**United
      States**


**Securities
      and Exchange Commission**


**Washington,
      D.C. 20549**


**FORM
      10-Q/A**




(Mark
      One)





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





For
      the
      quarterly period ended March 31, 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
              (IRS
                  EmployerIncorporation
                  or organization)
              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





State
      the
      number of shares outstanding of each of the issuer’s classes of common equity,
      as of the latest practicable date: 97,388,513 common shares as of August 17,
      2007.










**Explanatory
      note**





This
      Amendment to our Quarterly Report on Form 10-Q/A is being filed to amend our
      Quarterly Report on Form 10-Q for the period ended March 31, 2007, as filed
      with
      the Securities and Exchange Commission on May 10, 2007 (“Original Filing”) for
      the purpose of reversing the impairment loss of $1,429,925 recorded against
      our
      building in South Korea during the first quarter of 2007. On July 24, 2007,
      we
      received evidence that LG Electronics (“LGE”) communicated its intention to
      terminate our Supply Agreement to Mr. Don Suh, in October 2006, in the form
      of
      an email to Mr. Suh’s personal email account. The mid-October email to Mr. Suh
      from LGE was first disclosed to SpatiaLight executives during settlement
      discussions by LGE’s legal counsel on July 24, 2007. At the time of the October
      2006 email, Mr. Suh was our Senior Vice President for Marketing and Sales.
      He
      was later appointed to Chief Executive Officer on November 6, 2006, and was
      subsequently terminated on December 12, 2006. O n
      March
      9, 2007, we received oral notification from LGE of their intent to discontinue
      the production of all rear projection televisions. As a result of the October
      2006 email, we concluded that the asset impairment loss related to our building
      in South Korea should be recorded in the fourth quarter of 2006. We had
      previously recorded the impairment loss in the first quarter of 2007, based
      upon
      the March 9, 2007 notification from LGE.





Except
      for the items described above, no other information in the Original Filing
      is
      amended hereby, and this amendment does not reflect events occurring after
      the
      Original Filing or modify or update those disclosures affected by subsequent
      events. This Amendment continues to speak as of the date of the Original filing,
      and does not modify or update any other item or disclosures in the Original
      Filing.




2





SPATIALIGHT,
      INC.


Quarterly
      Report on Form 10-Q/A


For
      the
      Quarter Ended March 31, 2007





Table
      of Contents





**PART
                I**
            **FINANCIAL
                INFORMATION**Item
                1.
            Condensed
                Consolidated Financial Statements (unaudited)Condensed
                Consolidated Balance Sheets as ofMarch
                31, 2007 and December 31, 2006
            
            4Condensed
                Consolidated Statements of Operationsfor
                the Three Months Ended March 31, 2007 and 2006
            
            5Condensed
                Consolidated Statement of Stockholders’ Equity(Deficit)
                for the Three Months Ended March 31, 2007
            
            6Condensed
                Consolidated Statements of Cash Flowsfor
                the Three Months Ended March 31, 2007 and 2006
            
            7Notes
                to Condensed Consolidated Financial Statements
            
            8Item
                2.
            Management’s
                Discussion and Analysisof
                Financial Condition and Results of Operations
            
            27Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risks
            
            37Item
                4.
            Controls
                and Procedures
            
            37**PART
                II**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings.
            
            38Item
                1A.
            Business
                Risks and Uncertainties.
            
            39Item
                2.
            Unregistered
                Sales of Securities and Use of Proceeds
            
            41Item
                3.
            Defaults
                Upon Senior Securities.
            
            41Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            41Item
                5.
            Other
                Information
            
            41Item
                6.
            Exhibits
                and Reports on Form 8-K
            
            41SIGNATURES
            
            43




3


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




**ITEM
      1.**  **Condensed
      Consolidated Financial Statements**


SPATIALIGHT,
                  INC.CONDENSED
                  CONSOLIDATED BALANCE SHEETSMarch
                  31,
              
              December
                  31,2007
              
              2006(unaudited)
              
              (Note
                  2)ASSETSCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              54,805
              
              $
              220,256Accounts
                  receivable, net of $0 allowance for doubtfulaccounts
                  as of March 31, 2007 and December 31, 2006, respectively
              
              
              48,355
              
              
              52,238Inventory,
                  net
              
              
              370,312
              
              
              423,075Prepaids
                  and other current assets
              
              
              316,288
              
              
              307,428Total
                  current assets
              
              
              789,760
              
              
              1,002,997Property,
                  plant and equipment, net
              
              
              4,933,084
              
              
              5,205,926Other
                  assets
              
              
              37,070
              
              
              37,121Total
                  assets
              
              $
              5,759,914
              
              $
              6,246,044LIABILITIES
                  AND STOCKHOLDERS' EQUITY (DEFICIT)Current
                  liabilities:Senior
                  secured convertible notes - current portion
              
              $
              9,707,079
              
              $
              9,596,086Unsecured
                  short term loans
              
              
              670,945
              
              
              591,070Accounts
                  payable
              
              
              2,166,280
              
              
              1,916,249Accrued
                  expenses and other current liabilities
              
              
              1,339,231
              
              
              1,793,232Total
                  current liabilities
              
              
              13,883,535
              
              
              13,896,637Related
                  party convertible notes
              
              
              1,188,000
              
              
              1,188,000Total
                  liabilities
              
              
              15,071,535
              
              
              15,084,637Commitments
                  and contingenciesStockholders'
                  equity (deficit):Common
                  stock, $.01 par value:100,000,000
                  shares authorized as of March 31, 2007 and December 31,
                  2006;47,773,092
                  and 44,482,616 shares issued and outstandingat
                  March 31, 2007 and December 31, 2006, respectively
              
              
              477,730
              
              
              444,826Additional
                  paid-in capital
              
              
              98,461,529
              
              
              94,756,700Prepaid
                  non-cash interest to related party
              
              
              (2,024,982
              )
              
              (2,314,266
              )Other
                  comprehensive income
              
              
              292,461
              
              
              336,975Accumulated
                  deficit
              
              
              (106,518,359
              )
              
              (102,062,828
              )Total
                  stockholders' equity (deficit)
              
              
              (9,311,621
              )
              
              (8,838,593
              )Total
                  liabilities and stockholders' equity (deficit)
              
              $
              5,759,914
              
              $
              6,246,044See
                  accompanying notes to condensed consolidated financial
                  statements.





4


SPATIALIGHT,
                INC.CONDENSED
                CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)Three
                months ended March 31,2007
            
            2006(As
                Restated -See
                Note 2)Revenue
            
            $
            46,448
            
            $
            85,694Cost
                of revenue and manufacturing expenses
            
            
            748,205
            
            
            1,548,330Gross
                margin
            
            
            (701,757
            )
            
            (1,462,636
            )Operating
                expenses:Selling,
                general and administrative expenses (including stock-basedcompensation
                of $276,987 and $668,837 for the three monthmonth
                periods ended March 31, 2007 and 2006, respectively).
            
            
            1,261,831
            
            
            2,640,094Research
                and development expenses
            
            
            294,102
            
            
            242,071Total
                operating expenses
            
            
            1,555,933
            
            
            2,882,165Operating
                loss
            
            
            (2,257,690
            )
            
            (4,344,801
            )Other
                income (expense):Interest
                expense:Interest
                expense
            
            
            (287,409
            )
            
            (282,988
            )Non-cash
                interest expense
            
            
            (1,889,314
            )
            
            (1,012,771
            )Total
                interest expense
            
            
            (2,176,723
            )
            
            (1,295,759
            )Loss
                from revaluation of warrants
            
            
            -
            
            
            (12,418
            )Foreign
                currency translation gain (loss)
            
            
            (39,617
            )
            
            4,573Interest
                and other income
            
            
            20,299
            
            
            16,536Total
                other income (expenses)
            
            
            (2,196,041
            )
            
            (1,287,068
            )Loss
                before income tax expense
            
            
            (4,453,731
            )
            
            (5,631,869
            )Income
                tax expense
            
            
            (1,800
            )
            
            (800
            )Net
                loss
            
            $
            (4,455,531
            )
            $
            (5,632,669
            )Net
                loss per share - basic and diluted
            
            $
            (0.10
            )
            $
            (0.15
            )Weighted
                average shares used in computingnet
                loss per share- basic and diluted
            
            
            45,774,256
            
            
            38,590,722See
                accompanying notes to condensed consolidated financial
                statements




5


SPATIALIGHT,
                INC.CONDENSED
                CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
                (unaudited)THREE
                MONTHS ENDED MARCH 31, 2007




**PREPAID****NONCASH**
            
            
            
            
            
            **TOTAL****ADDITIONAL**
            
            **INTEREST
                TO**
            
            
            
            **OTHER**
            
            **STOCKHOLDERS'****COMMON
                STOCK**
            
            **PAID-IN**
            
            **RELATED**
            
            **ACCUMULATED**
            
            **COMPREHEN-**
            
            **EQUITY****SHARES**
            
            **AMOUNT**
            
            **CAPITAL**
            
            **PARTY**
            
            **DEFICIT**
            
            **SIVE
                  INCOME**
            
            **(DEFICIT)**Balance,
                January 1, 2007
            
            
            44,482,616
            
            $
            444,826
            
            $
            94,756,700
            
            $
            (2,314,266
            )
            $
            (102,062,828
            )
            $
            336,975
            
            $
            (8,838,593
            )Stock-based
                compensation expense
            
            
            -
            
            
            -
            
            
            276,987
            
            
            -
            
            
            -
            
            
            -
            
            
            276,987Issuance
                    of common shares, net of issuance costs of
                    $170,254
            
            
            2,190,476
            
            
            21,904
            
            
            2,107,842
            
            
            -
            
            
            -
            
            
            -
            
            
            2,129,746Issuance
                    of common shares for waivers of certain contractual rights by
                    September
                    and
            
            
            
            
            
            
            
            
            
            
            
            -
            
            
            -
            
            
            -
            
            
            -November
                2006 investors
            
            
            1,100,000
            
            
            11,000
            
            
            1,320,000
            
            
            -
            
            
            -
            
            
            -
            
            
            1,331,000Amortization
                of pre-paid interest
            
            
            -
            
            
            -
            
            
            -
            
            
            289,284
            
            
            -
            
            
            -
            
            
            289,284Comprehensive
                loss:Net
                loss (Restated. See Note 2)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,455,531
            )
            
            -
            
            
            (4,455,531
            )Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (44,514
            )
            
            (44,514
            )Total
                comprehensive loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,455,531
            )
            
            (44,514
            )
            
            (4,500,045
            )Balance,
                March 31, 2007 (Restated. See Note 2)
            
            
            47,773,092
            
            $
            477,730
            
            $
            98,461,529
            
            $
            (2,024,982
            )
            $
            (106,518,359
            )
            $
            292,461
            
            $
            (9,311,621
            )


See
      accompanying notes to condensed consolidated financial statements




6


SPATIALIGHT,
                  INC.CONDENSED
                  CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)Three
                  months ended March 31,2007
              
              2006(As
                  Restated -See
                  Note 2)Cash
                  flows from operating activities:Net
                  loss
              
              $
              (4,455,531
              )
              $
              (5,632,669
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Inventory
                  reserve adjustment
              
              
              -
              
              
              412,594Depreciation
                  and amortization
              
              
              194,264
              
              
              228,884Stock-based
                  compensation expense
              
              
              276,987
              
              
              668,837Non-cash
                  interest expense
              
              
              1,889,314
              
              
              1,012,771Loss
                  from revaluation of warrants
              
              
              -
              
              
              12,418Non-cash
                  foreign currency translation loss
              
              
              39,617
              
              
              4,573Loss
                  on sale of fixed assets
              
              
              -
              
              
              1,545Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              3,882
              
              
              (27,760
              )Inventory
              
              
              52,762
              
              
              (88,684
              )Prepaids
                  and other current assets
              
              
              (6,898
              )
              
              (110,580
              )Other
                  assets
              
              
              51
              
              
              12,992Accounts
                  payable
              
              
              250,033
              
              
              (424,222
              )Accrued
                  expenses and other current liabilities
              
              
              (614,000
              )
              
              (294,798
              )Net
                  cash used in operating activities
              
              
              (2,369,519
              )
              
              (4,224,099
              )Cash
                  flows from investing activities:Purchase
                  of property, plant and equipment
              
              
              (13,883
              )
              
              (226,841
              )Net
                  cash used in investing activities
              
              
              (13,883
              )
              
              (226,841
              )Cash
                  flows from financing actitivies:Proceeds
                  from issuance of short-term notes
              
              
              1,038,972
              
              
              3,666,977Payment
                  on short-term notes
              
              
              (950,721
              )
              
              (2,306,320
              )Proceeds
                  from the sale of common shares and warrants, net of issuance
                  costs
              
              
              2,129,746
              
              
              4,386,482Proceeds
                  from exercise of warrants and options
              
              
              -
              
              
              40,245Net
                  cash provided by financing activities
              
              
              2,217,997
              
              
              5,787,384Net
                  increase (decrease) in cash and cash equivalents
              
              
              (165,405
              )
              
              1,336,444Effect
                  of exchange rate changes on cash
              
              
              (46
              )
              
              8,402Cash
                  and cash equivalents at beginning of period
              
              
              220,256
              
              
              42,565Cash
                  and cash equivalents at end of period
              
              $
              54,805
              
              $
              1,387,411Non-cash
                  financing activities:Shares
                  issued for interest and liquidated damages
              
              $
              1,331,000
              
              $
              -Supplemental
                  disclosure of cash flow information:Income
                  taxes paid during the period
              
              $
              1,800
              
              $
              800Interest
                  paid during the period
              
              $
              264,849
              
              $
              247,162See
                  accompanying notes to condensed consolidated financial
                  statements.
  7
 **SPATIALIGHT,
            INC.**
 Notes
            to
            Condensed Consolidated Financial Statements
            (Unaudited)





**Note
      1.**  **Business
      Description**





We
      are in
      the business of manufacturing high-resolution liquid crystal on silicon (LCoS)
      microdisplays. We are currently focused on manufacturing our core product,
      our
      T-3 LCoS Set, to our customers and prospective customers, who are located
      primarily in Asia. The T-3 model has a 1920 pixels by 1080 pixels configuration.
      Our previously manufactured T-1 model has a lower resolution of 1280 pixels
      by
      960 pixels configuration. We are focusing on manufacturing the T-3 model of
      our
      LCoS Sets rather than the T-1 model because we believe that the market demand
      for that higher resolution product will be significantly greater. Our current
      and prospective customers are original equipment manufacturers (“OEMs”) engaged
      in the businesses of manufacturing high definition televisions or manufacturing
      light engines for incorporation into high definition televisions and near to
      eye
      head mounted displays (“HMDs”). Our products are suitable for incorporation into
      other potential applications including rear projection computer monitors,
      wireless communication devices, portable games and digital assistants. Currently
      we are working with OEMs of high definition televisions, light engines for
      incorporation into high definition televisions, near-to-eye head mounted display
      devices, and micro-projectors for mobile electronics applications.





**Note
      2.**  **Basis
      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 Article 10
      of
      Regulation S-X. Accordingly, they do not include all of the information and
      footnotes necessary for a fair presentation of financial condition, results
      of
      operations and cash flows in conformity with 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 Annual Report on Form 10-K/A, which
      contains the audited financial statements and notes thereto, together with
      the
      Management’s Discussion and Analysis, for the year ended December 31, 2006. The
      interim results for the three month period ended March 31, 2007 are not
      necessarily indicative of results for the full fiscal year or any future interim
      period. The accompanying consolidated balance sheet at December 31, 2006 has
      been derived from the audited financial statements at 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 10K/A filed with the SEC on August 21, 2007, we have suffered
      recurring operating losses and negative cash flows from operations. We have
      continued to suffer operating losses during the first three months of 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. If we do
      not
      receive additional funds, we will be required to scale back or terminate
      operations and/or seek protection under applicable bankruptcy laws.
      Additionally, as more fully described in Note 7, our Senior Secured Convertible
      Notes, maturing in November 2007, are held by four noteholders. Two of the
      noteholders have alleged that certain events of default under the Senior Secured
      Convertible Notes have occurred. We strongly dispute that any events of default
      have occurred that would allow the noteholders to call the notes, and we plan
      to
      vigorously defend our position. We believe, after reviewing with outside
      counsel, that it is not probable that the noteholders would prevail in calling
      the loans based on any of the alleged events of default; therefore, we have
      not
      accrued for the alleged redemption premiums and liquidated damages of $1.5
      million and $683,000, respectively, as of March 31, 2007. However, should the
      noteholders pursue their call for immediate redemption of the Senior Secured
      Convertible Notes, and prevail on their claim in a court of law, the Senior
      Secured Convertible Notes and related redemption premiums and liquidated damages
      would immediately become due and payable. Moreover, we will be required to
      repay
      or refinance the Notes at their maturity date in November 2007, and will need
      to
      obtain additional financing to repay the noteholders.




8


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


In
      2006,
      a substantial percentage of our product deliveries, which were in small
      quantities, were made to LG Electronics (“LGE”). We have been informed by LGE of
      their intent to discontinue production of rear projection televisions (“RPTVs”).
      We do not expect significant further sales to LGE. We intend to replace the
      revenues from LGE with revenues from sales of our T-3 LCoS set to other
      customers, as well as sales of products to manufacturers of head mounted
      displays and microprojectors. Due to the development and ramp up time periods
      required, significant revenue is not anticipated until at least the second
      half
      of 2007.





We
      are
      subject to U.S. Securities and Exchange Commission (“SEC”) investigations
      relating to the unauthorized filing of consents of our former auditor, BDO
      Seidman, LLP, as an exhibit to certain registration statements and into
      transactions of our securities relating to Argyle Capital Management, a firm
      controlled by our former Chief Executive Officer. We may be subject to penalties
      and claims relating thereto. These matters are discussed in Note  13.





These
      matters raise substantial doubt about our ability to continue as a going
      concern. The recoverability of a major portion of the recorded asset amounts
      shown in the accompanying 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
      recorded asset amounts or amounts and classifications of liabilities that might
      be necessary should we be unable to continue as a going concern.





*Restatement*




This
      Amendment to our Quarterly Report on Form 10-Q/A is being filed to amend our
      Quarterly Report on Form 10-Q for the period ended March 31, 2007, as filed
      with
      the Securities and Exchange Commission on May 10, 2007 (“Original Filing”) for
      the purposes of reversing an impairment loss of $1,429,925 recorded against
      our
      building in South Korea during the first quarter of 2007. On
      July
      24, 2007, we received evidence that LG Electronics (“LGE”) communicated its
      intention to terminate our Supply Agreement to Mr. Don Suh, in October 2006,
      in
      the form of an email to Mr. Suh’s personal email account. The mid-October email
      to Mr. Suh from LGE was first disclosed to SpatiaLight executives during
      settlement discussions by LGE’s legal counsel on July 24, 2007. At the time of
      the October 2006 email, Mr. Suh was our Senior Vice President for Marketing
      and
      Sales. He was later appointed to Chief Executive Officer on November 6, 2006,
      and was subsequently terminated on December 12, 2006. O n
      March
      9, 2007, we received oral notification from LGE of their intent to discontinue
      the production of all rear projection televisions. As a result of the October
      2006 email, we concluded that the asset impairment loss related to our building
      in South Korea should be recorded in the fourth quarter of 2006. We had
      previously recorded the impairment loss in the first quarter of 2007, based
      upon
      the March 9, 2007 notification from LGE.




9


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


Therefore,
      we have restated our condensed consolidated financial statements for the quarter
      ended March 31, 2007.




The
      following table outlines the effects of the restatement described above for
      the
      period that has been previously reported as of and for the three month period
      ended March 31, 2007.




Previously
            
            AsReported
            
            Restated**Condensed
                Consolidated Statement of Operations:**Impairment
                loss
            
            $
            1,429,925
            
            $
            -Total
                operating expenses
            
            $
            2,985,858
            
            $
            1,555,933Operating
                loss
            
            $
            (3,687,615
            )
            $
            (2,257,690
            )Loss
                before income tax expense
            
            $
            (5,883,656
            )
            $
            (4,453,731
            )Net
                loss
            
            $
            (5,885,456
            )
            $
            (4,455,531
            )Net
                loss per share: basic and diluted
            
            $
            (0.13
            )
            $
            (0.10
            )




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





From
      inception through March 31, 2007, we have sustained recurring net losses from
      operations totaling approximately $106.5 million and at March 31, 2007, had
      total stockholders’ deficit of approximately $9.3 million and working capital
      deficiency of approximately $13.1 million. During the three months ended March
      31, 2007, we experienced a net cash decrease of approximately $165,000. 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 2,190,476 of our
      common shares in February 2007. The funds from this financing were used to
      fund
      our operations for the first quarter of 2007. We recognized net losses for
      the
      three months ended March 31, 2007, of approximately $4.5 million.





As
      disclosed in Note 14 - Subsequent Events, 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 18 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 may be sold under the Equity Credit Agreement
      only after the approval of our stockholders, and 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 draw downs from the Equity Credit Agreement, cash payments
      from our customers, the exercises of stock options and warrants, and additional
      sales of our common shares.




10


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


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




We
      have
      stock compensation plans for employees and directors which are described in
      Note
      6 to our consolidated financial statements in our 2006 Annual Report on Form
      10K
      as filed with the SEC on March 16, 2007. 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 binomial
      model to calculate a derived service period. All of our stock compensation
      is
      accounted for as an equity instrument.





Under
      the
      provisions of SFAS 123R, we recorded $276,987 and $668,837, or $0.01 and $0.02
      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 March 31, 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:


Three
                  months ended March 31,2007
              
              2006Dividend
                  yield
              
              
              -
              
              
              -Expected
                  volatility
              
              
              86
                  - 89
              %
              
              92.80
              %Risk-free
                  interest rate
              
              
              4.51
                  - 5.10
              %
              
              4.60
              %Expected
                  lives (in years)
              
              
              5.21
                  to 5.75
              
              
              5.21
                  to 5.46


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 during the period, which approximates the rate in effect
      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 was $0.88 and $1.95, respectively. As
      required by SFAS No. 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 forfeiture experience as needed.




11


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


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


Number
                  of Shares
              
              Weighted
                  Average Exercise Price
              
              Weighted
                  Average Remaining Contractual Term (in years)
              
              Aggregate
                  Intrinsic Value at March 31, 2007Outstanding
                  December 31, 2006
              
              
              5,719,894
              
              $
              3.15
              
              
              5.8Options
                  granted under the plans
              
              
              987,000
              
              $
              1.20Options
                  exercised
              
              
              -Options
                  forfeited or expired
              
              
              (357,500
              )
              $
              3.74Outstanding
                  March 31, 2007
              
              
              6,349,394
              
              $
              2.81
              
              
              6.11
              
              $
              1,400Options
                  vested and exercisableat
                  March 31, 2007
              
              
              5,437,394
              
              $
              3.08
              
              
              5.48
              
              $
              1,400




Aggregate
      intrinsic value is the sum of the amounts by which the quoted market price
      of
      our stock at March 31, 2007, $0.39 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 (“in-the-money-options”). No options were exercised during
      the three months ended March 31, 2007. The aggregated intrinsic value of options
      exercised on the dates the options were exercised was $112,865 for the three
      month period ended March 31, 2006.




As
      of
      March 31, 2007, total expected compensation cost of options outstanding but
      not
      yet vested is approximately $644,245. This cost is expected to be recognized
      through February 2009. We recorded no income tax benefits for stock-based
      compensation expense arrangements for the three months ended March 31, 2007,
      as
      we have cumulative operating losses, for which a full valuation allowance has
      been established.




If
      the
      tax deduction realized from the exercise of stock options is less than
      recognized compensation expense, the tax shortfall is recognized in equity
      to
      the extent of available windfall tax benefits realized in the prior year, if
      any; otherwise, it is recognized within our Consolidated Statements of
      Operations. Under the modified-prospective transition method of
      SFAS No. 123R, we were permitted to calculate a cumulative memo
      balance of windfall tax benefits from post-1995 years for purposes of
      accounting for future tax shortfalls. We elected to apply the long-form method
      for determining the pool of windfall tax benefits and have a pool of windfall
      tax benefits.




12


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


**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 three months ended
      March 31, 2007 and 2006 because the effect of their assumed exercise or
      conversion would be antidilutive.


As
                  of March 31,2007
              
              2006Number
                  of Potentially Dilutive Shares
              
              Weighted
                  Average Exercise/Conversion Price
              
              Number
                  of Potentially Dilutive Shares
              
              Weighted
                  Average Exercise/Conversion PriceStock
                  options and warrants
              
              
              11,985,920
              
              $
              2.42
              
              
              7,380,231
              
              $
              3.60Convertible
                  notes
              
              
              3,404,807
              
              $
              3.29
              
              
              3,404,807
              
              $
              3.29Total
              
              
              15,390,727
              
              
              
              
              
              10,785,038





**Note
      6.**  **Property,
      Plant and Equipment, net**





Property,
      plant and equipment include:


March
                  31, 2007
              
              December
                  31, 2006Building
              
              $
              3,236,425
              
              $
              3,305,102Other
                  equipment and instruments
              
              
              1,746,881
              
              
              2,332,603Machinery
                  and manufacturing equipment
              
              
              1,679,808
              
              
              1,688,943Office
                  furniture and fixtures
              
              
              384,918
              
              
              463,414Tooling
              
              
              371,700
              
              
              371,700Leasehold
                  improvements
              
              
              152,315
              
              
              165,937Computer
                  hardware and software
              
              
              302,274
              
              
              352,825Total
                  property, plant and equipment
              
              
              7,874,321
              
              
              8,680,524Accumulated
                  depreciation
              
              
              (2,941,237
              )
              
              (3,474,598
              )Property,
                  plant and equipment, net
              
              $
              4,933,084
              
              $
              5,205,926




13


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


**Note** **7.**  **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
              
              Variable
                  (3)Interest
                  rate at 3/31/07
              
              
              7.02
              %
              
              10.40
              %
              
              19.00
              %
              
              19.00
              %Maturity
                  date
              
              
              9/22/2007
              
              
              4/28/2007
              
              
              1/10/2007
              
              
              1/10/2007Maximum
                  amount of line
              
              
              200,000
              
              
              200,000
              
              
              195,750
              
              
              98,411
              
              
              694,161Amount
                  outstanding at 3/31/07
              
              
              198,462
              
              
              146,859
              
              
              195,750
              
              
              98,411
              
              
              639,482Remaining
                  available
              
              
              1,538
              
              
              53,141
              
              
              -
              
              
              -
              
              
              54,679Approximate
                  US dollar equivalent
              
              $
              208,226
              
              $
              154,084
              
              $
              205,381
              
              $
              103,253
              
              $
              670,945
  (1)
                  Yield ratio of annual bank debenture plus 1.857%(2)
                  Yield ratio of annual industrial financial debenture plus
                  4.0%(3)
                  Pusan Bank's internal market related base rate plus
                  5.56%





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 Kyongnam Bank the amount outstanding as
      of
      the maturity dates noted above and are in discussions with each of these banks
      regarding repayment terms.





Related
      Party and Senior Secured Convertible notes outstanding at March 31, 2007 consist
      of the following:





*Argyle
      Notes:*





In
      1998,
      we received $1,188,000 in cash in exchange for notes payable in that amount
      to
      Argyle Capital Management Corporation (Argyle), a company owned and controlled
      by Robert A. Olins, our former Chief Executive Officer, Secretary, Treasurer,
      and a former Director. The 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 November 2004 Financing Senior Secured Convertible
      Notes
      due November 30, 2007 described below. Both principal and interest are
      convertible into our common shares at $0.50 per share. On May 23, 2001, the
      due
      date of the notes was extended until December 31, 2002. On the extension date,
      the beneficial conversion effect representing the excess aggregate value of
      the
      common shares receivable upon conversion of the notes based on the then current
      market price of $1.90 per share, over the aggregate conversion price for such
      common shares (limited to the original proceeds of $1,188,000), was recorded
      as
      additional paid-in capital. The resulting $1,188,000 discount to the debt
      arising from the beneficial conversion feature was originally being amortized
      through December 31, 2002. The effective interest rate for financial statement
      purposes due to this discount differs from the actual contractual interest
      received or receivable in cash or shares by Argyle. This discount, along with
      the contractual 6% interest rate, resulted in a new effective interest rate
      of
      72% per annum as of the May 23, 2001 extension date when compared to the
      outstanding principal balances. The effective rate prior to extension had been
      the 6% per annum contractual rate.




14


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


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





We
      paid
      interest on the Argyle notes by issuing 142,360 common shares with a market
      value of $354,476 in 2003, and 142,360 common shares with a market value of
      $800,063 in 2004. The market value of the shares was based on the closing price
      of the shares on the day before issuance, and was recorded as interest expense.
      On March 4, 2004, we issued 71,676 common shares with a market value of $338,311
      as a prepayment of interest on the Argyle notes of $35,640 for the period
      January 1, 2005 to June 30, 2005. Prepaid interest was computed using the
      closing price of the shares of $4.72 on March 3, 2004. In December 2004, we
      issued 50,000 common shares, and in January 2005, we issued 448,768 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 $8.12 on December
      21,
      2004. As of March 31, 2007, total prepaid interest on the Argyle notes for
      the
      period April 1, 2007 to December 31, 2008 is $2,024,982, which is classified
      as
      a deduction from stockholders’ equity (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
      those notes at the time of the conversion.





Non-cash
      interest expense includes $271,463 for the three months ended March 31, 2007
      and
      2006 resulting from the beneficial conversion price of interest payable, which
      is convertible into common shares at $0.50 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
      March
      31, 2007, the carrying value of the Argyle notes totaled $1,188,000 representing
      the unpaid principal balance *.*




15


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


*November
      2004 Financing:*





On
      November 30, 2004, we completed a non-brokered private placement of $10 million
      of senior secured 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 our 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
      are due November 30, 2007.





The
      Senior Secured Convertible Notes are convertible, at the option of their
      holders, into our common shares at the conversion price of $9.72 per share.
      The
      Senior Secured Convertible Notes are senior to notes that we issued to Argyle
      Capital Management Corporation (the “Argyle Notes”), which is wholly owned by
      Robert A. Olins, our former Chief Executive Officer, Secretary, Treasurer and
      a
      former Director, 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 in either cash or shares, interest on the Argyle Notes 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 a registration
      statement for resale of the shares issuable upon conversion of the Senior
      Secured Convertible Notes and to maintain its effectiveness to allow the holders
      of our Senior Secured Convertible Notes to convert their notes and sell the
      underlying common shares freely.  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 our 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. One of the holders
      of
      the Senior Secured Convertible Notes, Portside Growth & Opportunity Fund,
      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 is resolved. That amount would equal $615,000
      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.




16


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


Portside
      Growth & Opportunity Fund 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, another
      noteholder, joined in the claim that a default occurred as a result of certain
      indebtedness incurred as a result of the failure to make the November 2005
      interest payment in a timely fashion. Each of 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.





On
      March
      28, 2007, Portside Growth & Opportunity Fund, holders of $4,500,000 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. We believe, after review with outside
      legal counsel, that these allegations lack merit and would not entitle the
      noteholders to call the notes, or the other remedies that they are
      seeking.  We believe that the noteholders have undertaken to make
      allegations of events of default that lack merit in an attempt to obtain an
      amendment to the terms of the Senior Secured Convertible Notes to reduce the
      conversion price, accelerate repayment and increase the interest rate.  We
      have rejected offers from the noteholders in this regard, and plan to vigorously
      defend our position. If the noteholders prevail in calling the Notes, the entire
      $10 million debt obligation would become due and payable immediately, including
      the redemption premiums of $1.5 million and liquidated damages of
      $683,000.  We have not accrued the above described redemption premiums or
      liquidated damages as of March 31, 2007 or December 31, 2006.




17


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


Activity
      in notes payable for the three months ended March 31, 2007 is as
      follows:





**Debt
                Principal:**
            
            **Balance
                at December 31, 2006**
            
            **Addition
                or New Discount**
            
            **(Payment)
                or Discount Amortization**
            
            **Conversion
                to Equity**
            
            **Balance
                at March 31, 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
            )
            
            -
            
            
            13,050
            
            
            -
            
            
            (34,810
            )Reimbursement
                of investor's legal fees
            
            
            (30,556
            )
            
            -
            
            
            8,333
            
            
            -
            
            
            (22,223
            )Senior
                Secured Convertible NotesAIR
                discount
            
            
            (325,498
            )
            
            -
            
            
            89,610
            
            
            -
            
            
            (235,888
            )Total
            
            $
            10,784,086
            
            $
            -
            
            $
            110,993
            
            $
            -
            
            $
            10,895,079**Interest:**Accrued
                Argyle note 6%
            
            $
            -
            
            $
            17,820
            
            $
            -
            
            $
            (17,820
            )
            $
            -Argyle
                note beneficial interest
            
            
            -
            
            
            271,463
            
            
            -
            
            
            (271,463
            )
            
            -Senior
                Secured Convertible Notes 10%
            
            
            84,353
            
            
            247,154
            
            
            (246,575
            )
            
            -
            
            
            84,932Total
            
            $
            84,353
            
            $
            536,437
            
            $
            (246,575
            )
            $
            (289,283
            )
            $
            84,932




The
      maturity date of the Senior Secured Convertible Notes is November 30, 2007.
      Consequently, we have classified the net balance of $9,707,079 related to these
      notes, as a current debt in the condensed consolidated balance sheet at March
      31, 2007. The $1,188,000 outstanding balance of the Argyle Notes continues
      to be
      classified as long-term debt at March 31, 2007 as they are due on December
      31,
      2008.





Non-cash
      interest expense is as follows:


Three
                  months ended March 31,2007
              
              2006Amortization
                  of discounts on Senior Secured Convertible Notes
              
              $
              110,993
              
              $
              110,993Liquidated
                  damages on the October 2005, January 2006, September2006
                  and November 2006 financings
              
              
              190,806
              
              
              614,457Beneficial
                  conversion privileges of interest on Argyle note
              
              
              271,463
              
              
              271,463Expense
                  associated with waiver agreements with September andNovember
                  2006 investors settled in stock
              
              
              1,300,194
              
              
              -Amortization
                  of prepaid financing costs
              
              
              15,858
              
              
              15,858Total
                  non-cash interest expense
              
              $
              1,889,314
              
              $
              1,012,771





**Note** **8.**  **Issuance
      of Securities**





Exercise
      of Stock Options and Warrants in the Three Months Ended March 31,
      2007





No
      stock
      options or warrants were exercised during the three months ended March 31,
      2007.





Issuance
      of Shares, Stock Options and Warrants During the Three Months ended March 31,
      2007





During
      the fourth quarter of 2006, we entered into an agreement to grant options to
      purchase 950,000 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 at date of grant
      using a binomial model. The estimated value was increased to $176,747 based
      on a
      revision to an 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. Stock-based compensation
      expense during the first quarter 2007 include $139,329 associated with this
      option grant agreement.




18


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


On
      January 8, 2007, we issued a fully vested option to purchase 25,000 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 $1.35,
      exercise price $1.35, 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.





On
      February 23, 2007, when the price of our common stock was $1.31, we sold to
      five
      institutional investors that participated in the November 2006 Financing, an
      aggregate of 2,190,476 of our common shares at a purchase price of $1.05 per
      share. In addition, we issued 600,000 common shares, valued at $786,000, as
      a
      fee to obtain a one-time waiver of contractual prohibitions under the November
      2006 Financing against offering shares of our common stock for less than $1.30
      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 to Registration Rights Agreements
      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 Agreement in the amount of approximately $31,000 and a
      contingent obligation to issue 250,000 warrants to purchase common shares,
      the
      Company issued to Bluegrass Growth Fund, L.P. and Bluegrass Growth Fund, LTD.
      an
      aggregate of 500,000 common shares. The common shares, valued at $545,000,
      were
      issued on March 6, 2007, when the price of our common stock was $1.09, and
      were
      issued pursuant to the Company’s Registration Statement on Form S-3 (File No.
      333-137100), which was declared effective by the U.S. Securities and Exchange
      Commission on February 14, 2007.





Stock-based
      compensation, included in selling, general and administrative expenses, is
      as
      follows:


Three
                  months ended March 31,2007
              
              2006Options
                  granted to employees and directors
              
              $
              109,168
              
              $
              668,837Options
                  issued for services
              
              
              167,819
              
              
              -$
              276,987
              
              $
              668,837




19


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


**Note
      9.**  **Segment
      Information and Significant Customer Information**





Our
      chief
      operating decision-maker is our Chief Executive Officer. The chief operating
      decision-maker reviews only financial information prepared on a basis
      substantially consistent with the accompanying 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 March 31, 2007, except for the following:


South
                  KoreaCash
              
              $
              1,075Accounts
                  receivable
              
              
              46,755Prepaid
                  expenses
              
              
              57,217Deposits
              
              
              3,515Building,
                  net
              
              
              2,959,868Machinery
                  and manufacturing equipment, net
              
              
              732,700Office
                  furniture and fixtures, net
              
              
              110,938Other
                  equipment and instruments, net
              
              
              688,446Inventory,
                  net
              
              
              347,672$
              4,948,186




The
      following table summarizes our product revenue percentages for the three months
      ended March 31, 2007 and 2006.


Three
                  months ended March 31,2007
              
              2006LCoS
                  (T-3) sets
              
              
              100
              %
              
              85
              %Other
                  (primarily supporting electronics)
              
              
              -
              
              
              15
              %Total
              
              
              100
              %
              
              100
              %




Of
      our
      total revenue in 2007, 96% was derived from the sales of our LCoS Sets to LG
      Electronics (“LGE”), a customer located in South Korea. LGE made up 96% of our
      accounts receivable balance at March 31, 2007. For the three months ended March
      31, 2006, sales to LGE comprised 82% of our total sales, and 92% of our accounts
      receivable balance at March 31, 2006.




20


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


**Note** **10.**  **Inventory,
      net**





Inventory
      consisted of the following as of March 31, 2007 and December 31,
      2006:


March
                  31,
              
              December
                  31,2007
              
              2006Raw
                  materials
              
              $
              506,352
              
              $
              531,114Work-in-progress
              
              
              11,406
              
              
              26,088Finished
                  goods
              
              
              146,601
              
              
              161,285664,359
              
              
              718,487Inventory
                  reserve
              
              
              (294,047
              )
              
              (295,412
              )Total
                  inventory, net
              
              $
              370,312
              
              $
              423,075





**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 in accordance with FIN 48, to the extent applicable, is classified
      in
      the financial statements as interest expense. Penalties recognized in accordance
      with FIN 48, 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, nor was any interest
      expense recognized for the period ended March 31, 2007.





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





In
      July
      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.





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.





21


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


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.





**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.





*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 7.




*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 March 31,
      2007.




22


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


*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 & Opportunity Fund, holders of $4,500,000 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.





We
      believe, after review with outside legal counsel, that these allegations lack
      merit and would not entitle the noteholders to call the notes and other remedies
      that they are seeking.  We believe that the noteholders have undertaken to
      make allegations of events of default that lack merit in an attempt to obtain
      an
      amendment to the terms of the Senior Secured Convertible Notes to reduce the
      conversion price, accelerate repayment and increase the interest rate.  We
      have rejected offers from the noteholders in this regard, and plan to vigorously
      defend our position. If the noteholders prevail in calling the Notes, the entire
      $10 million debt obligation would become due and payable immediately, together
      with a redemption premium of $1.5 million and liquidated damages of
      $683,000.  We have not accrued the above described redemption premium or
      liquidated damages as of March 31, 2007 or December 31, 2006.





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 in our post-effective amendments to the Form S-3
      Registration Statement registering the common shares underlying the Senior
      Secured Convertible Notes (the “Financing Registration Statement”) (File No.
      333-122391) and the Form S-3 Registration Statement registering common shares
      on
      a “shelf” (the “Shelf Registration Statement”) (File No. 333-122392), we failed
      to obtain authorization from BDO Seidman LLP before filing their consent to
      incorporate their report on our financial statements for the fiscal years ended
      December 31, 2002 and 2003 as an exhibit to Amendment Nos. 5 and 6 to the
      Financing Registration Statement and to Amendment Nos. 3 and 4 to the Shelf
      Registration Statement. We received the requisite authorized consents from
      BDO
      Seidman, LLP to incorporate by reference their report on the consolidated
      financing statements into the Financing Registration Statement and the Shelf
      Registration Statement when initially filed and in previous amendments thereto
      and BDO Seidman, LLP has not withdrawn these previous consents.





The
      Audit
      Committee of our Board of Directors conducted an investigation and review of
      the
      developments pertaining to the BDO Seidman, LLP consent issue with the
      assistance of independent counsel.




23


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


The
      Audit
      Committee delivered its draft report, dated October 31, 2005, to our then-Chief
      Executive Officer, Robert A. Olins. The Report concluded that the evidence
      does
      not support a finding that any of our employees included the unauthorized BDO
      Seidman, LLP consents in the amendments to the Registration Statements referred
      to above with fraudulent intent or with specific knowledge that BDO Seidman,
      LLP
      had not authorized the filing of these consents. It concluded that the evidence
      was consistent with our inclusion of the consents due to lack of communication,
      a series of misunderstandings and/or a failure of inquiry. As to Mr. Olins,
      the
      Report concluded that the Audit Committee found no evidence that Mr. Olins
      was
      informed that BDO Seidman, LLP had not authorized the filing of these consents.
      However, it also found no evidence that Mr. Olins inquired or determined whether
      BDO Seidman, LLP had in fact authorized inclusion of the consents in these
      filings. The Audit Committee Report determined that Mr. Olins, as our Chief
      Executive Officer, did not exercise sufficient diligence in supervising the
      filing of the amendments to the Registration Statements, that this was a
      particularly serious failing in light of the SEC having highlighted the need
      for
      consents from BDO Seidman, LLP, and that as CEO he bears responsibility for
      the
      filings. The Audit Committee also stated its belief that, throughout the process
      of preparing and filing the amendments to the Registration Statements, Mr.
      Olins
      acted with our best interests and the best interests of our stockholders in
      mind, and that his lack of diligence was not motivated by self-interest and
      that
      nothing related to this incident personally benefited him financially.





The
      Audit
      Committee recommended three remedial actions. It concluded that the membership
      of the Board of Directors should be supplemented with a financial expert within
      the meaning of SEC rules. It also concluded that we must improve our corporate
      governance and disclosure controls, including hiring a full-time Chief Financial
      Officer and a Controller (who can be the same person). It further concluded
      that
      by reason of Mr. Olins’ responsibility as CEO for supervision of corporate
      filings, he should reimburse us for the sum of $50,000, a portion of the costs
      incurred by us by reason of the unauthorized BDO Seidman, LLP consents and
      the
      resulting inquiries. In compliance with the Audit Committee Report, in December
      2005, Mr. Olins made the $50,000 payment to reimburse the Company. To date,
      our
      Board of Directors has not been supplemented with a financial expert and
      although we have not hired a fulltime CFO or Controller, we have hired a
      Director of Accounting and Finance.





We
      have
      been advised by the Staff of the SEC that the Staff is conducting an
      investigation into matters and events pertaining to the filing of the
      unauthorized BDO Seidman, LLP consents and into transactions in our securities
      by Mr. Olins and an entity he controls. We have been cooperating fully with
      the
      Staff with respect to these matters.





*Other
      matters*





Following
      the filing in July 2005 of Amendment No. 6 to the Financing Registration
      Statement and Amendment No. 4 to the “shelf” registration statement, which
      contained the unauthorized consents referred to above, the Staff of the SEC
      declared both of the registration statements effective. In August 2005, we
      filed
      post-effective Amendments No. 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 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 500,000 common shares to three institutional purchasers
      for $5.40 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 $4.25 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 investor’s purchase price and lowest believed resale price,
      multiplied by the 340,000 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.





**Note
      14.**  **Subsequent
      Events**





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 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 may be sold under the Equity Credit
      Agreement only after the approval of our stockholders, and will be priced at
      95%
      of the closing bid price on the date of sale. As of May 4, 2007 we have elected
      to sell and the Investors have purchased 1,176,445 common shares with a value
      of
      $300,000.





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 Securities Purchase Agreement and
      Registration Rights Agreement dated November 28, 2006 (the “November 2006
      Financing”), the Securities Purchase Agreement and Registration Rights Agreement
      dated February 26, 2007 (the “February 2007 Financing”), and a Waiver dated
      February 26, 2007 (the “February 2007 Waiver”); (ii) returned for cancellation
      warrants to purchase 4,800,000 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 $1.30 per share without the
      Investors’ consent; and (iv) entered into an Escrow Agreement pursuant to which
      we will issue in escrow, from time to time, an unspecified number of common
      shares, and the Investors will deliver to escrow 4,002,307 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 $4,354,387.




25


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


All
      new
      securities to be issued by us 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 U.S.
      Securities and Exchange Commission on February 14, 2007.





On
      April
      20, 2007, we received a notice from the NASDAQ Stock Market that we do not
      meet
      the requirements for continued listing on the NASDAQ Stock Market under
      Marketplace Rule 4310(c)(8)(D) because the closing bid price for our common
      shares was less than the minimum of $1.00 per share for the last 30 consecutive
      trading days. Unless the closing bid price for our common shares exceeds $1.00
      per share for 10 consecutive trading days prior to October 17, 2007, the staff
      of the NASDAQ may notify us that our common shares will be delisted from the
      NASDAQ Capital Market.





On
      April
      27, 2007 the Company received a NASDAQ Staff Determination that we do not meet
      the requirements for continued listing upon the NASDAQ Capital Market under
      Marketplace Rule 4310(c)(8)(C) because the aggregate market value of our
      publicly held common shares was less than $35,000,000 for 10 consecutive trading
      days, and was not corrected within the 30 day cure period.




We
      have
      requested a hearing to provide the NASDAQ staff with information relating to
      the
      future compliance with the listing standards. Subject to compliance with all
      other marketplace rules while the appeal is pending, we expect our common shares
      to continue trading on the NASDAQ Capital Market under the HDTV symbol until
      after the hearing.





26


**ITEM
      2.**  **Management’s Discussion and Analysis of Financial Condition and Results of
      Operations.**





*This
      Form 10-Q/A 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 March 31, 2007, and our results of operations for the three
      months ended March 31, 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 Annual Report on Form 10-K/A filed
      with the Securities and Exchange Commission 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, almost all of whom are
      located primarily in Asia, are original equipment manufacturers (“OEMs”) engaged
      in the business of manufacturing high definition rear projection televisions
      (“RPTVs”) or manufacturing light engines for incorporation into high definition
      RPTVs. Our products are also suitable for incorporation into other potential
      display applications including front projection systems, near to eye head
      mounted displays, micro-projectors, wireless communication devices, portable
      games and digital assistants.




We
      are
      currently offering one core product, our T-3 LCoS Set, consisting of three
      of
      our proprietary SpatiaLight imagEngineTM LCoS microdisplays with a 1920 pixels by
      1080 pixels configuration for use in RPTVs. Our previously offered product,
      the
      T-1 LCoS Set had lower resolution with a 1280 pixels by 960 pixels
      configuration. 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
      focusing on manufacturing our T-3 LCoS Sets because we believe that the market
      demand for the higher resolution product will be significantly greater and
      the
      higher resolution product will command a higher price. We are developing a
      smaller product, designated the T-4 LCoS Set, which will maintain the high
      resolution of 1920 pixels by 1080 pixels and allow lower price points for use
      in
      projection screen sizes of between 50” and 60”.





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.




27




*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 LGE. Since the third quarter of 2006, we have been
      in a
      position to supply LGE’s requirements with quality product meeting all agreed
      upon specifications .
      We do
      not expect significant future sales to LGE and are negotiating with LGE for
      termination compensation under our exclusive supply agreement . The
      loss
      of LGE as a customer could significantly harm our future sales and results
      of
      operations ; and
      our
      historical substantial dependence on one customer is subject to risks set forth
      under Item 1A Risk Factors.





*Status
      of Business in China*




We
      have
      provided sample products to Jiangxi Greatsource Display Tech Co., Ltd. (KHD),
      a
      Chinese manufacturer of LCoS light engines and televisions. KHD demonstrated
      an
      85” commercial product employing our imagers at the January 2007 CES show. At
      this time, we do not have any purchase orders from KHD. We are continuing to
      work with other China TV makers in efforts to obtain a design win.





*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
      the
      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 Head Mounted Displays
      (“ HMDs ”)
      using
      our LCoS imager in a full High Definition 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.





We
      have
      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.





*Manufacturing
      of LCoS Sets*




We
      completed construction of our South Korean manufacturing facility in January
      2005. The facility began producing products for commercial sale in limited
      quantities in the second quarter of 2005 and is designed with the capacity,
      on
      full employment, to produce up to 28,000 LCoS Sets per month. The facility
      has
      been specially designed for expansion to a capacity of 120,000 LCoS Sets per
      month in several expansion phases.





During
      2006, we moved our entire manufacturing from California to South Korea. As
      part
      of the transition process, we experienced some manufacturing problems as the
      line was set up and restarted in South Korea, all of which have been resolved.
      We believe that the combination of a new facility designed to our specifications
      and highly qualified personnel provides us with more exacting controls over
      the
      external variables that can impact our manufacturing process. Since the third
      quarter of 2006, we have been in position to manufacture commercial quantities
      of high quality product according to customer specifications.




28





*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. Another factor is that our
      product focus has been on the high definition rear projection television (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.




For
      these
      reasons, we have taken the following initiatives:




·
            Find
                additional Tier 1 customers for the RPTV product (strong focus on
                adding
                at least one other customer).


·
            Complete
                an agreement with at least one and preferably two China TV
                manufacturers.


·
            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).


·
            Engage
                in new product development for applications other than RPTV (including
                Near-To-Eye (NTE) displays such as Head Mounted Displays (HMD) and
                micro-projector products).





We
      are
      currently offering one core product, our T-3 LCoS Set, with a 1920 pixels by
      1080 pixels configuration, to our customers and prospective customers, all
      of
      whom are located primarily in Asia. Our LCoS Set is comprised of three of our
      proprietary SpatiaLight imagEngineTM LCoS microdisplays. They are constructed
      with a silicon chip, a layer of liquid crystals and a glass cover plate in
      contrast to the more common construction of liquid crystals sandwiched between
      two glass plates. Our displays are also known as, and commonly referred to
      as,
      liquid crystal on silicon (LCoS), liquid crystal displays (LCD), active matrix
      liquid crystal displays and spatial light modulators. For applications such
      as
      large screen RPTV, the LCoS cell (T3P) is designed for a three panel
      configuration for maximum brightness. We are working to find a solution using
      the LGE light engine platform that will allow other customers quick market
      entry. We are focusing on manufacturing the T-3 model of our LCoS Sets (as
      opposed to our old T-1 LCoS Set with a resolution of 1280 pixels by 960 pixels)
      for projection TV applications because we believe that the market demand for
      the
      higher resolution product will be significantly greater. A new smaller diagonal
      product (T4P) which will still maintain the high resolution of 1920 pixels
      by
      1080 pixels completes development, we will introduce that to allow lower price
      points in conjunction with smaller screen sizes (50” to 60” for T4P as opposed
      to 60” + for T3P).




We
      are
      also working cooperatively with firms such as Foreal Spectrum (Foreal) of San
      Jose, California, to jointly provide a solid state light source based LCoS
      light
      engine solution. The long lifetime of these solid state light sources is
      attractive to both the consumer and commercial display maker when compared
      to
      the standard high pressure mercury arc lamp. In the case of laser diode sources,
      the low angular divergence of the light source facilitates the optical system
      design enabling thin cabinets with form factors approaching those of plasma
      TV’s
      at much lower weight.




We
      have
      recently signed a Joint Market Agreement with Foreal for the LCoS/ LED based
      light engine developed by Foreal. Full production volumes amongst the four
      customers targeted by the two companies are expected to be in the vicinity
      of
      twenty thousand sets per month.




29





We
      have
      previously announced a Memorandum of Understanding (MOU) working with Deocom
      of
      South Korea on Head Mounted Displays using initially our T-3 imager in a full
      HD
      mode. We expect our cooperative efforts to lead to some product sales in the
      short term and a growing commercial and consumer market. We have also recently
      signed a Purchase Agreement with Deocom to supply LCoS imagers for use in head
      mounted displays (HMD). This agreement anticipates immediate shipments of
      samples for prototype and pre-production runs, followed by mass production
      later
      this year. We expect this market to grow significantly over time.





We
      have
      also announced an MOU between SpatiaLight, SI InfoComm and SCRAM Technologies
      for the joint development of a micro-projector, a new category of product
      targeted at mobile electronics driven applications.




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 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 opinion certain pre-effective amendments to the
      registration statement, we notified the holders of our 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 & Opportunity Fund,
      the holder of $4,500,000 of the Senior Secured Convertible Notes, filed a claim
      for liquidated damages in the amount of $683,000 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 & Opportunity Fund has also claimed additional events of default
      under the Senior Secured Convertible Notes relating to alleged (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) grant of a security interest
      by
      our South Korean subsidiary in certain assets located in South Korea; and (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, another noteholder, joined in the claim that a default occurred
      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.




30





On
      March
      28, 2007, Portside Growth & Opportunity Fund filed suit 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. We believe, after
      review with outside legal counsel, that these allegations lack merit and would
      not entitle the noteholders to call the notes or to the other remedies they
      are
      seeking.  We believe that the noteholders have undertaken to make
      allegations of events of default that lack merit in an attempt to obtain an
      amendment to the terms of the Senior Secured Convertible Notes to reduce the
      conversion price, accelerate repayment and increase the interest rate. We have
      rejected offers from the noteholders in this regard, and plan to vigorously
      defend our position. If the noteholders prevail in calling the Notes, the entire
      $10 million debt obligation would become due and payable immediately, together
      with a redemption premium of $1.5 million and liquidated damages of
      $683,000.  We do not believe we are contractually obligated to pay
      redemption premium and liquidated damages of $1.5 million and approximately
      $0.7
      million, respectively, and accordingly, we have not accrued such amounts in
      the
      consolidated financial statements as of March 31, 2007 or December 31, 2006.





*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 received 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.




31





*SEC
      Investigations*





We
      have
      been advised by the Staff of the SEC that the Staff is conducting an
      investigation into matters and events pertaining to the filing of the
      unauthorized BDO Seidman, LLP consents and transactions in our securities by
      Mr.
      Robert Olins, our former Chief Executive Officer and a former Director, and
      an
      entity he controls. We have received and responded to a request from the Staff
      for all information relating to transactions in our securities by Mr. Olins
      and
      the entity he controls. We have been cooperating with the Staff with respect
      to
      this matter. We cannot determine whether we or our management will be adversely
      affected by these investigations.





LIQUIDITY
      AND CAPITAL RESOURCES




As
      of
      March 31, 2007, we had approximately $55,000 in cash and cash equivalents,
      a
      decrease of approximately $165,000 from the December 31, 2006 balance of
      approximately $220,000. Our net working capital deficiency at March 31, 2007
      was
      approximately $13.1 million compared to approximately $12.9 million at December
      31, 2006.





Net
      cash
      used in operating activities totaled approximately $2.4 million and $4.2 million
      for the three months ended March 31, 2007 and 2006, respectively. Cash used
      in
      operating activities decreased for the three month periods ended March 31,
      2007
      as compared to the same periods in 2006 primarily due to decreased operations
      in
      both of our facilities due to financial constraints.





Net
      cash
      used in investing activities totaled approximately $14,000 and $227,000 for
      the
      three months ended March 31, 2007 and 2006, respectively. Cash used in investing
      activities in 2007 and 2006 were primarily related to purchases of equipment
      used in our South Korean facility.





Net
      cash
      provided by financing activities in the three months ended March 31, 2007 and
      2006 was approximately $2.2 million and $5.8 million, 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 2,190,476 of our common shares in
      February 2007. The funds from this financing were used to fund our operations
      for the first quarter 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 1,300,000 of our common shares in mid-January 2006, at a purchase
      price of $2.62 per share, and approximately $1.1 million that we received from
      the sale of 500,000 shares sold on March 17, 2006, at a purchase price of $2.18
      per share. We borrowed an additional 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.





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 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 may be sold under the Equity Credit
      Agreement only after the approval of our stockholders, and 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.




32





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 Securities Purchase Agreement and
      Registration Rights Agreement dated November 28, 2006 (the “November 2006
      Financing”), the Securities Purchase Agreement and Registration Rights Agreement
      dated February 26, 2007 (the “February 2007 Financing”), and a Waiver dated
      February 26, 2007 (the “February 2007 Waiver”); (ii) returned for cancellation
      warrants to purchase 4,800,000 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 $1.30 per share without the Investors’
consent, and (iv) entered into an Escrow Agreement pursuant to which we will
      issue in escrow, from time to time, an unspecified number of common shares,
      and the Investors will deliver to escrow 4,002,307 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 $4,354,387.





RESULTS
      OF OPERATIONS





*Three
      months ended March 31, 2007 and 2006*





*Revenue* . ** We
      recognized revenue of approximately $46,000 and $86,000 during the quarter
      ended
      March 31, 2007 and 2006, respectively. Revenue in both periods was derived
      primarily from sales of LCoS Sets to LG Electronics.





The
      following table summarizes our sales revenue by product for the first quarter
      2007 and 2006.


Three
                  months ended March 31,2007
              
              2006LCoS
                  (T-3) sets
              
              
              100
              %
              
              85
              %Other
                  (primarily supporting electronics)
              
              
              -
              
              
              15
              %Total
              
              
              100
              %
              
              100
              %





Revenue
      from one customer, LG Electronics (LGE), accounted for 96% and 82% of our total
      revenue for the three months ended March 31, 2007 and 2006, respectively. We
      were informed by LGE of their intent to discontinue production of RPTVs (both
      LCoS and DLP). The loss of this customer and our inability to obtain additional
      purchase orders from our current or prospective customers to replace the lost
      expected revenue in a timely manner could significantly harm our sales and
      results of operations.




*Gross
      Margin* .
      Gross
      margin was reduced from approximately negative $1,463,000 during the first
      quarter of 2006 to negative gross margin of approximately $702,000 during the
      first quarter 2007. The first quarter of both periods includes the costs to
      operate our South Korean manufacturing facility. We have reduced staffing in
      our
      South Korean manufacturing facility during the first quarter 2007 in light
      of
      significantly reduced sales and our expectations of reduced future sales in
      the
      near-term. Additionally, cost of revenue during the first quarter of 2006
      includes a reserve of approximately $413,000, 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 believe there are still opportunities to sell both
      products, but we have shifted our focus to the manufacture and sale of our
      T-3
      LCoS Set products. 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.




33





*Selling,
      general and administrative costs.* Cash-based selling, general and administrative costs were approximately $985,000
      and $1,971,000 during the three months ended March 31, 2007 and 2006,
      respectively, a decrease of $986,000 or 50%. Salaries, wages and other payroll
      related expenses decreased approximately $336,000 and included an aggregate
      reduction in headcount of nine individuals 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 $155,000. 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 investigation, these expenses were more
      concentrated during the first quarter of 2006. Accounting and consulting
      expenses declined by approximately $181,000 due to slightly reduced fees
      associated with compliance with the Sarbanes-Oxley Act of 2002 and timing
      differences. Shipping expenses declined by approximately $97,000. The higher
      shipping costs during the first quarter of 2006 related to moving equipment
      and
      supplies from our California facility to our South Korean facility in
      conjunction with the final transition to locate all our manufacturing in our
      South Korean facility. The remaining reduction in costs between periods is
      primarily due to our cost reduction measures due to financial constraints during
      the first quarter 2007.





*Stock-based
      compensation included in selling, general and administrative
      costs.* Stock-based compensation was approximately $277,000 and $669,000 in the three
      months ended March 31, 2007 and 2006, respectively.





*Research
      and development costs* .
      Research and development costs were approximately $294,000 and $242,000 for
      the
      three months ended March 31, 2007 and 2006, respectively, an increase of $52,000
      or 21% as a result of increased spending related to our earlier-mentioned
      agreements with Deocom, Foreal and the Joint Development Agreement with SI
      Infocommand SCRAM Technologies.





*Interest
      expense.* Interest
      expense for the three months ended March 31, 2007 increased approximately $4,000
      from $283,000 during first quarter 2006 to $287,000 for the first quarter 2007.





*Non-cash
      interest expense.*  ** Non-cash
      interest expense was approximately $1,889,000 and $1,013,000 for the three
      months ended March 31, 2007 and 2006, respectively. Non-cash interest expense
      includes expense associated with the amortization of the beneficial conversion
      price of shares issued to prepay interest on the notes payable to Argyle Capital
      Management Corporation, a company wholly owned by Robert A. Olins, our former
      Chief Executive Officer, Secretary, Treasurer, Principal Financial and
      Accounting Officer and a Director. The beneficial conversion interest represents
      the excess value of the shares received or receivable at current market prices
      over the $0.50 per share conversion price. Also included in non-cash interest
      expense is the amortization of note discounts and note financing costs of the
      Senior Secured Convertible Notes. The first quarter of 2007 includes
      approximately $1.3 million of expense associated with obtaining waivers for
      certain contractual provisions from our September and November 2006 investors.
      Partially offsetting this increase is a decrease in liquidated damages between
      periods. Liquidated damages accrued during 2006 related to our October and
      January 2006 financings whereas liquidated damages during the first quarter
      of
      2007 related to our September 2006 and February 2007 financings.




34





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.


·
            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 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.




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. 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.




35





*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.




36





**ITEM
      3. Quantitative and Qualitative Disclosures About Market
      Risks.**





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 March 31, 2007, our cash and cash equivalents totaled approximately
      $55,000. Short term debt under our South Korean lines of credit totaled
      approximately $671,000 at March 31, 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 March 31, 2007, we had no hedging contracts. During the first
      three months of 2007, the foreign currency transaction gains, realized and
      unrealized, were not material.





**ITEM
      4. Controls and Procedures.**




**Disclosure
      Controls and Procedures.** As
      of
      March 31, 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 Control 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 (e.g., when we
      commence to sell our products in increased volume in the ordinary course of
      business) because of changes in conditions or deterioration in the degree of
      compliance with policies or procedures. Because of the inherent limitations
      in a
      cost-effective control system, misstatements due to error or fraud may occur
      and
      not be detected.




37





*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**





There
      have been no significant changes in the Company’s Internal Control that occurred
      during the quarter covered by this report that have materially affected, or
      are
      reasonably likely to materially affect, the Company’s Internal
      Control.





**PART
      II.**  **OTHER
      INFORMATION**





**ITEM
      1**  **Legal
      Proceedings**





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. We intend
      to
      vigorously defend this claim.




On
      March
      28, 2007, Portside Growth and Opportunity Fund, holders of $4,500,000 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. We
      intend to vigorously defend this claim.




38





We
      have
      received notice of an investigation by the SEC into the circumstances related
      to
      our filing of an unauthorized consent by BDO Seidman, LLP in connection with
      certain registration statements and transactions in our common shares by Mr.
      Robert Olins, our former Chief Executive Officer and a former Director and
      an
      entity he controls. No legal proceeding has been commenced against us and we
      are
      cooperating with the SEC in their investigation.





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**  **Business
      Risks and Uncertainties**





The
      following risk factors are in addition to the risks disclosed in our 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
      of the holders of the Senior Secured Convertible Notes issued by us in November
      2004 have made claims of default.**





On
      March
      28, 2007, Portside Growth & Opportunity Fund, holders of $4,500,000 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. In the event that this claim is
      determined adversely to the Company, we may be obligated to repay $10,000,000
      in
      principal amount of our outstanding Senior Secured Convertible Notes, together
      with accrued interest at 12% per annum, a premium of $1,500,000 and liquidated
      damages in the amount of $683,000. We do not presently have available cash
      reserves to fund the potential liability and an adverse outcome in this matter
      would materially and adversely affect our financial condition 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 transactions in our securities by our former
      Chief Executive Officer.**





We
      have
      been advised by the Staff of the SEC that the Staff is conducting an
      investigation into the circumstances relating to our unauthorized filing of
      a
      consent by BDO Seidman, LLC as an exhibit to a registration statement and into
      certain transactions in our securities by Mr. Olins and an entity he controls.
      We have been cooperating with the Staff with respect to this matter but cannot
      predict whether the Staff may recommend that sanctions be imposed against us.
      In
      the event that the Staff seeks to impose sanctions against us in they could
      be
      in the form of an injunction against violations of the securities laws and
      fines
      and penalties, which could be material and adversely affect our financial
      condition.




39





**Future
      offerings of our common shares, or securities convertible into or exercisable
      for our common shares, could cause the market price of our common shares to
      decrease significantly, even if our business operations are performing well.**





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 providing for the issuance from time to
      time
      of our common shares having an aggregate value of up to $4,354,387. In addition,
      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 in the near future. Furthermore, market perceptions regarding
      the likelihood that we will be required to issue and sell additional common
      shares in the near 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.





**Our
      ability to fund under the Equity Credit Agreement is dependent upon the number
      of shares authorized by the Shareholders and the market price of the
      stock.**





We
      could
      issue up to 71,435,407 additional shares of common stock under our Equity Credit
      Agreement, based on the price of our common stock on May 8, 2007 or $0.22 per
      share. As of May 8, 2007, we have 100,000,000 common shares authorized, of
      which
      33,526,948 are available for issuance (after taking into account reserves for
      options, warrants and convertible debt). In the event that the Shareholders
      of
      our common stock do not approve an increase in the number of authorized shares
      at our Annual Shareholders’ Meeting, or the stock price of our common shares
      decreases significantly, we may not be able to sell additional common shares
      under the Equity Credit Agreement in excess of those shares already authorized.
      This could have a material adverse effect on our financial condition and ability
      to continue as a going concern.





**Our
      common shares may be removed from trading on the NASDAQ Stock Market, may become
      subject to the rules applicable to “penny stocks” and may otherwise become
      illiquid.**





On
      April
      20, 2007, we received a notice from the NASDAQ Stock Market that we do not
      meet
      the requirements for continued listing on the NASDAQ Stock Market under
      Marketplace Rule 4310(c)(2) because the closing bid price for our common shares
      was less than the minimum of $1.00 per share for 30 consecutive trading days.
      Unless the closing bid price for our common shares exceeds $1.00 per share
      for
      10 consecutive trading days prior to October 17, 2007, the staff of the NASDAQ
      may notify us that the common stock will be delisted from the NASDAQ Capital
      Market.  On
      April
      27, 2007 we received a NASDAQ Staff Determination that we do not meet the
      requirements for continued listing upon the NASDAQ Capital Market under
      Marketplace Rule 4310(c)(4) because the aggregate market value of our publicly
      held common shares was below $35,000,000 for 10 consecutive trading days, and
      was not corrected within the 30 day cure period. Although we are appealing
      the
      delisting of our common shares and expect that they will continue to be listed
      on the NASDAQ pending the results of that appeal, we cannot predict whether
      our
      common shares will trade on the NASDAQ Capital Market in the future. The
      liquidity of our common shares will be adversely affected if they are delisted
      from the NASDAQ Stock Market. In addition, if our common shares are delisted
      from the NASDAQ Capital Market, sales of our common shares may be subject to
      additional limitations applicable to “penny stocks” which will make it more
      difficult and expensive to purchase and sell our common shares.




40





**ITEM
      2.**  **Unregistered
      Sales of Equity Securities and Use of Proceeds**





None.





**ITEM
      3**  **Defaults
      Upon Senior Securities**





Holders
      of $9,000,000 in principal amount of our Senior Secured Convertible Notes have
      alleged that we have defaulted in the payment of the installment of interest
      due
      November 30, 2005. In addition, one of these holders, who holds $4,500,000
      principal amount of the Senior Secured Convertible Notes, has alleged that
      we
      have defaulted in our failure to maintain the effectiveness of the registration
      statement on Form S-3 pertaining to the Senior Secured Convertible Notes in
      such
      manner as to permit such holder to sell its shares pursuant to that registration
      statement and that we have defaulted under the terms of the Senior Secured
      Convertible Notes by entering into certain types of debt financing transactions.
      As a consequence of these alleged defaults, these holders have demanded the
      immediate redemption of the principal amount of their Senior Secured Convertible
      Notes plus payment of a redemption premium of $675,000 to each of them.





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





None.





**ITEM
      5**  **Other
      Information**




None.




**ITEM
      6**  **Exhibits
      and Reports on Form 8-K**


4.1
              
              Restated
                  Certificate of Incorporation*4.2
              
              Certificate
                  of Amendment of Certificate of Incorporation of SpatiaLight,
                  Inc.*4.3
              
              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*
  41
  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.




42




**SIGNATURES**





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


Date:
August
              20, 2007SpatiaLight, Inc.By:
            /s/
              David F. HakalaDavid
                F. Hakala
              Acting
                Chief Executive Officer, Chief OperatingOfficer,
              Principal
                Financial and Accounting
                Officer


43


EXHIBIT
      INDEX





4.1
            
            Restated
                Certificate of Incorporation*4.2
            
            Certificate
                of Amendment of Certificate of Incorporation of SpatiaLight,
                Inc.*4.3
            
            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.





44