United States
                       Securities and Exchange Commission
                             Washington, D.C. 20549
--------------------------------------------------------------------------------
                                    FORM 10-Q

(Mark One)

[X]   Quarterly  Report under Section 13 or 15(d) of the Securities and Exchange
      Act of 1934

                  For the quarterly period ended June 30, 2005

[_]   Transition report under Section 13 or 15(d) of the Exchange Act

           For the transition period from ____________ to ___________

                        Commission File Number 000-19828

                                SpatiaLight, Inc.
             (Exact name of registrant as specified in its charter)

           New York                                      16-1363082
           --------                                      ----------
(State or other jurisdiction of                (IRS Employer Identification No.)
  Incorporation or organization)

           Five Hamilton Landing, Suite 100, Novato, California 94949
           ----------------------------------------------------------
                    (Address of principal executive offices)

                                 (415) 883-1693
                                 --------------
                           (Issuer's telephone number)


      Check  whether  the issuer (1) filed all  reports  required to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing  requirements  for the past 90 days.  Yes [X] No
[_]

      Indicate by check mark whether the registrant is an accelerated  filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]


                      APPLICABLE ONLY TO CORPORATE ISSUERS:

      State the number of shares  outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 36,706,013 common shares as of
August 8, 2005.


                                       1
<PAGE>

                                SPATIALIGHT, INC.

                          Quarterly Report on Form 10-Q
                       For the Quarter Ended June 30, 2005


                                Table of Contents
                                -----------------

<TABLE>
<CAPTION>
PART I            FINANCIAL INFORMATION

<S>             <C>                                                                      <C>
      Item 1.   Condensed Consolidated Financial Statements (unaudited)

                Condensed Consolidated Balance Sheets as of
                June 30, 2005 and December 31, 2004........................................3

                Condensed Consolidated Statements of Operations
                for the Three and Six Months Ended June 30, 2005 and 2004..................4

                Condensed Consolidated Statement of Stockholders' Equity
                for the Six Months Ended June 30, 2005.....................................5

                Condensed Consolidated Statements of Cash Flows
                for the Six Months Ended June 30, 2005 and 2004............................6

                Notes to Condensed Consolidated Financial Statements.......................7

      Item 2.   Management's Discussion and Analysis
                of Financial Condition and Results of Operations..........................18

      Item 3.   Quantitative and Qualitative Disclosures about Market Risks...............37

      Item 4.   Controls and Procedures...................................................38

PART II  OTHER INFORMATION

      Item 2.   Changes in Securities and Use of Proceeds.................................41

      Item 4.   Submission of Matters to a Vote of Security Holders.......................41

      Item 5.   Other Information.........................................................42

      Item 6.   Exhibits and Reports on Form 8-K..........................................43

                Signatures................................................................44
</TABLE>


                                       2
<PAGE>

PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements

                                SPATIALIGHT, INC.
                     CONSDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                             June 30,      December 31,
                                                               2005            2004
                                                           ------------    ------------
                                                           (unaudited)
<S>                                                        <C>             <C>
ASSETS

Current assets
  Cash and cash equivalents                                   $    390,925    $  9,087,551
  Accounts receivable, net of allowance of $0 and
    $345,030 at June 30, 2005 and December 31, 2004,
    respectively                                                    79,424         264,053
  Inventory                                                      1,190,348       1,173,314
  Prepaids and other current assets                                942,281         949,711
  Prepaid non-cash interest to related party                     1,157,133         913,889
                                                              ------------    ------------
    Total current assets                                         3,760,111      12,388,518

Property, plant and equipment, net                               6,346,064         858,212
Construction in progress                                                --       2,801,521
Prepaid non-cash interest to related party                       2,892,831       3,474,386
Other assets                                                        73,398         123,774
                                                              ------------    ------------

   Total assets                                               $ 13,072,404    $ 19,646,411
                                                              ============    ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities

  Accounts payable                                            $  1,452,384    $    601,394
  Note purchase option liability                                     2,102         659,874
  Accrued expenses and other current liabilities                   770,199       2,533,546
                                                              ------------    ------------
  Total current liabilities                                      2,224,685       3,794,814

Senior secured and other convertible notes                      10,118,126       9,885,140
                                                              ------------    ------------

   Total liabilities                                            12,342,811      13,679,954
                                                              ------------    ------------

Commitments

Stockholders' equity
  Common stock, $.01 par value:
  50,000,000 shares authorized;
   36,088,513 and 35,326,436 shares issued and outstanding,
   at June 30, 2005 and December 31, 2004, respectively            360,885         353,264
Additional paid-in capital                                      73,696,122      69,384,146
Notes receivable                                                   (48,496)       (241,462)
Common shares issuable                                                  --       4,038,149
Other comprehensive income                                          35,266          73,562

Accumulated deficit                                            (73,314,184)    (67,641,202)
                                                              ------------    ------------
  Total stockholders' equity                                       729,593       5,966,457
                                                              ------------    ------------


Total liabilities and stockholders' equity                    $ 13,072,404    $ 19,646,411
                                                              ============    ============
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       3
<PAGE>

                                SPATIALIGHT, INC.
           CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

<TABLE>
<CAPTION>
                                                                       Three months ended June 30,      Six months ended June 30,
                                                                      ----------------------------    ----------------------------
                                                                          2005            2004            2005            2004
                                                                      ------------    ------------    ------------    ------------
<S>                                                                   <C>             <C>             <C>             <C>
Revenue                                                               $     41,149    $    540,775    $    138,908    $    859,875
Cost of revenue                                                             89,044         425,649         158,888         772,331
                                                                      ------------    ------------    ------------    ------------
      Gross margin                                                         (47,895)        115,126         (19,980)         87,544
                                                                      ------------    ------------    ------------    ------------

Selling, general and administrative expenses:
   Selling, general and administrative expenses                          1,772,227       1,479,858       3,481,792       2,485,803
   Stock-based general and administrative expenses                           8,250         218,250         107,300         261,174
                                                                      ------------    ------------    ------------    ------------
      Total selling, general and administrative expenses                 1,780,477       1,698,108       3,589,092       2,746,977

   Research and development expenses                                     1,165,634         569,798       1,659,130       1,251,558
                                                                      ------------    ------------    ------------    ------------

      Total operating expenses                                           2,946,111       2,267,906       5,248,222       3,998,535
                                                                      ------------    ------------    ------------    ------------

      Operating loss                                                    (2,994,006)     (2,152,780)     (5,268,202)     (3,910,991)
                                                                      ------------    ------------    ------------    ------------

Other income (expenses):
  Interest expense:
      Interest expense                                                    (267,775)        (18,301)       (534,910)        (36,120)
      Non-cash interest expense                                           (277,592)       (187,696)       (555,184)       (375,392)
                                                                      ------------    ------------    ------------    ------------
        Total interest expense                                            (545,367)       (205,997)     (1,090,094)       (411,512)
                                                                      ------------    ------------    ------------    ------------

  Other income:
        Gain from the revaluation of note purchase option liability          6,537              --         657,772              --
        Interest and other income                                            8,389          24,800          27,542          42,632
                                                                      ------------    ------------    ------------    ------------
          Total other income                                                14,926          24,800         685,314          42,632
                                                                      ------------    ------------    ------------    ------------

        Total other income (expenses)                                     (530,441)       (181,197)       (404,780)       (368,880)
                                                                      ------------    ------------    ------------    ------------

Net loss                                                              $ (3,524,447)   $ (2,333,977)   $ (5,672,982)   $ (4,279,871)
                                                                      ============    ============    ============    ============

Net loss per share - basic and diluted                                $      (0.10)   $      (0.07)   $      (0.16)   $      (0.13)
                                                                      ============    ============    ============    ============

Weighted average shares used in computing
 net loss per share- basic and diluted                                  35,965,774      33,153,429      35,892,277      32,955,434
                                                                      ============    ============    ============    ============
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       4
<PAGE>

                                SPATIALIGHT, INC.
      CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (unaudited)
                         SIX MONTHS ENDED JUNE 30, 2005

<TABLE>
<CAPTION>
                                                             COMMON STOCK       ADDITIONAL                    COMMON
                                                        ---------------------     PAID-IN       NOTES          STOCK
                                                          SHARES      AMOUNT      CAPITAL     RECEIVABLE     ISSUABLE
                                                        ----------   --------   -----------   ----------    -----------
<S>                                                     <C>          <C>        <C>           <C>           <C>
Balance, January 1, 2005                                35,326,436   $353,264   $69,384,146   $ (241,462)   $ 4,038,149

Exercise of stock options and warrants                     180,572      1,806        98,955           --             --

Issuance of common shares issuable                         581,505      5,815     4,032,334           --     (4,038,149)

Issuance of options below FMV to employees                      --         --        16,500           --             --

Issuance of warrants for
 services                                                       --         --       164,187           --             --

Repayment of notes receivable from stockholder                  --         --            --      200,000             --

Accrued interest on notes receivable from stockholder           --         --            --       (7,034)            --

Comprehensive loss:

  Foreign currency translation adjustment                       --         --            --           --             --

  Net loss                                                      --         --            --           --             --

    Total comprehensive loss                                    --         --            --           --             --
                                                        ----------   --------   -----------   ----------    -----------

Balance, June 30, 2005                                  36,088,513   $360,885   $73,696,122   $  (48,496)   $        --
                                                        ==========   ========   ===========   ==========    ===========

<CAPTION>
                                                           OTHER                           TOTAL
                                                        COMPREHEN-     ACCUMULATED     STOCKHOLDERS'
                                                        SIVE INCOME      DEFICIT          EQUITY
                                                        -----------   -------------    -------------
<S>                                                     <C>           <C>              <C>
Balance, January 1, 2005                                $    73,562   $ (67,641,202)   $   5,966,457

Exercise of stock options and warrants                           --              --          100,761

Issuance of common shares issuable                               --              --               --

Issuance of options below FMV to employees                       --              --           16,500

Issuance of warrants for
 services                                                        --              --          164,187

Repayment of notes receivable from stockholder                   --              --          200,000

Accrued interest on notes receivable from stockholder            --              --           (7,034)

Comprehensive loss:

  Foreign currency translation adjustment                   (38,296)             --          (38,296)

  Net loss                                                       --      (5,672,982)      (5,672,982)
                                                                                        -------------

    Total comprehensive loss                                     --              --       (5,711,278)
                                                        -----------   -------------    -------------

Balance, June 30, 2005                                  $    35,266   $ (73,314,184)   $     729,593
                                                        ===========   =============    =============
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       5
<PAGE>

                                SPATIALIGHT, INC.
           CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

<TABLE>
<CAPTION>
                                                                               Six months ended June 30,

                                                                                  2005           2004
                                                                              -----------    -----------
<S>                                                                           <C>            <C>
Cash flows from operating activities:
Net loss                                                                      $(5,672,982)   $(4,279,871)

Adjustments to reconcile net loss to net cash used by operating activities:
  Depreciation and amortization                                                   237,563        219,991
  Stock-based general and administrative expenses                                 107,300        261,174
  Non-cash interest expense                                                       555,184        375,392
  Gain from revaluation of note purchase option liability                        (657,772)            --
  Accrued interest on notes receivable from stockholder                            (7,034)       (28,332)
  Changes in operating assets and liabilities:
     Accounts receivable                                                          184,629       (709,400)
     Inventory                                                                    (17,034)      (131,744)
     Prepaid and other current assets                                              96,930       (226,072)
     Other assets                                                                  10,825         (4,100)
     Accounts payable                                                             850,990       (253,792)
     Accrued expenses and other current liabilities                            (1,149,412)        66,209
                                                                              -----------    -----------

             Net cash used in operating activities                             (5,460,813)    (4,710,545)
                                                                              -----------    -----------

Cash flows from investing activities:
  Acquisition of property, plant and equipment                                 (3,537,829)      (244,080)
                                                                              -----------    -----------

           Net cash used in investing activities                               (3,537,829)      (244,080)
                                                                              -----------    -----------

Cash flows from financing activities:
  Payments received from notes receivable                                         200,000             --
  Proceeds from exercise of warrants and options                                  100,761      1,070,210
                                                                              -----------    -----------

           Net cash provided by financing activities                              300,761      1,070,210
                                                                              -----------    -----------

Net decrease in cash and cash equivalents                                      (8,697,881)    (3,884,415)

Effect of exhange rate differences on cash                                          1,255             --

Cash and cash equivalents at beginning of period                                9,087,551      6,359,969
                                                                              -----------    -----------
Cash and cash equivalents at end of period                                    $   390,925    $ 2,475,554
                                                                              ===========    ===========

Non-cash financing activities:
  Common shares issued upon conversion of interest and notes                  $        --    $ 1,138,374
                                                                              ===========    ===========
  Warrants issued for fundraising services provided                           $    73,387    $        --
                                                                              ===========    ===========
</TABLE>

     See accompanying notes to condensed consolidated financial statements.


                                       6
<PAGE>

                               SPATIALIGHT, INC.
        Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1. Business Description

We are in the  business  of  manufacturing  high-resolution  liquid  crystal  on
silicon (LCoS)  microdisplays.  We are currently offering two types of products,
(i)  LCoS  Sets  and  (ii)  display  units,  to our  customers  and  prospective
customers,  who are located  primarily  in Asia.  We currently  manufacture  two
models  of our  LCoS  Sets.  The T-3  model  has a 1920  pixels  by 1080  pixels
configuration,  while the T-1 model has a lower resolution of 1280 pixels by 960
pixels configuration.

Our current customers and current  prospective  customers are original equipment
manufacturers  (OEMs) engaged in the businesses of manufacturing high definition
televisions  or  manufacturing   light  engines  for  incorporation   into  high
definition  televisions.  Our products are also suitable for incorporation  into
other  potential  display   applications   including  rear  projection  computer
monitors, wireless communication devices, portable games and digital assistants,
although we are not currently working with OEMs on any of these products.

Note 2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-Q and Article 10 of
Regulation  S-X.  Accordingly,  they do not include all of the  information  and
footnotes necessary for a fair presentation of financial  condition,  results of
operations and cash flows in conformity  with  accounting  principles  generally
accepted  in the United  States of America.  In our  management's  opinion,  the
interim condensed  consolidated  financial  statements included herewith contain
all  adjustments  (consisting  of normal  recurring  accruals  and  adjustments)
necessary  for  their  fair   presentation.   The  unaudited  interim  condensed
consolidated  financial statements should be read in conjunction with our Annual
Report on Form 10-K/A, which contains the audited financial statements and notes
thereto,  together with the Management's  Discussion and Analysis,  for the year
ended December 31, 2004. The interim  results for the period ended June 30, 2005
are not necessarily indicative of results for the full fiscal year.

Certain prior period amounts have been  reclassified  in order to conform to the
current period presentation.

Note 3. Liquidity

From  inception  through June 30, 2005, we have  sustained  recurring net losses
from operations  totaling  approximately $73.3 million and at June 30, 2005, had
total  equity  of  approximately   $0.7  million  and  net  working  capital  of
approximately $1.5 million. During the three and six months ended June 30, 2005,
we experienced net cash outflows of approximately $3.7 million and $8.7 million,
respectively.  We recognized  net losses for the three and six months ended June
30, 2005, of approximately $3.5 million and $5.7 million, respectively.

We expect to meet our cash needs and fund our working capital  requirements with
our existing cash balances and from certain  additional  sources.  Those sources
include proceeds of approximately $2.7 million that we received from the sale of
500,000  of our  common  shares on August  5,  2005 from a  currently  effective
"shelf"  registration  statement,  as more  fully  described  in Note 12.  Other
anticipated sources are cash payments from our customers, the exercises of stock
options and warrants and additional  sales of our common shares from the "shelf"
registration statement. There can be no assurances with


                                       7
<PAGE>

respect to these potential sources. In addition,  the purchasers in the November
2004 Financing have the option,  which expires on August 31, 2005, to lend us an
additional $5 million on the same terms as the November 2004 Financing,  as more
fully  described in Note 7. It is uncertain  whether the November 2004 Financing
purchasers  will  exercise  this option.  Robert A. Olins,  our Chief  Executive
Officer and a director  and  Greenpark  Limited,  an  unaffiliated  shareholder,
jointly and severally committed to provide us with additional  financing as more
fully described in Note 7. We believe that our current cash and cash equivalents
as of June 30,  2005,  combined  with the  proceeds  from the August 2005 Equity
Financing  and the  financing  commitment  from  Robert A.  Olins and  Greenpark
Limited will be sufficient to meet our capital and  liquidity  requirements  for
our operations through at least the second quarter of 2006.

Note 4. Stock-Based Compensation

We account for our  stock-based  compensation  arrangements  for  employees  and
directors  using the intrinsic  value method  pursuant to Accounting  Principles
Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." As such,
compensation  expense is recorded when, on the date of grant,  the fair value of
the underlying common shares exceeds the exercise price for stock options or the
purchase price for issuances or sales of common shares. Pursuant to Statement of
Financial  Accounting  Standards  (SFAS) No.  123  "Accounting  for  Stock-Based
Compensation,"  we disclose the pro forma effects of using the fair value method
of accounting for stock-based  employee and director  compensation  arrangements
and  record  compensation  expense  for the fair  value of  options  granted  to
non-employees.

If we had elected the fair value method of accounting  for employee and director
stock options,  compensation  cost would have been accrued at the estimated fair
value of stock  option  grants  over the  service  period,  regardless  of later
changes in stock prices and price volatility.

The table below shows net loss per share for the three and six months ended June
30, 2005 and 2004 as if we had elected the fair value method of  accounting  for
stock options.

<TABLE>
<CAPTION>
                                                  Three months ended June 30,    Six months ended June 30,
                                                      2005           2004           2005           2004
                                                  -----------    -----------    -----------    -----------
<S>                                               <C>            <C>            <C>            <C>
Net loss as reported                              $(3,524,447)   $(2,333,977)   $(5,672,982)   $(4,279,871)

Add: Stock-based employee/director compensation
  included in reported net loss, net of any
  applicable related tax effects                        8,250          8,250         16,500         51,174
Deduct: total stock-based employee compensation
  determined under fair value method for all
  awards, net of any applicable related
  tax effects                                      (1,270,330)      (367,839)    (2,313,430)      (780,528)
                                                  -----------    -----------    -----------    -----------

Pro forma net loss, as adjusted                   $(4,786,527)   $(2,693,566)   $(7,969,912)   $(5,009,225)
                                                  ===========    ===========    ===========    ===========

Net loss per share:
Basic and diluted, as reported                    $     (0.10)   $     (0.07)   $     (0.16)   $     (0.13)
Basic and diluted, as adjusted                    $     (0.13)   $     (0.08)   $     (0.22)   $     (0.15)
</TABLE>


                                       8
<PAGE>

Note 5. Per Share Information

Basic net loss per common  share  excludes  dilution and is computed by dividing
net loss by the weighted  average  number of common shares  outstanding  for the
period.  Diluted net loss per common share reflects the potential  dilution that
could  occur if  securities  or other  contracts  to issue  common  shares  were
exercised or converted into common shares. The table below reflects  potentially
dilutive securities which were excluded from the computation of diluted net loss
per share for the three  months  and six  months  ended  June 30,  2005 and 2004
because the effect of their assumed exercise would be antidilutive.

<TABLE>
<CAPTION>
                                                        As of June 30,
                                           2005                                2004
                             ---------------------------------   ---------------------------------
                              Number of                           Number of
                             Potentially    Weighted Average     Potentially    Weighted Average
                              Dilutive     Exercise/Conversion    Dilutive     Exercise/Conversion
                               Shares             Price            Shares             Price
                             -----------   -------------------   -----------   -------------------
<S>                          <C>           <C>                   <C>           <C>
Stock options and warrants     6,646,211   $              4.00     5,938,195   $              2.37
Convertible notes              3,404,807   $              3.29     2,376,000   $              0.50
                             -----------                         -----------
  Total                       10,051,018                           8,314,195
                             ===========                         ===========
</TABLE>

Note 6. Property, Plant and Equipment

Property, plant and equipment include:

                                                    As of
                                        June 30, 2005    December 31, 2004
                                        -------------    -----------------

Building                                $   3,990,410    $              --
Other equipment and instruments             2,127,571            1,901,333
Machinery and manufacturing equipment       1,224,708                   --
Office furniture and fixtures                 662,851              545,201
Tooling                                       371,700              344,890
Leasehold improvements                        175,654              175,654
Computer software                             126,803                   --
Computer hardware                              55,287                   --
                                        -------------    -----------------

Total property, plant and equipment         8,734,984            2,967,078
Accumulated depreciation                   (2,388,920)          (2,108,866)
                                        -------------    -----------------
Property, plant and equipment, net      $   6,346,064    $         858,212
                                        =============    =================

Note 7. Notes Payable

Convertible notes at June 30, 2005 consist of the following:

Argyle Notes:


                                       9
<PAGE>

In 1998,  we received  $1,188,000  in cash in exchange for notes payable in that
amount to Argyle Capital Management  Corporation  (Argyle),  a company owned and
controlled  by  Robert  A.  Olins,  our  Chief  Executive  Officer,   Secretary,
Treasurer, and a Director. The notes accrue interest at a contractual rate of 6%
per annum,  and are secured by substantially  all of our assets.  Both principal
and interest are  convertible  into our common shares at $0.50 per share. On May
23, 2001, the due date of the notes was extended until December 31, 2002. On the
extension  date,  the  beneficial  conversion  effect  representing  the  excess
aggregate  value of the common shares  receivable  upon  conversion of the notes
based on the then current  market price of $1.90 per share,  over the  aggregate
conversion  price for such common  shares  (limited to the original  proceeds of
$1,188,000),   was  recorded  as  additional  paid-in  capital.   The  resulting
$1,188,000  discount to the debt arising from the beneficial  conversion feature
was originally being amortized through December 31, 2002. The effective interest
rate for  financial  statement  purposes due to this  discount  differs from the
actual contractual  interest received or receivable in cash or shares by Argyle.
This discount,  along with the  contractual 6% interest rate,  resulted in a new
effective  interest rate of 72% per annum as of the May 23, 2001  extension date
when compared to the outstanding principal balances. The effective rate prior to
extension had been the 6% per annum contractual rate.

On  September  20,  2002,  the due date  was  extended  until  March  31,  2004.
Accordingly,  the  remaining  unamortized  discount  at the  extension  date  of
$198,000  was  being  amortized  through  March  31,  2004,  resulting  in a new
effective  interest  rate of 17% per  annum  when  compared  to the  outstanding
principal  balances.  On December 31, 2003, the due date was extended until June
30, 2005.  Accordingly,  the  remaining  unamortized  discount of $33,000 at the
extension  date was being  amortized  through June 30, 2005,  resulting in a new
effective  interest  rate  of 8% per  annum  when  compared  to the  outstanding
principal  balances.  On November  30,  2004,  the due date was  extended  until
December  31,  2008.  The  remaining  unamortized  discount  of  $11,000  at the
extension date was amortized through June 30, 2005.

On March 4, 2004, we issued 71,676 common shares with a market value of $338,311
as a  prepayment  of  interest  payable on the Argyle  notes of $35,640  for the
period January 1, 2005 to June 30, 2005. Prepaid interest was computed using the
closing  price of the shares of $4.72 on March 3, 2004.  In  December  2004,  we
issued 50,000 common  shares,  and in January  2005,  we issued  448,764  common
shares,  as a prepayment of interest payable on the Argyle notes of $249,480 for
the period July 1, 2005 through  December  31,  2008.  These shares had a market
value of  $4,049,964,  based on the  closing  price  of the  shares  of $8.12 on
December 21, 2004.  As of June 30, 2005,  total  prepaid  interest on the Argyle
notes for the  period  July 1, 2005 to  December  31,  2008 is  $4,049,964  with
$1,157,133  classified  as a  current  asset,  and  $2,892,831  classified  as a
non-current asset.

At June 30, 2005,  the carrying  value of the Argyle  notes  totaled  $1,188,000
representing the principal unpaid balance.

The November 2004 Financing:

On November  30,  2004,  we completed a  non-brokered  private  placement of $10
million of senior secured notes (the 2004 Senior Secured Convertible Notes). The
2004 Senior Secured Convertible Notes accrue interest at 10%, payable quarterly,
and the interest is payable in cash or common shares,  at our option (if certain
conditions  are met).  The value of the shares for the  purposes of  calculating
interest  payments shall be equal to the 20-day  trailing  average of the volume
weighted  average  prices  of our  common  shares  at the end of each  quarterly
interest period. The 2004 Senior Secured  Convertible Notes are due November 30,
2007.


                                       10
<PAGE>

The 2004 Senior Secured Convertible Notes are convertible,  at the option of the
holders,  into our common shares at the conversion price of $9.72 per share. The
conversion price of the principal amount of the 2004 Senior Secured  Convertible
Notes is equal to a 25% premium above the ten-day trailing average of the volume
weighted  average price of our common  shares for the period ended  November 29,
2004,  which was $7.78. As part of the November 2004  Financing,  the purchasers
required Argyle to enter into an intercreditor and subordination  agreement (the
Intercreditor  Agreement)  pursuant to which Argyle  agreed to  subordinate  our
obligations to Argyle and the senior security  interest in substantially  all of
our assets that were granted under the Argyle Notes to the interest  represented
by the purchasers of the 2004 Senior  Secured  Convertible  Notes.  In addition,
under the terms of the November 2004 Financing, we are prohibited from using the
funds to repay debt or to pay dividends.

We are  required  to file a  registration  statement  for  resale of the  shares
issuable  upon  conversion  of the  notes  and have the  registration  statement
declared  effective no later than 120 days after December 21, 2004.  Pursuant to
our  amended  registration  rights  agreement  with  the  noteholders,   if  the
registration  does not become  effective by April 20,  2005,  or does not remain
effective,  we may be  required to pay each  noteholder  cash equal to 1% of the
purchase  price of the  notes,  and 1% for  every 30 days  thereafter  until the
registration becomes effective.  However,  each of the noteholders has agreed to
waive its right to these payments in the event that the applicable  registration
statement is declared  effective  no later than July 29, 2005.  On July 29, 2005
the SEC declared the registration  statement  effective pursuant to Section 8(a)
of the Securities Act of 1933, as amended.

In consideration for Argyle entering into the Intercreditor Agreement, our Board
of Directors authorized us to enter into an extension and modification agreement
with Argyle with respect to the Argyle  Notes (the  Extension  Agreement)  under
which the due date of the Argyle Notes was extended to December 31, 2008.

Under the terms of the November  2004  Financing,  Robert A. Olins and Greenpark
Limited, an unaffiliated  shareholder,  jointly and severally committed,  in the
event that the Board of Directors  determines  that such financing is necessary,
to provide us with up to an additional  $6 million in future  financing on terms
and  conditions  to be  determined  at the  time of any such  transaction.  That
financing  commitment  shall be reduced by any funds that we receive from future
sales or exercises of our equity, debt or derivative  securities,  including the
sale of our common  shares  under the  prospectus  that we filed with the SEC on
January 28, 2005, as a part of a "shelf" registration process. As of the date of
this  filing,  taking into  account the August 2005 Equity  Financing  and stock
option  exercises,  we had received an  aggregate  total of  $3,761,413  thereby
reducing the commitment by Mr. Olins and Greenpark Limited by an equal aggregate
amount.

Under the terms of the November  2004  Financing,  the  purchasers  received the
right  (additional  investment rights or AIR) to purchase up to an additional $5
million  of senior  secured  convertible  notes  subject  to the same  terms and
conditions,  including  the same  conversion  price as the  notes  issued in the
November 2004  Financing.  The AIR originally  expired on November 30, 2005, but
was amended on December 21, 2004 to expire on August 31, 2005. The fair value of
the AIR was  calculated  on the November 30, 2004  issuance  date at  $1,072,248
using the  Black-Scholes  option  pricing  model (see table  below.) This AIR is
being treated as a derivative  and has been  recorded as a note purchase  option
liability and as a discount on the 2004 Senior Secured  Convertible  Notes.  The
AIR is not a  hedging  derivative.  The  fair  value of the  derivative  will be
recalculated  on a quarterly  basis until  exercise or expiration to reflect the
changing  market price of the stock,  the remaining  contractual  term,  and the
changing  volatility.  The  objective in entering into the agreement for the AIR
was that it was  required  by the  lenders in order to  complete  the  financing
agreement.  Below is a table reflecting the fair value of the


                                       11
<PAGE>

AIR at each period end date and the Black-Scholes  assumptions used to calculate
the fair value. The assumptions changed from the November 2004 valuation date in
that the market price of our common shares had changed, the contractual life had
changed due to the December 21, 2004 amendment,  and the volatility changed as a
result of the changes in market price and contractual life. Any reduction in the
note purchase option  liability due to the revaluation of the AIR is recorded as
a gain  from  the  revaluation  of the note  purchase  option  liability  and is
included in other income.

<TABLE>
<CAPTION>
                                    Gain                                                Risk-Free
                                 Recognized    Cumulative     Current                   Interest     Contractual
Fair Value Date*    Fair Value   for Quarter      Gain      Stock Price   Volatility      Rate          Term
-----------------   ----------   -----------   ----------   -----------   ----------    ---------    -----------
<S>                 <C>          <C>           <C>          <C>           <C>           <C>          <C>
November 30, 2004   $1,072,248   $        --   $       --   $      8.83           67%        2.50%     1 year
December 31, 2004   $  659,874   $   412,374   $  412,374   $      8.95           52%        2.50%    8 months
March 31, 2005      $    8,639   $   651,235   $1,063,609   $      5.05           49%        2.50%    5 months
June 30, 2005       $    2,102   $     6,537   $1,070,146   $      5.67           54%        3.00%    2 months
</TABLE>

*  Exercise  price for all dates is $9.72 per share and  dividend  yield for all
dates is zero.


The $1,072,248  discount  applied to the 2004 Senior Secured  Convertible  Notes
gave rise to a  beneficial  conversion  feature of $156,610  resulting  from the
excess aggregate value of the common shares issuable upon conversion of the 2004
Senior Secured Convertible Notes into common shares over the discounted carrying
value of the 2004 Senior  Secured  Convertible  Notes at the issuance  date. The
resulting beneficial  conversion feature is treated as an additional discount to
the 2004 Senior Secured  Convertible Notes and an increase in additional paid-in
capital, and will be amortized,  along with the original discount related to the
value of the AIR, over the life of the 2004 Senior Secured Convertible Notes. In
addition,  $100,000 of legal fees  reimbursed to one of the lenders was recorded
as a note discount and is being amortized over the life of the notes. Additional
financing  costs of $117,162  were  recorded as prepaid  expenses  and are being
amortized over the life of the notes.

Activity in notes payable for the six months ended June 30, 2005 is as follows:

<TABLE>
<CAPTION>
                                            Balance at                     (Payment) or                     Balance at
                                           December 31,     Addition or      Discount       Conversion       June 30,
Debt Principal:                                2004        New Discount    Amortization     to Equity          2005
                                           ------------    -------------   ------------    ------------    ------------
<S>                                        <C>             <C>             <C>             <C>             <C>
Argyle                                     $  1,188,000    $          --   $         --    $         --    $  1,188,000
Argyle discount                                 (11,000)              --         11,000              --              --
November financing                           10,000,000               --             --              --      10,000,000
November financing beneficial conversion       (152,260)              --         26,100              --        (126,160)
Reimbursement of investor's legal fees          (97,222)              --         16,666              --         (80,556)
November financing AIR discount              (1,042,378)              --        179,220              --        (863,158)
                                           ------------    -------------   ------------    ------------    ------------
                  Total                    $  9,885,140    $          --   $    232,986    $         --    $ 10,118,126
                                           ============    =============   ============    ============    ============

Interest:
Accrued Argyle 6%                          $         --    $      35,640   $         --    $    (35,640)   $         --
Beneficial interest                                  --          302,670             --        (302,670)             --
November financing                               84,932          500,000       (502,740)             --          82,192
                                           ------------    -------------   ------------    ------------    ------------
                  Total                    $     84,932    $     838,310   $   (502,740)   $   (338,310)   $     82,192
                                           ============    =============   ============    ============    ============
</TABLE>


                                       12
<PAGE>

Non-cash interest expense is as follows:

                                                       Six months ended June 30,
                                                           2005          2004
                                                         --------     --------
Amortization of note discounts and prepaid financing
costs                                                    $252,514     $ 11,000
Effect of beneficial conversion privileges
  on accrued interest                                     302,670      364,392
                                                         --------     --------
                                                         $555,184     $375,392
                                                         ========     ========

Activity  in notes  payable  for the  three  months  ended  June 30,  2005 is as
follows:

<TABLE>
<CAPTION>
                                            Balance at                     (Payment) or
                                            March 31,       Addition or      Discount      Conversion      Balance at
Debt Principal:                                2005        New Discount    Amortization     to Equity     June 30, 2005
                                           ------------    -------------   ------------    -----------    -------------
<S>                                        <C>             <C>             <C>             <C>            <C>
Argyle                                     $  1,188,000    $          --   $         --    $        --    $   1,188,000
Argyle discount                                  (5,500)              --          5,500             --               --
November financing                           10,000,000               --             --             --       10,000,000
November financing beneficial conversion       (139,210)              --         13,050             --         (126,160)
Reimbursement of investor's legal fees          (88,889)              --          8,333             --          (80,556)
November financing AIR discount                (952,768)              --         89,610             --         (863,158)
                                           ------------    -------------   ------------    -----------    -------------
                 Total                     $ 10,001,633    $          --   $    116,493    $        --    $  10,118,126
                                           ============    =============   ============    ===========    =============

Interest:
Accrued Argyle 6%                          $         --    $      17,820   $         --    $   (17,820)   $          --
Beneficial interest                                  --          151,335             --       (151,335)              --
November financing                               84,932          250,000       (252,740)            --           82,192
                                           ------------    -------------   ------------    -----------    -------------
                 Total                     $     84,932    $     419,155   $   (252,740)   $  (169,155)   $      82,192
                                           ============    =============   ============    ===========    =============
</TABLE>

Non-cash interest expense is as follows:

                                                     Three months ended June 30,
                                                          2005         2004
                                                        --------     --------
Amortization of note discounts and prepaid
  financing costs                                       $126,257     $  5,500
Effect of beneficial conversion privileges
  on accrued interest                                    151,335      182,196
                                                        --------     --------
                                                        $277,592     $187,696
                                                        ========     ========

Note 8. Issuance of Securities

Exercise of Stock  Options and  Warrants in the Three and Six Months  Ended June
30, 2005

During the second quarter of 2005,  57,550 and 105,557 common shares were issued
upon the exercise of employee/director stock options and warrants, respectively.
During  the first six months of 2005,  75,015 and  105,557  common  shares  were
issued  upon the  exercise of  employee/director  stock  options  and  warrants,
respectively.  The warrant  exercises  were cashless  exercises  pursuant to the
warrant


                                       13
<PAGE>

agreements. Total cash received from option exercises were for the three and six
months ended June 30, 2005 was $50,563 and $100,761, respectively.

Issuance of Shares,  Stock Options and Warrants During the Six Months ended June
30, 2005

In June 2005, we issued a fully vested warrant to purchase  75,000 of our common
shares to an unaffiliated investment bank for compensation for services provided
pursuant to a service agreement.  A value of $73,387 was assigned to the warrant
using the Black-Scholes pricing model and the following assumptions: stock price
$5.71, exercise price $7.50,  historical volatility 65%, risk free interest rate
3%,  dividend  yield of 0 and a  contractual  life of 12 months.  This amount is
included in current assets as prepaid  fundraising costs and will be capitalized
in the equity section of the balance sheet upon a relevant  financing closing or
will be expensed in the event a financing does not occur prior to the expiration
of the warrant.

In February  2005,  we issued a fully vested  warrant to purchase  75,000 common
shares as  payment to a sales  agent.  A value of $90,800  was  assigned  to the
warrant using the  Black-Scholes  pricing  model and the following  assumptions:
stock price $4.66,  exercise price $4.50,  historical  volatility 64%, risk free
interest rate 2.50%,  dividend  yield of 0 and a contractual  life of 10 months.
This amount is included in stock-based general and administrative expenses.

In January 2005,  581,505  common  shares with a value of $4,038,149  previously
recorded as common shares issuable were issued.

Other  expenses  totaling  $8,250 and $16,500 in the three and six months  ended
June 30, 2005 relate to the valuation of an employee stock option issued with an
exercise price lower than the market price on the grant date and are included in
stock-based  general and  administrative  expenses.  This expense  relates to an
option granted in 2003.

Issuance of Shares Under Installment Note

In consideration for the financing commitment by Greenpark Limited, we agreed to
reduce by $600,000 the amount owed by Greenpark Limited to us under that certain
warrant installment  agreement,  dated as of October 14, 2002. Mr. Olins advised
the  Board of  Directors  that any  consideration  that the  Board of  Directors
determined was owed to Mr. Olins for the financing  commitment should instead be
given  as  consideration  to  Greenpark  Limited  for its  participation  in the
financing  commitment.  As a  result,  Mr.  Olins  was  not,  and  is not to be,
compensated for his  participation in the financing  commitment and the Board of
Directors  weighed that fact in their  negotiation  with Greenpark  Limited with
respect to amending the installment  agreement described above. Pursuant to that
installment agreement, in November 2002, Greenpark Limited exercised its warrant
to purchase  746,268 common shares at the exercise price of $2.00 per share, for
an aggregate  purchase price of  $1,492,536.  Under the  installment  agreement,
Greenpark Limited is required to make periodic installment payments towards such
aggregate purchase price. There is a 6% annual interest rate with respect to the
balance of the share purchase  price owed to us and all accrued  interest is due
with the final payment. We issued all of the 746,268 shares to Greenpark Limited
in 2003. As of June 30, 2005,  Greenpark Limited owed to us a remaining adjusted
principal  balance of $48,496  (reflecting  the  purchase  price  reduction  and
principal  payments) plus accrued interest,  which is due in periodic  payments,
with the final  payment  due on or  before  May 17,  2005.  We will not give any
further  financial   consideration  to  Greenpark  Limited  for  such  financing
commitment  and  anticipate  collection  of the  remaining  balance plus accrued
interest by the end of the third quarter of 2005.


                                       14
<PAGE>

Stock-based compensation is as follows:

                                      Three months               Six months
                                     ended June 30,             ended June 30,
                                   -------------------      -------------------
                                     2005       2004          2005       2004
                                   --------   --------      --------   --------
Options granted to employees and
  directors                        $  8,250   $  8,250      $ 16,500   $ 51,174
Warrants issued for services             --    210,000        90,800    210,000
                                   --------   --------      --------   --------
                                   $  8,250   $218,250      $107,300   $261,174
                                   ========   ========      ========   ========

Note 9. Segment Information and Significant Customer Information

Our chief operating  decision-maker  is our Chief Executive  Officer.  The chief
operating  decision-maker reviews only financial information prepared on a basis
substantially   consistent  with  the  accompanying   financial   statements  of
operations.  Therefore,  we have determined that we operate in a single business
segment. All of our assets are located at our facilities in the United States at
June 30, 2005, except for the following:

<TABLE>
<CAPTION>
                                               Korea      Hong Kong     Japan        Total
                                             ----------   ---------   ----------   ----------
<S>                                          <C>          <C>         <C>          <C>
Cash                                         $  171,232   $      --   $       --   $  171,232
Building, net                                 3,955,727          --           --    3,955,727
Machinery and manufacturing equipment, net    1,176,093          --           --    1,176,093
Office furniture and fixtures, net              130,210          --           --      130,210
Other equipment and instruments, net             89,102          --           --       89,102
Inventory                                        26,628     426,465      454,616      907,709
                                             ----------   ---------   ----------   ----------
                                             $5,548,992   $ 426,465   $  454,616   $6,430,073
                                             ==========   =========   ==========   ==========
</TABLE>

Of our total revenue in 2005, 78% was derived from the sales of our LCoS Sets to
LG Electronics,  a customer  located in the Republic of Korea. The remaining 22%
was derived from the sales of our LCoS Sets to  customers in Hong Kong,  Taiwan,
China and the United  States.  For the three and six months ended June 30, 2005,
98% and 78% of our revenue was derived from LG Electronics,  respectively.  This
customer made up 100% of our accounts receivable balance at June 30, 2005.

Note 10. Inventory

Inventory consisted of the following:

                            As of
                    June 30,    December 31,
                      2005          2004
                   ----------   ------------
Raw materials      $  730,848   $    691,168
Work-in-progress       16,935         31,684
Finished goods        442,565        450,462
                   ----------   ------------
                   $1,190,348   $  1,173,314
                   ==========   ============


                                       15
<PAGE>

Note 11. Recent Accounting Pronouncements

In June 2005, the Financial  Accounting  Standards Board (FASB) issued Statement
No. 154,  "Accounting Changes and Error Corrections" (FAS 154), a replacement of
APB No. 20, "Accounting Changes" and FASB Statement No. 3, "Reporting Accounting
Changes in  Interim  Financial  Statements."  FAS 154  applies to all  voluntary
changes in accounting  principle and changes the requirements for accounting for
and reporting of a change in accounting  principle.  This statement  establishes
that, unless impracticable, retrospective application is the required method for
reporting a change in accounting principle in the absence of explicit transition
requirements  specific  to the  newly  adopted  accounting  principle.  It  also
requires the reporting of an error  correction  which  involves  adjustments  to
previously issued financial  statements similar to those generally applicable to
reporting  an  accounting  change  retrospectively.  FAS  154 is  effective  for
accounting  changes and  corrections  of errors made in fiscal  years  beginning
after  December 15,  2005.  We do not expect the adoption of FAS 154 will have a
material impact on our results of operations or financial condition.

In  March  2005,  the  FASB  issued   Interpretation  No.  47,  "Accounting  for
Conditional Asset Retirement Obligations."  Interpretation No. 47 clarifies that
an  entity  must  record  a  liability  for  a  "conditional"  asset  retirement
obligation  if the fair value of the  obligation  can be  reasonably  estimated.
Interpretation  No. 47 also  clarifies  when an  entity  would  have  sufficient
information  to  reasonably  estimate  the fair  value  of an  asset  retirement
obligation.  Interpretation  No. 47 is  effective  no later  than the end of the
fiscal year ending after  December 15, 2005.  We are  currently  evaluating  the
provision  and do not expect the adoption of  Interpretation  No. 47 will have a
material impact on our results of operations or financial condition.

In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" to revise
SFAS No. 123,  "Accounting  for  Stock-Based  Compensation"  and  supersede  APB
Opinion  No. 25,  "Accounting  for Stock  Issued to  Employees"  and its related
implementation  guidance.  It requires companies to recognize their compensation
costs related to share-based payment transactions in financial statements. These
costs are to be  measured  based on the fair  value of the  equity or  liability
instruments issued. We will apply SFAS No. 123R in the first quarter of 2006. We
have not yet  evaluated  the impact that the adoption of SFAS No. 123R will have
on our financial  statements;  however, the adoption could materially impact our
results of operations.

In December  2004,  the FASB issued SFAS No.  153,  "Exchanges  of  Non-monetary
Assets -- an Amendment of APB Opinion No. 29," which  eliminates  the  exception
for non-monetary  exchanges of similar  productive assets and replaces it with a
general  exception  for  exchanges  of  non-monetary  assets  that  do not  have
commercial  substance.  A non-monetary  exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS No. 153 will be effective for non-monetary asset exchanges
occurring in fiscal  periods  beginning  after June 15, 2005.  We are  currently
evaluating  SFAS No.  153 and do not expect  the  adoption  will have a material
impact on our results of operations or financial condition.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs -- an Amendment
of ARB No.  43,  Chapter  4," which  clarifies  that  abnormal  amounts  of idle
facility  expense,  freight,  handling costs and wasted  material  (spoilage) be
recognized as current period  charges.  In addition,  SFAS No. 151 requires that
allocation of fixed production  overheads to the costs of conversion be based on
the normal


                                       16
<PAGE>

capacity  of the  production  facilities.  SFAS No.  151 will be  effective  for
inventory  costs incurred in fiscal years beginning after June 15, 2005. We have
not evaluated the impact of SFAS No. 151 to our overall  result of operations or
financial condition.

Note 12. Subsequent Events

August 2005 Equity Financing

On August 5, 2005, we sold 500,000 of our common  shares at a purchase  price of
$5.40 per share to certain institutional  investors.  Those shares were included
in our Form S-3 "shelf" registration  statement (File No.333-122932),  which was
declared   effective  by  the  SEC  in  July  2005.  We  received   proceeds  of
approximately $2.7 million from the transaction,  which we are using for working
capital and other general corporate purposes.  The purchasers in the August 2005
Equity  Financing have a 30-day  option,  which expires on September 4, 2005, to
purchase an additional aggregate of 225,000 of our common shares included in the
"shelf" registration statement at a purchase price of $5.50 per share. As of the
date of this filing,  1,500,000 of our common  shares  included in our currently
effective "shelf" registration statement,  including those subject to the 30-day
option described above, have not been sold.


                                       17
<PAGE>

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

This Form 10-Q contains certain forward-looking statements within the meaning of
Section 21E of the  Securities  and  Exchange  Act of 1934,  as  amended,  which
statements are subject to the Safe Harbor provisions created by that statute. In
this  report,  the  words   "anticipates,"   "believes,"   "expects,"  "future,"
"intends," and similar expressions  identify  forward-looking  statements.  Such
statements are subject to certain risks and  uncertainties,  including,  but not
limited to, those  discussed  herein,  those  contained in this Item 2 and those
discussed  in the  Company's  Annual  Report on Form  10-K/A  as filed  with the
Securities and Exchange  Commission on July 13, 2005.  Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
of the date hereof. The Company undertakes no obligation to publicly release the
results of any revisions to these forward-looking  statements that may be needed
to reflect  events or  circumstances  after the date  hereof or to  reflect  the
occurrence of unanticipated events.

The  following  is a  discussion  and  analysis  of our  condensed  consolidated
financial  condition as of June 30, 2005,  and our results of operations for the
three and six months ended June 30, 2005 and 2004. The following  should be read
in conjunction with our unaudited condensed  consolidated  financial  statements
and related notes appearing elsewhere herein.

OVERVIEW

We are in the business of manufacturing high-resolution LCoS microdisplays.  Our
current customers and prospective customers are original equipment manufacturers
(OEMs) engaged in the businesses of manufacturing high definition televisions or
manufacturing light engines for incorporation into high definition  televisions.
Our products are also suitable for  incorporation  into other potential  display
applications including rear projection computer monitors, wireless communication
devices,  portable games and digital  assistants,  although we are not currently
working with OEMs on any of these products.

Status of Business with LG Electronics, Inc.

In July 2004, we entered into an agreement with LG Electronics (see Exhibit 10.5
to our  Annual  Report  on Form  10-K/A  filed  with the SEC on July 13,  2005),
providing  for us to  sell  our T-3  LCoS  Sets to LG  Electronics.  Under  that
agreement,  LG  Electronics  agreed to purchase from us a minimum of 21,000 LCoS
Sets over an initial six-month delivery period,  which was originally  scheduled
to  commence  in  January  2005,  subject  to  LG  Electronics'   completion  of
pre-production requirements.

In July 2005,  we commenced  delivering  commercial  production  LCoS Sets to LG
Electronics,  although  we  delivered  a smaller  quantity of LCoS Sets than was
contemplated  under the July 2004  agreement for the first  delivery  month.  We
delivered  those  LCoS Sets  based upon our  expectation  that in the  immediate
future  we will  receive  a firm  purchase  order  from LG  Electronics  for its
purchase  from us of an  aggregate  minimum  quantity of 9,300 LCoS Sets for the
period July through  December  2005.  Under the purchase order that we expect to
receive,  we will have the option to increase the initial  order to an aggregate
maximum quantity of 16,800 LCoS Sets.

Our  agreement  with  LG  Electronics   states  that  the  parties'  rights  and
obligations  are subject to a limited  quantity of trial LCoS Sets, all of which
have  been  delivered  to  LG  Electronics,   meeting  certain  final  technical
specifications  for  product  performance.  LG  Electronics  and  we  have  been
cooperating  since  July 2004 to assure  that the trial LCoS Sets meet the final
specifications  called for by the agreement.  LG Electronics completed the final
stage  integration  of our LCoS Sets into their rear  projection  televisions in
July 2005 and LG Electronics


                                       18
<PAGE>

subsequently  informally  advised us that our  product  met the  specifications,
which enabled us to commence executing  commercial  production  deliveries to LG
Electronics  in July.  In August 2005,  we expect to receive the formal  written
qualification  letter from LG  Electronics  stating  that we have met the agreed
upon technical specifications. Until we receive that qualification letter, there
can be no  assurances  that LG  Electronics  will purchase any LCoS Sets from us
beyond those that we delivered to them in July 2005.

LG  Electronics  announced in a joint press release with us in January 2005 that
they were  planning an initial  rollout of 71-inch and 62-inch LCoS  televisions
incorporating our LCoS Sets commencing in the second quarter of 2005. Based upon
our  discussions  with LG  Electronics  and other public  statements by them, we
believe that LG Electronics  currently  intends to commence this initial rollout
during the third quarter of 2005. LG Electronics also announced that its initial
product  rollout will be into the United  States,  South  Korean and  Australian
consumer  markets,  with  future  plans for  expansion  into other  markets.  We
believe,  based upon discussions with LG Electronics,  that the expected initial
purchase  order  for  9,300  LCoS  Sets will  fully  enable  LG  Electronics  to
effectively launch their LCoS-based televisions into the intended target markets
on time for the 2005 holiday shopping season.

We  are  now  working  and  negotiating  with  LG  Electronics  to  formalize  a
constructive  amendment and restatement of the original  agreement to govern our
anticipated   product  deliveries  going  forward.   We  expect  that  the  most
significant  amendment will be reducing the minimum initial  six-month  quantity
commitment,  which will be for the period  July  through  December  2005,  to an
aggregate of 9,300 LCoS Sets,  with the option for us to increase that amount to
an  aggregate  maximum  quantity  of  16,800  LCoS  Sets.  We  believe  that the
anticipated  revised  six-month  minimum  LCoS  Set  quantity  will be  mutually
beneficial  for LG  Electronics  and us.  That  minimum  quantity  will allow LG
Electronics to move forward with full execution of its consumer market launch of
high definition televisions incorporating our LCoS Sets, as described above.

We anticipate  that the other material  terms of our original  agreement with LG
Electronics will remain  substantially the same when it is amended and restated,
which we expect to consummate  in August 2005.  Deliveries  scheduled  under our
agreement  with LG Electronics  are presently  scheduled to follow the July 2005
delivery  on a monthly  basis.  Under  the  agreement,  commencing  in the first
delivery  month,  LG Electronics is required to provide us with rolling  monthly
firm purchase orders six months in advance of the scheduled delivery and rolling
twelve-month  advance projections of its anticipated future orders. We expect to
receive firm purchase  orders for January and February 2006 from LG  Electronics
later this month.  Although the agreement does not contain any minimum  purchase
requirements after the initial six-month delivery period, the agreement projects
that LG Electronics will commence larger mass-production scale purchases of LCoS
Sets from us in the seventh  delivery month,  which we currently expect to occur
in January 2006. LG  Electronics  has advised us that it expects the larger mass
production  purchases  to commence as scheduled  in the seventh  delivery  month
based upon its strategic  marketing  plans. The agreement is scheduled to have a
two-year delivery term with monthly deliveries of LCoS Sets.

Our  agreement  with LG  Electronics  provides  that we will be their  exclusive
supplier of three-chip LCoS  microdisplay  products for twelve months  beginning
from the date that we commence shipments under the agreement.  Furthermore,  our
agreement provides that LG Electronics will have the exclusive right in Korea to
purchase T-3 microdisplay  products from us for the twelve months beginning from
the date that we commenced  shipments under the agreement.  In the event that LG
Electronics  purchases  more than  60,000  LCoS Sets for  delivery  between  the
seventh (7th) and twelfth  (12th)  delivery  months of our  agreement,  which we
currently expect will be January through June 2006, LG Electronics has the right
to extend its exclusivity period for twelve additional months. In the event that
LG  Electronics  does not purchase  that  quantity of LCoS Sets during that time
period,  we have the right under the  agreement to continue to be the  exclusive
supplier of LCoS products to LG Electronics during the second delivery year.

In the first half of 2005, a substantial  percentage of our product  deliveries,
which  were in small  quantities,  were made to LG  Electronics.  Based upon our
agreement with LG Electronics and our present expectations,  it is likely that a
substantial percentage of our anticipated future product deliveries in 2005 will
be made to LG  Electronics  as


                                       19
<PAGE>

well.  The loss of LG  Electronics  as a customer or any delays in our  delivery
schedule to LG Electronics could harm our future sales or results of operations;
and our  substantial  dependence  on one  customer is subject to risks set forth
under the heading "Business Risks and Uncertainties."

Business in China and Taiwan

To date, we have delivered  limited  quantities of our microdisplay  products to
our  Chinese  and  Taiwanese  customers.  A  substantial  portion of our product
deliveries were in 2004. The quantities of our products delivered to our Chinese
and Taiwanese  customers are sufficient only for  engineering  testing and pilot
program purposes.  To date, our Chinese and Taiwanese customers have not ordered
quantities of our products that would enable them to launch  commercial sales of
LCoS high definition televisions.

We have continuing  business  relationships with approximately ten customers and
prospective  customers  in China  and  Taiwan.  Current  Chinese  and  Taiwanese
customers are at different  stages in the development  and product  introduction
processes, and their efforts are progressing at a slower rate than we originally
anticipated.  There were no shipments to our Chinese and Taiwanese  customers in
the fourth quarter of 2004. We made small shipments to one of these customers in
both the first and second quarter of 2005. We are  maintaining our plans to ship
our products to our Chinese and Taiwanese  customers,  although at a slower rate
of shipment than  originally  expected.  While we have purchase  orders in place
with our Chinese and Taiwanese customers, such orders are cancelable at any time
by  such  customers.  We  therefore  cannot  provide  assurance  concerning  the
quantities  of our  products  that we will  sell to our  Chinese  and  Taiwanese
customers in the future.

Although  our  Chinese  and  Taiwanese   customers'   progression  from  product
prototyping to mass production has been far slower than we had  anticipated,  we
remain  positive  about  our  business  prospects  in China and  Taiwan  and the
potential  for China and Taiwan to become  large  markets  for us. We  currently
believe  that Chinese and  Taiwanese  television  manufacturers  tend to apply a
market strategy of following the successful business models of global television
manufacturing  leaders,  rather  than acting as leaders  themselves  in terms of
introducing new  technologies to the marketplace.  We therefore  believe that if
the LCoS technology gains greater  acceptance in the high definition  television
marketplace,  and if industry  leaders,  such as Sony,  JVC and LG  Electronics,
present  their LCoS based  televisions  to the worldwide  consumer  markets in a
prominent  fashion,  it will then be more likely that the Chinese and  Taiwanese
television manufacturers will follow these business models and ramp up their own
lines of LCoS high definition televisions. We believe that our present course of
continuing to transact  business  with major  Chinese and  Taiwanese  television
manufacturers  is  positioning  us to be a leading  LCoS  supplier  in China and
Taiwan in the future.

In May 2004,  we opened a  representative  office in  Shanghai,  China,  for the
purpose of conducting,  coordinating and supporting our business  relations with
our Chinese customers and prospective customers.

We  believe  that  the  addition  of our  Korean  manufacturing  plant  and  the
representative  office in  Shanghai  will  improve  our  ability to  effectively
conduct  business in South Korea,  China,  Taiwan and throughout  other parts of
Asia as well.

Other Business Development

We are currently  developing working  relationships with prospective  customers,
located  primarily  in Japan and other parts of the  Pacific  Rim region.  These
prospective customers fall into two general


                                       20
<PAGE>

categories:  television  manufacturers  and  light  engine  suppliers.  We  have
provided samples of our LCoS Sets to certain of such prospective customers,  but
we do not have any  formal  agreements  with  such  parties.  While we have made
significant  progress  with  respect  to  product  integration  and  negotiating
purchase orders with certain of these  prospective  customers,  we cannot assure
that we will receive any purchase  orders binding on any of these  companies for
their purchase of our products in the near future. Even assuming that we receive
purchase orders that are binding on the prospective customers,  these orders and
our sales to these  customers  and to our  existing  customers  are  subject  to
certain contingencies described under "Business Risks and Uncertainties."

Manufacturing Capacity

We completed  construction of our Korean manufacturing facility in January 2005.
The Korean facility will serve as our central commercial manufacturing base. The
facility commenced  producing products for commercial sale in the second quarter
of 2005.  The facility is designed with the  capacity,  on full  employment,  to
produce  up to 28,000  LCoS Sets per  month.  The  facility  has been  specially
designed  for  expansion to a capacity of 120,000 LCoS Sets per month in several
expansion  phases.  We believe that the facility can be expanded in an efficient
manner in the event that such expansion  becomes  necessary based upon increased
or perceived increased demand for our products from our customers.

We are currently  continuing  to install  additional  manufacturing  and related
equipment in the facility and we are actively hiring personnel. We are currently
training our new  operators  and  supervisors  in key  processes  and  equipment
familiarization.  We believe that this is making our production  transition more
efficient  and reducing the chances of our  incurring  unexpected  delays in the
transition  process.  While we cannot provide any assurances  against unexpected
delays,  we  believe  that our  transition  approach  constitutes  a  proactive,
measured and responsible  plan to deal with mass production  readiness risks and
to prepare  ourselves to manage our  manufacturing  facility in Korea on a basis
consistent with the anticipated demand for our products.

Currently we manufacture our LCoS Sets in limited  commercial  quantities at our
facilities in  California  and the Republic of Korea.  Once the Korean  facility
reaches full-production mode, we intend to transition the California facility to
research and development and special project operations. We will not lay off any
U.S. employees as the result of opening the Korean facility.

Business Strategy

We are currently offering two types of products to our customers and prospective
customers,  all of whom are located  primarily in Asia.  One product is our LCoS
Set, which is comprised of three of our proprietary  SpatiaLight  imagEngine(TM)
LCoS microdisplays.  They are constructed with a silicon chip, a layer of liquid
crystals and a glass cover plate in contrast to the more common  construction of
liquid crystals sandwiched between two glass plates. Our displays are also known
as, and  commonly  referred  to as,  liquid  crystal on silicon  (LCoS),  liquid
crystal displays (LCD),  active matrix liquid crystal displays and spatial light
modulators.  Our other  product,  the display  unit,  is  comprised of LCoS Sets
fitted onto a light engine  designed by Fuji Photo Optical Co., Ltd.  (Fuji) and
us and  manufactured  by Fuji. We do not currently have any formal  agreement in
place with Fuji.

We currently manufacture two models of our LCoS Sets. The "T-1" model has a 1280
pixels by 960 pixels  configuration  and the newer  generation "T-3" model has a
higher resolution 1920 pixels by 1080 pixels configuration.


                                       21
<PAGE>

Since we commenced delivering our products to our customers in the third quarter
of 2003, there has been a significant  shift in the type of product that we have
delivered to our customers based upon their demand.  The shift in deliveries has
been in the direction of more LCoS Sets and less display units.  We believe that
this shift is significant because LCoS Sets are a higher margin product line and
require less working  capital than display units,  although LCoS Sets yield less
revenue  than  display  units  per unit  sold.  It is our  short-term  strategic
objective to operate  primarily as a seller of LCoS Sets and decrease our supply
of display  units to our  customers.  It is our  longer-term  strategic  goal to
exclusively sell LCoS Sets to our customers.

A number of our Chinese customers  currently purchase display units because they
have not yet  developed  their own light  engines.  We believe  that the display
unit, which is a turnkey product offering,  has served as a short-term  solution
and helped us to capture  market share in China because many of our  competitors
did not possess a turnkey solution.

While we will continue to offer display units to those current  customers who do
not have their own light engine solution,  we expect that new customer  business
in the future will  exclusively be for LCoS Sets rather than display units.  Our
supply  agreement  with LG  Electronics  is  exclusively  for LCoS  Sets,  as LG
Electronics  has developed its own light engine designed to incorporate our LCoS
Sets.  We expect that there will be a shift in products  demanded by our Chinese
customers,  over  time,  from  display  units to LCoS  Sets.  These  trends  are
consistent with our overall product strategy.

We believe that the T-3 model will become the  standard for the next  generation
of rear  projection  display  devices and will provide the most cost  effective,
high-resolution  microdisplays  in the  industry  and will  position  us to be a
potential  market  leader.  We  believe  that the  T-3's  ability  to  deliver 2
megapixel resolution in a high performance,  reliable, and cost effective manner
was a key factor in our obtaining the supply agreement with LG Electronics.  The
T-3 model is the central component of our ongoing customer  acquisition strategy
described above.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2005, we had approximately $391,000 in cash and cash equivalents,
a decrease of  approximately  $8.7 million from the December 31, 2004 balance of
approximately  $9.1  million.  Our net  working  capital  at June  30,  2005 was
approximately  $1.5 million  compared to a net working capital of  approximately
$8.6  million at  December  31,  2004.  This  decrease  in working  capital  was
primarily due to the use of cash to fund the  construction of our  manufacturing
facility in Korea including the purchase of the equipment for that facility,  as
well as to fund our operating expenses.

Net cash used in operating  activities  totaled  approximately  $3.8 million and
$2.5 million for the three months ended June 30, 2005 and 2004, respectively and
$5.5  million and $4.7  million for the six months ended June 30, 2005 and 2004,
respectively

Net cash used in investing  activities  totaled  approximately  $0.2 million and
$0.1 million for the three months ended June 30, 2005 and 2004, respectively and
approximately  $3.5  million and $0.2  million for the six months ended June 30,
2005 and 2004.

Net cash  provided by  financing  activities  in the three months ended June 30,
2005 and 2004 were  approximately  $0.3 million and $0.7 million , respectively,
and  approximately  $0.3  million and $1.1 million for the six months ended June
30,  2005 and  2004,  respectively.  In the  second  quarter  of 2005,


                                       22
<PAGE>

cash  was  provided  by  the  partial  repayment  of  notes  receivable  from  a
shareholder  and from the exercise of employee  stock options and in 2004,  cash
was provided primarily from the exercise of employee stock options and warrants.

We expect to meet our cash needs and fund our working capital  requirements with
our existing cash balances and from certain  additional  sources.  Those sources
include proceeds of approximately $2.7 million that we received from the sale of
500,000  of our  common  shares on August  5,  2005 from a  currently  effective
"shelf"  registration  statement,  as  more  fully  described  in Note 12 of our
condensed consolidated financial statements.  Other anticipated sources are cash
payments  from our  customers,  the  exercises of stock options and warrants and
additional sales of our common shares from the "shelf"  registration  statement.
There can be no assurances with respect to these potential sources. In addition,
the purchasers in the November 2004 Financing have the option,  which expires on
August 31, 2005,  to lend us an  additional  $5 million on the same terms as the
November  2004  Financing,  as more fully  described in Note 7 of our  condensed
consolidated  financial  statements.  It is uncertain  whether the November 2004
Financing  purchasers  will  exercise  this option.  Robert A. Olins,  our Chief
Executive  Officer  and  a  Director  and  Greenpark  Limited,  an  unaffiliated
shareholder,  jointly  and  severally  committed  to provide us with  additional
financing  as  more  fully  described  in Note 7 of our  condensed  consolidated
financial  statements.  We believe that our current cash and cash equivalents as
of June 30,  2005,  combined  with the  proceeds  from the  August  2005  Equity
Financing  and the  financing  commitment  from  Robert A.  Olins and  Greenpark
Limited will be sufficient to meet our capital and  liquidity  requirements  for
our operations through at least the second quarter of 2006.

RESULTS OF OPERATIONS

Revenue.  We  recognized  revenue of  approximately  $41,000 and $139,000 in the
three and six months ended June 30, 2005 and approximately $541,000 and $860,000
for the three and six months ended June 30, 2004, respectively.  Revenue for the
six-month  period  in  2005  was  from  the  sale of LCoS  Sets  and  supporting
electronics.  Revenue in the same period of 2004 was primarily  from the sale of
display  units.  Our  revenue  for the  first  half of 2005 was  lower  than the
comparable  period  in 2004  because  LCoS Sets have a lower  sales  price  than
display  units and  because  our  sales  strategy  has  changed,  as more  fully
described under the heading  "Business  Strategy" above. The second quarter 2005
revenue was derived primarily from sales of LCoS Sets to LG Electronics in order
to reach the  specifications  required  to  fulfill  the our  agreement  with LG
Electronics.  During the same period for 2004,  we  recognized  sales of display
units to our  Chinese  customers,  of which a portion  was later  written off as
uncollectible.


                                       23
<PAGE>

Revenue  from one  customer,  LG  Electronics,  accounted  for 78% of our  total
revenue for the six months  ended June 30, 2005.  The loss of this  customer and
our  inability  to  obtain  additional  purchase  orders  from  our  current  or
prospective  customers to replace the lost  expected  revenue in a timely manner
could harm our sales or results of  operations.  Accounts  receivable  from this
customer accounted for 100% of total accounts receivable as of June 30, 2005.

Cost of revenue.  Cost of revenue was approximately  $89,000 and $159,000 in the
three and six months ended June 30, 2005 and approximately $426,000 and $772,000
for the three and six months  ended June 30, 2004,  respectively.  In the second
quarter of 2005, the cost of revenue doubled per the revenue earned due to items
returned and remade for LG  Electronics  as LG  Electronics  refined and changed
their  specifications.  Cost of revenue in the first  half of 2004  includes  an
adjustment  to restate  inventory  at the lower of cost or market as our initial
purchases were at a cost higher than we expected to recover from future sales.

Gross  margin.  Gross margin was  approximately  $(48,000) and $(20,000) for the
three and six months ended June 30, 2005 and approximately  $115,000 and $88,000
for the three and six months ended June 30, 2004, respectively. The gross margin
decreased approximately $163,000 and $108,000 for the three and six months ended
June 30, 2005 from our gross margin for the same  periods in 2004.  The decrease
in gross  margins for the three and six month  periods was  primarily due to the
increase  in  costs in  meeting  changing  specification  plans  required  by LG
Electronics  and the fixed sales  price of the LCoS sets per the LG  Electronics
agreement.

Selling,  general and administrative costs. Selling,  general and administrative
costs were  approximately  $1,772,000  and  $1,480,000 in the three months ended
June 30, 2005 and 2004,  respectively  and  $3,482,000 and $2,486,000 in the six
months ended June 30, 2005 and 2004,  respectively,  and  included  professional
services,  sales and  administrative  salaries and related  taxes and  benefits,
rent, depreciation, travel, insurance and office expenses. Professional services
increased by  approximately  $300,000 in the six months ended June 30, 2005 from
2004 due to the various SEC filings related to a routine SEC review of our Forms
S-3, Form 10K for the year ended  December 31, 2004 and Form 10Q for the quarter
ended March 31, 2005. Rent increased by approximately $44,000, medical insurance
(caused by additional staff) increase by approximately  $39,000 and auto expense
increase by approximately  $49,000,  while office supplies and other general and
administrative  expenses  related to our new Korean  facility were incurred that
had no comparable  expense in the second half of 2004. During the second quarter
of 2005, there was an approximately  $193,000  increase in selling,  general and
administration cost from the same period in 2004. The increase was the result of
an  approximately  $30,000  increase  in salary and wages  expense for the sales
department,  an  approximately  $41,000  increase in  automobile  expense due to
increase travel by our sales  personnel,  an  approximately  $64,000 increase in
freight expense due to the shipment of equipment from our California facility to
our Korean  manufacturing  plant,  accounting  costs increased by  approximately
$115,000 due to the support needed for the routine SEC review and an approximate
$56,000 increase in consulting due to the additional  requirements  necessitated
by  the  Sarbanes  Oxley  Act  of  2002  along  with  research  related  to  the
implementation of our Navision software. These expenses were partially offset by
decreases in  administration  travel of approximately  $73,000 and of salary and
wages for administrative personnel of approximately $94,000.

Stock-based compensation.  Stock-based compensation was approximately $8,000 and
$218,000  in the three  months  ended June 30, 2005 and 2004,  respectively  and
approximately  $107,000  and  $261,000 in the six months ended June 30, 2005 and
2004, respectively. The amounts incurred relate to common shares, stock options,
and  warrants  issued.  Expenses in the first half of 2005 and 2004  include the
issuance of stock options to an employee in 2003 at an exercise price lower than
the fair market value of the stock on the date of grant that are being  expensed
over the  vesting  period.  Expenses in the second  quarter of 2005  include the
value of a warrant issued for sales services.  Expenses in the second quarter of
2004 relate  primarily to 250,000 warrants issued to a sales consultant in April
2004 valued at $210,000.

Research  and   development   costs.   Research  and   development   costs  were
approximately  $1,166,000  and  $570,000 in the three months ended June 30, 2005
and 2004,  respectively  and  $1,659,000


                                       24
<PAGE>

and  $1,252,000  in the six months  ended June 30, 2005 and 2004,  respectively.
During  the second  quarter of 2005,  significant  effort has been  expended  on
developing the LCoS sets to meet LG Electronics'  new  specifications  and there
has been a ramping  up of the  Korean  plant to  prepare  for  commercial  scale
production.  However,  certain  expenses for the first half of 2005 decreased by
approximately  $91,000 from the same period in 2004. The decrease was the result
of a reduction of travel expenses incurred by our research and development group
of approximately $68,000 and a reduction of consulting expenses of approximately
$37,000.

Interest  expense.  Interest  expense for the three  months  ended June 30, 2005
increased  approximately  $250,000  from  the  same  period  in 2004  due to the
issuance  of the $10  million of Senior  Secured  Convertible  Notes in November
2004, which accrues interest at 10% annually.  For the six months ended June 30,
2005,  interest  expense  totaled  approximately   $535,000,   resulting  in  an
approximate $499,000 increase over the same period in 2004. The increase was the
result of the November 2004 Senior Secured Convertible Notes

Non-cash interest expense.. Non-cash interest expense was approximately $555,000
and  $375,000  for the six months  ended June 30,  2005 and 2004,  respectively.
Non-cash interest expense was approximately  $278,000 and $188,000 for the three
months ended June 30, 2005 and 2004,  respectively.  Non-cash  interest  expense
relates to the beneficial price of shares issued to prepay interest on the notes
payable to Argyle  Capital  Management  Corporation,  a company  wholly owned by
Robert A. Olins,  our Chief  Executive  Officer  and  Director.  The  beneficial
conversion  interest  represents  the  excess  value of the shares  received  or
receivable at current market prices over the $0.50 per share  conversion  price.
Also included in non-cash interest expense is the amortization of note discounts
and note  financing  costs.  The increase in the three and six months ended June
30,  2005 as  compared  to the same  periods  in 2004  primarily  related to the
amortization  of note discounts and note financing  costs from the November 2004
Senior Secured Convertible Notes.

Critical Accounting Policies

Revenue  Recognition  - We  enter  into  commercial  transactions  to  sell  our
products.  We evaluate  revenue  recognition  for these  transactions  using the
following criteria (collectively called the Revenue Recognition Criteria):

      o     Evidence of an  arrangement:  Before revenue is recognized,  we must
            have evidence of an agreement with the customer reflecting the terms
            and  conditions  to deliver  our  products.  Contracts  are used for
            specialized  arrangements with customers,  including deliveries over
            an extended period of time, and  arrangements for letters of credit.
            Standard agreements require receipt of a purchase order.

      o     Delivery:  For products,  delivery is considered to occur when title
            and risk of loss have been transferred,  which, for us, is generally
            when product has been delivered to a common carrier.

      o     Fixed  or  determinable  fee:  We  consider  a fee  to be  fixed  or
            determinable if the fee is not subject to refund or adjustment. If a
            portion  of the  arrangement  fee is not fixed or  determinable,  we
            recognize  that amount as revenue when the amount  becomes  fixed or
            determinable.  We do not consider a fee to be fixed and determinable
            if any  amount  is due more than 180 days  from the  delivery  date.
            Payment  terms of less than 180 days are  evaluated  based  upon the
            country in which the  arrangement  is entered into to assess whether
            the fee is fixed and determinable.

      o     Collection  is  deemed  reasonably  assured:  Collection  is  deemed
            reasonably  assured  if we  expect  the  customer  to be able to pay
            amounts under the  arrangement  as those  amounts  become due. If


                                       25
<PAGE>

            we determine that collection is not probable,  we recognize  revenue
            when  collection  becomes  reasonably  assured  (generally upon cash
            collection).

Inventory  valuation - We value  inventories  at the lower of cost (based on the
first-in,  first-out  method) or market value. We include  materials,  labor and
manufacturing  overhead in the cost of  inventories.  In  determining  inventory
market values,  we give substantial  consideration to the expected selling price
of the product based on historical recovery rates. If we assess the market value
of our  inventory  to be less than cost given  current  prices and future  sales
commitments we write it down to its  replacement  cost or net realizable  value.
Our estimates may differ from actual results due to the quantity and quality and
mix of products in  inventory,  consumer and retailer  preferences  and economic
conditions.

Income tax assets and  liabilities  - In  establishing  our deferred  income tax
assets and  liabilities,  we make  judgments  and  interpretations  based on the
enacted  tax  laws  and  published  tax  guidance  that  are  applicable  to our
operations.  We record deferred tax assets and liabilities and evaluate the need
for  valuation  allowances  to reduce  the  deferred  tax  assets to  realizable
amounts.  The  likelihood of a material  change in our expected  realization  of
these assets is dependent on future taxable  income,  our ability to use foreign
tax credit carryforwards and carrybacks, final U.S. and foreign tax settlements,
and the  effectiveness  of our tax planning  strategies in the various  relevant
jurisdictions.  Due to our  lack  of  profitable  operating  history,  potential
limitations on usage of operating  losses and general  uncertainty,  we provided
for a 100%  valuation  allowance  against our deferred  tax assets.  We are also
subject to  examination  of our income tax  returns  for  multiple  years by the
Internal Revenue Service and other tax authorities.  We periodically  assess the
likelihood of adverse  outcomes  resulting from these  examinations to determine
the  adequacy  of our  provision  for  income  taxes.  Changes to our income tax
provision or the valuation of the deferred tax assets and liabilities may affect
our annual effective income tax rate.

BUSINESS RISKS AND UNCERTAINTIES

We have a history  of losses and may incur  losses in the  future and  therefore
cannot assure you that we will achieve profitability.

We have incurred losses to date and have experienced cash shortages. For the six
months  ended  June 30,  2005,  we  incurred  net losses of  approximately  $5.7
million.  In addition,  we had an  accumulated  deficit of  approximately  $73.3
million as of June 30, 2005. We expect additional losses as we continue spending
for commercial scale production and other business activities as well as further
research and development of our products.  As a result, we will need to generate
substantial  sales to support our costs of doing business before we can begin to
recoup our operating losses and accumulated deficit and achieve profitability.

While we have obtained  financing and financing  commitments that we expect will
be sufficient to fund our currently anticipated financial needs at least through
the second quarter of 2006, if we are unable to obtain further  financing in the
future or generate  required  working  capital  for future  capital  needs,  our
ability to operate could suffer or cease.

Our  operations  to date  have  consumed  substantial  amounts  of cash and will
continue to require  substantial  amounts of capital in the future.  In order to
remain competitive,  we must continue to make significant  investments essential
to our ability to operate profitably,  including further investments in research
and development,  equipment, facilities and production activities. Our financial
condition and liquidity have been strongly  assisted  through:  private sales of
our common shares including


                                       26
<PAGE>

approximately  $2.7 million  received from the sale of our common shares under a
"shelf" registration on August 5, 2005; the $10.0 million, less expenses, raised
by us in the November 2004 Financing; the approximately $5.0 million raised from
the  sale  in  December  2003 of  1,000,000  of our  common  shares  which  were
registered for sale by means of a "shelf"  registration;  and approximately $3.0
million raised through  exercises of stock options and warrants through 2004 and
the first half of 2005.  The August  2005  Equity  Financing  purchasers  have a
30-day  option,  which  expires on September 4, 2005,  to purchase an additional
225,000 shares under our "shelf"  registration  at a purchase price of $5.50 per
share.  The  purchasers in the November 2004  Financing  have the option,  which
expires  on August 31,  2005,  to lend us an  additional  $5 million on the same
terms as the November  2004  Financing as more fully  described in Note 7 to our
condensed consolidated financial statements.  It is uncertain whether either our
August  2005  Equity  Financing   purchasers  or  our  November  2004  Financing
purchasers  will exercise these options.  We have no assurance that  outstanding
stock  options  and  warrants  will be  exercised.  Robert A.  Olins,  our Chief
Executive  Officer  and  a  Director  and  Greenpark  Limited,  an  unaffiliated
shareholder,  jointly  and  severally  committed  to provide us with  additional
financing  as  more  fully  described  in Note 7 to our  condensed  consolidated
financial statements.  Taking into account our current financial condition,  our
financing  commitments  and the  August  2005  Equity  Financing,  we will still
require   additional   financing  to  satisfy  our  increasing  working  capital
requirements in the future.  Reliance on private equity purchase  agreements and
public  offerings and  exercises of derivative  securities to finance our future
operations  entails the  additional  risks of default by  purchasers  under such
equity purchase  agreements or our inability to sell publicly  registered shares
and an  insufficient  number of warrants being exercised owing to the prevailing
market  prices of our  underlying  common  shares.  In the event that we require
additional financing in the future and we are unable to obtain further financing
on satisfactory  terms, or we are unable to generate sales  sufficient to offset
our costs,  or if our costs of  development  and  operations are greater than we
anticipate,  we may be unable to increase  the size of our  business at the rate
desired or may be required to delay, reduce, or cease certain of our operations,
any of which could materially harm our business and financial results.

The  obligations  arising from the November 2004 Financing  restricts our future
financing  alternatives  and may result in financial  difficulties for us in the
future.

The $10 million 2004 Senior  Secured  Convertible  Notes issued  pursuant to the
November 2004 Financing bear a 10% rate of interest and are not  prepayable,  in
whole or in part, prior to their maturity on November 30, 2007. Therefore, we do
not have the ability to refinance the 2004 Senior Secured Convertible Notes with
debt obligations bearing more favorable terms to us or out of the proceeds of an
equity financing until their above-noted maturity date. However, after the first
anniversary of the November 2004 Financing's closing, we have the right to force
conversion of the 2004 Senior Secured  Convertible  Notes into our common shares
in the event that our common  shares trade at or above $14.58 (150% of the $9.72
conversion  price of the 2004  Senior  Secured  Convertible  Notes)  for  twenty
consecutive trading days. Furthermore, the 2004 Senior Secured Convertible Notes
are  secured by  virtually  all of the assets of our  Company,  other than those
located in Korea, and it may therefore be difficult for us to obtain future debt
financing;  however,  the  terms  of the  November  2004  Financing  allow us to
subordinate the security interests of the 2004 Senior Secured  Convertible Notes
to a  security  interest  given  to a bank or  other  institution  arising  from
accounts receivable,  contractual rights,  inventory or similar financing. If we
default in meeting our  obligations  under the 2004 Senior  Secured  Convertible
Notes,  the  indebtedness  which they evidence will become  immediately  due and
payable,  and the holders of such 2004 Senior Secured  Convertible Notes will be
entitled  to  foreclose  on our assets to the  serious  detriment  of our future
operations. As noted elsewhere in this 10-Q, the 2004 Senior Secured Convertible
Notes are  convertible  into our common  shares and the  issuance of such


                                       27
<PAGE>

shares  (including  any shares  issued in payment of interest on such notes) may
have a dilutive effect on the value of our outstanding common shares.

We are  required  to file a  registration  statement  for  resale of the  shares
issuable upon conversion of the 2004 Senior Secured  Convertible  Notes and have
the  registration  statement  declared  effective  no later  than 120 days after
December 21, 2004.  Pursuant to our amended  registration  rights agreement with
the noteholders,  because the registration did not become effective by April 20,
2005, we are subject to the obligation to pay each  noteholder  cash equal to 1%
of the purchase  price of the notes (which  equals an aggregate  total amount of
$100,000),  and 1% for every 30 days thereafter until the  registration  becomes
effective.  However,  each of the  noteholders  has agreed to waive its right to
these  payments  in the event  that the  applicable  registration  statement  is
declared  effective  no later  than  July  29,  2005.  On July 29,  2005 the SEC
declared the registration  statement  effective  pursuant to Section 8(a) of the
Securities Act of 1933, as amended.

We are subject to lengthy  development  periods and product  acceptance  cycles,
which may significantly harm our business.

Our business model requires us to develop microdisplays that perform better than
existing  technologies,  manufacture our LCoS Sets and/or display units in bulk,
and sell the  resulting  LCoS Sets and/or  display  units to OEMs that will then
incorporate them into their products.  OEMs make the determination  during their
product development programs whether to incorporate our LCoS Sets and/or display
units in their products.  This requires us to invest significant amounts of time
and capital in  designing  our LCoS Sets and/or  display  units before we can be
assured that we will  generate any  significant  sales to our  customers or even
recover our  investment.  If we fail to recover our  investment in the LCoS Sets
and/or  display  units,  it could  seriously  harm our financial  condition.  In
addition,  the time period that our  products  may be demanded by our  customers
could  be  limited  by the  acceptance  of  new  technologies  developed  by our
competitors.

We  incur  substantial   operational  and  research  and  development  costs  in
connection with products and technologies that may not be successful.

We currently have nine  full-time  engineering  and ten full-time  manufacturing
personnel  based  in  California  working  on  microdisplays.  We are  currently
actively hiring personnel for our manufacturing facility located in the Republic
of  Korea.   We  currently  have  6  full-time   engineering  and  27  full-time
manufacturing  personnel based in the Republic of Korea and we expect to hire an
additional 5 engineers and 150 manufacturing  personnel by the end of 2005. This
staffing creates significant operational and research and development costs that
may not be  recouped.  Even if our  current  LCoS Sets  become  accepted  and/or
successful, we must continue to use, and may increase in number, our engineering
and manufacturing  personnel to develop future  generations of our microdisplays
because of the rapid  technological  changes in our  industry.  As a result,  we
expect  to  continue   incurring   significant   operational  and  research  and
development costs.

We are currently  manufacturing and shipping our products in limited  commercial
quantities,  but  unanticipated  difficulties in  manufacturing  our products in
larger  quantities  may make it difficult to meet customer  demands from time to
time  and  our  operating   results  could  be  significantly   harmed  by  such
difficulties.

Problems in  production of our LCoS Sets or display units or lower than expected
manufacturing  yields could significantly harm our business because we will have
already   incurred  the  costs  for  the  materials


                                       28
<PAGE>

used in the  microdisplay  manufacturing  process.  These  problems  could cause
delays  that might lead our  current  and  prospective  customers  to seek other
sources.

We currently obtain silicon backplanes,  a vital component in our microdisplays,
from the Far East. Some Asian countries are subject to earthquakes, typhoons and
political instability. Unless we obtain an alternative source, any disruption or
termination  of our silicon  manufacturing  source's  operation in Taiwan or air
transportation with the Far East could significantly harm our operations.

Our LCoS Sets are assembled by combining the silicon  backplanes with electronic
components. The design and manufacture of LCoS Sets and display units are highly
complex processes that are sensitive to a wide variety of factors, including the
level  of  contaminants  in the  manufacturing  environment,  impurities  in the
materials used, and the  performance of personnel and equipment.  We lease clean
room space in California and have built a manufacturing plant in the Republic of
Korea  where we  currently  manufacture  our LCoS Sets.  We  believe  that these
current  arrangements  provide us with strong quality  controls and  effectively
protect our  proprietary  technology  in our products,  but the risks  discussed
above associated with the highly complex processes of manufacturing these liquid
crystal microdisplays remain applicable.

We continue to have  working  arrangements  with the  manufacturer  of the light
engines and lamps required in the assembly of our display units. We have entered
into an agreement  for the supply of prisms and filters  which are also required
for the assembly of such units. We do not have other such  agreements  which are
binding upon the  manufacturers of the other components and no such manufacturer
is bound to  furnish  us with  any  specific  quantities  of their  products  at
previously  specified  prices.  At this  date,  we are not aware that any of our
component manufacturers has a known shortage of critical material.

Because the manufacture of our LCoS Sets involves  highly complex  processes and
technical problems may arise as we manufacture our liquid crystal microdisplays,
we cannot  assure the  manufacturing  yields of our products.  Current  purchase
orders and anticipated  future  purchase  orders,  which we cannot assure,  will
require us to produce greater  quantities of our LCoS Sets than we have produced
in  the  past.  Problems  in  production,  including  problems  associated  with
increasing our  production  output or lower than expected  manufacturing  yields
could  significantly harm our business and operating results.  In addition,  the
complexity of our manufacturing processes will increase as the sophistication of
our LCoS Sets and display units  increases,  and such  complexities  may lend to
similar  difficulties  that  could  harm our  business  and  operating  results.
Although we believe  that we will be able to mass  produce our LCoS Sets,  other
companies,  including some with  substantially  greater  resources than us, have
found great  difficulty or failed to do so. We do not have reliable  information
about why other  companies  have failed to  manufacture  similar  liquid crystal
microdisplays  and can therefore  make no assurances  that we will not encounter
similar problems.

While we commenced  producing products in our new manufacturing  facility in the
Republic of Korea,  which will serve as our principal facility for manufacturing
our microdisplay  products,  we may encounter  difficulties in transitioning our
manufacturing  operations and  difficulties in maintaining our quality  controls
over the manufacturing and production processes, any of which would be likely to
cause significant harm to our business.

Our decision to locate our principal manufacturing operations in the Republic of
Korea may cause us to encounter one or more  potential  problems that could harm
our  business.   Such  potential   problems  could  arise  in  connection   with
transitioning our  manufacturing  operations to the new facility in the Republic
of Korea. Other


                                       29
<PAGE>

problems may arise in the training of  employees,  which may occur as the result
of cultural or language differences, which may create misunderstandings or cause
inefficiencies  in  our  operations.   The  geographic  separation  between  our
corporate offices in the United States and our principal manufacturing operation
in the Republic of Korea could result in  managerial  or  supervisory  problems,
which could lead to decreased quality controls and a subsequent material harm to
our business.

Geopolitical  conditions or potential  military  conflicts  between allies,  the
United States and the Republic of Korea,  and North Korea may negatively  impact
our business.

We commenced producing products in our principal manufacturing operations in the
Republic of Korea  during the second  quarter of 2005 and our  largest  expected
customer,  LG  Electronics,  resides in the  Republic of Korea.  The Republic of
Korea and North  Korea are  technically  at war with  each  other,  despite  the
mutually  agreed  upon  existence  of the  Demilitarized  Zone and the  relative
absence of physical conflict for several decades. Any escalation in the existing
conflict between these countries or any commencement,  or perceived commencement
of a military  conflict between the United States and North Korea, may limit our
ability to  effectively  operate our  manufacturing  facility in the Republic of
Korea and also may  substantially  limit our ability to sell  products  into the
Republic  of  Korea  because  of  the  negative  economic,   physical  or  other
destructive  impact  that  such a  conflict  could  have on our  most  important
customer. Any such disruptions to our manufacturing operations and/or ability to
consummate   sales  to  a  substantial   customer  could  adversely  affect  the
development of our business and our financial condition.

If the high  definition  television  market does not  continue to develop and if
other potential  markets for our products do not materialize,  then our business
will likely be significantly harmed.

High definition  television  programming  has only recently become  available to
consumers, and widespread market acceptance,  although anticipated, is uncertain
at this time.  The market demand for high  definition  televisions is considered
contingent  upon  such  widespread  acceptance  of  high  definition  television
programming. Our current sales and marketing efforts are focused on OEMs of high
definition televisions and OEMs of light engines designed for incorporation into
high  definition  televisions.  Therefore,  if the  market  for high  definition
televisions does not continue to grow and develop, then we will have significant
difficulty  selling our products,  which will have a material  adverse effect on
our results of operations.

Various  potential  target  markets  for  our  products,  including  projectors,
monitors, and portable microdisplays,  are uncertain and may be slow to develop.
In addition,  companies in those markets could utilize  competing  technologies.
For us to succeed in selling our products into these  potential  markets we must
offer end-product  manufacturers better and less expensive microdisplay products
than our competitors, and the manufacturers themselves will also have to develop
commercially  successful  products  using our  products.  In the  event  that we
attempt to market and sell our products into these potential target markets,  if
we are not able to succeed in selling our products into these potential markets,
then our results of operations and overall business may be negatively affected.

If our products do not become widely accepted by our customers or the end-users,
our business could be significantly harmed.

      Our LCoS Sets and/or  display  units may not be  accepted by a  widespread
market.  Even if we  successfully  obtain  customer  orders,  our  customers may
determine not to introduce or may terminate  products  utilizing the  technology
for a variety of reasons, including the following:


                                       30
<PAGE>

      o     superior technologies developed by our competitors;

      o     price considerations; and

      o     lack of anticipated or actual market demand for the products.

We currently have purchase order  agreements with a limited number of customers.
Despite  our  reasonable  efforts  to retain  these  customers  and  obtain  new
customers,  we may not be successful in either of these regards. The loss of any
one or more of these  customers  or a failure  to  obtain  new  customers  could
materially harm our business and financial condition.

We may become  largely  dependent on one customer for our future  revenues,  and
failure  to expand  our  customer  base or receive  additional  orders  from our
existing  customer base will make us vulnerable to substantial loss of potential
revenues.

In the first half of 2005, a  substantial  percentage of our revenue was derived
from LG Electronics.  Based upon our agreement with LG Electronics, it is likely
that a substantial percentage of our anticipated future revenues will be derived
from LG Electronics as well. If we cannot  diversify our customer base or derive
increased revenues from our existing customer base through  additional  purchase
orders and product  deliveries,  and therefore become primarily  reliant on only
one customer for a substantial  percentage of our anticipated  revenues, we will
be  vulnerable to a substantial  decline in  anticipated  revenues if we lose LG
Electronics as a customer for any reason or if LG Electronics  were to otherwise
reduce,  delay or cancel its  orders.  Any such  events  could  cause a material
adverse effect on our business, operations and financial condition and the value
of our common shares could decline substantially.

Our ability to retain and receive  additional  purchase  orders from our current
customers and to attract and receive purchase orders from prospective  customers
may depend upon the  acceptance  of LG  Electronics'  products  in the  consumer
marketplace.  If LG  Electronics'  television  products  incorporating  our LCoS
technology  are not  commercially  successful,  demand for our products from our
current and prospective  customers may not  materialize,  which could negatively
impact our results of operations and our financial condition.

We cannot  assure you that we will obtain  additional  purchase  orders from our
current or prospective  customers,  or, if we do, that such orders will generate
significant revenues.

Even though we have received  purchase  orders for our LCoS Sets and/or  display
units from LG  Electronics  and from  several  Chinese  OEMs and we may  receive
additional purchase orders from our prospective customers,  we may have problems
implementing   volume  production  of  our  products.   Furthermore,   sales  to
manufacturers  in the  electronics  industry  are subject to severe  competitive
pressures,  rapid technological change and product obsolescence.  Customers may,
at any time,  cancel  purchase  orders or commitments or reduce or delay orders,
thereby  increasing  our inventory  and overhead  risks.  In addition,  purchase
orders  received from our Chinese  customers  are for limited  quantities of our
products. Therefore, despite the purchase orders received from current customers
and other purchase  orders that we may receive from  prospective  customers,  we
cannot assure you that these  agreements will result in significant  revenues to
us.

If our customers' products are not successful,  our business would be materially
harmed.


                                       31
<PAGE>

We do not  currently  sell any  products to  end-users.  Instead,  we design and
manufacture  various  product  solutions  that our  customers  (i.e.,  OEMs) may
incorporate  into  their  products.  As a result,  our  success  depends  almost
entirely upon the widespread market acceptance of our customers'  products.  Any
significant  absence of, or slowdown in the demand for our  customers'  products
would materially harm our business.

Our  dependence on the success of the products of our customers  exposes us to a
variety of risks, including our need to do the following:

      o     maintain  customer  satisfaction  with our design and  manufacturing
            services;

      o     match our design and manufacturing capacity with customer demand and
            maintain satisfactory delivery schedules;

      o     anticipate  customer order  patterns,  changes in order mix, and the
            level and timing of orders that we can meet; and

      o     adjust to the  cyclical  nature of the  industries  and  markets  we
            serve.

Our  failure to address  these  risks may cause us to lose sales or for sales to
decline.

The high definition television industry is highly competitive,  which may result
in lost sales or lower gross margins.

We serve the highly  competitive  high  definition  television  industry that is
characterized by price erosion,  rapid technological change and competition from
major  domestic and  international  companies.  This intense  competition  could
result in downward  pricing  pressures,  lower sales,  reduced margins and lower
market share.

Companies  competing  in the  LCoS  microdisplay  market  include  Sony and JVC,
although we presently believe that Sony has developed LCoS microdisplays for its
own use and not for  sale to  other  OEM's.  A major  competitor  of ours in the
reflective  microdisplay  market,  although  not using  liquid  crystals  in the
display, is Texas Instruments,  which is producing a micro-mechanical  structure
of moving mirrors on a silicon  backplane,  a technology  known as digital light
processing,  or DLP. Texas  Instruments has had significant  success selling its
DLP products to its  customers in the business  front  projector  market and the
rear projection  high definition  television  market.  Some of our  competitors,
including  Texas  Instruments and JVC, have greater market  recognition,  larger
customer bases,  and  substantially  greater  financial,  technical,  marketing,
distribution and other resources than we possess.  As a result, they may be able
to introduce new products and respond to customer  requirements more quickly and
effectively than we can.

Rapid and significant technological advances have characterized the microdisplay
market.  There can be no  assurance  that we will be able to effect  any of such
technological  advances or that we will have  sufficient  funds to invest in new
technologies  or products or  processes.  Although we believe  that our displays
have specifications and capabilities, which equal or exceed that of commercially
available  LCD,  cathode  ray tube  (CRT) and DLP based  display  products,  the
manufacturers  of these  products  may  develop  further  improvements  of their
existing technology that would eliminate or diminish our anticipated  advantage.
In  addition,   numerous  competitors  have  substantially   greater  financial,
technical,  marketing,  distribution  and  other  resources  than we  have.  The
acceptance  of our LCoS Sets and/or


                                       32
<PAGE>

display  units will be dependent  upon the  pricing,  quality,  reliability  and
useful life of these products  compared to competing  technologies,  as to which
there can be no assurance.

Our competitive  position could suffer if one or more of our customers decide to
design and manufacture  their own  microdisplay  products,  to contract with our
competitors, or to use alternative technologies.  In addition,  customers in the
television  manufacturing  industry  typically  develop a second source.  Second
source suppliers may win an increasing share of our customer's  product demands.
Our ability to compete successfully depends on a number of factors,  both within
and outside our control. These factors include the following:

      o     our success in designing and manufacturing new display technologies;

      o     our ability to address the needs of customers;

      o     the  quality,  performance,  reliability,  features,  ease  of  use,
            pricing, and diversity of our display products;

      o     foreign   currency   fluctuations,   which   may   cause  a  foreign
            competitor's  products  to be priced  significantly  lower  than our
            displays;

      o     the quality of our customer services;

      o     the efficiency of our production sources; and

      o     the rate at which customers  incorporate our displays into their own
            products;   and   products  or   technologies   introduced   by  our
            competitors.

Fluctuations  in the  exchange  rate of the United  States  dollar  and  foreign
currencies could have a material adverse effect on our financial performance and
profitability.

A portion of our costs is  denominated  in  foreign  currencies,  including  the
Korean Won, the Euro and the Japanese Yen. As a result,  changes in the exchange
rates of these currencies or any other applicable  currencies to the U.S. dollar
will affect our costs of good sold and  operating  margins,  and could result in
exchange  losses.  We cannot fully  predict the impact of future  exchange  rate
fluctuations on our profitability.  From time to time, we may engage in exchange
rate-hedging  activities  in an effort to mitigate  the impact of exchange  rate
fluctuations,  although we have not engaged in any such  hedging  activities  to
date.  However,  we cannot  offer  assurance  that any hedging  technique we may
implement will be effective.  If it is not effective,  we may experience reduced
operating margins.

Our business is significantly  affected by conditions or events occurring in the
electronics industry generally.

The  electronics  industry has  experienced  significant  economic  downturns at
various times,  characterized by diminished product demand,  accelerated erosion
of average selling prices, and production  over-capacity.  Since the electronics
industry is cyclical in nature, we may experience  substantial  period-to-period
fluctuations in future operating results because of general industry  conditions
or events occurring in the general economy.

Our operating results are subject to significant fluctuations.


                                       33
<PAGE>

Our results of operations have varied significantly from  quarter-to-quarter  in
the past and are likely to vary  significantly  in the  future,  which  makes it
difficult to predict our future operating results.  Accordingly, we believe that
quarter-to-quarter  comparisons of our operating  results are not meaningful and
should not be relied upon as an indicator of our future performance. Some of the
factors that cause our operating results to fluctuate include the following:

      o     introductions  of displays and market  acceptance of new generations
            of displays;

      o     timing of expenditures in anticipation of future orders;

      o     changes in our cost structure;

      o     availability of labor and components;

      o     pricing and availability of competitive products and services;

      o     the timing of orders;

      o     the volume of orders  relative to the  capacity  we can  contract to
            produce;

      o     evolution in the life cycles of customers' products; and

      o     changes or anticipated changes in economic conditions.

The market price of our common shares is highly volatile.

The market price of our common shares has been highly volatile, reflecting among
other things reported  losses,  receipts of additional  financing and investors'
perceptions about our business  prospects.  Some research has shown that similar
volatility in other companies  correlates with class action securities  lawsuits
although to date we have not been a defendant in any such  lawsuit.  The trading
price of our common  shares in the future  could  continue to be subject to wide
fluctuations in response to various factors, including the following:

      o     quarterly variations in our operating results;

      o     actual or anticipated  announcements of technical innovations or new
            product developments by us or our competitors;

      o     public announcements regarding our business developments;

      o     changes in analysts' estimates of our financial performance;

      o     sales of large numbers of our common shares by our shareholders;

      o     general conditions in the electronics industry; and

      o     worldwide economic and financial conditions.

In  addition,  the stock  market has  experienced  significant  price and volume
fluctuations  that  have  particularly  affected  the  market  prices  for  many
high-technology  companies  and that often have been


                                       34
<PAGE>

unrelated to the operating  performance of these  companies.  These broad market
fluctuations  and other  factors may  adversely  affect the market  price of our
common shares.

By further  increasing the number of our common shares that may be sold into the
market,  any future  offerings of our equity  securities  could cause the market
price of our  common  shares to  decrease  significantly,  even if our  business
operations are performing well.

The total number of common  shares  included in the  Amendment No. 6 to Form S-3
Registration Statement that we filed with the SEC on July 27, 2005 (Registration
Number 333-122391), principally relating to the November 2004 Financing plus the
2,000,000  common  shares  included in the  Amendment  No. 4 to Form S-3 "Shelf"
Registration  Statement  filed by us with the SEC on July  27,  2005  represents
approximately  11% of the total number of our common shares that were issued and
outstanding as of August 1, 2005. Sales of these shares, into the public market,
or the  perception  that future sales of these common shares could occur,  might
adversely  affect the  prevailing  market price of our common shares in the near
future. On July 29, 2005 the SEC declared the registration  statements effective
pursuant to Section 8(a) of the Securities Act of 1933, as amended. On August 5,
2005,  we sold 500,000 of our common shares at $5.40 per share under our "shelf"
registration,  which became  effective on July 29, 2005. These purchasers have a
30-day  option,  which  expires on September 4, 2005,  to purchase an additional
225,000 shares under our "shelf"  registration  at a purchase price of $5.50 per
share. As of the date of this filing, 1,500,000 of our common shares included in
our currently  effective  "shelf"  registration,  including those subject to the
30-day  option  described  in Note 12 of our  Condensed  Consolidated  Financial
Statements, have not been sold.

Our common shares may not be liquid.

Our  common  shares are  currently  traded on The NASDAQ  SmallCap  Market.  Our
shareholders  may find that it is more  difficult to sell our common shares than
shares that are listed on The NASDAQ National Market, American Stock Exchange or
New  York  Stock  Exchange.   The  trading  volume  of  our  common  shares  has
historically  been adversely  affected due to their limited  marketability,  but
such volume has increased  significantly  in recent periods.  Nevertheless,  any
substantial  sales of our common  shares may result in a material  reduction  in
price, reflecting the volatility of the trading market for our common shares.

If we lose our key  personnel  or are  unable to attract  and retain  additional
personnel, our ability to compete could be harmed.

Our development and operations depend substantially on the efforts and abilities
of our senior management and qualified technical personnel. Our products require
sophisticated  production,  research and development and technical support.  The
competition  for qualified  management and technical  personnel is intense.  The
loss of services of one or more of our key employees or the inability to add key
personnel  could  have a  material  adverse  affect  on us;  particularly  since
currently  we do not  have  any  insurance  policies  in  place  to  cover  that
contingency.  Our  success  will  depend  upon our ability to attract and retain
highly qualified scientific, marketing,  manufacturing,  financial and other key
management  personnel.  We face intense  competition  for the limited  number of
people available with the necessary  technical  skills and  understanding of our
products and technology. We cannot assure you that we will be able to attract or
retain such personnel or not incur significant costs in order to do so.

Our future success depends on our ability to protect our proprietary  technology
and our registered intellectual property.


                                       35
<PAGE>

We believe  that our  success  depends  in part on  protecting  our  proprietary
technology. We rely on a combination of patent,  copyright,  trademark and trade
secret laws, as well as confidentiality and assignment of inventions  agreements
from our employees,  consultants and advisors and other contractual  provisions,
to establish and protect our intellectual  property rights.  If we are unable to
protect our  intellectual  property  from use by third  parties,  our ability to
compete  in the  industry  will  be  harmed.  Policing  unauthorized  use of our
products and  technology is difficult,  however.  Despite our efforts to protect
our proprietary rights, we face the following risks:

      o     pending patent applications may not be issued;

      o     patents   issued   to  us  may  be   challenged,   invalidated,   or
            circumvented;

      o     unauthorized  parties may obtain and use information  that we regard
            as  proprietary  despite  our  efforts  to protect  our  proprietary
            rights;

      o     others may independently develop similar technology or design around
            any patents issued to us;

      o     breach of confidentiality agreements;

      o     intellectual   property  laws  may  not  protect  our   intellectual
            property; and

      o     effective protection of intellectual  property rights may be limited
            or unavailable in some foreign countries, such as China, in which we
            may  operate.  Specifically,  although  we  consider  the  following
            unlikely  because  of the  complex  technological  structure  of our
            products, one or more of our current or prospective Chinese,  Korean
            or  Taiwanese  customers,  or their  respective  employees  or other
            persons  including our competitors,  that have or gain access to our
            products  for  testing  purposes,  may  seek  to  misappropriate  or
            improperly convert to their own use our intellectual  property and a
            lack of adequate remedies and impartiality under the Chinese, Korean
            and other foreign legal systems may adversely  impact our ability to
            protect our intellectual property.

There can be no assurance  that we will have adequate  remedies in the event any
of the  foregoing  materializes.  Failure to protect our  intellectual  property
would limit our ability to produce and market our products in the future,  which
would  materially  adversely  affect our revenues  generated by the sale of such
products.  In  addition,  third  parties  could  assert  that our  products  and
technology  infringe their patents or other  intellectual  property rights. As a
result,  we  may  become  subject  to  future  patent   infringement  claims  or
litigation,  the  defense of which is costly,  time-consuming  and  diverts  the
attention of management and other personnel.

Political,   economic  and  regulatory  risks   associated  with   international
operations may limit our ability to do business abroad.

A substantial  number of our customers,  manufacturers and suppliers are located
outside of the United States,  principally  in the Far East.  Our  international
operations  are  subject  to  political  and  economic  conditions  abroad,  and
protectionist   trade  legislation  in  either  the  United  States  or  foreign
countries,  such as a change in the current tariff structures,  export or import
compliance  laws, or other trade policies,  any of which could adversely  affect
our ability to manufacture  or sell displays in foreign  markets and to purchase
materials or equipment from foreign  suppliers.  Certain of our current purchase


                                       36
<PAGE>

order  agreements with customers are governed by foreign law and therefore,  are
subject to uncertainty with regard to their enforceability.

Risks related to doing business in China may negatively affect our business.

Our business is subject to significant political and economic  uncertainties and
may be adversely  affected by  political,  economic and social  developments  in
China. Over the past several years, the Chinese  government has pursued economic
reform policies  including the  encouragement of private  economic  activity and
greater economic  decentralization.  The Chinese  government may not continue to
pursue these policies or may significantly alter them to our detriment from time
to time with little, if any, prior notice.

A lack of adequate remedies and impartiality  under the Chinese legal system may
adversely  impact  our  ability  to do  business  in China  and to  enforce  the
agreements or purchase orders to which we are, or may become, a party.

At various  times  during  recent  years,  the United  States and China have had
significant   disagreements   over   political,   economic  and  social  issues.
Controversies may arise in the future between these two countries. Any political
or trade  controversies  between  the United  States  and China,  whether or not
directly  related to our  business,  could  adversely  affect our  ability to do
business in China.

We do not pay cash dividends.

We have never paid any cash dividends on our common shares and do not anticipate
that we will pay cash dividends in the near future. Moreover, under the terms of
the November 2004 Financing,  we are prohibited from paying cash dividends while
the 2004 Senior Secured  Convertible Notes issued in the November 2004 Financing
remain  outstanding.  Instead,  we intend to apply any  future  earnings  to the
expansion and development of our business.

Our  reported  financial  results  may  be  adversely  affected  by  changes  in
accounting principles generally accepted in the United States.

We prepare our consolidated  financial  statements in conformity with accounting
principles  generally  accepted  in the U.S.  These  accounting  principles  are
subject to  interpretation  by the Financial  Accounting  Standards  Board,  the
American Institute of Certified Public  Accountants,  the SEC and various bodies
formed to interpret  and create  appropriate  accounting  policies.  A change in
these  policies  or  interpretations  could  have a  significant  effect  on our
reported  financial  results,  and could affect the  reporting  of  transactions
completed  before the  announcement  of a change.  For  example,  the  Financial
Accounting  Standards Board has implemented  changes to United States  Generally
Accepted  Accounting  Principles  that require us to record a charge to earnings
for employee  stock option  grants for all awards  unvested at and granted after
December  31,  2005.  This  regulation  will  negatively  impact  our  earnings.
Technology companies  generally,  and our Company,  specifically,  rely on stock
options as a major component of our employee compensation  packages.  Due to the
new requirement to expense options, we are less likely to achieve  profitability
and we may consider  decreasing  or  eliminating  option  grants.  Decreasing or
eliminating  option  grants may  negatively  impact our  ability to attract  and
retain qualified employees.

Item 3.  Quantitative and Qualitative Disclosures About Market Risks.

We are exposed to the impact of  interest  rate  changes  and  foreign  currency
fluctuations.


                                       37
<PAGE>

Interest  Rate Risk.  Our  exposure  to market rate risk for changes in interest
rates  relates  primarily to our cash  accounts.  We invest excess cash and cash
equivalents in a checking  account or money market account with reputable  banks
both in the United  States and the Republic of Korea.  Our cash  accounts in the
United States are not FDIC or otherwise insured, to the extent that the accounts
exceed $100,000; and our cash accounts in the Republic of Korea are not insured.
As of June  30,  2005,  our  cash and  cash  equivalents  totaled  approximately
$391,000.

Foreign Currency Risk. We are exposed to foreign exchange rates  fluctuations as
we convert the financial  statements of our foreign subsidiary into U.S. dollars
in  consolidation.  If there is a change in foreign currency exchange rates, the
conversion of the foreign  subsidiary's  financial  statements into U.S. dollars
will lead to a  translation  gain or loss which is recorded  as a  component  of
other  comprehensive  income or loss.  In addition,  we have certain  assets and
liabilities that are denominated in currencies other than the relevant  entity's
functional  currency.  Changes in the functional  currency value of these assets
and  liabilities  create  fluctuations  that will lead to a transaction  gain or
loss. During the second quarter of 2005, the foreign currency transaction gains,
realized and unrealized, were not material.

Item 4.  Controls and Procedures.

Disclosure  Controls  and  Procedures.  As of June 30, 2005,  management  of our
Company,  under the supervision of our principal executive officer (CEO) and our
principal financial and accounting officer (Controller), evaluated (the Controls
Evaluation)  the  effectiveness  of the design and operation of our  "disclosure
controls  and  procedures",  as  such  term  is  defined  under  Rule  13a-15(e)
promulgated  under the Securities  Exchange Act of 1934, as amended  (Disclosure
Controls),  and whether  any  changes in the  Company's  internal  control  over
financial  reporting  (Internal  Controls),  as  such  term is  defined  in Rule
13a-15(f)  under the Exchange Act,  during the most recent  fiscal  quarter have
materially affected, or are reasonably likely to materially affect, our Internal
Controls.

Limitations on the Effectiveness of Controls.  Our CEO and our Controller do not
expect that our  Disclosure  Controls or our  Internal  Control  over  financial
reporting will prevent all error and all fraud. A control system,  no matter how
well  conceived  and  operated,  can  provide  only  reasonable,  not  absolute,
assurance that the control system's objectives will be met. Further,  the design
of a control  system must reflect the fact that there are resource  constraints,
and the benefits of controls must be considered relative to their costs. We have
only had limited revenue derived from the sale of our  microdisplay  products in
the  current  reporting  period  and since we  commenced  operations.  While the
Controls  Evaluation  has accounted  for such limited sales and revenue,  new or
additional  controls  may or may not be  required  once  we  begin  selling  our
microdisplay  products in increased  volume in the ordinary  course of business.
Because of the inherent  limitations  in all control  systems,  no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within our Company have been detected. These inherent limitations
include the realities that judgments in decision-making  can be faulty, and that
breakdowns  can occur because of simple error or honest  mistake.  Additionally,
controls  can be  circumvented  by the  individual  acts  of  some  persons,  by
collusion of two or more persons, or by management override of the controls. The
design of any system of controls also is based in part upon certain  assumptions
about the  likelihood of future  events,  and there can be no assurance that any
design will succeed in achieving  its stated  goals under all  potential  future
conditions. Over time, specific controls may or may not become inadequate (e.g.,
when we commence to sell our products in increased volume in the ordinary course
of business)  because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Because of the


                                       38
<PAGE>

inherent  limitations in a cost-effective  control system,  misstatements due to
error or fraud may occur and not be detected.

Conclusion regarding the Effectiveness of Disclosure Controls and Procedures

Based on all of the material  weaknesses  related to our  internal  control over
financial reporting, which are set forth below, and which were identified during
the  Controls  Evaluation,  our  CEO  and  our  Controller  concluded  that  our
disclosure  controls  and  procedures  were not  effective  as of the end of the
period covered by this Form 10-Q.

Changes in Internal Controls

Due to the hiring of our permanent, full-time corporate controller in June 2005,
we  believe  that  our  internal   controls  over   financial   reporting   have
significantly improved.

Controls Evaluation

Our management assessed the effectiveness of our internal control over financial
reporting as of June 30, 2005,  and this  assessment  identified  the  following
material weaknesses in the company's internal control over financial reporting.

      The material weaknesses identified were:

      o     Our corporate governance is deficient because:

            o     We do not have a  corporate  governance  or formal  disclosure
                  committee.

            o     Our  Audit  Committee  does not have a  financial  expert  (as
                  defined by SEC rules.)

      o     We have  inadequate  controls  and  procedures  (1) to  monitor  the
            tracking  and movement of  inventory,  and (2) to prevent and detect
            the unauthorized  use of inventory due to an inadequate  segregation
            of duties.

      o     We lack  information  technology  controls and procedures that would
            likely prevent  unauthorized  access to the accounting and financial
            systems,  and ensure that the accounting  and financial  records are
            recoverable in the event of a disaster.

In  making  its  assessment  of  internal  control  over  financial   reporting,
management used the criteria issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Each of the material  weaknesses  identified  by  management  during the control
evaluation  for the period  ended  December  31,  2004 and March 31,  2005,  was
reported  in  Item  9A of  our  Form  10-K/A  and  Item  4 of  our  Form  10Q/A,
respectively, both of which were filed with the SEC on July 13, 2005.

Management has taken the following steps to address the material  weaknesses set
forth in our Form 10K/A for the year ended  December 31, 2004 and our Form 10Q/A
for the quarter ended March 31, 2005 referenced above:


                                       39
<PAGE>

      Fraud training program - We have implemented a procedure for the reporting
of fraud to the Audit Committee of the Board of Directors.  All of our employees
have been trained on  understanding  what  constitutes  corporate  fraud and the
procedures for reporting  corporate  fraud.  Our Audit  Committee and management
have established related procedures for the receipt,  retention and treatment of
complaints  regarding  accounting,  internal  accounting  controls  or  auditing
matters and the Audit Committee has  established  procedures that will provide a
mechanism for the  confidential,  anonymous  submission by employees of concerns
regarding  questionable  accounting or auditing  matters.  These procedures were
implemented during the second quarter of 2005.

      Procedures  for archiving  Audit  Committee  meeting  minutes - During the
first  quarter  of 2005 we  implemented  procedures  for  archiving  minutes  of
meetings of the Audit Committee

      Issuance of common shares to a company wholly owned by our Chief Executive
Officer - The material  weakness  relating to issuance of common shares arose in
connection  with a situation  where our Board of  Directors,  in November  2004,
authorized  the  issuance  of common  shares to Argyle in  January  2005,  but a
portion of the  authorized  common  shares were  delivered to Argyle in December
2004.  Through  action taken by our Board of  Directors  in March 2005,  we have
implemented  new  controls  over the  process for  issuance of common  shares to
Robert Olins, our CEO, Secretary,  Treasurer and Director, and to Argyle Capital
Management  Corporation  (Argyle),  a company wholly-owned by Mr. Olins, whereby
American Stock Transfer & Trust Company, our transfer agent, is not permitted to
transfer any shares from our treasury account to Mr. Olins or to Argyle, without
prior  written  authorization  executed by a majority of the Board of  Directors
excluding Mr. Olins.

      Safeguarding of our common shares held in connection with notes receivable
-  Through  action  taken by our  Board of  Directors  in  March  2005,  we have
implemented new procedures with respect to the safeguarding of our common shares
held in  connection  with notes  receivable.  We have  established  controls and
procedures  for   maintaining   escrow  accounts  for  common  shares  that  are
deliverable to other parties upon the performance of certain future  conditions,
such as fulfillments of payments under notes receivable.

      Our management  believes that the actions described in the two immediately
preceding  paragraphs have fully and adequately  addressed the material weakness
"We do not have  adequate  controls  over (1) the process for issuance of common
shares to a company  wholly-owned by the Company's chief executive officer;  and
(2) the  safeguarding  of its  common  shares  held  in  connection  with  notes
receivable."  That material weakness was disclosed in our Form 10-K/A filed with
the SEC on July 13, 2005.

      Chief Financial Officer (CFO) and Corporate Controller - During the second
quarter of 2005, we hired a Corporate  Controller,  Assistant  Vice President of
Accounting and Finance.  We have  discontinued our search for a CFO.  Management
believes  that  because we have  hired a highly  qualified  full-time  corporate
controller, such person will obviate the need for us to hire a CFO.

      Information technology controls and procedures - In March 2005, we entered
into  an  International   Program  License  Agreement  with  Microsoft  Business
Solutions Corporation, pursuant to which we are licensing the Microsoft Business
Solutions  Navision  software  system   (Navision).   Navision  is  an  advanced
information  technology  -  enterprise  resource  planning  system  that has the
capability to support our management's accounting and financial systems. We also
have contracted with a reputable company to lead the company-wide implementation
of the Navision system. In connection with the  implementation  of Navision,  we
are implementing  systematic controls designed to prevent


                                       40
<PAGE>

unauthorized  access to our accounting and financial  systems,  which we believe
that Navision will facilitate.  We are also implementing physical and electronic
back-up and storage  procedures to help ensure that our accounting and financial
records will be recoverable in the event of a disaster.

      The implementation of Navision in our California office has been completed
in July 2005 and our  management  anticipates  that  Navision in our Republic of
Korea offices will become active by the end of the third quarter of 2005.

Management has taken the following steps to address the material  weaknesses set
forth in our Form 10Q for the quarter ended June 30, 2005:

      Controls   and   procedures   of   inventory  -  The   Navision   software
implementation  has required that additional  policies and procedures be adopted
and our  management  believes that this will assist in addressing the identified
inadequate controls and procedures described in the Controls Evaluation.

      Controls and procedures of information technology - In connection with the
implementation of Navision, we are implementing  systematic controls designed to
prevent  unauthorized  access to our accounting and financial systems,  which we
believe  that  Navision  will  facilitate.  We have  hired a  full-time  Network
Administrator and we are in the process of improving our physical and electronic
back-up and storage  procedures to help ensure that our accounting and financial
records will be recoverable in the event of a disaster.

      We have not taken any steps, as of the date of this filing, to address the
material  weaknesses  relating  to the  facts  that we do not  have a  corporate
governance or formal disclosure committee, and that the audit committee does not
have a  financial  expert,  as defined by SEC rules.  We do not  presently  have
specific  plans  with  respect  to  adding a  director  who would  constitute  a
financial  expert or with  respect to  establishing  a corporate  governance  or
formal disclosure committee.

PART II. OTHER INFORMATION

ITEM 2 Changes in Securities and Use of Proceeds.

In June 2005, we issued a fully vested warrant to purchase  75,000 common shares
at an exercise price of $7.50 per share,  which was not registered with the SEC.
This warrant was issued as a payment to an investment bank in consideration  for
services  rendered.  As of the date of this filing,  the investment bank has not
exercised  the warrant and therefore we have not received any proceeds from that
transaction.  In  issuing  this  warrant,  we  relied  upon the  exemption  from
securities  registration afforded by Section 4(2) of the Securities Act of 1933,
as amended.

ITEM 4 Submission of Matters to a Vote of Security Holders.

At the Annual Meeting of  Shareholders  held on June 1, 2005,  our  shareholders
approved the following:

Proposal 1:

The  election of the  following  individuals  as our  directors to serve for the
ensuing year and until his successor is duly elected and qualified:


                                       41
<PAGE>

                                     For       Against   Abstain
                                  ----------   -------   -------
Lawrence J. Matteson              33,922,701    None     177,696

Robert A. Olins                   33,957,689    None     142,708

Claude Piaget                     33,931,541    None     168,856

Robert C. Munro                   33,965,508    None     134,889


Proposal 2:

      The ratification of the appointment of Odenberg, Ullakko, Muranishi & Co.,
      LLP as our independent  registered public  accountants for the fiscal year
      ending December 31, 2005.

            For: 34,090,957   Against: 9,040   Abstain: 400

      ITEM 5 Other Information.

On August 5, 2005, we sold 500,000 of our common shares at $5.40 per share under
our "shelf" registration,  which became effective on July 29, 2005. Our proceeds
from the sale totaled approximately $2.7 million. These purchasers have a 30-day
option,  which expires on September 4, 2005,  to purchase an additional  225,000
shares under our "shelf"  registration  at a purchase  price of $5.50 per share.
Proceeds from this financing will go towards  working  capital and other general
corporate  purposes.  As of the date of this  filing,  1,500,000  of our  common
shares included in our currently effective "shelf" registration  including those
subject to the 30-day option described in Note 12 of our Condensed  Consolidated
Financial Statements, have not been sold.


                                       42
<PAGE>

ITEM 6 Exhibits and Reports on Form 8-K.

(a)   Exhibits

      4.1   Amended and Restated Certificate of Incorporation*

      4.2   Bylaws*

      10.1  Form of Purchase Agreement

      31.1  Rule 13a-14(a)/15d-14(a) Certification of Robert A. Olins

      31.2  Rule 13a-14(a)/15d-14(a) Certification of Kim Tsuchimoto

      32.1  Certifications of Robert A. Olins and Kim Tsuchimoto  Pursuant to 18
            U.S.C.  Section  1350,  As Adopted  Pursuant  to Section  906 of the
            Sarbanes-Oxley Act of 2002.

(b)   Report on Form 8-K:

      The Company filed no reports on Form 8-K during the quarter ended June 30,
      2005.

*Previously filed.


                                       43
<PAGE>

                                   SIGNATURES

      In accordance  with the  requirements  of the  Securities  Exchange Act of
1934, as amended,  the Registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                Date: August 9, 2005
                                     -------------------------------------------

                                SpatiaLight, Inc.


                                 By: /s/ ROBERT A. OLINS
                                    --------------------------------------------
                                 Robert A. Olins
                                 Chief Executive Officer


                                 By: /s/ KIM TSUCHIMOTO
                                    --------------------------------------------
                                 Kim Tsuchimoto
                                 Controller and Principal Financial and
                                 Accounting Officer


                                       44