**United
      States**


**Securities
      and Exchange Commission**


**Washington,
      D.C. 20549**




**FORM
      10-Q**




(Mark
      One)





x
            Report
                under Section 13 or 15(d) of the Securities Exchange Act of
                1934





For
      the
      quarterly period ended September 30, 2007





o
            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
              Incorporation
                or
                organization)
            (I.R.S.
                Employer Identification
                No.)





Five
      Hamilton Landing, Suite 100, Novato, California 94949


(Address
      of principal executive offices)





(415)
      883-1693


(Issuer’s
      telephone number)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      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
xNo
o




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




Large
      accelerated filer o  Accelerated
      filer x  Non-accelerated filer o




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


Yes
oNo
x





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date. As of November 7, 2007, there were
      5,976,648 common shares of the registrant’s common stock, par value $0.01 per
      share, issued and outstanding.










SPATIALIGHT,
      INC.


Quarterly
      Report on Form 10-Q


For
      the
      Quarter Ended September 30, 2007





Table
      of Contents


**PART
                  I**
              **FINANCIAL
                  INFORMATION**Item
                  1.
              Financial
                  StatementsCondensed
                  Consolidated Balance Sheets as of September 30, 2007 (unaudited)
                  and
                  December 31, 2006
              
              3Condensed
                  Consolidated Statements of Operations for the Three and Nine Months
                  Ended
                  September 30, 2007 and 2006 (unaudited)
              
              4Condensed
                  Consolidated Statement of Stockholders’ Deficit for the Nine Months Ended
                  September 30, 2007 (unaudited)
              
              5Condensed
                  Consolidated Statements of Cash Flows for the Nine Months Ended
                  September
                  30, 2007 and 2006 (unaudited)
              
              6Notes
                  to Condensed Consolidated Financial Statements (unaudited)
              
              7Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              
              26Item
                  3.
              Quantitative
                  and Qualitative Disclosures about Market Risks
              
              38Item
                  4.
              Controls
                  and Procedures
              
              38**PART
                  II**
              **OTHER
                  INFORMATION**
              
              39Item
                  1.
              Legal
                  Proceedings
              
              39Item
                  1A.
              Risk
                  Factors
              
              40Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              43Item
                  3.
              Defaults
                  Upon Senior Securities
              
              44Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              
              44Item
                  5.
              Other
                  Information
              
              44Item
                  6.
              Exhibits
              
              44SIGNATURES
              
              46




2


**PART
      I.**  **FINANCIAL
      INFORMATION**




**ITEM
      1.**  **Financial
      Statements.**


SPATIALIGHT,
                  INC.CONDENSED
                  CONSOLIDATED BALANCE SHEETSSeptember
                  30,
              
              December
                  31,2007
              
              2006(unaudited)
              
              (Note
                  2)ASSETSCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              27,998
              
              $
              220,256Accounts
                  receivable, net of $0 allowance for doubtfulaccounts
                  as of September 30, 2007 and December 31, 2006,
                  respectively
              
              
              -
              
              
              52,238Inventory,
                  net
              
              
              302,876
              
              
              423,075Prepaids
                  and other current assets
              
              
              364,278
              
              
              307,428Total
                  current assets
              
              
              695,152
              
              
              1,002,997Property,
                  plant and equipment, net
              
              
              4,712,042
              
              
              5,205,926Other
                  assets
              
              
              77,964
              
              
              37,121Total
                  assets
              
              $
              5,485,158
              
              $
              6,246,044LIABILITIES
                  AND STOCKHOLDERS' DEFICITCurrent
                  liabilities:Senior
                  secured convertible notes
              
              $
              9,929,066
              
              $
              9,596,086Unsecured
                  short term loans
              
              
              630,658
              
              
              591,070Settlement
                  liability
              
              
              829,569
              
              
              -Accounts
                  payable
              
              
              2,991,263
              
              
              1,916,249Accrued
                  expenses and other current liabilities
              
              
              3,428,146
              
              
              1,793,232Total
                  current liabilities
              
              
              17,808,702
              
              
              13,896,637Convertible
                  notes (to related party at December 31, 2006)
              
              
              1,188,000
              
              
              1,188,000Total
                  liabilities
              
              
              18,996,702
              
              
              15,084,637Commitments
                  and contingenciesStockholders'
                  deficit:Common
                  stock, $.01 par value:15,000,000
                  and 2,000,000 shares authorized at September 30, 2007 andand
                  December 31, 2006, respectively; 3,578,792 and 889,652 shares
                  issued;3,533,449
                  and 889,652 shares outstanding at September 30, 2007and
                  December 31, 2006, respectively
              
              
              35,789
              
              
              8,897Additional
                  paid-in capital
              
              
              105,001,146
              
              
              95,192,629Treasury
                  stock, at cost, 45,343 shares, at September 30, 2007
              
              
              (929,535
              )
              
              -Prepaid
                  non-cash interest (to related party at December 31, 2006)
              
              
              (1,446,416
              )
              
              (2,314,266
              )Other
                  comprehensive income
              
              
              310,063
              
              
              336,975Accumulated
                  deficit
              
              
              (116,482,591
              )
              
              (102,062,828
              )Total
                  stockholders' deficit
              
              
              (13,511,544
              )
              
              (8,838,593
              )Total
                  liabilities and stockholders' deficit
              
              $
              5,485,158
              
              $
              6,246,044See
                  accompanying notes to condensed consolidated financial
                  statements.




3





SPATIALIGHT,
      INC.


CONDENSED
        CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)


Three
                months ended
              September
                30,
            
            Nine
                months ended
              September
                30,2007
            
            2006
            
            2007
            
            2006Revenue
            
            $
            -
            
            $
            298,046
            
            $
            50,112
            
            $
            442,888Cost
                of revenue and manufacturing expenses
            
            
            418,774
            
            
            1,665,324
            
            
            1,731,725
            
            
            4,815,668Gross
                margin
            
            
            (418,774
            )
            
            (1,367,278
            )
            
            (1,681,613
            )
            
            (4,372,780
            )Operating
                expenses:Selling,
                general and administrative expenses (includingstock-based
                compensation of $73,008 and $184,797 for the three month periods
                ended
                September 30, 2007 and 2006, respectively,
                and  $535,761 and $1,829,790 for the nine month periods
                ended  September 30, 2007 and 2006,
                respectively)1,447,850
            
            
            1,918,043
            
            
            4,326,335
            
            
            7,452,509Research
                and development expenses
            
            
            329,241
            
            
            269,582
            
            
            1,028,733
            
            
            922,828Total
                operating expenses
            
            
            1,777,091
            
            
            2,187,625
            
            
            5,355,068
            
            
            8,375,337Operating
                loss
            
            
            (2,195,865
            )
            
            (3,554,903
            )
            
            (7,036,681
            )
            
            (12,748,117
            )Other
                income (expense):Interest
                expense:Interest
                expense
            
            
            (348,149
            )
            
            (40,206
            )
            
            (940,148
            )
            
            (355,178
            )Non-cash
                interest expense
            
            
            (398,314
            )
            
            (643,907
            )
            
            (5,925,089
            )
            
            (2,130,407
            )Total
                interest expense
            
            
            (746,463
            )
            
            (684,113
            )
            
            (6,865,237
            )
            
            (2,485,585
            )Gain
                from revaluation of warrants
            
            
            -
            
            
            21,945
            
            
            -
            
            
            43,638Foreign
                currency translation gain
            
            
            35,287
            
            
            27,283
            
            
            77,343
            
            
            39,635Interest
                and other income (expense)
            
            
            (41,317
            )
            
            15,803
            
            
            (20,789
            )
            
            39,993Total
                other income (expenses)
            
            
            (752,493
            )
            
            (619,082
            )
            
            (6,808,683
            )
            
            (2,362,319
            )Loss
                before income tax expense
            
            
            (2,948,358
            )
            
            (4,173,985
            )
            
            (13,845,364
            )
            
            (15,110,436
            )Income
                tax expense
            
            
            -
            
            
            -
            
            
            1,800
            
            
            800Net
                loss
            
            $
            (2,948,358
            )
            $
            (4,173,985
            )
            $
            (13,847,164
            )
            $
            (15,111,236
            )Net
                loss per share - basic and diluted
            
            $
            (1.25
            )
            $
            (5.06
            )
            $
            (9.37
            )
            $
            (18.89
            )Weighted
                average shares used in computingnet
                loss per share- basic and diluted
            
            
            2,349,689
            
            
            825,334
            
            
            1,478,251
            
            
            800,057See
                accompanying notes to condensed consolidated financial
                statements.




4




CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (unaudited)


NINE
        MONTHS ENDED SEPTEMBER 30, 2007


****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            ****
            **OTHER**
            ****
            **TOTAL**
            ********
            ****
            ****
            ****
            ****
            ****
            **ADDITIONAL**
            ****
            ****
            ****
            ****
            ****
            **PREPAID**
            ****
            ****
            ****
            **COMPRE-**
            ****
            **STOCK**
            ********
            ****
            **COMMON
                STOCK**
            ****
            **PAID-IN**
            ****
            **TREASURY
                STOCK**
            ****
            **NONCASH**
            ****
            **ACCUMULATED**
            ****
            **HENSIVE**
            ****
            **HOLDERS'**
            ********
            ****
            **SHARES**
            ****
            **AMOUNT**
            ****
            **CAPITAL**
            ****
            **SHARES**
            ****
            **AMOUNT**
            ****
            **INTEREST**
            ****
            **DEFICIT**
            ****
            **INCOME**
            ****
            **DEFICIT**
            ****Balance,
                January 1, 2007
            
            
            889,652
            
            $
            8,897
            
            $
            95,192,629
            
            
            -
            
            $
            -
            
            $
            (2,314,266
            )
            $
            (102,062,828
            )
            $
            336,975
            
            $
            (8,838,593
            )Stock-based
                compensation expense
            
            
            3,000
            
            
            30
            
            
            535,731
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            535,761Issuance
                of common shares, net of issuance costsof
                $197,969
            
            
            43,810
            
            
            438
            
            
            2,101,592
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,102,030Issuance
                of common shares under the April 2007Equity
                Credit Agreement, net of commitmentfees
                of $38,179
            
            
            2,168,720
            
            
            21,688
            
            
            2,929,407
            
            
            (34,703
            )
            
            711,411
            
            
            -
            
            
            (572,599
            )
            
            -
            
            
            3,089,907Issuance
                of common shares for waivers ofcertain
                contractual rights by September andNovember
                2006 investors
            
            
            22,000
            
            
            220
            
            
            1,330,780
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,331,000Return
                of common shares and warrants under theSettlement
                Agreement
            
            
            -
            
            
            -
            
            
            (602,055
            )
            
            80,046
            
            
            (1,640,946
            )
            
            -
            
            
            -
            
            
            -
            
            
            (2,243,001
            )Issuance
                and sale of common shares from Escrowunder
                the Settlement Agreement
            
            
            451,610
            
            
            4,516
            
            
            3,513,062
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            3,517,578Amortization
                of pre-paid interest
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            867,850
            
            
            -
            
            
            -
            
            
            867,850Comprehensive
                loss:Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (13,847,164
            )
            
            -
            
            
            (13,847,164
            )Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (26,912
            )
            
            (26,912
            )Total
                comprehensive loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (13,847,164
            )
            
            (26,912
            )
            
            (13,874,076
            )Balance,
                September 30, 2007
            
            
            3,578,792
            
            $
            35,789
            
            $
            105,001,146
            
            
            45,343
            
            $
            (929,535
            )
            $
            (1,446,416
            )
            $
            (116,482,591
            )
            $
            310,063
            
            $
            (13,511,544
            )





See
      accompanying notes to condensed consolidated financial statements.




5


SPATIALIGHT,
        INC.


CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
  Nine
                  months ended September 30,2007
              
              2006Cash
                  flows from operating activities:Net
                  loss
              
              $
              (13,847,164
              )
              $
              (15,111,236
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Inventory
                  reserve adjustment
              
              
              95,180
              
              
              442,433Depreciation
                  and amortization
              
              
              547,831
              
              
              669,055Stock-based
                  compensation expense
              
              
              535,761
              
              
              1,829,790Non-cash
                  interest expense
              
              
              5,925,089
              
              
              2,130,407Gain
                  from revaluation of warrants
              
              
              -
              
              
              (43,638
              )Non-cash
                  foreign currency translation gain
              
              
              (77,343
              )
              
              (39,635
              )(Gain)
                  loss on sale of fixed assets
              
              
              42,800
              
              
              (3,376
              )Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              52,238
              
              
              (130,936
              )Inventory
              
              
              25,019
              
              
              5,623Prepaids
                  and other current assets
              
              
              134,036
              
              
              (46,021
              )Other
                  assets
              
              
              (40,844
              )
              
              25,959Accounts
                  payable
              
              
              1,075,014
              
              
              (43,723
              )Accrued
                  expenses and other current liabilities
              
              
              154,916
              
              
              197,262Net
                  cash used in operating activities
              
              
              (5,377,467
              )
              
              (10,118,036
              )Cash
                  flows from investing activities:Purchase
                  of property, plant and equipment
              
              
              (30,826
              )
              
              (580,220
              )Proceeds
                  from sale of property, plant and equipment
              
              
              -
              
              
              84,166Net
                  cash used in investing activities
              
              
              (30,826
              )
              
              (496,054
              )Cash
                  flows from financing actitivies:Proceeds
                  from issuance of short-term notes
              
              
              1,133,405
              
              
              6,811,150Payment
                  on short-term notes
              
              
              (1,110,032
              )
              
              (6,559,226
              )Proceeds
                    from the sale of common shares and warrants, net of
                    issuancecosts
                    and commitment fees
              
              
              5,191,937
              
              
              10,559,324Proceeds
                  from exercise of warrants and options
              
              
              -
              
              
              40,245Net
                  cash provided by financing activities
              
              
              5,215,310
              
              
              10,851,493Net
                  increase (decrease) in cash and cash equivalents
              
              
              (192,983
              )
              
              237,403Effect
                  of exchange rate changes on cash
              
              
              725
              
              
              876Cash
                  and cash equivalents at beginning of period
              
              
              220,256
              
              
              42,565Cash
                  and cash equivalents at end of period
              
              $
              27,998
              
              $
              280,844Non-cash
                  financing activities:Shares
                  issued for interest and liquidated damages
              
              $
              1,331,000
              
              $
              948,714Shares
                  issued for the Settlement Agreement
              
              $
              3,517,578
              
              $
              -Supplemental
                  disclosure of cash flow information:Income
                  taxes paid during the period
              
              $
              1,800
              
              $
              1,800Interest
                  paid during the period
              
              $
              552,624
              
              $
              302,758




See
        accompanying notes to condensed consolidated financial statements.
  6


**SPATIALIGHT,
      INC.**


Notes
      to
      Condensed Consolidated Financial Statements (Unaudited)





**Note
      1. B** **usiness
      Description**





SpatiaLight,
      Inc. is a New York corporation formed in 1989. We conduct operations through
      our
      two wholly-owned subsidiaries, SpatiaLight Technologies, Inc. and SpatiaLight
      Korea, Inc. As used in this Form 10-Q, terms such as the “Company,” “we,” “our,”
and similar terms refer to SpatiaLight, Inc. and its wholly-owned subsidiaries,
      unless otherwise noted.





We
      are in
      the business of manufacturing high-resolution liquid crystal on silicon (LCoS)
      microdisplays. We are currently focused on manufacturing our core product,
      the
      T-3S LCoS Set, which has a 1920 pixels by 1080 pixels configuration for sale
      to
      our current and prospective head mounted display (“HMD”) market customers. Our
      previously manufactured T-3P LCoS Set has the same resolution of 1920 pixels
      by
      1080 pixels, configured in sets of three imagers and ASICS for rear projection
      television (RPTV) applications. We are focusing on manufacturing the T-3S LCoS
      Sets rather than the T-3P LCoS Sets because we believe that the demand for
      the
      HMD products will be greater than for RPTV due to the intense competition in
      the
      TV market from flat panel displays such as LCD and plasma. Our current and
      prospective customers include manufacturers of near-to-eye display systems
      such
      as head mounted displays, and small projection displays (microprojectors or
      nanoprojectors) targeted for use with mobile electronics projects. In addition
      we will support selected front and rear projection based television and monitor
      opportunities.





**Note
      2. B** **asis
      of Presentation**





The
      accompanying condensed consolidated financial statements include the accounts
      of
      SpatiaLight, Inc. and its wholly-owned subsidiaries, SpatiaLight Technologies,
      Inc. and SpatiaLight Korea, Inc. All significant intercompany accounts and
      transactions have been eliminated in consolidation.





The
      accompanying condensed consolidated financial statements have been prepared
      in
      accordance with U. S. generally accepted accounting principles for interim
      financial information and with the instructions to Form 10-Q and Rule 10-01
      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 U.S. generally accepted accounting
      principles. 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 2006 Annual Report on Form 10-K/A filed
      with the SEC on August 21, 2007, which contains our audited consolidated
      financial statements, related financial notes and Management’s Discussion and
      Analysis, for the year ended December 31, 2006. The interim results for the
      nine
      month period ended September 30, 2007 are not necessarily indicative of results
      for the full fiscal year or any future interim period. The accompanying
      consolidated balance sheet as of December 31, 2006 has been derived from the
      audited financial statements as of that date but does not include all
      disclosures required by U.S. generally accepted accounting
      principles.





The
      accompanying condensed consolidated financial statements have been prepared
      assuming we will continue as a going concern. As reported in our 2006 Annual
      Report on Form 10-K/A, we have suffered recurring operating losses and negative
      cash flows from operations. We have continued to suffer operating losses for
      the
      nine month period ended September 30, 2007. While we plan on raising additional
      capital, no assurance can be given that we will be able to raise sufficient
      funds to continue our operations and meet our capital and liquidity
      requirements. If we do not receive additional funds, we will likely be required
      to scale back or terminate operations and/or may seek protection under
      applicable bankruptcy laws.




7


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


As
      more
      fully described in Note 8, our Senior Secured Convertible Notes, maturing in
      November 2007, are held by four noteholders. As a result of our common stock
      no
      longer trading on the Nasdaq Capital Market as of June 15, 2007, the Senior
      Secured Convertible Notes became redeemable on demand by the holders at 115%
      of
      the principal amount plus accrued interest and late charges. We have received
      redemption notices from holders of $9,000,000 in original principal amount
      of
      Senior Secured Convertible Notes and have accrued $1,500,000 in redemption
      premiums through September 30, 2007. We do not presently have a source of funds
      with which to redeem the Senior Secured Convertible Notes and may be required
      to
      seek protection under applicable bankruptcy laws if such redemption is required
      by the noteholders. We also have increased the rate at which we accrue and
      pay
      interest from 10% per annum to 12% per annum in accordance with the terms of
      the
      Senior Secured Convertible Notes, commencing on June 15, 2007. As a result
      of
      our failure to redeem the Senior Secured Convertible Notes within five days
      after receipt of the redemption notice, the noteholders may withdraw any part
      of
      the redemption notice and elect to convert the withdrawn amount at a new
      conversion rate equal to the lowest weighted price of the common shares between
      June 15, 2007 and the date of withdrawal. In early July 2007, the noteholders
      partially withdrew their redemption notices with respect to $150,000 in
      principal amount of the Senior Secured Convertible Notes. We have received
      a
      notice of conversion from each noteholder to convert the withdrawn amount at
      a
      conversion rate of $2.525 per common share.





During
      2006, a substantial percentage of our T-3 LCoS Set sales were made to LG
      Electronics (“LGE”). LGE informed us that it intended to discontinue production
      of rear projection televisions (“RPTVs”) and failed to fulfill the remaining
      portion of our supply agreement for the T-3 LCoS Sets. We do not expect
      significant future sales to LGE and are engaged in settlement negotiations
      relating to the failure to fulfill our supply agreement. We intend to replace
      the anticipated revenues from LGE with revenues from sales of our T-3 LCoS
      Sets
      to other customers, as well as sales of products to manufacturers of HMDs and
      microprojectors. Due to the development and start-up time periods required,
      however, we do not anticipate significant revenue until the second quarter
      of
      2008. No assurance can be given as to the level of revenue, if any, that we
      will
      earn in the future.





We
      are
      subject to investigations by the United States Securities and Exchange
      Commission (“SEC”) relating to the unauthorized filing of consents of our former
      auditor, BDO Seidman, LLP, as an exhibit to certain registration statements
      and
      our issuance of securities without legend or restrictions to Argyle Capital
      Management Corporation (“Argyle”), a firm controlled by our former Chief
      Executive Officer for payment of interest on our promissory notes payable to
      Argyle in December 2004 and January 2005. We received a Wells Notice dated
      May
      25, 2007 from the SEC and have been advised that they intend to pursue civil
      enforcement actions against us in connection with these investigations and
      we
      may be subject to penalties and claims by our stockholders.





These
      matters raise substantial doubt about our ability to continue as a going
      concern. The recoverability of a major portion of the amounts recorded as assets
      shown in the accompanying condensed consolidated balance sheet is dependent
      upon
      our continued operations. Our condensed consolidated financial statements do
      not
      include any adjustments relating to the recoverability and classification of
      the
      amounts recorded as assets or amounts and classifications of liabilities that
      might be necessary should we be unable to continue as a going
      concern.




8


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


*Reverse
      Stock Split and Increase in Authorized Shares*





Pursuant
      to the recommendation of our Board of Directors and approval of our stockholders
      at the Annual Shareholders Meeting on July 13, 2007, on August 8, 2007, we
      filed
      an Amendment to our Amended and Restated Certificate of Incorporation that
      combined 50 existing common shares into one new common share (a 1-for-50 reverse
      stock split) and increased the number of common shares we are authorized to
      issue after such combination to 15 million, with a par value of $0.01 per share.
      The 1-for-50 reverse split was effective with the opening of trading on August
      24, 2007, and our common stock began trading as adjusted for the reverse stock
      split on that same day. We have retroactively adjusted all share and per share
      information to reflect the reverse stock split in the condensed consolidated
      financial statements and notes thereto, as well as throughout the rest of this
      Form 10-Q Report for all periods presented. Stockholders’ deficit was
      restated to give retroactive recognition of the reverse stock split for all
      periods presented by reclassifying from common stock to additional paid-in
      capital the par value of the reduction of shares resulting from the reverse
      stock split.





**Note** **3.**  **Liquidity**





From
      inception through September 30, 2007, we have sustained recurring net losses
      from operations totaling approximately $116.5 million and at September 30,
      2007,
      had total stockholders’ deficit of approximately $13.5 million and working
      capital deficiency of approximately $17.1 million. During the nine months ended
      September 30, 2007, our net cash decreased approximately $192,000. In the first
      quarter of 2007, cash was primarily provided by the gross proceeds of
      approximately $2.3 million that we received from the sale of 43,810 of our
      common shares in February 2007. During the second and third quarters of 2007,
      cash was primarily provided by the gross proceeds of approximately $3.1 million
      that we received from the sale of 2,168,720 of our common shares under an Equity
      Credit Agreement with certain institutional investors (the “Equity Credit
      Agreement”) that we entered into effective April 24, 2007, as further described
      in Note 9. The proceeds from these financings were used to fund our operations
      for the first three quarters of 2007. We recognized net losses for the nine
      months ended September 30, 2007 of approximately $13.8 million. We believe
      that
      our cash resources, including draws on the Equity Credit Agreement, will be
      sufficient to fund our operations and meet our capital and liquidity
      requirements through November 30, 2007.





**Note
      4.**  **Stock-Based
      Compensation**




We
      have
      stock compensation plans for employees and directors which are described in
      more
      detail in Note 6 to our consolidated financial statements in our 2006 Annual
      Report on Form 10-K/A. We adopted Statement of Financial Accounting Standards
      No. 123 (revised 2004), *Share-Based
      Payment* ,
      (“SFAS
      123R”) effective January 1, 2006. SFAS 123R requires the recognition of the fair
      value of stock compensation, including stock options, in net income (loss).
      We
      recognize the stock compensation expense over the requisite service period
      of
      the individual grantees, which generally equals the vesting period of the grant
      or, in the case of options granted with a market condition, we use a lattice
      model to calculate a derived service period. All of our stock-based compensation
      is accounted for as an equity instrument. Equity instruments issued to
      non-employees are recorded at their fair market value as determined in
      accordance with SFAS 123R and EITF Issue No. 96-18, *Accounting
      for Equity Instruments that are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling, Goods and Services* (“EITF
      96-18”).




9


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


Under
      the
      provisions of SFAS 123R and EITF 96-18, we recorded $73,008 and $184,797, or
      $0.03 and $0.22 per share, of stock-based compensation, net of estimated
      forfeitures, in selling, general and administrative expenses, in our condensed
      consolidated statement of operations for the three month periods ended September
      30, 2007 and 2006, respectively, and $535,761 and $1,829,790, or $0.36 and
      $2.29
      per share for the nine month periods ended September 30, 2007 and 2006,
      respectively. We utilized the Black-Scholes valuation model for estimating
      the
      fair value of the stock compensation granted after the adoption of SFAS 123R,
      with the following weighted-average assumptions:


Nine
                  months ended September 30,2007
              
              2006Dividend
                  yield
              
              
              -
              
              
              -Expected
                  volatility
              
              
              86%
                  - 89
              %
              
              93%
                  - 99
              %Risk-free
                  interest rate
              
              
              4.51
                  - 5.10
              %
              
              4.60%
                  - 5.20
              %Expected
                  lives (in years)
              
              
              5.21
                  to 5.75
              
              
              5.2
                  - 5.8


The
      dividend yield of zero is based on the fact that we have never paid cash
      dividends, have no present intention to pay cash dividends, and are prohibited
      from paying dividends under the terms of the Senior Secured Convertible Notes
      issued in November 2004. Expected volatility is based upon historical volatility
      of our common stock over the period commensurate with the expected life of
      the
      options. The risk-free interest rate is derived from the average U.S. Treasury
      Constant Maturity Rate in effect during the period at the time of the grant.
      The
      expected term is calculated using the simplified method prescribed by the SEC’s
      Staff Accounting Bulletin 107. Our currently unvested options generally vest
      over two years from the date of grant. Our options generally have a 10-year
      contractual term. Based on the above assumptions, the weighted-average fair
      values of the options granted under the stock option plans for 2007 and 2006
      were $44.00 and $97.50, respectively. As required by SFAS 123R, we estimate
      forfeitures of employee stock options and recognize compensation cost only
      for
      those awards expected to vest. Forfeiture rates are determined for three groups
      of employees - directors, senior management and all other employees - based
      on
      historical experience. Estimated forfeitures are adjusted to actual forfeitures
      as necessary.





A
      summary
      of options under our stock option plans as of December 31, 2006 and changes
      during the nine months ended September 30, 2007 are as follows:


Number
                  of Shares
              
              Weighted
                  Average Exercise Price
              
              Weighted
                  Average Remaining Contractual Term (in years)
              
              Aggregate
                  Intrinsic Value at September 30, 2007Outstanding
                  December 31, 2006
              
              
              114,398
              
              $
              157.50
              
              
              5.80Options
                  granted under the plans
              
              
              19,740
              
              $
              60.19Options
                  exercised
              
              
              -
              
              $
              -Options
                  forfeited or expired
              
              
              (83,239
              )
              $
              154.84Outstanding
                  September 30, 2007
              
              
              50,899
              
              $
              123.80
              
              
              6.84
              
              $
              -Options
                  vested and exercisableat
                  September 30, 2007
              
              
              37,609
              
              $
              145.96
              
              
              5.96
              
              $
              -




10


**SPATIALIGHT,
      INC.**


Notes
      to
      Condensed Consolidated Financial Statements (Unaudited)


Aggregate
        intrinsic value is the sum of the amounts by which the quoted market price
        of
        our stock at September 30, 2007, $0.25 per share, exceeded the exercise price
        of
        the options, for those options for which the quoted market price was in excess
        of the exercise price (such options are referred to as “in-the-money-options”).
        As shown above, all of our options have exercise prices above the quoted
        market
        price, and therefore have no intrinsic value at September 30, 2007. No options
        were exercised during the nine months ended September 30, 2007. The aggregated
        intrinsic value of options exercised on the dates the options were exercised
        was
        $112,865 for the nine month period ended September 30, 2006.
  As
        of
        September 30, 2007, the estimated compensation cost of outstanding options
        that
        had not yet vested was approximately $382,030. This cost is expected to be
        recognized through February 2009. We recorded no income tax benefits for
        stock-based compensation expense arrangements for the nine months ended
        September 30, 2007, as we have cumulative operating losses, for which a full
        valuation allowance has been established.
 
 **Note** **5.**  **Per
        Share Information**
 
 Basic
        net
        loss per share is computed by dividing our 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 nine months ended
        September 30, 2007 and 2006 because the effect of their assumed exercise
        or
        conversion would be antidilutive.
 As
                    of September 30,2007
                
                2006Number
                    of Potentially Dilutive Shares
                
                Weighted
                    Average Exercise/Conversion Price
                
                Number
                    of Potentially Dilutive Shares
                
                Weighted
                    Average Exercise/Conversion PriceStock
                    options and warrants
                
                
                67,630
                
                $
                133.58
                
                
                136,688
                
                $
                170.50Convertible
                    notes
                
                
                127,193
                
                $
                87.96
                
                
                68,096
                
                $
                164.50Settlement
                    liability (*)
                
                
                3,318,276
                
                $
                0.25
                
                
                -Total
                
                
                3,513,099
                
                
                
                
                
                204,784
  *  The
        Settlement liability (see Note 9) of $829,569 at September 30, 2007 is settled
        in shares, and potentially dilutive shares reflect the number of shares that
        would be issued in the future to settle the Settlement liability based on
        the
        current market price per share at the end of the period.
 
 11
 **SPATIALIGHT,
          INC.**
 Notes
          to
          Condensed Consolidated Financial Statements (Unaudited)
  **Note** **6.**  **Inventory,
        net**
 
 Inventory
        consisted of the following as of September 30, 2007 and December 31,
        2006:
 September
                    30,
                
                December
                    31,2007
                
                2006Raw
                    materials
                
                $
                501,427
                
                $
                531,114Work-in-progress
                
                
                19,780
                
                
                26,088Finished
                    goods
                
                
                172,261
                
                
                161,285693,468
                
                
                718,487Inventory
                    reserve
                
                
                (390,592
                )
                
                (295,412
                )Total
                    inventory, net
                
                $
                302,876
                
                $
                423,075
 
 **Note
        7.**  **Property,
        Plant and Equipment, net**
 
 Property,
        plant and equipment include:
 September
                    30,
                  2007
                
                December
                    31,
                  2006Building
                
                $
                3,369,923
                
                $
                3,305,102Other
                    equipment and instruments
                
                
                1,740,003
                
                
                2,332,603Machinery
                    and manufacturing equipment
                
                
                1,711,953
                
                
                1,688,943Office
                    furniture and fixtures
                
                
                277,885
                
                
                463,414Tooling
                
                
                26,810
                
                
                371,700Leasehold
                    improvements
                
                
                41,502
                
                
                165,937Computer
                    hardware and software
                
                
                290,019
                
                
                352,825Total
                    property, plant and equipment
                
                
                7,458,095
                
                
                8,680,524Accumulated
                    depreciation
                
                
                (2,746,053
                )
                
                (3,474,598
                )Property,
                    plant and equipment, net
                
                $
                4,712,042
                
                $
                5,205,926
 
 Due
        to
        the default status of our short-term loans in South Korea described in Note
        8,
        each of the banks has registered a lien against our South Korean building.
        These
        liens, in the aggregate, total approximately $739,000.
 
 12
 
 **SPATIALIGHT,
              INC.**
 Notes
              to
              Condensed Consolidated Financial Statements (Unaudited)
 **Note** **8.**  **S** **hort-Term
        Loans and Notes Payable**
 
 *Short-Term
        Loans*
 
 Our
        wholly-owned subsidiary, SpatiaLight Korea, has revolving credit facilities
        with
        four separate South Korean banks as detailed below (amounts in thousands,
        Korean
        Won, unless otherwise stated):
 Bank
                
                Shinhan
                    Bank
                
                Kyongnam
                    Bank
                
                Korea
                    Exchange Bank
                
                Pusan
                    Bank
                
                TotalInterest
                    rate type
                
                Variable
                    (1)
                
                Variable
                    (2)
                
                Fixed
                    (1)
                
                Variable
                    (1)Interest
                    rate at 9/30/07
                
                
                16.66
                %
                
                16.51
                %
                
                19.00
                %
                
                19.00
                %Maturity
                    date
                
                
                4/15/2007
                
                
                10/30/2007
                
                
                1/10/2007
                
                
                1/10/2007Maximum
                    amount of line
                
                
                136,696
                
                
                177,000
                
                
                187,773
                
                
                75,804
                
                
                577,273Amount
                    outstanding at 9/30/07
                
                
                136,696
                
                
                177,000
                
                
                187,773
                
                
                75,804
                
                
                577,273Remaining
                    available
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -Approximate
                    US dollar equivalent
                
                $
                149,337
                
                $
                193,369
                
                $
                205,138
                
                $
                82,814
                
                $
                630,658
  (1)
                      Past due interest rates apply as loans are past due.(2)
                      Yield ratio of annual industrial financial debenture plus
                      10.0%
 Interest
        under each of the credit facilities is payable monthly. We are required to
        repay
        funds on the credit facilities by the maturity dates of each of the respective
        credit facilities as noted in the table above. We have not repaid the Korean
        Exchange Bank, the Pusan Bank or the Shinhan Bank the amounts outstanding
        as of
        the maturity dates noted above and are in discussions with each of these
        banks
        to revise the repayment terms. Due to the default status of three of the
        four
        credit facilities, all of the banks have registered liens against our South
        Korean building totaling an aggregate of approximately $739,000.
 
 Senior
        Secured Convertible Notes and Secured Convertible Notes outstanding at September
        30, 2007 consist of the following:
 
 *Argyle
        Notes:*
 
 In
        1998,
        we received $1,188,000 in cash in exchange for notes payable in that amount
        (the
“Argyle Notes”) to Argyle Capital Management Corporation (“Argyle”), a company
        owned and controlled by Robert A. Olins, our former Chief Executive Officer,
        Secretary, Treasurer, and a former Director. The Argyle Notes accrue interest
        at
        a contractual rate of 6% per annum, and are secured by substantially all
        of our
        assets, although these notes are subordinated to the Senior Secured Convertible
        Notes due November 30, 2007 described below. Both principal and interest
        are
        convertible into our common shares at $25.00 per share. The maturity date
        of the
        Argyle Notes has been extended several times, most recently on November 30,
        2004, when the due date was extended until December 31, 2008. The beneficial
        conversion effect representing the excess aggregate value of the common shares
        receivable upon conversion of the notes based on the appropriate market price
        at
        the time of measurement, 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 discount was amortized through
        non-cash interest in the financial statements, and was completely amortized
        in
        June 2005.
  13
 **SPATIALIGHT,
            INC.**
 Notes
            to
            Condensed Consolidated Financial Statements (Unaudited)
 In
        December 2004, we issued 1,000 common shares, and in January 2005, we issued
        8,975 common shares, as a prepayment of interest 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 $406.00
        on
        December 21, 2004. As of September 30, 2007, total prepaid interest on the
        Argyle Notes for the period October 1, 2007 to December 31, 2008 is $1,446,416,
        which is classified as a deduction from stockholders’ deficit in the
        accompanying condensed consolidated balance sheets. If Argyle elects to convert
        the notes prior to December 31, 2008, Argyle will return shares representing
        unearned interest on the Argyle Notes at the time of the
        conversion.
 
 Non-cash
        interest expense includes $814,389 for the nine months ended September 30,
        2007
        and 2006 resulting from the beneficial conversion price of interest, which
        is
        convertible into common shares at $25.00 per share. This non-cash interest
        was
        computed as the excess of the market price of the shares issued for the interest
        over the calculated amount of interest due for the period.
  At
        September 30, 2007, the carrying value of the Argyle Notes totaled $1,188,000
        representing the unpaid principal balance *.*
 
 *November
        2004 Financing:*
 
 On
        November 30, 2004, we completed a non-brokered private placement (the “November
        2004 Financing”) of $10 million of senior secured convertible notes (the “Senior
        Secured Convertible Notes”). The Senior Secured Convertible Notes accrue
        interest at 10% per annum, payable quarterly in cash or our common shares
        at our
        option, if certain conditions are met, such as the availability of an effective
        registration statement pursuant to which resales may be made or the availability
        of Rule 144(k) for resale of the common shares underlying the Senior Secured
        Convertible Notes. The value of the shares for the purposes of calculating
        interest payments is equal to the 10-day trailing average of the volume weighted
        average prices of our common shares at the end of each quarterly interest
        period. The Senior Secured Convertible Notes, originally due November 30,
        2007,
        are in default as described further below.
 
 The
        Senior Secured Convertible Notes are convertible, at the option of their
        holders, into our common shares at the conversion price of $486.00 per share.
        The Senior Secured Convertible Notes are senior to the Argyle Notes, based
        upon
        an Intercreditor Agreement.  This Intercreditor Agreement precludes us from
        repaying the Arygle Notes in cash or other property until the holders of
        our
        Senior Secured Convertible Notes have been repaid.  The Intercreditor
        Agreement does not, however, preclude us from paying interest on the Argyle
        Notes in either cash or shares provided there has not been an event of default
        under the Senior Secured Convertible Notes, as defined in the agreement. 
Under the terms of the Intercreditor Agreement, Argyle maintains its rights
        to
        convert the Argyle Notes into common shares under the conversion terms of
        the
        Argyle Notes, as described above, at any time.  The holders of our Senior
        Secured Convertible Notes have a senior security interest in substantially
        all
        of our assets, except those located in South Korea.  However, the holders
        of our Senior Secured Convertible Notes have a pledge on SpatiaLight Korea’s
        shares.  In addition, under the terms of the November 2004 Financing, we
        are prohibited from using the proceeds from the financing to repay debt or
        to
        pay dividends, and we are prohibited from paying dividends while the Senior
        Secured Convertible Notes are outstanding.
 
 We
        were
        required under an amended registration rights agreement, to file and maintain
        the effectiveness of a registration statement for resale of the shares issuable
        upon conversion of the Senior Secured Convertible Notes.  We reported in
        Post Effective Amendment No. 2 to our registration statement on Form S-3
        relating to the Senior Secured Convertible Notes (Reg. No. 333-122391), that
        in
        late August 2005 we advised the holders of the Senior Secured Convertible
        Notes
        that until the matter concerning the filing of an unauthorized consent of
        our
        former auditors, BDO Seidman, LLP, is resolved, sales using the prospectus
        which
        is the subject of that registration statement may result in potential liability.
        A holder of $4.5 million of the Senior Secured Convertible Notes, Portside
        Growth and Opportunity Fund (“Portside”), has claimed that the post-effective
        amendment resulted in an obligation for the Company to pay each noteholder
        liquidated damages in cash equal to 1% of the purchase price of the notes,
        and
        1% for every 30 days thereafter, until the matter concerning the consent
        was
        resolved. That amount would equal, in the aggregate, $683,000 as of February
        14,
        2006 (when the post-effective amendment to the registration statement was
        declared effective).  We do not believe that we are contractually obligated
        to make this payment and therefore we have not accrued the alleged liquidated
        damages.  However, should the noteholders pursue their claim for liquidated
        damages pursuant to the registration rights agreement and prevail on their
        claim
        in a court of law, the alleged liquidated damages would immediately become
        due
        and payable.
  14
 **SPATIALIGHT,
            INC.**
 Notes
            to
            Condensed Consolidated Financial Statements
            (Unaudited)
 Portside
        has also claimed additional events of default under the Senior Secured
        Convertible Notes based on (i) failure to make an interest payment due in
        November 2005 on a timely basis; (ii) incurrence of prohibited indebtedness
        to
        our former officers and/or directors of the Company; (iii) incurrence of
        prohibited indebtedness by our South Korean subsidiary to certain banks in
        South
        Korea; (iv) granting of a security interest by our South Korean subsidiary
        in
        certain assets located in South Korea; (v) repayment by us of indebtedness
        to
        our officers or directors and by our South Korean subsidiary of indebtedness
        under bank credit facilities. Smithfield Fiduciary LLC (“Smithfield”), another
        noteholder that holds $4.5 million of the Senior Secured Convertible Notes,
        joined in the claim that a default occurred as a result of certain indebtedness
        incurred and as a result of the failure to make the November 2005 interest
        payment in a timely fashion. These notices call for us to redeem $9.0 million
        in
        the aggregate principal amount of the Senior Secured Convertible Notes and
        to
        pay a redemption premium of $675,000 to each of these noteholders. Furthermore,
        the noteholders claim that the interest rate on the Senior Secured Convertible
        Notes has increased from 10% per annum to 12% per annum as a result of the
        claimed defaults.
 
 On
        March
        28, 2007, Portside filed suit against the Company and certain named directors
        and officers, claiming the Company was in breach of its obligations under
        the
        Senior Secured Convertible Notes and that certain directors and officers
        had
        breached their fiduciary duties in connection with loans made by them to
        the
        Company and loans made by certain South Korean banks to the Company’s South
        Korean subsidiary. On June 28, 2007, SpatiaLight and Portside agreed to a
        Stipulation of Discontinuance, without prejudice, with regard to their
        respective claims and counterclaims. This Stipulation includes a Standstill
        Period of 30 days to allow for the opportunity for productive discussions
        to
        take place between the parties or their agents prior to either party filing
        any
        subsequent claims. As of the date of this filing, no further action has been
        taken by Portside.
 
 On
        June
        15, 2007, as a result of our stock no longer trading on the Nasdaq Capital
        Market, the Senior Secured Convertible Notes became redeemable on demand
        by the
        holders at 115% of the principal amount plus accrued interest and late charges.
        We have received redemption notices from Portside and Smithfield and have
        not
        redeemed either Note within the time required by the notice. As a result
        of our
        failure to redeem the Senior Secured Convertible Notes within five days after
        receipt of the redemption notice, the noteholders may withdraw any part of
        the
        redemption notice and elect to convert the withdrawn amount at a new conversion
        rate equal to the lowest weighted price of the common shares between June
        15,
        2007 and the date of withdrawal. In early July 2007, Portside withdrew its
        redemption notice with respect to $100,000 and Smithfield withdrew its
        redemption notice with respect to $50,000. We have received a notice of
        conversion from each noteholder to convert the withdrawn amount at a conversion
        rate of $2.525 per common share. We have accrued $1.5 million in redemption
        premiums through September 30, 2007 and have increased the rate at which
        we
        accrue and pay interest from 10% per annum to 12% per annum in accordance
        with
        the terms of the Senior Secured Convertible Notes, commencing on June 15,
        2007.
  15
 **SPATIALIGHT,
            INC.**
 Notes
            to
            Condensed Consolidated Financial Statements
            (Unaudited)
 We
        failed
        to make the quarterly interest payment of approximately $294,000 due on August
        31, 2007 on the Senior Secured Convertible Notes. Under the terms of the
        Senior
        Secured Convertible Notes, we may make interest payments either in cash or
        by
        conversion to our common shares, subject to certain limitations. We have
        recorded approximately $393,000 in accrued and unpaid interest related to
        these
        notes as of September 30, 2007.
 
 Activity
        in notes payable for the nine months ended September 30, 2007 is as
        follows:
 **Debt
                    Principal:**
                
                **Balance
                    at December 31, 2006**
                
                **Addition
                    or New Discount**
                
                **(Payment)
                    or Discount Amortization**
                
                **Conversion
                    to Equity**
                
                **Balance
                    at September 30, 2007**Argyle
                    note
                
                $
                1,188,000
                
                $
                -
                
                $
                -
                
                $
                -
                
                $
                1,188,000Senior
                    Secured Convertible Notes
                
                
                10,000,000
                
                
                -
                
                
                -
                
                
                -
                
                
                10,000,000Senior
                    Secured Convertible Notesbeneficial
                    conversion feature
                
                
                (47,860
                )
                
                -
                
                
                39,150
                
                
                -
                
                
                (8,710
                )Reimbursement
                    of investor's legal fees
                
                
                (30,556
                )
                
                -
                
                
                25,000
                
                
                -
                
                
                (5,556
                )Senior
                    Secured Convertible NotesAIR
                    discount
                
                
                (325,498
                )
                
                -
                
                
                268,830
                
                
                -
                
                
                (56,668
                )Total
                
                $
                10,784,086
                
                $
                -
                
                $
                332,980
                
                $
                -
                
                $
                11,117,066**Interest:**Accrued
                    Argyle note 6%
                
                $
                -
                
                $
                53,461
                
                $
                -
                
                $
                (53,461
                )
                $
                -Argyle
                    note beneficial interest
                
                
                -
                
                
                814,389
                
                
                -
                
                
                (814,389
                )
                
                -Senior
                    Secured Convertible Notes 10% (A)
                
                
                84,353
                
                
                807,155
                
                
                (498,630
                )
                
                -
                
                
                392,877Total
                
                $
                84,353
                
                $
                1,675,005
                
                $
                (498,630
                )
                $
                (867,850
                )
                $
                392,877
  (A) The
            interest rate was increased to 12% per annum commencing on June 15,
            2007.
 
 We
        have
        classified the net balance of $9,929,066 related to the Senior Secured
        Convertible Notes as a current liability in the condensed consolidated balance
        sheet at September 30, 2007 as they are due on November 30, 2007. The $1,188,000
        outstanding balance of the Argyle Notes continues to be classified as long-term
        debt at September 30, 2007 as they are due on December 31, 2008.
 
 16
 **SPATIALIGHT,
            INC.**
 Notes
            to
            Condensed Consolidated Financial Statements (Unaudited)
 Non-cash
        interest expense is as follows:
 Nine
                    months ended
                  September
                    30,2007
                
                2006Amortization
                    of Senior Secured Convertible Notes
                
                $
                332,980
                
                $
                332,980Senior
                    Secured Convertible Notes 10% interest paid in common
                    stock
                
                
                -
                
                
                497,647Redemption
                    premium on the Senior Secured Convertible Notes
                
                
                1,500,000
                
                
                -Liquidated
                    damages on the October 2005, January 2006, September2006
                    and November 2006 financings
                
                
                302,806
                
                
                437,817Beneficial
                    conversion privileges of interest on Argyle note
                
                
                814,389
                
                
                814,389Expense
                    associated with waiver agreements with February 2007 andNovember
                    2006 investors settled in stock
                
                
                1,300,194
                
                
                -Loss
                    associated with the Settlement Agreement
                
                
                1,627,146
                
                
                -Amortization
                    of prepaid financing costs
                
                
                47,574
                
                
                47,574Total
                    non-cash interest expense
                
                $
                5,925,089
                
                $
                2,130,407
 Activity
        in notes payable for the three months ended September 30, 2007 is as
        follows:
 **Debt
                    Principal:**
                
                **Balance
                    at June 30, 2007**
                
                **Addition
                    or New Discount**
                
                **(Payment)
                    or Discount Amortization**
                
                **Conversion
                    to Equity**
                
                **Balance
                    at September 30, 2007**Argyle
                    note
                
                $
                1,188,000
                
                $
                -
                
                $
                -
                
                $
                -
                
                $
                1,188,000Senior
                    Secured Convertible Notes
                
                
                10,000,000
                
                
                -
                
                
                -
                
                
                -
                
                
                10,000,000Senior
                    Secured Convertible Notesbeneficial
                    conversion feature
                
                
                (21,760
                )
                
                -
                
                
                13,050
                
                
                -
                
                
                (8,710
                )Reimbursement
                    of investor's legal fees
                
                
                (13,889
                )
                
                -
                
                
                8,333
                
                
                -
                
                
                (5,556
                )Senior
                    Secured Convertible NotesAIR
                    discount
                
                
                (146,278
                )
                
                -
                
                
                89,610
                
                
                -
                
                
                (56,668
                )Total
                
                $
                11,006,073
                
                $
                -
                
                $
                110,993
                
                $
                -
                
                $
                11,117,066**Interest:**Accrued
                    Argyle note 6%
                
                $
                -
                
                $
                17,820
                
                $
                -
                
                $
                (17,820
                )
                $
                -Argyle
                    note beneficial interest
                
                
                -
                
                
                271,463
                
                
                -
                
                
                (271,463
                )
                
                -Senior
                    Secured Convertible Notes 10% (A)
                
                
                90,411
                
                
                302,466
                
                
                -
                
                
                
                
                
                392,877Total
                
                $
                90,411
                
                $
                591,749
                
                $
                -
                
                $
                (289,283
                )
                $
                392,877
 (A)  The
        interest rate was increased to 12% per annum commencing on June 15,
        2007.
 
 Non-cash
        interest expense is as follows:
 
 Three
                  months ended
                September
                  30,2007
              
              2006Amortization
                  of discounts on Senior Secured Convertible Notes
              
              $
              110,993
              
              $
              110,993Senior
                  Secured Convertible Notes 10% interest paid in common
                  stock
              
              
              -
              
              
              245,593Beneficial
                  conversion privileges of interest on Argyle note
              
              
              271,463
              
              
              271,463Amortization
                  of prepaid financing costs
              
              
              15,858
              
              
              15,858Total
                  non-cash interest expense
              
              $
              398,314
              
              $
              643,907
  17
   **SPATIALIGHT,
        INC.**
 Notes
        to
        Condensed Consolidated Financial Statements (Unaudited)
 
 **Note** **9.** **Issuance
        of Securities**
 
 Exercise
        of Stock Options and Warrants in the Nine Months Ended September 30,
        2007
 
 No
        stock
        options or warrants were exercised during the three or nine months ended
        September 30, 2007.
 
 Issuance
        of Shares, Stock Options and Warrants in the Nine Months Ended September
        30,
        2007
 
 During
        the fourth quarter of 2006, we entered into an agreement to grant options
        to
        purchase 19,000 common shares to our former Executive Vice President of
        Strategic Planning for services under a consulting agreement. The options
        contain market conditions and were initially valued at $59,529 on the date
        of
        grant using a binomial model. The estimated value was increased to $176,747
        based on a revised assumption as to when the vested options would be exercised.
        The following assumptions were used for valuing this grant: no dividend yield,
        expected volatility of 81%, risk free rate of 4.74% and expected lives (derived
        service period) varying from 47 days to 278 days. This agreement to grant
        options was cancelled in April 2007. Stock-based compensation expense during
        the
        first three quarters of 2007 includes $142,317 associated with this option
        grant
        agreement.
 
 On
        January 8, 2007, we issued a fully vested option to purchase 500 of our common
        shares to a consultant for compensation for services provided pursuant to
        a
        service agreement. A value of $28,490 was assigned to the option using the
        Black-Scholes pricing model and the following assumptions: stock price $67.50,
        exercise price $67.50, historical volatility 81%, risk free interest rate
        4.77%,
        dividend yield of zero and a contractual life of 10 years. This amount is
        included in stock-based compensation expense for the nine month period ended
        September 30, 2007.
 
 On
        February 23, 2007, when the price of our common stock was $65.50, we sold
        to
        five institutional investors that had also participated in the November 2006
        financing (“November 2006 Financing”), an aggregate of 43,810 of our common
        shares at a purchase price of $52.50 per share (“February 2007 Financing”). In
        addition, we issued 12,000 common shares, valued at $786,000, as a fee to
        obtain
        a one-time waiver (“February 2007 Waiver”) of contractual prohibitions under the
        November 2006 Financing against offering shares of our common stock for less
        than $65.00 per share. We received aggregate proceeds of $2.3 million, before
        issuance costs, from the sale of these shares, which was used for working
        capital and other corporate purposes. We made the sale pursuant to our “shelf”
registration statement on Form S-3 (File No. 333-137100), which was declared
        effective by the SEC on February 14, 2007.
 
 On
        March
        6, 2007, we entered into First Amendments amending the Registration Rights
        Agreements dated September 26, 2006 between the Company and each of Bluegrass
        Growth Fund, L.P. and Bluegrass Growth Fund, LTD. In exchange for the
        forgiveness of accrued liquidated damages under the Registration Rights
        Agreements in the amount of approximately $31,000, the rescission of a
        contingent obligation to issue 5,000 warrants to purchase common shares,
        and
        amending the Registration Rights Agreement filing date, the Company issued
        to
        Bluegrass Growth Fund, L.P. and Bluegrass Growth Fund, LTD. an aggregate
        of
        10,000 common shares. The common shares, valued at $545,000, were issued
        on
        March 6, 2007, when the price of our common stock was $54.50, and were issued
        pursuant to the Company’s Registration Statement on Form S-3 (File No.
        333-137100), which was declared effective by the SEC on February 14,
        2007.
  18
 **SPATIALIGHT,
          INC.**
 Notes
          to
          Condensed Consolidated Financial Statements (Unaudited)
  On
          April
          26, 2007, we entered into an Equity Credit Agreement (the “Equity Credit
          Agreement”) with six institutional investors (“Investors”) that participated in
          the November 2006 and February 2007 Financings, under which we may elect
          to sell
          and the Investors are required to purchase from time to time our common
          shares,
          having an aggregate market value of $15,400,000 over a period of eighteen
          months. The first $3,700,000 in common shares sold or to be sold by us
          pursuant
          to the Equity Credit Agreement will be priced at 100% of the closing bid
          price
          on the date of sale. The balance of the common shares to be sold by us
          under the
          Equity Credit Agreement will be priced at 95% of the closing bid price
          on the
          date of sale. As of September 30, 2007 we have elected to sell and the
          Investors
          have purchased 2,168,720 common shares with a net value of $3,089,907 under
          this
          Equity Credit Agreement. Due to a lack of authorized shares prior to the
          effectiveness of our reverse split and increase in authorized shares on
          August
          8, 2007, we used 34,703 of the common shares held in treasury to fulfill
          part of
          the above-mentioned sales of our common shares under this agreement. As
          the
          treasury shares were recorded at the $20.50 per share fair value or $711,411
          while the sale price on the date of the sale under the Equity Credit Agreement
          was $4.00 per common share or $138,812, we have recorded an increase in
          accumulated deficit for the difference, amounting to
          $572,599.
 
 In
        connection with the Equity Credit Agreement, we also entered into a Waiver,
        Rescission and Settlement Agreement effective as of April 24, 2007 (the
“Settlement Agreement”) with the Investors under which the Investors (i)
        released disputed claims under the November 2006 Financing Securities Purchase
        Agreement and Registration Rights Agreement, the February 2007 Financing
        Securities Purchase Agreement and Registration Rights Agreement, and the
        February 2007 Waiver described above; (ii) returned for cancellation warrants
        to
        purchase 96,000 common shares that were issued in the November 2006 Financing;
        (iii) cancelled the future financings restriction under which we could not
        sell
        common shares for less than $65.00 per share without the Investors’ consent; and
        (iv) entered into an Escrow Agreement pursuant to which we will issue into
        escrow, from time to time, an unspecified number of common shares, and the
        Investors will deliver to escrow 80,046 common shares previously issued pursuant
        to the November 2006 Financing and the February 2007 Financing. Under the
        terms
        of the Settlement Agreement, the Investors’ shares and shares we contribute to
        the escrow account will be periodically removed from escrow and sold, with
        the
        sales proceeds provided to the Investors, until they receive a total of
        $4,347,147. We recorded a settlement liability in the amount of $4,347,147
        based
        on the Investors' gross investment in the November 2006 and February 2007
        financings, in aggregate $5.3 million, plus a one-time commitment fee to
        the
        Investors of $185,000, as consideration for the $15.4 million equity line
        of
        credit, less proceeds previously received by the Investors from the sale
        of
        their common shares. We recorded a $1.627 million loss on the settlement
        as part
        of non-cash interest expense in the three month period ended June 30, 2007.
        The
        settlement loss was calculated by reducing the $4.3 million settlement liability
        to the Investors by: 1) the fair value of the warrants returned for cancellation
        of $602,055, recorded as a reduction of additional paid-in capital; 2) the
        fair
        market value of the 80,046 common shares placed in escrow by the Investors,
        or
        $1.64 million, recorded as treasury stock; 3) the reversal of a $292,000
        accrued
        liability for liquidated damages, waived under the Settlement Agreement;
        and 4)
        the $185,000 prepaid financing commitment fee for the Equity Credit Agreement.
        The prepaid financing commitment fee will be amortized on a pro-rata basis
        as
        common shares are issued under the Equity Credit Agreement, and recorded
        as a
        reduction of proceeds from the sale of the common shares. The fair value
        of the
        warrants to purchase 96,000 common shares was calculated at $602,055 at April
        24, 2007 using the Black-Scholes option pricing model, using the following
        assumptions: stock price $17.00, exercise price $87.50, volatility 86%, risk
        free interest rate 4.58%, remaining contractual life 4.6 years and dividend
        yield of zero. At September 30, 2007, $829,569 remained as the settlement
        liability reflecting the issuance and sale by the Investors of 451,610 shares
        of
        our common stock pursuant to the Settlement Agreement.
  19
 **SPATIALIGHT,
          INC.**
 Notes
          to
          Condensed Consolidated Financial Statements (Unaudited)
 Any
        new
        securities we issue under either the Equity Credit Agreement or the Settlement
        Agreement are registered pursuant to our Registration Statement on Form S-3
        (File No. 333-137100), which was declared effective by the SEC on February
        14,
        2007.
 
 On
        June
        15, 2007, trading in our common stock no longer occurred on the Nasdaq Capital
        Market as a result of the review by the Nasdaq Listing Qualifications Panel
        and
        their determination that we did not meet the minimum aggregate common stock
        value necessary to continue trading on the Nasdaq Stock Market. Our securities
        are quoted on the Over-the-Counter Bulletin Board under “SPLT”.
 
 Stock-based
        compensation, included in selling, general and administrative expenses, is
        as
        follows:
 
 Three
                  months ended
                September
                  30,
              
              Nine
                  months ended
                September
                  30,2007
              
              2006
              
              2007
              
              2006Options
                  granted to employees and directors
              
              $
              72,468
              
              $
              184,797
              
              $
              364,414
              
              $
              1,829,790Options
                  issued to consultants for services
              
              
              540
              
              
              -
              
              
              171,347
              
              
              -$
              73,008
              
              $
              184,797
              
              $
              535,761
              
              $
              1,829,790
  **Note
        10.** **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 condensed consolidated financial
        statements of operations. Therefore, we have determined that we operate in
        a
        single business segment. All of our assets are located at our facility in
        the
        United States at September 30, 2007, except for the following:
 South
                    KoreaCash
                
                $
                27,994Prepaid
                    expenses
                
                
                76,298Deposits
                
                
                44,409Building
                    and leasehold improvements, net
                
                
                3,045,526Machinery
                    and manufacturing equipment, net
                
                
                698,626Office
                    furniture and fixtures, net
                
                
                101,877Other
                    equipment and instruments, net
                
                
                577,432Inventory,
                    net
                
                
                302,876Total
                
                $
                4,875,038
  20


**SPATIALIGHT,
        INC.**
 Notes
        to
        Condensed Consolidated Financial Statements (Unaudited)
  The
          following table summarizes our product revenue percentages for the nine
          months
          ended September 30, 2007 and 2006:


Nine
                  months ended September 30,2007
              
              2006LCoS
                  (T-3) sets
              
              
              100
              %
              
              96
              %Other
                  (primarily supporting electronics)
              
              
              -
              
              
              4
              %Total
              
              
              100
              %
              
              100
              %




Of
      our
      total revenue in 2007, 90% was derived from the sales of LCoS Sets to LGE,
      a
      customer located in South Korea. For the nine months ended September 30, 2006,
      sales to LGE comprised 96% of our total sales, and 100% of our accounts
      receivable balance at September 30, 2006.




**Note
      11.**  **Income
      taxes**





We
      adopted the provisions of FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes - an Interpretation of FASB Statement No.
      109* ,
      or FIN
      48, on January 1, 2007. Upon adoption of FIN 48, we commenced a review of our
      tax positions taken in our tax returns that remain subject to examination.
      Based
      upon our review, we do not believe we have any unrecognized tax benefits or
      that
      there is a material impact on our financial condition or results of operations
      as a result of implementing FIN 48.





We
      file
      income tax returns in the U.S. federal jurisdiction and various state
      jurisdictions. We are subject to U.S. federal or state income tax examinations
      by tax authorities for all years in which we reported net operating losses
      that
      are being carried forward for tax purposes. We do not believe there will be
      any
      material changes in our unrecognized tax positions over the next 12 months.





Interest
      recognized, to the extent applicable, is classified in the financial statements
      as interest expense. Penalties recognized, to the extent applicable, are
      reported in other income (expense). As of the date of adoption of FIN 48, we
      did
      not have any accrued interest or penalties associated with any unrecognized
      tax
      benefits, and no interest or penalty expense was recognized for the nine month
      period ended September 30, 2007.





In
      addition, we have net operating loss carryforwards (“NOLs”) that may be subject
      to substantial annual limitations due to ownership change limitations provided
      by the Internal Revenue Code and similar state provisions. We have not evaluated
      whether there are any changes in ownership that would limit the future use
      of
      our NOLs.





**Note** **12.**  **Recent
      Accounting Pronouncements**





In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes — an Interpretation of FASB Statement
      No. 109* (“FIN 48”),
      which provides clarification related to the process associated with accounting
      for uncertain tax positions recognized in financial statements. FIN 48
      prescribes a more-likely-than-not threshold for financial statement recognition
      and measurement of a tax position taken, or expected to be taken, in a tax
      return. FIN 48 also provides guidance related to, among other things,
      classification, accounting for interest and penalties associated with tax
      positions, and disclosure requirements. We adopted FIN 48 on
      January 1, 2007 and the impact on our financial statements was not
      material.




21




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




In
      September 2006, the Financial Accounting Standards Board (FASB) issued Statement
      No. 157, *Fair
      Value Measurements* (“FAS
      157”). This statement defines fair value, establishes a framework for measuring
      fair value under generally accepted accounting principles (GAAP), and expands
      disclosures about fair value measurements. SFAS No. 157 is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years. The transition adjustment, which
      is measured as the difference between the carrying amount and the fair value
      of
      those financial instruments at the date this statement is initially applied,
      is
      recognized as a cumulative effect adjustment to the opening balance of retained
      earnings for the fiscal year in which this statement is initially applied.
      The
      provisions of SFAS No. 157 are effective for us beginning January 1, 2008.
      We
      are currently evaluating the impact of adopting SFAS No. 157 on our consolidated
      financial statements.




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities* (“SFAS No. 159”).
      SFAS No. 159 expands opportunities to use fair value measurement in
      financial reporting and permits entities to choose to measure many financial
      instruments and certain other items at fair value. SFAS No. 159 is
      effective for fiscal years beginning after November 15, 2007. We have not
      decided if we will choose to measure any eligible financial assets and
      liabilities at fair value.





In
      June
      2007, the EITF reached a consensus on EITF Issue No. 07-03, *Accounting
      for Nonrefundable Advance Payments for Goods or Services to Be Used in Future
      Research and Development Activities* (EITF
      07-3). Under EITF 07-03, nonrefundable advance payments for goods or services
      to
      be received in the future for use in research and development activities should
      be deferred and capitalized. Such amounts should be expensed as the related
      goods are delivered or services are performed. If our expectations change such
      that we do not expect the goods to be delivered or services to be rendered,
      the
      capitalized advance payment should be charged to expense. EITF 07-03 is
      effective for new contracts entered into beginning January 1, 2008. We have
      not
      yet determined the impact that EITF 07-03 will have on our consolidated
      financial statements.





**13.**  **Commitments
      and Contingencies**





*Lease
      Commitments*





In
      September 2004, we entered into a 50 year term lease with the Gyeongnam
      provincial government for 8.3 acres of undeveloped land in Jinsa, Gyeongnam
      province in South Korea. We have received a 100% land lease payment exemption
      because the land has been designated a “free economic zone” by the South Korean
      national government and the South Korean government also certified us as a
“high
      technology” company. Under our agreement with the Gyeongnam provincial
      government, we could lose our land lease payment exemption in the event that
      we
      lose our “high technology” certification, which could increase the costs of
      operating the facility and negatively impact our business. Additionally, if
      we
      were to lose the lease, we might be required to donate the building to the
      South
      Korean government.




22


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




*Alleged
      Events of Default on Senior Secured Convertible Notes*





Certain
      allegations of events of default related to the November 2004 Financing have
      been communicated to us as more fully described in Note 8.





*Guarantees
      and Indemnifications*




As
      permitted under New York law and in accordance with our Bylaws, we indemnify
      our
      officers and directors for certain events or occurrences while the officer
      or
      director is or was serving at the Company’s request in such capacity. The term
      of the indemnification period is for the officer’s or director’s lifetime. The
      maximum amount of potential future indemnification is unlimited. We are unable
      to estimate the fair value of these indemnification agreements and accordingly,
      we have not recorded any liabilities for these agreements as of September 30,
      2007.





*Other*





Don
      Suh,
      our former Chief Executive Officer, has filed a claim against the Company
      alleging the Company terminated his employment in violation of the
      Sarbanes-Oxley Whistleblower laws and the Corporate and Criminal Fraud
      Accountability Act of 2002 and is seeking damages of at least $250,000 plus
      a
      year’s worth of benefits. We do not believe that his assertions have merit but
      cannot predict the ultimate outcome of any potential litigation.





On
      March
      28, 2007, Portside Growth and Opportunity Fund, holders of $4.5 million of
      the
      Senior Secured Convertible Notes, filed suit against the Company and certain
      named directors and officers, claiming the Company was in breach of its
      obligations under the Senior Secured Convertible Notes and that certain
      directors and officers had breached their fiduciary duties in connection with
      loans made by them to the Company and loans made by certain South Korean banks
      to the Company’s South Korean subsidiary. On June 28, 2007, SpatiaLight and
      Portside agreed to a Stipulation of Discontinuance, without prejudice, with
      regard to their respective claims and counterclaims. This Stipulation includes
      a
      Standstill Period of 30 days to allow for the opportunity for productive
      discussions to take place between the parties or their agents prior to either
      party filing any subsequent claims. As of the date of this filing, no further
      action has been taken by Portside.





On
      June
      15, 2007, as a result of our stock no longer trading on the Nasdaq Capital
      Market, the Senior Secured Convertible Notes issued in the November 2004
      Financing became redeemable on demand by the holders at 115% of the principal
      amount plus accrued interest and late charges. We have received redemption
      notices from two holders of the Senior Secured Convertible Notes. We have
      accrued $1.5 million in redemption premiums as of September 30, 2007 and have
      increased the rate at which we accrue and pay interest from 10% per annum to
      12%
      per annum in accordance with the terms of the Senior Secured Convertible Notes,
      commencing on June 15, 2007.





We
      failed
      to make the quarterly interest payment of approximately $294,000 due on August
      31, 2007 on the Senior Secured Convertible Notes.





On
      October 9, 2007, we received a demand letter from Shinhan Bank threatening
      the
      commencement of legal action towards our property rights in South Korea if
      we do
      not promptly repay all amounts owed under the line of credit (approximately
      $160,000 including principal and accrued interest). As of the date of this
      filing, no further action has been taken by Shinhan Bank.




23




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




We
      are a
      party to other routine claims and lawsuits from time to time in the ordinary
      course of business. While the outcome of such matters cannot be predicted with
      certainty, we believe that the resolution of any such matters individually
      or in
      the aggregate will not have a material adverse effect on our business, financial
      condition or results of operations.





*U.S.
      Securities and Exchange Commission Investigations*





As
      previously reported, we failed to obtain authorization from BDO Seidman LLP
      before filing their consent to certain registration statements filed in 2005,
      incorporating their report on our financial statements for the fiscal years
      ended December 31, 2002 and 2003 as an exhibit to these certain registration
      statements. We received the requisite authorized consents from BDO Seidman,
      LLP
      to incorporate by reference their report on the consolidated financial
      statements into the registration statements when initially filed and in previous
      amendments thereto and BDO Seidman, LLP has not withdrawn these previous
      consents. Over the period of 1999 through early 2005 the Company paid interest
      on a Convertible Note held by Argyle Capital Management through the issuance
      of
      shares in a manner prescribed by the Note. Over the period of 2000 to early
      2005, these shares were issued free of legend and without restriction on the
      basis of an opinion provided by the Company’s corporate counsel at the time. We
      have received a Wells Notice dated May 25, 2007 from the SEC and have been
      advised that the SEC intends to pursue civil remedies against the Company in
      connection with the filing of the unauthorized BDO Seidman, LLP consents and
      our
      issuance of securities without legend or restrictions to Argyle for payment
      of
      interest on the Argyle Notes, specifically focusing on our prepayment of
      interest in December 2004 and January 2005. We cannot predict the eventual
      outcome of this investigation, nor can a reasonable estimate of the costs that
      might result from the SEC’s investigation be made. However, the Company at this
      time does not believe the SEC to be seeking financial penalties against the
      Company. In the event of an adverse outcome, our business as well as our future
      results of operations, financial position and/ or cash flows could be materially
      affected.





*Other
      matters*





Both
      registration statements that included the unauthorized BDO Seidman, LLP consents
      were used to sell common shares after the Staff of the SEC declared the
      registration statements effective. It is conceivable that there may be
      litigation against us or our officers or directors under Section 11 of the
      Securities Act. Although we do not believe that the filing of an invalid consent
      constitutes a materially misleading statement or an omission to disclose a
      material fact within the meaning of Section 11 of the Securities Act, a contrary
      determination could result in a liability for us.




24


**SPATIALIGHT,
        INC.**
 Notes
        to
        Condensed Consolidated Financial Statements (Unaudited)
  At
      present, we are unable to ascertain the exact amount of damages, if any, to
      which we could potentially be subject under a Section 11 claim instituted by
      any
      persons who directly purchased shares pursuant to those registration statements.
      Furthermore, at this date, we cannot ascertain the amount of damages, if any,
      for which we could be liable for claims instituted by any subsequent purchasers
      who could trace the shares purchased by them to those registration statements.
      In August 2005, we sold 10,000 common shares to three institutional purchasers
      for $270.00 per share pursuant to the “shelf” registration statement referenced
      herein. Each of those investors has since represented to us in writing, in
      connection with a separate transaction, that they have disposed of all of those
      shares. One of those institutional investors has represented to us that it
      sold
      those shares at a sale price at or higher than its purchase price from us.
      We
      believe, based upon discussions with the other two investors, that they sold
      their shares at a sale price of not lower than $212.50 per share. Therefore,
      we
      believe that our maximum damages pursuant to Section 11 claims from direct
      purchasers, which we would fully contest, would be $391,000, or the difference
      between the two investors’ purchase price and lowest believed resale price,
      multiplied by the 6,800 shares that they purchased and then resold.




In
      addition to any damage claims, which may be material to our financial condition,
      any lawsuit alleging securities law violations could require us to expend
      significant financial and managerial resources.





25


**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 Part II Item 1A and
      those
      discussed in the Company’s Annual Report on Form 10-K/A as filed with the U.S.
      Securities and Exchange Commission on August 21, 2007. 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 September 30, 2007, and our results of operations for the three
      and nine months ended September 30, 2007 and 2006. The following should be
      read
      in conjunction with our unaudited condensed consolidated financial statements
      and related notes appearing elsewhere herein and assumes that the reader has
      read the more detailed information found in our 2006 Annual Report on Form
      10-K/A filed with the SEC on August 21, 2007.





OVERVIEW





We
      are in
      the business of manufacturing high-resolution liquid crystal on silicon (“LCoS”)
      microdisplays. Our current and prospective customers include manufacturers
      of
      near-to-eye display systems such as head mounted displays (“HMDs”), small
      projection displays (microprojectors or nanoprojectors) targeted for use with
      mobile electronics projects, and makers of front and rear projection based
      televisions and monitors.




We
      are
      currently focused on manufacturing one core LCoS imager product, our T-3S LCoS
      Set, consisting of one of our proprietary SpatiaLight imagEngineTM LCoS
      microdisplays with a 1920 pixels by 1080 pixels configuration, modified for
      single panel operation, along with a drive ASIC. LCoS displays 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. We are currently focusing on manufacturing our T-3S LCoS
      Sets
      because we believe that market demand for the higher resolution product in
      HMD
      applications will be increasing significantly with the greater availability
      of
      1920 by 1080 resolution media both for gaming and entertainment video. We are
      developing a new product, designated the T-6S LCoS Set, with a resolution of
      800
      pixels by 600 pixels and a small diagonal of 0.33” to enable single panel
      operation for products such as nano-projectors.





We
      completed construction of our South Korean manufacturing facility in January
      2005. Since the third quarter of 2006, we have been in position to manufacture
      commercial quantities of high quality product according to customer
      specifications.





We
      are
      also working with other manufacturers to develop and market a light engine
      incorporating our microdisplays and a solid state light source. These solid
      state light sources (LED and laser) are attractive to both consumer and
      commercial display makers because of their longer life compared to high pressure
      mercury arc lamps. The lower angular divergence associated with laser sources
      also facilitate much thinner cabinet designs. However due to the intense
      competition in the TV display market from flat panel based displays we are
      focusing the bulk of our efforts on near to eye and nano-projector
      applications.




26




*Status
      of Business with LG Electronics, Inc.*




In
      2005
      and 2006, the majority of our product deliveries, which were in small
      quantities, were made to LG Electronics, Inc. (“LGE”). In October 2006, LGE
      notified us that they would not accept the contracted quantities. We do not
      expect significant future sales to LGE and are negotiating with LGE for
      termination compensation under our LCoS Supply Agreement, although no assurance
      can be given that we will receive any compensation from LGE. The decision by
      LGE
      to cease accepting deliveries of the T-3 LCoS Sets significantly reduced our
      expected future sales and future results of operations.





*Other
      Business Development*




We
      have
      signed a Joint Marketing Agreement with Foreal Spectrum, Inc. to jointly offer
      a
      light engine developed by Foreal using their light source and our T-3 LCoS
      Sets.
      We estimate that full production volumes for customers targeted for these
      products will be approximately 20,000 sets per month but have not entered into
      a
      commercial supply agreement at this time, nor can we provide assurance with
      regard to the level of future purchases.





We
      have
      entered a Memorandum of Understanding with Deocom Co., Ltd. of South Korea
      relating to the development and manufacture of HMDs using our LCoS imager in
      full High Definition (“HD”) mode. We have also signed a Purchase Agreement with
      and received the first purchase order from Deocom to supply LCoS imagers for
      use
      in HMDs. Initial supply quantities are limited to prototype and low volume
      production levels. The Purchase Agreement anticipates this market to grow as
      HMDs are adopted by the video game and entertainment industries. Deocom has
      made
      significant progress in their product development and customer acquisition
      activities, and we expect them to start accepting production in the fourth
      quarter of 2007.





We
      had
      also signed a Memorandum of Understanding with SI InfoComm, Inc. and SCRAM
      Technologies for the joint development of a micro-projector, a new category
      of
      product targeted at mobile electronics driven applications. Demonstrations
      of a
      microprojector employing our imager were made by SCRAM in June of
      2007.





In
      October of 2007 we signed an agreement with Daeyang E&C for the joint
      design, manufacture and distribution of an HMD system employing the SpatiaLight
      T3S LCoS imager product. This agreement is expected to provide revenue starting
      about mid-2008.





*Business
      Strategy*




In
      reviewing the risk factors for our business, it is clear that there are some
      overriding concerns and issues. One of these is the high level of focus and
      reliance in recent periods on one customer, LGE. In addition, flat panel
      displays continue to make progress in the market relative to microdisplay-based
      rear projection televisions (“RPTV’s”). Another factor is that our product focus
      has been on the RPTV application. While we certainly continue to work for
      success with the RPTV product, we also need to manage the risks inherent in
      this
      situation.




27




For
      these
      reasons, we have taken the following initiatives:




·
            Engage
                in new product development for applications other than RPTV (including
                Near-To-Eye (NTE) displays such as HMDs and nano-projector
                products).


·
            Find
                new customers for the single panel based product in the HMD and
                nano-projector market segments.


·
            Improve
                the competitiveness of LCoS based microdisplay products by working
                with
                firms involved in LED and laser diode light sources (instead of the
                standard high pressure mercury arc lamp light
                source).





We
      believe we have a solid core technology that can be used to meet the needs
      of a
      number of large and potentially high growth market segments. We believe that
      the
      manufacturing competence we have established at SpatiaLight Korea gives us
      a
      base from which to supply our current and future customers. To help us match
      these technical possibilities and capabilities successfully with market needs,
      we have established a new business and product development function operating
      out of Seoul, South Korea, that has already paid dividends in some of the
      agreements mentioned above.





*Contingent
      Liability Relating to Senior Secured Convertible Debt
      Financing*





On
      November 30, 2004, we completed a non-brokered private placement of $10 million
      in our Senior Secured Convertible Notes. Under the terms of the agreements
      entered in connection with the sale of our Senior Secured Convertible Notes,
      we
      were required to file and maintain the effectiveness of registration statement
      relating to the resale of common shares issuable upon conversion. The required
      registration statement (Reg. No. 333-122391) was filed on January 31, 2005,
      and
      became effective on July 29, 2005. However, as a result of our failure to obtain
      authorization from our former auditors, BDO Seidman, LLP, to file their consent
      to incorporate their report into certain pre-effective amendments to the
      registration statement, we notified the holders of the Senior Secured
      Convertible Notes that sales of our common shares under the registration
      statement could result in potential liability until an amendment could be filed
      correcting the lack of authorization. Portside Growth and Opportunity Fund,
      the
      holder of $4.5 million of the Senior Secured Convertible Notes, filed a claim
      for liquidated damages in the amount of $307,000 on the basis that the
      registration statement was not effective and sales of our common shares could
      not be made from August 2005 until February 2006, when an amendment correcting
      the lack of authorization by BDO Seidman, LLP was filed.





Portside
      Growth and Opportunity Fund (“Portside”) has also claimed additional events of
      default under the Senior Secured Convertible Notes relating to (i) an alleged
      failure to make an interest payment due in November 2005 on a timely basis;
      (ii)
      an incurrence of prohibited indebtedness to our former officers and/or directors
      of the Company; (iii) an incurrence of prohibited indebtedness by our South
      Korean subsidiary to certain banks in South Korea; (iv) a grant of a security
      interest by our South Korean subsidiary in certain assets located in South
      Korea; and (v) a repayment by us of indebtedness to our officers or directors
      and by our South Korean subsidiary of indebtedness under bank credit facilities.
      Smithfield Fiduciary LLC (“Smithfield”), another noteholder, that holds $4.5
      million of the Senior Secured Convertible Notes, joined in the claim that a
      default occurred as a result of certain indebtedness incurred and as a result
      of
      the failure to make the November 2005 interest payment in a timely fashion.
      These notices call for us to redeem $9.0 million in the aggregate principal
      amount of our Senior Secured Convertible Notes and to pay a redemption premium
      of $675,000 to each of these noteholders. Furthermore, the noteholders claim
      that the interest rate on the Senior Secured Convertible Notes has increased
      from 10% per annum to 12% per annum as a result of the claimed
      defaults.




28




On
      March
      28, 2007, Portside filed suit against the Company and certain named directors
      and officers, claiming the Company was in breach of its obligations under the
      Senior Secured Convertible Notes and that certain directors and officers had
      breached their fiduciary duties in connection with loans they made to the
      Company and loans made by certain South Korean banks to the Company’s South
      Korean subsidiary. On June 28, 2007, SpatiaLight and Portside agreed to a
      Stipulation of Discontinuance, without prejudice, with regard to their
      respective claims and counterclaims. This Stipulation includes a Standstill
      Period of 30 days to allow for the opportunity for productive discussions to
      take place between the parties or their agents prior to either party filing
      any
      subsequent claims. As of the date of this filing, no further action has been
      taken by Portside.





On
      June
      15, 2007, as a result of our stock no longer trading on the Nasdaq Capital
      Market, the Senior Secured Convertible Notes were in default under the Senior
      Secured Convertible Note agreement and became redeemable on demand by the
      holders at 115% of the principal amount plus accrued interest and late charges.
      We have received a notice of redemption from Portside and Smithfield calling
      for
      us to redeem their $9 million in the aggregate principal amount, plus accrued
      interest and late charges, but have not yet redeemed any of the Senior Secured
      Convertible Notes. In early July 2007, Portside elected to withdraw its notice
      of redemption with respect to $100,000 and Smithfield elected to withdraw its
      notice of redemption with respect to $50,000. Under the terms of the Senior
      Secured Convertible Notes, the conversion rate with respect to the withdrawn
      amounts has been reset from $486.00 per share to $2.525 per share. The
      noteholders may withdraw their redemption notices with respect to additional
      amounts in the future and the conversion rate with respect to such withdrawn
      amounts will be reset to the lowest weighted average price for common shares
      between June 15, 2007 and the date of such withdrawal. We have accrued $1.5
      million in redemption premiums through September 30, 2007 and have increased
      the
      rate at which we accrue and pay interest from 10% per annum to 12% per annum
      in
      accordance with the terms of the Senior Secured Convertible Notes, commencing
      on
      June 15, 2007.





We
      failed
      to make the quarterly interest payment of approximately $294,000 due on August
      31, 2007 on the Senior Secured Convertible Notes. We have recorded approximately
      $393,000 in accrued and unpaid interest related to these notes as of September
      30, 2007.





*Contingent
      Liability Relating to Registration of Securities*





We
      failed
      to obtain an express authorization from BDO Seidman, LLP to file their consent
      to incorporate their report on our consolidated financial statements for the
      years ended December 31, 2002 and December 31, 2003 in Pre-effective Amendment
      Nos. 5 and 6 to our registration statement on Form S-3 (File No. 333-122391)
      and
      in Pre-effective Amendment Nos. 3 and 4 to our registration statement on Form
      S-3 (File No. 333-122392). We did receive the requisite authorization from
      BDO
      Seidman, LLP to incorporate by reference their report on the consolidated
      financial statements into the registration statements when initially filed
      and
      in earlier amendments to the registration statements and BDO Seidman, LLP has
      not withdrawn these previous consents.





Both
      of
      the registration statements containing the unauthorized BDO Seidman, LLP
      consents were declared effective in July 2005. In August 2005, we filed
      Post-effective Amendments Number 1 to both of these registration statements
      (those post-effective amendments were subsequently withdrawn and replaced by
      additional post-effective amendments), which disclosed the filing of the
      unauthorized consents. Because both registration statements were used to sell
      common shares after the SEC declared the registration statements effective,
      it
      is conceivable that there may be litigation against us or our officers or
      directors under Section 11 of the Securities Act. Although we do not believe
      that the filing of an invalid consent constitutes a materially misleading
      statement or an omission to disclose a material fact within the meaning of
      Section 11 of the Securities Act, a contrary determination could result in
      a
      liability for us. We are unable to ascertain the exact amount of damages, if
      any, to which we could be subject under a Section 11 claim instituted by any
      persons who directly purchased shares pursuant to those registration statements.
      Furthermore, we cannot ascertain the amount of damages, if any, for which we
      could be liable for claims instituted by any subsequent purchasers who could
      trace the shares purchased by them to those registration statements. In addition
      to any damage claims, which may be material to our financial condition, any
      lawsuit alleging securities law violations could require us to expend
      significant financial and managerial resources.




29




*SEC
      Investigations*





We
      received a Wells Notice from the SEC dated May 25, 2007 and have been advised
      by
      the Staff of the SEC that the Staff intends to recommend civil remedies,
      including an injunction against future violations of securities laws, in
      connection with our filing of the unauthorized BDO Seidman, LLP consents and
      our
      issuance of securities without legend or restrictions to Argyle Capital
      Management Corporation (“Argyle”) for payment of interest in December 2004 and
      January 2005 on notes payable by the Company to Argyle. We cannot determine
      whether we or our management will be adversely affected by any remedies which
      may be imposed by the SEC.





LIQUIDITY
      AND CAPITAL RESOURCES




As
      of
      September 30, 2007, we had approximately $28,000 in cash and cash equivalents,
      a
      decrease of approximately $192,000 from the December 31, 2006 balance of
      approximately $220,000. Our net working capital deficiency at September 30,
      2007
      was approximately $17.1 million compared to approximately $12.9 million at
      December 31, 2006.





Net
      cash
      used in operating activities totaled approximately $1.2 million and $2.4 million
      for the three months ended September 30, 2007 and 2006, respectively, and
      approximately $5.4 million and $10.1 million for the nine months ended September
      30, 2007 and 2006, respectively. Cash used in operating activities decreased
      for
      the three and nine month periods ended September 30, 2007 as compared to the
      same periods in 2006 primarily due to decreased operations as a result of
      financial constraints.





Net
      cash
      used in investing activities totaled approximately $20,000 for the three months
      ended September 30, 2007 and approximately $181,000 for the three months ended
      September 30, 2006. Net cash used in investing activities totaled approximately
      $31,000 and $496,000 for the nine months ended September 30, 2007 and 2006,
      respectively. Cash used in investing activities in 2007 and 2006 were primarily
      related to equipment purchases for use in our South Korean facility.





Net
      cash
      provided by financing activities in the three months ended September 30, 2007
      and 2006 was approximately $1.0 million and $2.4 million, respectively, and
      approximately $5.2 million and $10.9 million for the nine months ended September
      30, 2007 and 2006, respectively. In the first quarter of 2007, cash was provided
      by the gross proceeds of approximately $2.3 million that we received from the
      sale of 43,810 of our common shares in February 2007. During the second and
      third quarters of 2007, cash was primarily provided by the gross proceeds of
      approximately $3.1 million that we received from the sale of 2,168,720 of our
      common shares under the Equity Credit Agreement entered into in April 2007.
      The
      funds from these financings were used to fund our operations for the first
      three
      quarters of 2007. In the first quarter of 2006, cash was primarily provided
      by
      the net proceeds of approximately $3.3 million that we received from the sale
      of
      26,000 of our common shares in mid-January 2006, at a purchase price of $131.00
      per share, and approximately $1.1 million that we received from the sale of
      10,000 shares sold on March 17, 2006, at a purchase price of $109.00 per share.
      We also borrowed approximately $1.4 million on our lines of credit with South
      Korean banks during the first quarter of 2006, which was repaid early in the
      second quarter of 2006. In the second quarter of 2006, cash was primarily
      provided by the net proceeds of approximately $2.4 million that we received
      from
      the sale of 15,000 of our common shares on April 7, 2006 at a purchase price
      of
      $163.00 per share and approximately $1.7 million that we received from the
      sale
      of 12,020 of our common shares on June 6, 2006 at a purchase price of $140.00
      per share.




30




On
      April
      26, 2007, we entered into an Equity Credit Agreement with six Investors that
      participated in the November 2006 and February 2007 financings, under which
      we
      may elect to sell and the Investors are required to purchase from time to time
      our common shares having an aggregate market value of $15,400,000 over a period
      of eighteen months. The first $3,700,000 in common shares sold by us pursuant
      to
      the Equity Credit Agreement will be priced at 100% of the closing bid price
      on
      the date of sale. The balance of the common shares sold under the Equity Credit
      Agreement will be priced at 95% of the closing bid price on the date of sale.
      We
      expect to meet our immediate cash needs and fund our immediate working capital
      requirements with the Equity Credit Agreement, cash payments from our customers,
      the exercises of stock options and warrants, and additional sales of our common
      shares.





In
      connection with the Equity Credit Agreement, we also entered into a Waiver,
      Rescission and Settlement Agreement effective as of April 24, 2007 (the
“Settlement Agreement”) with the Investors under which the Investors (i)
      released disputed claims under the November 2006 Financing Securities Purchase
      Agreement and Registration Rights Agreement, the February 2007 Financing
      Securities Purchase Agreement and Registration Rights Agreement, and the
      February 2007 Waiver; (ii) returned for cancellation warrants to purchase 96,000
      common shares that were issued in the November 2006 Financing; (iii) cancelled
      the future financings restriction under which we could not sell common shares
      less than $65.00 per share without the Investors’ consent, and (iv) entered into
      an Escrow Agreement pursuant to which we will issue into escrow, from time
      to
      time, an unspecified number of common shares, and the Investors will deliver
      to
      escrow 80,046 common shares previously issued pursuant to the November 2006
      Financing and the February 2007 Financing. Under the terms of the Settlement
      Agreement, the Investors’ shares and the shares we contribute to the escrow
      account will be periodically removed from escrow and sold, with the sales
      proceeds provided to the Investors until they receive a total of $4,347,147.
      We
      recorded a settlement liability in the amount of $4,347,147 based on the
      Investors' gross investment in the November 2006 and February 2007 financings,
      in aggregate $5.3 million, plus a one-time commitment fee to the Investors
      of
      $185,000, as consideration for the $15.4 million equity line of credit, less
      proceeds previously received by the Investors from the sale of their common
      shares. We recorded a $1.627 million loss on the settlement as part of non-cash
      interest expense in the three month period ended June 30, 2007. The settlement
      loss was calculated by reducing the $4.3 million settlement liability to the
      Investors by: 1) the fair value of the warrants returned for cancellation of
      $602,055, recorded as a reduction of additional paid-in capital; 2) the fair
      market value of the 80,046 common shares placed in escrow by the Investors,
      or
      $1.64 million, recorded as treasury stock; 3) the reversal of a $292,000 accrued
      liability for liquidated damages, waived under the Settlement Agreement; and
      4)
      the $185,000 prepaid financing commitment fee for the Equity Credit Agreement.
      The prepaid financing commitment fee will be amortized on a pro-rata basis
      as
      common shares are issued under the Equity Credit Agreement, and recorded as
      a
      reduction of proceeds from the sale of the common shares. The fair value of
      the
      warrants to purchase 96,000 common shares was calculated at $602,055 at April
      24, 2007 using the Black-Scholes option pricing model, using the following
      assumptions: stock price $17.00, exercise price $87.50, volatility 86%, risk
      free interest rate 4.58%, remaining contractual life 4.6 years and dividend
      yield of zero. At September 30, 2007, $829,569 remained as the settlement
      liability reflecting the issuance and sale by the Investors of 451,610 shares
      of
      our common stock.




31




RESULTS
      OF OPERATIONS





*Three
      months ended September 30, 2007 and 2006*





*Revenue* . ** We
      recognized revenue of approximately $298,000 during the quarter ended September
      30, 2006 primarily from sales of LCoS Sets to LGE. We recognized no revenue
      during the third quarter 2007.





LGE
      has
      informed us that they intend to discontinue production of RPTVs (both LCoS
      and
      DLP) and they are no longer ordering T-3 LCoS Sets from us. The loss of this
      customer and our inability to obtain additional purchase orders from our current
      or prospective customers to replace the loss in expected revenue in a timely
      manner has significantly harmed our sales and results of operations during
      2007.




*Gross
      Margin* .
      Gross
      margin was reduced from approximately negative $1.37 million during the third
      quarter of 2006 to negative gross margin of approximately $419,000 during the
      third quarter of 2007. The third quarter of both periods includes the costs
      to
      operate our South Korean manufacturing facility. We reduced staffing in our
      South Korean manufacturing facility during 2007 in light of significantly
      reduced sales and our expectations of reduced future sales in the near-term.





*Selling,
      general and administrative costs.* Cash-based selling, general and administrative costs were approximately $1.37
      million and $1.73 million during the three months ended September 30, 2007
      and
      2006, respectively, a decrease of $358,000 or 21%. Salaries, wages and other
      payroll related expenses decreased approximately $441,000 and included an
      aggregate reduction in headcount of five individuals in our U.S. operations,
      including our former Senior Vice President, Marketing and Sales and our former
      Assistant Vice President, Legal Counsel. Partially offsetting this decrease
      was
      an increase in legal expense of approximately $111,000. Both periods included
      legal expenses associated with involvement with the ongoing SEC investigations.
      However, the third quarter of 2007 also included expenses related to our ongoing
      settlement talks with LGE, as well as discussions with the noteholders of our
      Senior Secured Convertible notes. Accounting and consulting expenses increased
      by approximately $39,000 due to the cost of restating our 2006 Form 10K as
      well
      as our restating our 2007 first and second quarter Form 10-Q’s related to the
      timing of recording the impairment loss on our South Korean facility. We had
      originally recorded the loss in the first quarter of 2007. Based upon subsequent
      information from LGE, we concluded that the impairment loss should have been
      recorded during the fourth quarter of 2006. The remaining decrease in costs
      between periods is primarily due to overall reductions in spending related
      to
      financial constraints.





*Stock-based
      compensation included in selling, general and administrative
      costs.* Stock-based compensation was approximately $73,000 and $185,000 for the three
      months ended September 31, 2007 and 2006, respectively. The decline is due
      to
      fewer options being issued during 2007 at a lower exercise price due to an
      overall decline in the market price of our stock.




32




*Research
        and development costs* .
        Research and development costs were approximately $329,000 and $270,000 for
        the
        three months ended September 30, 2007 and 2006, respectively, an increase
        of
        $59,000 or 22% reflecting an increase in spending related to new projects
        that
        are in the development stage.
 
 *Interest
        expense.* Cash-based interest expense for the three months ended September 30, 2007
        increased approximately $308,000 from $40,000 during third quarter 2006 to
        $348,000 for the third quarter 2007. Approximately $246,000 of the increase
        was
        due to issuing our common shares in lieu of cash to the Senior Secured
        noteholders for the payment of one quarter’s interest during 2006. The remaining
        increase was due to higher interest rates on the lines of credit in South
        Korea
        as well as the Senior Secured Convertible Notes.
 
 *Non-cash
        interest expense.*  ** Non-cash
        interest expense was approximately $398,000 and $644,000 for the three months
        ended September 30, 2007 and 2006, respectively, and is detailed as follows:
  Three
                    months ended September 30,2007
                
                2006Amortization
                    of discounts on Senior Secured Convertible Notes
                
                $
                110,993
                
                $
                110,993Senior
                    Secured Convertible Notes 10% interest paid in common
                    stock
                
                
                -
                
                
                245,593Beneficial
                    conversion privileges of interest on Argyle note
                
                
                271,463
                
                
                271,463Amortization
                    of prepaid financing costs
                
                
                15,858
                
                
                15,858Total
                    non-cash interest expense
                
                $
                398,314
                
                $
                643,907
  *Nine
        months ended September 30, 2007 and 2006*
 
 *Revenue* . ** We
        recognized revenue of approximately $50,000 and $443,000 during the nine
        months
        ended September 30, 2007 and 2006, respectively. Revenue in both periods
        was
        derived primarily from sales of LCoS Sets to LGE.
 
 The
        following table summarizes our sales revenue by product for the first three
        quarters of 2007 and 2006.
 Nine
                    months ended September 30,2007
                
                2006LCoS
                    (T-3) sets
                
                
                100
                %
                
                96
                %Other
                    (primarily supporting electronics)
                
                
                -
                
                
                4
                %Total
                
                
                100
                %
                
                100
                %
 
 Revenue
        from one customer, LGE, accounted for 90% and 96% of our total revenue for
        the
        nine months ended September 30, 2007 and 2006, respectively. LGE has informed
        us
        of their intent to discontinue production of RPTVs (both LCoS and DLP) and
        has
        not ordered T-3 LCoS Sets from us since early in 2007. The loss of this customer
        and our inability to obtain additional purchase orders from our current or
        prospective customers to replace the loss in expected revenue in a timely
        manner
        has significantly harmed our sales and results of operations during 2007.
  *Gross
        Margin* .
        Gross
        margin was reduced from approximately negative $4.37 million during the first
        nine months of 2006 to negative gross margin of approximately $1.68 million
        during the first nine months of 2007. Both periods include the costs to operate
        our South Korean manufacturing facility. We reduced staffing in our South
        Korean
        manufacturing facility during the first half 2007 in light of significantly
        reduced sales and our expectations of reduced future sales in the near-term.
        Additionally, cost of revenue during the second quarter of 2007 included
        an
        addition to inventory reserve of approximately $93,000, which was recorded
        to
        reserve some components used in the T-3 Set that are unlikely to have
        alternative uses. Cost of revenue during the first three quarters of 2006
        included a reserve of approximately $442,000, which was recorded to reserve
        the
        remaining value of our T-1 LCoS Set inventory as well as a percentage of
        our
        light engine inventory. We are not currently manufacturing either the T-1
        LCoS
        Set or the light engine products and had no sales of either of these products
        during 2007 or 2006.
  33
  *Selling,
        general and administrative costs.* Cash-based selling, general and administrative costs were approximately $3.79
        million and $5.62 million during the nine months ended September 30, 2007
        and
        2006, respectively, a decrease of $1.83 million or 33%. Salaries, wages and
        other payroll related expenses decreased approximately $1.31 million and
        included an aggregate reduction in headcount of five individuals in our U.S.
        operations, including our former Executive Vice President of Strategic Planning,
        our former Senior Vice President, Marketing and Sales and our former Assistant
        Vice President, Legal Counsel. Legal expenses decreased approximately $128,000.
        While both periods included legal expenses associated with the routine review
        of
        our registration statements on Form S-3 and involvement with the ongoing
        SEC
        investigations, these expenses were more concentrated during the first three
        quarters of 2006. Accounting and consulting expenses decreased by approximately
        $87,000 due primarily to costs associated with filing registration statements
        during the first three quarters of 2006 compared with the first three quarters
        of 2007. Travel and entertainment expenses decreased by approximately $101,000
        and advertising decreased by approximately $71,000, both primarily due to
        our
        limited financial resources during 2007. The remaining decrease in costs
        between
        periods is primarily due to reduced activities related to resource
        constraints.
 
 *Stock-based
        compensation included in selling, general and administrative
        costs.* Stock-based compensation was approximately $536,000 and $1.83 million in
        the
        nine months ended September 30, 2007 and 2006, respectively. The decline
        is due
        to fewer options being issued during 2007 at a lower exercise price due to
        an
        overall decline in the market price of our stock.
 
 *Research
        and development costs* .
        Research and development costs were approximately $1.03 million and $923,000
        for
        the nine months ended September 30, 2007 and 2006, respectively, an increase
        of
        $106,000 or 11% reflecting an increase in spending related to new projects
        that
        are in the development stage.
 
 *Interest
        expense.* Cash-based interest expense for the nine months ended September 30, 2007
increased
        approximately $585,000 from $355,000 during
        the first three quarters of 2006 to $940,000 for the first three quarters
        of
        2007. Approximately $498,000 of the increase was due to issuing our common
        shares in lieu of cash to the Senior Secured noteholders for the payment
        of two
        quarter’s interest during 2006, whereas we paid the interest in cash during
        2007. The remaining increase was due to higher interest rates on the lines
        of
        credit in South Korea as well as the Senior Secured Convertible
        Notes.
 
 *Non-cash
        interest expense.*  ** Non-cash
        interest expense was approximately $5.93 million and $2.13 million for the
        nine
        months ended September 30, 2007 and 2006, respectively and is detailed as
        follows:
 Nine
                    months ended September 30,2007
                
                2006Amortization
                    of Senior Secured Convertible Notes
                
                $332,980
                
                $332,980Senior
                    Secured Convertible Notes 10% interest paid in common
                    stock
                
                -
                
                497,647Redemption
                    premium on the Senior Secured Convertible Notes
                
                1,500,000
                
                -Liquidated
                    damages on the October 2005, January 2006, September2006
                    and November 2006 financings
                
                302,806
                
                437,817Beneficial
                    conversion privileges of interest on Argyle note
                
                
                814,389
                
                
                814,389Expense
                    associated with waiver agreements with February 2007 andNovember
                    2006 investors settled in stock
                
                
                1,300,194
                
                
                -Loss
                    associated with the Settlement Agreement
                
                
                1,627,146
                
                
                -Amortization
                    of prepaid financing costs
                
                
                47,574
                
                
                47,574Total
                    non-cash interest expense
                
                $
                5,925,089
                
                $
                2,130,407
  34
  As
        a
        result of our stock no longer trading on the Nasdaq Capital Market, the Senior
        Secured Convertible Notes became redeemable on demand by the holders at 115%
        of
        the principal amount plus accrued interest and late charges. Therefore, we
        accrued $1,500,000 in redemption premiums. The nine months ended September
        30,
        2007 included approximately $1.6 million of expense associated with the
        Settlement Agreement (see Note 9 to the condensed consolidated financial
        statements) with the Investors from our November 2006 and February 2007
        financings under which the Investors (i) released disputed claims under the
        November 2006 Financing, the February 2007 Financing, and the February 2007
        Waiver; (ii) returned for cancellation warrants to purchase 96,000 common
        shares
        that were issued in the November 2006 Financing; (iii) cancelled the future
        financings restriction under which we could not sell common shares less than
        $65.00 per share without the Investors’ consent, and (iv) entered into an Escrow
        Agreement pursuant to which we will issue into escrow, from time to time,
        an unspecified number of common shares, and the Investors delivered to escrow
        80,046 common shares previously issued pursuant to the November 2006 Financing
        and the February 2007 Financing. Liquidated damages accrued during nine months
        ended September 30, 2006 related to our October 2005 and January 2006 financings
        whereas liquidated damages accrued during nine months ended September 30,
        2007
        related to our September 2006 and November 2006 financings. Additionally,
        the
        nine months ended September 30, 2007 includes approximately $1.3 million
        of
        expense associated with obtaining waivers for certain contractual provisions
        from our September and November 2006 investors.
 
 Critical
        Accounting Policies
 
 *Revenue
        Recognition* - We
        evaluate revenue recognition for transactions using the following criteria
        (collectively called the Revenue Recognition Criteria):
 
 ·
              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.
 ·
              Delivery:
                  For products, delivery is considered to occur when title and risk
                  of loss
                  have been transferred, which generally occurs upon shipment.
 ·
              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 laws or trade practices of the country in which
                  the
                  arrangement is entered into to assess whether the fee is fixed
                  and
                  determinable.
  35
  ·
              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. We reduce product revenue for customer
                  returns
                  and sales allowances and record an allowance for doubtful accounts
                  should
                  collectibility become questionable. If it is determined that an
                  account is
                  uncollectible, the account is written off against the allowance.
 
 *Inventory
        Valuation* - We
        value inventories at the lower of cost (based on the first-in, first-out
        method)
        or market value. We include raw 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 costs we write it down to its replacement cost or its net realizable
        value. Our estimates may differ from actual results due to the quantity,
        quality
        and mix of products in inventory, consumer and retailer preferences and economic
        conditions.
  *Stock-based
        Payments -* Effective January 1, 2006 we adopted Statement of Financial Accounting Standards
        No. 123 (revised 2004), *Share-Based
        Payment* ,
        (“SFAS
        123R”) using the modified prospective method and therefore have not restated
        prior periods’ results for the adoption of SFAS 123R. Under the fair value
        recognition provisions of SFAS 123R, we recognize stock-based compensation
        net
        of an estimated forfeiture rate and therefore only recognize compensation
        cost
        for those shares expected to vest over the service period of the award. Prior
        to
        SFAS 123R adoption, we accounted for share-based payments under APB 25 and
        accordingly, generally recognized compensation expense related to stock options
        with intrinsic value and accounted for forfeitures as they occurred. Equity
        instruments issued to non-employees are recorded at their fair market value
        as
        determined in accordance with SFAS 123R and EITF Issue No. 96-18, *Accounting
        for Equity Instruments that are Issued to Other Than Employees for Acquiring,
        or
        in Conjunction with Selling, Goods and Services* (“EITF
        96-18”).
  We
        estimated the fair value of options granted using the Black-Scholes option
        pricing model and the assumptions shown in Note 4, Stock-Based Compensation,
        to
        our condensed consolidated financial statements or, in the case of options
        granted with a market condition, we use a lattice model. Calculating stock-based
        compensation expense under the provisions of SFAS 123R requires the input
        of
        highly subjective assumptions, including the expected term of the stock-based
        awards, stock price volatility, and pre-vesting option forfeitures. We estimate
        the expected life of options granted based on the simplified method provided
        in
        Staff Accounting Bulletin No. 107 for “plain vanilla” options. We estimate the
        volatility of our common stock at the date of grant based on the historical
        volatility of our common stock.  In addition, we are required to estimate
        the expected forfeiture rate and only recognize expense for those shares
        expected to vest. We estimate the forfeiture rate based on historical experience
        of our stock-based awards that are granted, exercised and cancelled. If our
        actual forfeiture rate is materially different from our estimate, the
        stock-based compensation expense could be significantly different from what
        we
        have recorded in the current period. The assumptions used in calculating
        the
        fair value of stock-based awards represent our best estimates, but these
        estimates involve inherent uncertainties and the application of management
        judgment. As a result, if factors change and we use different assumptions,
        our
        stock-based compensation expense could be materially different in the future.
        As
        required under SFAS 123R, we review our valuation assumptions at each grant
        date
        and, as a result, are likely to periodically change the valuation assumptions
        used to value employee stock-based awards granted in future periods. The
        guidance in SFAS 123R is relatively new and best practices are not well
        established. The application of the various valuation assumptions may be
        subject
        to further interpretation and refinement over time. There are significant
        differences among valuation models and there is a possibility that we will
        adopt
        different valuation models and assumptions in the future. This may result
        in a
        lack of comparability with other companies that use different models, methods
        and assumptions and in a lack of consistency in future periods. See Note
        4-“Stock-Based Compensation” in the condensed consolidated financial statements
        for additional information.
  36
  *Research
        and Development* -
        Research and development costs, including the costs of prototype and
        pre-production LCoS Sets, pre-production display units, and other pre-production
        activities at our South Korean manufacturing facility are charged to expense
        when incurred.
 
 *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, 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.
 
 *Impairment
        of Long-Lived Assets* -
        We
        account for the impairment of long-lived assets in accordance with SFAS
        No. 144, *Accounting
        for the Impairment or Disposal of Long-Lived Assets* .
        An
        impairment of a long-lived asset exists when the carrying value of an asset
        exceeds its fair value and when the carrying value is not recoverable through
        future undiscounted cash flows from operations. We review the carrying value
        of
        long-lived assets for impairment when events or changes in circumstances
        indicate that the carrying amount of assets may not be recoverable.
  Considerable
        management judgment is required in determining if and when a condition would
        trigger an impairment assessment of our long-lived assets and once such a
        determination has been made, considerable management judgment is required
        to
        determine the fair market value of the long-lived asset. In determining the
        fair
        value of the asset, we consider the associated net present value of estimated
        future cash flows and/ or independently performed appraisals. Such estimated
        future cash flows are based on assumptions about our expected future operating
        performance. Our estimates of future cash flows may differ from actual cash
        flows due to, among other things, technological changes, economic conditions
        or
        changes to our business operations. Impairments are recognized in operating
        results to the extent that the carrying value exceeds the estimated fair
        value
        of the long-lived assets.
 
 Recent
        Accounting Pronouncements
 
 Recent
        accounting pronouncements are disclosed in Note 12 of the notes to the condensed
        consolidated financial statements.
  37
  **ITEM
        3. Quantitative and Qualitative Disclosures About Market
        Risk.**
 
 We
        are
        exposed to the impact of interest rate changes and foreign currency
        fluctuations.
 
 *Interest
        Rate Risk* .
        Our
        exposure to market rate risk for changes in interest rates relates primarily
        to
        our cash accounts and our lines of credit in South Korea. We invest excess
        cash
        and cash equivalents in a checking account or money market account with
        reputable banks both in the United States and South 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 South Korea are not insured.
        As of September 30, 2007, our cash and cash equivalents totaled approximately
        $28,000. Short term debt under our South Korean lines of credit totaled
        approximately $631,000 at September 30, 2007.
 
 *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. Changes in the functional currency value of these assets
        and
        liabilities create fluctuations that will lead to a transaction gain or loss.
        When appropriate, we may enter into hedging transactions in order to mitigate
        our risk from foreign currency fluctuations. We may use hedging programs
        in the
        future and may use currency forward contracts, currency options and/ or other
        derivative financial instruments commonly utilized to reduce financial market
        risks if it is determined that such hedging activities are appropriate to
        reduce
        risk. We do not hold or purchase any foreign currency contracts for trading
        purposes. As of September 30, 2007, we had no hedging contracts. During the
        first nine months of 2007, the foreign currency transaction gains were not
        material.
 
 **ITEM
        4. Controls and Procedures.**
  **Disclosure
        Controls and Procedures.** As
        of
        September 30, 2007, management of our Company, under the supervision of our
        principal executive and financial officer (CEO), 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 our "internal controls and procedures for financial reporting"
        (“Internal Controls”).
  *Limitations
        on the Effectiveness of Controls.* Our CEO
        does not expect that our Disclosure Controls or our Internal Controls 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 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 the 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 because of
        changes
        in conditions or deterioration in the degree of compliance with policies
        or
        procedures. Because of the inherent limitations in a cost-effective control
        system, misstatements due to error or fraud may occur and not be detected.
  38
  *Conclusion
        regarding the Effectiveness of Disclosure Controls.* As
        defined under Sections 13a-15(e) and 15d-15(e) of the Exchange Act, the term
        “disclosure controls and procedures” means controls and other procedures of an
        issuer that are designed to ensure that information required to be disclosed
        by
        the issuer in the reports that it files or submits under the Exchange Act
        is
        recorded, processed, summarized and reported, within the time periods specified
        in the SEC’s rules and forms. Disclosure Controls include, without limitation,
        controls and procedures designed to ensure that information required to be
        disclosed by an issuer in the reports that it files or submits under the
        Exchange Act is accumulated and communicated to the issuer’s management,
        including the issuer’s CEO, to allow timely decisions regarding required
        disclosure. Based on his evaluation, as described in Item 9A “Controls and
        Procedures” in our Annual report on Form 10-K/A filed with the SEC on August 21,
        2007, the CEO has concluded that our disclosure controls and procedures were
        not
        effective to ensure that material information is recorded, processed, summarized
        and reported by management on a timely basis in order to comply with our
        disclosure obligations under the Exchange Act, and the rules and regulations
        promulgated thereunder.
 
 **Changes
        in Internal Controls.**  We
        appointed Ms. Kathy Barnett, Sonoma, California, as a member of the Board
        of
        Directors of SpatiaLight effective October 12, 2007. Ms. Barnett satisfies
        the
        requirements of a financial expert as defined by the Securities and Exchange
        Commission and will be appointed to chair the Audit Committee of the
        Board of Directors. There have been no other changes in the Company’s Internal
        Controls that occurred during the quarter covered by this report that have
        materially affected, or are reasonably likely to materially affect, the
        Company’s Internal Controls.
 
 **PART
        II.**  **OTHER
        INFORMATION**
 
 **ITEM
        1.**  **Legal
        Proceedings.**
 
 On
        March
        28, 2007, Portside Growth and Opportunity Fund (“Portside”), holders of $4.5
        million of the Senior Secured Convertible Notes, filed suit against the Company
        and certain named directors and officers, in the Supreme Court of the State
        of
        New York, claiming the Company was in breach of its obligations under the
        Senior
        Secured Convertible Notes and that certain directors and officers had breached
        their fiduciary duties in connection with loans made by them to the Company
        and
        loans made by certain South Korean banks to the Company’s South Korean
        subsidiary. On June 28, 2007, SpatiaLight and Portside agreed to a Stipulation
        of Discontinuance, without prejudice, with regard to their respective claims
        and
        counterclaims. This Stipulation includes a Standstill Period of 30 days to
        allow
        for the opportunity for productive discussions to take place between the
        parties
        or their agents prior to either party filing any subsequent claims. As of
        the
        date of this filing, no further action has been taken by Portside.
 
 We
        have
        received notice that the SEC intends to pursue civil remedies in connection
        with
        our filing of an unauthorized consent by BDO Seidman, LLP in connection with
        certain registration statements, and our issuance of securities without legend
        or restrictions to Argyle Capital Management Corporation, an entity controlled
        by our former Director, CEO, President, Treasurer and Secretary, for payment
        of
        interest on the promissory notes issued by the Company to Argyle, specifically
        focusing on our prepayment of interest in December 2004 and January 2005.
        No
        legal proceeding has been commenced against us.
  39
  On
        October 9, 2007, we received a demand letter from Shinhan Bank threatening
        the
        commencement of legal action towards our property rights in South Korea if
        we do
        not promptly repay all amounts owed under the line of credit (approximately
        $160,000 including principal and accrued interest). As of the date of this
        filing, no further action has been taken by Shinhan Bank.
 
 We
        are a
        party to other routine claims and lawsuits from time to time in the ordinary
        course of business. While the outcome of such ordinary course proceedings
        cannot
        be predicted with certainty, we believe that the resolution of any such matters
        individually or in the aggregate will not have a material adverse effect
        on our
        business, financial condition or results of operations.
 
 **ITEM
        1A.**  **Risk
        Factors.**
 
 The
        following risk factors are in addition to the risks disclosed in our 2006
        Annual
        Report on Form 10-K/A filed with the SEC on August 21, 2007, to which you
        are
        directed for additional risks associated with our business.
 
 **Certain
        holders of the Senior Secured Convertible Notes issued by us in November
        2004
        have made claims of default, which could materially affect our financial
        conditions.**
 
 On
        March
        28, 2007, Portside Growth and Opportunity Fund (“Portside”) and Smithfield
        Fiduciary (“Smithfield”), holders of $9 million of the Senior Secured
        Convertible Notes, claimed that the Company is in breach of its obligations
        under the Senior Secured Convertible Notes. In the event that these claims
        are
        determined adversely to the Company, we may be obligated to repay $10 million
        in
        principal amount of our outstanding Senior Secured Convertible Notes, together
        with accrued interest at 12% per annum, a premium of $1.5 million and liquidated
        damages in the amount of $683,000. We do not presently have a source of funds
        with which to make such payments and we may be required to seek protection
        under
        applicable bankruptcy laws if such payments are required by the
        noteholders.
 
 **Redemption
        of the Senior Secured Convertible Notes issued by us in November 2004 could
        materially affect our financial condition.**
 
 On
        June
        15, 2007, as a result of our stock no longer trading on the Nasdaq Capital
        Market, the Senior Secured Convertible Notes became redeemable on demand
        by the
        holders at 115% of the principal amount plus accrued interest and late charges.
        We have received redemption notices from Portside and Smithfield. We have
        accrued $1,500,000 in redemption premiums through September 30, 2007 and
        have
        increased the rate at which we accrue and pay interest from 10% per annum
        to 12%
        per annum in accordance with the terms of the Senior Secured Convertible
        Notes,
        commencing on June 15, 2007. We failed to make the quarterly interest payment
        of
        approximately $294,000 due on August 31, 2007 either in cash or by conversion
        to
        our common shares. We have recorded approximately $393,000 in accrued interest
        on these notes as of September 30, 2007. We do not presently have a source
        of
        funds with which to redeem the Senior Secured Convertible Notes and may be
        required to seek protection under applicable bankruptcy laws if such redemption
        is required by the noteholders.
  40
  **The
        Conversion Rate under the Senior Secured Convertible Notes may be
        reset.**
 
 Under
        the
        terms of the Senior Secured Convertible Notes, a noteholder that has provided
        us
        with a notice of redemption may withdraw the notice with respect to all or
        part
        of the Senior Secured Convertible Notes and elect to convert such portion
        at a
        conversion rate equal to the lowest weighted average price per common share
        between the date of the redemption notice and the date of the withdrawal.
        In
        early July 2007, we received withdrawal notices and elections to convert
        $100,000 from Portside and $50,000 from Smithfield. The conversion rate with
        respect to these conversions will be $2.525 per common share. We have not
        issued
        shares required to be issued to Portside or Smithfield, which may be the
        basis
        of an additional default under the Senior Secured Convertible Notes. Future
        conversions may result in significant dilution of the common
        shares.
 
 **We
        have failed to make an interest payment on our Senior Secured Convertible
        Notes.**
 
 We
        were
        obligated to make a quarterly interest payment in the amount of approximately
        $294,000 on August 31, 2007 on the Senior Secured Convertible Notes. We have
        recorded approximately $393,000 in accrued and unpaid interest related to
        these
        notes as of September 30, 2007. Our failure may be the basis of an additional
        default under the Senior Secured Convertible Notes.
 
 **Our
        Korean lenders may enforce their claims against SpatiaLight
        Korea.**
 
 As
        of
        September 30, 2007, SpatiaLight Korea was indebted to four Korean banks in
        the
        aggregate amount of approximately $631,000 which banks have registered
        liens against the assets of SpatiaLight Korea. All of the indebtedness to
        the
        Korean Banks is in default and one or more of the Korean banks may attempt
        to
        seize the facility and/ or equipment owned by SpatiaLight Korea in satisfaction
        of the indebtedness. Opposition to the seizure of these facilities would
        require
        significant resources and we cannot determine if such resources would be
        available to us when needed, if at all, or on terms that are acceptable.
        The
        loss of these assets, through foreclosure or otherwise, would have a material
        adverse effect on our financial condition, results of operations and ability
        to
        continue as a going concern.
  **We
        are the subject of an investigation by the staff of the SEC regarding the
        circumstances surrounding our filing of certain consents of BDO Seidman,
        LLP
        without requisite authorization and our issuance of securities without legend
        or
        restrictions to Argyle for payment of interest on the Argyle Notes.**
 
 We
        have
        been advised by the SEC that they intend to pursue civil remedies in connection
        with the unauthorized filing of a consent by BDO Seidman, LLC as an exhibit
        to a
        registration statement and our issuance of securities without legend or
        restrictions to Argyle Capital Management Corporation for payment of interest
        on
        promissory notes payable by the Company to Argyle, specifically focusing
        on our
        prepayment of interest in December 2004 and January 2005. The Staff may impose
        sanctions against us in the form of an injunction against future violations
        of
        the securities laws and/ or fines and penalties, which could be material
        and
        adversely affect our financial condition. The Company, at this time, does
        not
        believe that the SEC is seeking financial penalties against the Company.
        Opposition to any sanctions may require significant resources and we cannot
        determine if such resources would be available to us when needed, if at all,
        or
        on terms that are acceptable.
 
 **Future
        offerings of our common shares pursuant to the April 2007 Equity Credit
        Agreement could cause the market price of our common shares to decrease
        significantly, even if our business operations are performing well.**
  41
  We
        have
        entered into an Equity Credit Agreement providing for the sale from time
        to time
        of our common shares having an aggregate value of $15,400,000 and a Waiver,
        Rescission and Settlement Agreement (“Settlement Agreement”) providing for the
        issuance from time to time of our common shares having an aggregate value
        of up
        to $4,347,147. We may offer additional securities under the Equity Credit
        Agreement and may be required to issue additional securities under the
        Settlement Agreement which could materially affect the number of common shares
        outstanding and dilute the price per share of our presently outstanding common
        shares.
 
 **The
        number of currently authorized shares and the current market price of our
        shares
        may limit the amount of funds that can be raised to fund our
        operations.**
 
 We
        currently have 15,000,000 authorized shares, of which 8,768,520 are available
        for issuance (after taking into account reserves for options, warrants and
        convertible debt). Based on the closing price of our shares on November 6,
        2007
        of $0.052 per share, we could raise an additional $456,000. In the event
        that we
        do not obtain an increase in our authorized shares, or the stock price of
        our
        common shares continues at the current level or decreases, we may not be
        able to
        obtain sufficient funding of our operations. This could have a material adverse
        effect on our financial condition and our ability to continue as a going
        concern.
 
 **We
        may offer additional securities under our registration statement related
        to
        $75,000,000 in common stock, warrants, subscription rights and units without
        notice to the stockholders.**
 
 We
        could
        issue an unspecified number of additional common shares under our current
        “Shelf” Registration Statement (Registration Number 333-137100). Sales of these
        shares into the public market, or the perception that future sales of these
        shares could occur, might adversely affect the prevailing market price of
        our
        common shares. Furthermore, market perceptions regarding the likelihood that
        we
        will be required to issue and sell additional common shares in the future
        to
        fund our ongoing operations, thereby diluting the ownership interests of
        current
        owners of our common shares, could have a material adverse effect on the
        market
        price of our common shares.
 
 **We
        amended our Certificate of Incorporation to declare a 50:1 reverse stock
        split
        and authorized up to 15,000,000 post-split common shares.**
 
 We
        amended our Certificate of Incorporation to combine 50 current common shares
        into one common share and authorize up to 15,000,000 post combination common
        shares. As a result, we have authorized a significant number of authorized
        and
        unissued common shares which may be issued without notice or approval from
        our
        stockholders. The issuance of a significant number of these shares (or the
        perception that we may issue a significant number of these shares), whether
        pursuant to our Equity Credit Agreement, our registration statement, or
        otherwise may adversely affect the price of our common shares on the
        market.
 
 **Our
        Common Stock is subject to the “Penny Stock” rules of the SEC and the trading
        market in our securities is limited, which makes transactions in our stock
        cumbersome and may reduce the value of an investment in our
        stock.**
 
 On
        September 10, 2007, our common shares were removed from registration on the
        Nasdaq Capital Market and became “penny stock” as defined by the Securities
        Exchange Act of 1934. Under the rules applicable to penny stock, a broker-dealer
        selling our common shares to anyone other than an established customer or
        accredited investor must make a special suitability determination regarding
        the
        purchaser and must receive the purchaser’s written consent to the transaction
        prior to the transaction, unless the broker-dealer is otherwise exempt.
 Generally, an individual with a net worth in excess of $1,000,000, or
        annual income exceeding $100,000 individually or $300,000 together with his
        or
        her spouse is considered an accredited investor.  In addition, under penny
        stock regulations the broker-dealer is required to:
 ·
                  Deliver,
                      prior to any transaction in our common shares, a disclosure
                      schedule
                      prepared by the Securities and Exchange Commissions relating
                      to the penny
                      stock market, unless the broker-dealer or the transaction is
                      otherwise
                      exempt;
  42
 ·
                  Disclose
                      commissions payable to the broker-dealer and its registered
                      representatives and current bid and offer quotations for the
                      securities;
  ·
                  Send
                      monthly statements disclosing recent price information pertaining
                      to the
                      penny stock held in a customer’s account, the account’s value and
                      information regarding the limited market in penny stocks;
                      and
 ·
                  Make
                      a special written determination that our common shares are
                      a suitable
                      investment for the purchaser and receive the purchaser’s written agreement
                      to the transaction, prior to conducting any penny stock transaction
                      in the
                      customer’s account.
 
 Because
        of these regulations, broker-dealers may encounter difficulties in their
        attempt
        to buy or sell our common shares, which may affect the ability of selling
        stockholders or other holders to sell their shares in the secondary market
        and
        have the effect of reducing the level of trading activity in the secondary
        market.  These additional sales practice and disclosure requirements could
        impede the buying or sale of our securities.
 
 **ITEM
        2.**  **Unregistered
        Sales of Equity Securities and Use of Proceeds.**
 
 None.
  43
  **ITEM
        3.**  **Defaults
        Upon Senior Securities.**
 
 On
        June
        15, 2007, as a result of our stock no longer trading on the Nasdaq Capital
        Market, the Senior Secured Convertible Notes became redeemable on demand
        by the
        holders at 115% of the principal amount plus accrued interest and late charges.
        We have received redemption notices from Portside and Smithfield and have
        not
        redeemed either Note within the time required by the notice. As a result
        of our
        failure to redeem the Senior Secured Convertible Notes within five days after
        receipt of the redemption notice, the noteholders may withdraw any part of
        the
        redemption notice and elect to convert the withdrawn amount at a new conversion
        rate equal to the lowest weighted price of the common shares between June
        15,
        2007 and the date of withdrawal. In early July 2007, Portside withdrew its
        redemption notice with respect to $100,000 and Smithfield withdrew its
        redemption notice with respect to $50,000. We have received a notice of
        conversion from each noteholder to convert the withdrawn amount at a conversion
        rate of $2.525 per common share. We have accrued $1.5 million in redemption
        premiums through September 30, 2007 and have increased the rate at which
        we
        accrue and pay interest from 10% per annum to 12% per annum in accordance
        with
        the terms of the Senior Secured Convertible Notes, commencing on June 15,
        2007.
 
 We
        failed
        to make the quarterly interest payment of approximately $294,000 due on August
        31, 2007 either in cash or by conversion to our common shares on the Senior
        Secured Convertible Notes. We have recorded approximately $393,000 in accrued
        interest as related to these notes of September 30, 2007.
 
 **ITEM
        4**  **Submission
        of Matters to a Vote of Security Holders**
 
 None.
 
 **ITEM
        5.**  **Other
        Information.**
  None.
 
 **ITEM
        6.**  **Exhibits.**
 3.1
                
                Restated
                    Certificate of Incorporation, as amended (as filed with Amendment
                    No. 1 to
                    Form S-3 filed on November 18, 1999)*3.2
                
                Certificate
                    of Amendment dated December 18, 1991 (as filed with Form 10-Q
                    filed on
                    August 9, 2007)*3.3
                
                Certificate
                    of Amendment dated July 21, 1999*3.4
                
                Certificate
                    of Amendment dated June 2, 2003 (as filed with Form 10-Q filed
                    on August
                    9, 2007)*3.5
                
                Certificate
                    of Amendment dated June 29, 2006 (as filed with Form 10-Q filed
                    on August
                    9, 2006)*3.6
                
                Certificate
                    of Amendment dated August 3, 2006 (as filed with Form 10-Q filed
                    on August
                    9, 2007)*3.7
                
                Bylaws*10.1
                
                Letter
                    Agreement between SpatiaLight, Inc. and certain investors dated
                    May 26,
                    2006*
  44
  10.2
                
                General
                    Release agreement between SpatiaLight, Inc. and Theodore H. Banzhaf
                    signed
                    June 13, 2006*10.3
                
                LCoS
                    Supply Agreement between SpatiaLight, Inc. and LG Electronics,
                    Inc. dated
                    July 1, 2004†*10.4
                
                SpatiaLight
                    2006 Incentive Plan*10.5
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of August 9, 2006*10.6
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of August 9, 2006*10.7
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of September 26, 2006*10.8
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of September 26, 2006*10.9
                
                Warrant
                    to Purchase 62,432 Common Shares - Bluegrass Growth Fund
                    LP*10.10
                
                Warrant
                    to Purchase 26,757 Common Shares - Bluegrass Growth Fund
                    Ltd.*10.11
                
                First
                    Amendment to Securities Purchase Agreement among SpatiaLight,
                    Inc. and
                    certain Purchasers dated as of October 25, 2006*10.12
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated
                    November 28, 2006*10.13
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchaser
                    dated
                    November 28, 2006*10.14
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated
                    February 23, 2007*10.15
                
                Waiver
                    between SpatiaLight and certain investors dated February 23,
                    2007*10.16
                
                Equity
                    Credit Agreement between SpatiaLight, Inc. and certain Investors
                    dated
                    April 24, 2007*10.17
                
                Waiver,
                    Rescission and Settlement Agreement between SpatiaLight, Inc.
                    and certain
                    Investors dated April 24, 2007*10.18
                
                Escrow
                    Agreement between SpatiaLight, Inc., certain Investors, and McLaughlin
                    & Stern LLP as escrow agent dated April 24, 2007*31.1
                
                Rule
                    13a-14(a)/15d-14(a) Certification of David F. Hakala32.1
                
                Certification
                    of David F. Hakala Pursuant to 18 U.S.C. Section 1350, As Adopted
                    Pursuant
                    to Section 906 of the Sarbanes-Oxley Act of
                    2002.
  *
        Previously filed.
  † Confidential
        Treatment has been requested with respect to certain portions of this exhibit.
        Omitted portions have been filed separately with the Securities and Exchange
        Commission.
 
 45
  **SIGNATURES**
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned thereunto
        duly authorized.
  SpatiaLight,
                  Inc.Date:
                November
                9, 2007
              By:
              /s/
                David F.
                HakalaDavid
                  F. Hakala
                Acting
                  Chief Executive Officer, Chief Operating
                Officer,
                  Principal Financial and Accounting
                  Officer
  46
  EXHIBIT
        INDEX
 3.1
                
                Restated
                    Certificate of Incorporation, as amended (as filed with Amendment
                    No. 1 to
                    Form S-3 filed on November 18, 1999)*3.2
                
                Certificate
                    of Amendment dated December 18, 1991 (as filed with Form 10-Q
                    filed on
                    August 9, 2007)*3.3
                
                Certificate
                    of Amendment dated July 21, 1999*3.4
                
                Certificate
                    of Amendment dated June 2, 2003 (as filed with Form 10-Q filed
                    on August
                    9, 2007)*3.5
                
                Certificate
                    of Amendment dated June 29, 2006 (as filed with Form 10-Q filed
                    on August
                    9, 2006)*3.6
                
                Certificate
                    of Amendment dated August 3, 2006 (as filed with Form 10-Q filed
                    on August
                    9, 2007)*3.7
                
                Bylaws*10.1
                
                Letter
                    Agreement between SpatiaLight, Inc. and certain investors dated
                    May 26,
                    2006*10.2
                
                General
                    Release agreement between SpatiaLight, Inc. and Theodore H. Banzhaf
                    signed
                    June 13, 2006*10.3
                
                LCoS
                    Supply Agreement between SpatiaLight, Inc. and LG Electronics,
                    Inc. dated
                    July 1, 2004†*10.4
                
                SpatiaLight
                    2006 Incentive Plan*10.5
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of August 9, 2006*10.6
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of August 9, 2006*10.7
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of September 26, 2006*10.8
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated as
                    of September 26, 2006*10.9
                
                Warrant
                    to Purchase 62,432 Common Shares - Bluegrass Growth Fund
                    LP*10.10
                
                Warrant
                    to Purchase 26,757 Common Shares - Bluegrass Growth Fund
                    Ltd.*10.11
                
                First
                    Amendment to Securities Purchase Agreement among SpatiaLight,
                    Inc. and
                    certain Purchasers dated as of October 25, 2006*10.12
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated
                    November 28, 2006*10.13
                
                Registration
                    Rights Agreement among SpatiaLight, Inc. and certain Purchaser
                    dated
                    November 28, 2006*10.14
                
                Securities
                    Purchase Agreement among SpatiaLight, Inc. and certain Purchasers
                    dated
                    February 23, 2007*10.15
                
                Waiver
                    between SpatiaLight and certain investors dated February 23,
                    2007*10.16
                
                Equity
                    Credit Agreement between SpatiaLight, Inc. and certain Investors
                    dated
                    April 24, 2007*10.17
                
                Waiver,
                    Rescission and Settlement Agreement between SpatiaLight, Inc.
                    and certain
                    Investors dated April 24, 2007*10.18
                
                Escrow
                    Agreement between SpatiaLight, Inc., certain Investors, and McLaughlin
                    & Stern LLP as escrow agent dated April 24, 2007*31.1
                
                Rule
                    13a-14(a)/15d-14(a) Certification of David F. Hakala32.1
                
                Certification
                    of David F. Hakala Pursuant to 18 U.S.C. Section 1350, As Adopted
                    Pursuant
                    to Section 906 of the Sarbanes-Oxley Act of
                    2002.
 
 *
        Previously filed.
  † Confidential
        Treatment has been requested with respect to certain portions of this exhibit.
        Omitted portions have been filed separately with the Securities and Exchange
        Commission.
  47