's Definitive Proxy Statement filed on June 13, 2003).3.3
              
              Bylaws
                  of the Registrant (incorporated by reference to exhibit 99.3 to
                  the
                  Registrant's Definitive Proxy Statement filed on June 14,
                  2001).4.1
              
              Form
                  of Warrant dated as of April 25, 2003 (incorporated by reference
                  to
                  exhibit 4.3 to the Registrant's Current Report on Form 8-K filed
                  on April
                  28, 2003).****4.2
              
              Form
                  of Series A Common Stock Purchase Warrant dated as of January 9,
                  2004
                  (incorporated by reference to exhibit 4.1 to the Registrant's Current
                  Report on Form 8-K filed on January 9, 2004).****4.3
              
              Form
                  of Series B Common Stock Purchase Warrant dated as of January 9,
                  2004
                  (incorporated by reference to exhibit 4.2 to the Registrant’s Current
                  Report on Form 8-K filed on January 9, 2004).****4.4
              
              Form
                  of Series C Common Stock Purchase Warrant dated as of January 9,
                  2004
                  (incorporated by reference to exhibit 4.3 to the Registrant's Current
                  Report on Form 8-K filed on January 9, 2004).****4.5
              
              Form
                   of Series D Warrant (incorporated by reference to exhibit 4.1
                  to the
                  Registrant's current report on Form 8-K filed on March 4,
                  2004).****4.6
              
              Form
                  of Series E Warrant (incorporated by reference to exhibit 4.2 to
                  the
                  Registrant's current report on Form 8-K filed on March 4,
                  2004).****10.1
              
              2000
                  Stock Option Plan, (incorporated by reference to exhibit 99.1 to
                  the
                  Registrant's Registration Statement on Form S-8 filed on March
                  14,
                  2000).*****10.2
              
              Form
                  of Agreement for Stock Option Grant pursuant to 2003 Stock Option
                  Plan
                  (incorporated by reference to exhibit 99.2 to the Registrant's
                  Registration Statement on Form S-8 filed on March 14, 2000).*****4.7
              
              Form
                  of Series F Warrant (incorporated by reference to exhibit 4.1 to
                  the
                  Registrant's current report on Form 8-K filed on October 26,
                  2004).4.8
              
              Form
                  of Common Stock Purchase Warrant dated October 20, 2005, filed
                  October 31,
                  2005, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.3
              
              Nonexclusive
                  Field of Use License Agreement relating to OLED Technology for
                  miniature,
                  high resolution displays between the Eastman Kodak Company and
                  FED
                  Corporation dated March 29, 1999 (incorporated by reference to
                  exhibit
                  10.6 to the Registrant's Annual Report on Form 10-K/A for the year
                  ended
                  December 31, 2000 filed on April 30, 2001).10.4
              
              Amendment
                  Number 1 to the Nonexclusive Field of Use License Agreement relating
                  to
                  the LED Technology for miniature, high resolution displays between
                  the
                  Eastman Kodak Company and FED Corporation dated March 16, 2000
                  (incorporated by reference to exhibit 10.7 to the Registrant's
                  Annual
                  Report on Form 10-K/A for the year ended December 31, 2000 filed
                  on April
                  30, 2001).10.5
              
              Lease
                  between International Business Machines Corporation and FED Corporation
                  dated May 28, 1999 (incorporated by reference to exhibit 10.9 to
                  the
                  Registrant's Annual Report on Form 10-K for the year ended December
                  31,
                  2000 filed on March 30, 2001).
   57
  10.6
              
              Amendment
                  Number 1 to the Lease between International Business Machines Corporation
                  and FED Corporation dated July 9, 1999 (incorporated by reference
                  to
                  exhibit 10.8 to the Registrant's Annual Report on Form 10-K for
                  the year
                  ended December 31, 2000 filed on
                March
                  30, 2001).10.7
              
              Amendment
                  Number 2 to the Lease between International Business Machines Corporation
                  and FED Corporation dated January 29, 2001 (incorporated by reference
                  to
                  exhibit 10.11 to the Registrant's Annual Report on Form 10-K for
                  the year
                  ended December 31, 2000 filed on March 30, 2001).10.8
              
              Amendment
                  Number 3 to Lease between International Business Machines Corporation
                  and
                  FED Corporation dated May 28, 2002.10.9
              
              Amendment
                  Number 4 to Lease between International Business Machines Corporation
                  and
                  FED Corporation dated December 14, 2004.10.10
              
              Registration
                  Rights Agreement dated as of April 25, 2003 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto
                  (incorporated by reference to exhibit 10.3 to the Registrant's
                  Current
                  Report on Form 8-K filed on April 28, 2003).10.11
              
              Securities
                  Purchase Agreement dated as of January 9, 2004 by and among eMagin
                  and the
                  investors identified on the signature pages thereto (incorporated
                  by
                  reference to exhibit 10.1 to the Registrant's Current Report on
                  Form 8-K
                  filed on January 9, 2004).10.12
              
              Registration
                  Rights Agreement dated as of January 9, 2004 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto
                  (incorporated by reference to exhibit 10.2 to the Registrant's
                  Current
                  Report on Form 8-K filed on January 9, 2004).10.13
              
              Master
                  Amendment Agreement dated as of February 17, 2004 by and among
                  eMagin and
                  the investors identified on the signature pages thereto (incorporated
                  by
                  reference to exhibit 10.1 to the Registrant's Current Report on
                  Form 8-K
                  filed on March 4, 2004).10.14
              
              Registration
                  Rights Agreement dated as of February 17, 2004 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto
                  (incorporated by reference to exhibit 10.2 to the Registrant's
                  Current
                  Report on Form 8-K filed on March 4, 2004).10.15
              
              Letter
                  Agreement amending the Master Amendment Agreement dated as of March
                  1,
                  2004 by and among eMagin and the parties to the Master Amendment
                  Agreement
                  (incorporated by reference to exhibit 10.3 to the Registrant's
                  Current
                  Report on Form 8-K filed on March 4, 2004).10.16
              
              Lease
                  between International Business Machines Corporation and FED Corporation
                  dated May 28, 1999, as filed in the Registrant's Form 10-K/A for
                  the year
                  ended December 31, 2000 incorporated by reference
                  herein.10.17
              
              Amendment
                  Number 2 to the Lease between International Business Machines Corporation
                  and FED Corporation dated January 29, 2001, as filed in the Registrant's
                  Form 10-K/A for the year ended December 31, 2000 incorporated by
                  reference
                  herein.10.18
              
              Secured
                  Note Purchase Agreement entered into as of November 27, 2001, by
                  and among
                  eMagin Corporation and certain investors named therein, as filed
                  in the
                  Registrant's Form 8-K dated December 18, 2001 incorporated herein
                  by
                  reference.10.19
              
              Securities
                  Purchase Agreement dated as of April 25, 2003 by and among eMagin
                  and the
                  investors identified on the signature pages thereto, filed April
                  28, 2003,
                  as filed in the Registrant's Form 8-K incorporated herein by
                  reference.10.20
              
              Registration
                  Rights Agreement dated as of April 25, 2003 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto
                  filed
                  April 28, 2003, as filed in the Registrant's Form 8-K incorporated
                  herein
                  by reference.10.21
              
              Securities
                  Purchase Agreement dated as of January 9, 2004 by and among eMagin
                  and the
                  investors identified on the signature pages thereto, filed January
                  9,
                  2004, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.22
              
              Registration
                  Rights Agreement dated as of January 9, 2004 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto.
                  Incorporated herein by reference to our January 9, 2004 Form
                  8-K.10.23
              
              Master
                  Amendment Agreement dated as of February 17, 2004 by and among
                  eMagin and
                  the investors identified on the signature pages thereto, filed
                  March 4,
                  2004, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.24
              
              Registration
                  Rights Agreement dated as of February 17, 2004 by and among eMagin
                  and
                  certain initial investors identified on the signature pages thereto,
                  filed
                  March 4, 2004, as filed in the Registrant's Form 8-K incorporated
                  herein
                  by reference.10.25
              
              Letter
                  Agreement amending the Master Amendment Agreement dated as of March
                  1,
                  2004 by and among eMagin and the parties to the Master Amendment
                  Agreement, filed March 4, 2004, as filed in the Registrant's Form
                  8-K
                  incorporated herein by reference.23.1
              
              Consent
                  of Independent Registered Public Accounting Firm.31.1
              
              Certification
                  by Chief Executive Officer pursuant to Sarbanes OxleySection
                  302.31.2
              
              Certification
                  by Chief Financial Officer pursuant to Sarbanes Oxley Section
                  302.32.1
              
              Certification
                  by Chief Executive Officer pursuant to 18 U.S. C. Section
                  1350.32.2
              
              Certification
                  by Chief Financial Officer pursuant to 18 U.S. C. Section
                  1350.
    58
  10.26
              
              2004
                  Non-Employee Compensation Plan, filed July 7, 2004, as filed in
                  the
                  Registrant’s Form S-8, incorporated herein by reference.*10.27
              
              Form
                  of Letter Agreement by and among eMagin and the holders of the
                  Class A,
                  Class B and Class C common stock purchase warrants, filed August
                  9, 2004,
                  as filed in the Registrant's Form 8-K incorporated herein by reference.10.28
              
              Securities
                  Purchase Agreement dated as of October 21, 2004 by and among eMagin
                  and
                  the purchasers listed on the signature pages thereto, filed October
                  26,
                  2004, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.29
              
              Placement
                  Agency Agreement dated as of October 21, 2004 by and among eMagin
                  and W.R.
                  Hambrecht & Co., LLC, filed October 26, 2004, as filed in the
                  Registrant's Form 8-K incorporated herein by reference.10.30
              
              Agreement,
                  dated as of June 29, 2004, by and between eMagin and Larkspur Capital
                  Corporation, filed October 26, 2004, as filed in the Registrant's
                  Form 8-K
                  incorporated herein by reference.10.31
              
              Amendment
                  No. 4 to Lease by and between eMagin and International Business
                  Machines
                  Corporation, filed December 20, 2004, as filed in the Registrant's
                  Form
                  8-K incorporated herein by reference.10.32
              
              Sublease
                  Agreement dated as of July 14, 2005 by and between eMagin andCapgemini
                  U.S., LLC, filed August 2, 2005,
                  as filed in the Registrant's Form 8-K incorporated herein by
                  reference.10.33
              
              Amended
                  and Restated 2003 Stock Option Plan, filed September 1, 2005, as
                  filed in
                  the Registrant’s Definitive Proxy Statement, incorporated herein by
                  reference.*10.34
              
              Amended
                  and Restated 2004 Non-Employee Compensation Plan, filed September
                  1, 2005,
                  as filed in the Registrant’s Definitive Proxy Statement, incorporated
                  herein by reference.*10.35
              
              2005
                  Employee Stock Purchase Plan, filed September 1, 2005, as filed
                  in the
                  Registrant’s Definitive Proxy Statement, incorporated herein by
                  reference.*10.36
              
              Securities
                  Purchase Agreement dated as of October 20, 2005, by and among eMagin
                  and
                  the purchasers listed on the signature pages thereto, filed October
                  31,
                  2005, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.37
              
              Registration
                  Rights Agreement dated as of October 20, 2005, by and among eMagin
                  and the
                  purchasers listed on the signature pages thereto, filed October
                  31, 2005,
                  as filed in the Registrant's Form 8-K incorporated herein by reference.
   59
  10.38
              
              Employment
                  Agreement effective as of January 1, 2006 by and between eMagin
                  and Gary
                  Jones, filed January 27, 2006, as filed in the Registrant's Form
                  8-K
                  incorporated herein by reference.10.39
              
              Employment
                  Agreement effective as of January 1, 2006 by and between eMagin
                  and Susan
                  Jones, filed January 27, 2006, as filed in the Registrant's Form
                  8-K
                  incorporated herein by reference.10.40
              
              Amendment
                  to Employment Agreement as of April 17, 2006 by and between eMagin
                  and
                  Gary Jones.10.41
              
              Amendment
                  to Employment Agreement as of April 17, 2006 by and between eMagin
                  and
                  Susan Jones.10.42
              
              Form
                  of Note Purchase Agreement dated July 21, 2006, by and among the
                  Company
                  and the investors named on the signature pages thereto,
                  filed July 25, 2006, as filed in the Registrant's Form 8-K incorporated
                  herein by reference.10.43
              
              Form
                  of 6% Senior Secured Convertible Note Due 2007-2008 of the Company
                  dated
                  July 21, 2006, filed July 25, 2006, as filed in the Registrant's
                  Form 8-K
                  incorporated herein by reference.10.44
              
              Form
                  of Common Stock Purchase Warrant of the Company dated July 21,
                  2006, filed
                  July 25, 2006, as filed in the Registrant's Form 8-K incorporated
                  herein
                  by reference.10.45
              
              Pledge
                  and Security Agreement dated as of July 21, 2006 by and between
                  the
                  Company and Alexandra Global Master Fund Ltd., as collateral agent,
                  filed
                  July 25, 2006, as filed in the Registrant's Form 8-K incorporated
                  herein
                  by reference.10.46
              
              Patent
                  and Trademark Security Agreement dated as of July 21, 2006 by and
                  between
                  the Company and Alexandra Global Master Fund Ltd., as collateral
                  agent,
                  filed July 25, 2006, as filed in the Registrant's Form 8-K incorporated
                  herein by reference.10.47
              
              Lockbox
                  Agreement dated as of July 21, 2006 by and between the Company
                  and
                  Alexandra Global Master Fund Ltd., as collateral agent, filed July
                  25,
                  2006, as filed in the Registrant's Form 8-K incorporated herein
                  by
                  reference.10.48
              
              Form
                  of Note Purchase Agreement dated July 21, 2006, by and between
                  the Company
                  and Stillwater LLC, filed July 25, 2006, as filed in the Registrant's
                  Form
                  8-K incorporated herein by reference.10.49*
              
              2004
                  Amended and Restated Non-Employee Compensation Plan, filed September
                  21,
                  2006, as filed in the Registrant's Definitive Proxy Statement incorporated
                  herein by reference.10.50
              
              Executive
                  Separation and Consulting Agreement dated as of January 11, 2007
                  by and
                  between eMagin Corporation and Gary W. Jones, filed January 19,
                  2007, as
                  filed in the Registrant's Form 8-K/A incorporated herein by
                  reference.10.51
              
              Letter
                  Agreement dated as of February 12, 2007 by and between eMagin Corporation
                  and Dr. K.C. Park, filed February 16, 2007, as filed in the Registrant's
                  Form 8-K incorporated herein by reference.10.52
              
              Allonge
                  to the 6% Senior Secured Convertible Notes Due 2007-2008 of eMagin
                  Corporation dated as of March 9, 2007, filed March 13, 2007, as
                  filed in
                  the Registrant's Form 8-K incorporated herein by
                  reference23.1
              
              Consent
                  of Independent Registered Public Accounting Firm.31.1
              
              Certification
                  by Chief Executive Officer pursuant to Sarbanes OxleySection
                  302.31.2
              
              Certification
                  by Chief Financial Officer pursuant to Sarbanes Oxley Section
                  302.32.1
              
              Certification
                  by Chief Executive Officer pursuant to 18 U.S.C. Section
                  1350.32.2
              
              Certification
                  by Chief Financial Officer pursuant to 18 U.S.C. Section
                  1350.*
                  Each of the Exhibits noted by an asterisk is a management compensatory
                  plan or arrangement.








60