UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





[X]
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
quarterly period ended October
31, 2008


or





[   ]
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
Transition Period from __________ to __________





Commission
      file number: None













PureDepth,
      Inc.


(Exact
      name of registrant as specified in its
charter)




Delaware
              (State or other jurisdiction
      of incorporation or
      organization)
            20-4831825
              (I.R.S.
      Employer Identification No.)




230 Twin
Dolphin Drive, Suite 230D, Redwood City, California 94065


(Address
      of principal executive offices) (Zip
Code)





(650)
      632-0800


(Registrant’s
telephone number, including area code)








(Registrant’s
former address, if changed since last report)






Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [X]No [  ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.






[   ]
      Large accelerated filer
            [   ]
      Accelerated filer[   ]
      Non-accelerated filer (Do not check if a smaller reporting
      company)
            [X] Smaller reporting
      company




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


Yes
[  ]            No [X]




As of
December 12, 2008, 68,866,352 shares of Issuer’s common stock, $0.001 par value,
were outstanding.





1


INDEX




PagePART I - FINANCIAL
      INFORMATIONItem
      1
            Financial
      Statements:
            3-
      Condensed Consolidated Balance Sheets (Unaudited)-
      Condensed Consolidated Statements of Operations and Comprehensive Loss
      (Unaudited)-
      Condensed Consolidated Statements of Cash Flows
(Unaudited)-
      Notes to Unaudited Condensed Consolidated Financial
    StatementsItem
      2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            18Item
      3
            Quantitative
      and Qualitative Disclosures about Market Risk
            28Item
      4T
            Controls
      and Procedures
            28PART II - OTHER
      INFORMATIONItem
      1
            Legal
      Proceedings
            29Item
      1A
            Risk
      Factors
            29Item
      2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            38Item
      3.
            Defaults
      Upon Senior Securities
            38Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            38Item
      5.
            Other
      Information
            38Item
      6.
            Exhibits
            39Signatures
            42








2




PART
I – FINANCIAL INFORMATION


Item
1 - Financial Statements


PUREDEPTH,
INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS


(Unaudited)




October
      31,
              2008
            
            
            January
      31, 2008ASSETSCurrent
      AssetsCash
      and cash equivalents
            
            $
            8,654,424
            
            
            $
            429,726Restricted
      cash
            
            
            15,000
            
            
            
            78,499Accounts
      receivable, net
            
            
            51,569
            
            
            
            12,000Inventory
            
            
            109,908
            
            
            
            -Other
      current assets
            
            
            219,793
            
            
            
            152,276Total
      current assets
            
            
            9,050,694
            
            
            
            672,501Property and Equipment,
      net
            
            
            277,518
            
            
            
            382,300Other
    AssetsIntellectual
      property, net
            
            
            2,650,873
            
            
            
            2,564,260Other
      assets
            
            
            45,949
            
            
            
            40,000Total
      Assets
            
            $
            12,025,034
            
            
            $
            3,659,061





LIABILITIES
      AND STOCKHOLDERS’ DEFICITCurrent LiabilitiesAccounts
      payable
            
            $
            302,059
            
            
            $
            379,556Accrued
      expenses
            
            
            360,280
            
            
            
            865,641Accrued
      interest
            
            
            109,776
            
            
            
            7,253Notes
      payable – current portion
            
            
            131,480
            
            
            
            135,870Deferred
      revenue – current portion
            
            
            939,757
            
            
            
            750,000Convertible
      debt, net of discount
            
            
            3,831,912
            
            
            
            -Other
      current liabilities
            
            
            13,646
            
            
            
            -Total
      current liabilities
            
            
            5,688,910
            
            
            
            2,138,320Long Term
      LiabilitiesNotes
      payable
            
            
            303,720
            
            
            
            312,309Long
      term debt
            
            
            -
            
            
            
            100,000Deferred
      revenue
            
            
            11,255,001
            
            
            
            2,033,654Other
      long term liabilities
            
            
            15,000
            
            
            
            -Total
      Liabilities
            
            
            17,262,631
            
            
            
            4,584,283Commitments
      and contingenciesStockholders' DeficitPreferred
      stock, $0.001 par value, 10,000,000 authorized and nooutstanding
      shares
            
            
            -
            
            
            
            -Common
      stock, $0.001 par value, 190,000,000 sharesauthorized,
      68,572,235 and 68,483,979 issued and outstanding
            
            
            68,573
            
            
            
            68,484Additional
      paid in capital
            
            
            34,952,241
            
            
            
            34,155,297Accumulated
      other comprehensive loss
            
            
            (489,844
            )
            
            
            (706,421
            )Accumulated
      deficit
            
            
            (39,768,567
            )
            
            
            (34,442,582
            )Total
      stockholders' deficit
            
            
            (5,237,597
            )
            
            
            (925,222
            )Total
      Liabilities and Stockholders' Deficit
            
            $
            12,025,034
            
            
            $
            3,659,061




The
accompanying footnotes are an integral part of these unaudited condensed
consolidated financial statements.




3


PUREDEPTH,
INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS


(Unaudited)





Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            October
      31,2008
            
            
            2007
            
            
            2008
            
            
            2007RevenueLicensing
            
            $
            213,895
            
            
            $
            187,500
            
            
            $
            590,895
            
            
            $
            562,500Services
            
            
            -
            
            
            
            32,088
            
            
            
            110,052
            
            
            
            67,087Product
      sales
            
            
            180,000
            
            
            
            77,000
            
            
            
            231,750
            
            
            
            207,317Total
      revenue
            
            
            393,895
            
            
            
            296,588
            
            
            
            932,697
            
            
            
            836,904Cost
      of licensing
            
            
            82,732
            
            
            
            80,634
            
            
            
            244,019
            
            
            
            234,603Cost
      of services
            
            
            -
            
            
            
            32,256
            
            
            
            87,473
            
            
            
            57,776Cost
      of product sales
            
            
            230,116
            
            
            
            65,023
            
            
            
            290,532
            
            
            
            184,565Total
      cost of revenue
            
            
            312,848
            
            
            
            177,913
            
            
            
            622,024
            
            
            
            476,944Gross
      margin
            
            
            81,047
            
            
            
            118,675
            
            
            
            310,673
            
            
            
            359,960Operating
      ExpensesDepreciation
            
            
            32,192
            
            
            
            30,348
            
            
            
            96,545
            
            
            
            68,810Research
      and development
            
            
            560,233
            
            
            
            701,284
            
            
            
            1,613,075
            
            
            
            1,870,661Sales
      and marketing
            
            
            581,074
            
            
            
            504,625
            
            
            
            784,138
            
            
            
            1,400,713General
      and administrative
            
            
            886,890
            
            
            
            1,150,831
            
            
            
            2,609,144
            
            
            
            4,127,035Total
      operating expenses
            
            
            2,060,389
            
            
            
            2,387,088
            
            
            
            5,102,902
            
            
            
            7,467,219Loss
      from operations
            
            
            (1,979,342
            )
            
            
            (2,268,413
            )
            
            
            (4,792,229
            )
            
            
            (7,107,259
            )Other Income (Expense)Interest
      income
            
            
            44,679
            
            
            
            29,122
            
            
            
            54,811
            
            
            
            177,292Interest
      expense
            
            
            (105,610
            )
            
            
            (14,041
            )
            
            
            (240,176
            )
            
            
            (41,804
            )Foreign
      exchange loss
            
            
            (285,183
            )
            
            
            (78,532
            )
            
            
            (348,866
            )
            
            
            (145,305
            )Other
      income
            
            
            475
            
            
            
            470
            
            
            
            475
            
            
            
            362Total
      other income (expense)
            
            
            (345,639
            )
            
            
            (62,981
            )
            
            
            (533,756
            )
            
            
            (9,455
            )Loss
      before income taxes
            
            
            (2,324,981
            )
            
            
            (2,331,394
            )
            
            
            (5,325,985
            )
            
            
            (7,116,714
            )Income
      tax provision
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            $
            (2,324,981
            )
            
            $
            (2,331,394
            )
            
            $
            (5,325,985
            )
            
            $
            (7,116,714
            )Net
      loss per share, basic and diluted
            
            $
            (0.03
            )
            
            $
            (0.03
            )
            
            $
            (0.08
            )
            
            $
            (0.11
            )Weighted
      average shares outstanding
            
            
            68,572,235
            
            
            
            67,424,122
            
            
            
            68,498,042
            
            
            
            66,953,379Comprehensive
      LossNet
      loss, per statement of operations
            
            $
            (2,324,981
            )
            
            $
            (2,331,394
            )
            
            $
            (5,325,985
            )
            
            $
            (7,116,714
            )Foreign
      exchange gain
            
            
            174,122
            
            
            
            62,122
            
            
            
            216,577
            
            
            
            62,122Comprehensive
      net loss
            
            $
            (2,150,859
            )
            
            $
            (2,269,272
            )
            
            $
            (5,109,408
            )
            
            $
            (7,054,592
            )





The
accompanying footnotes are an integral part of these unaudited condensed
consolidated financial statements.


4


PUREDEPTH,
INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




For
      Nine Months EndedOctober
      31, 2008
            
            
            October
      31, 2007CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
            
            $
            (5,325,985
            )
            
            $
            (7,116,714
            )Adjustments
      to reconcile net loss to net cash flows from operating
      activities:Depreciation
      and amortization
            
            
            340,564
            
            
            
            303,413Loss
      on disposal of assets
            
            
            1,314
            
            
            
            -Stock-based
      compensation expense
            
            
            567,055
            
            
            
            763,290Marketable
      securities
            
            
            -
            
            
            
            (44,247
            )Non-cash
      interest expense
            
            
            
            
            
            
            (2,822
            )Amortization
      of debt discount
            
            
            137,178
            
            
            
            -Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (39,569
            )
            
            
            (97,013
            )Restricted
      cash
            
            
            63,499
            
            
            
            (16,952
            )Inventory
            
            
            (109,908
            )
            
            
            -Other
      assets
            
            
            (73,466
            )
            
            
            (46,149
            )Accounts
      payable
            
            
            (77,497
            )
            
            
            74,288Deferred
      revenue
            
            
            9,411,104
            
            
            
            (562,500
            )Accrued
      expenses
            
            
            (505,361
            )
            
            
            332,348Accrued
      interest
            
            
            102,523
            
            
            
            41,604Other
      liabilities
            
            
            28,646
            
            
            
            -Net
      cash provided by (used in) operating activities
            
            
            4,520,097
            
            
            
            (6,371,454
            )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of securities
            
            
            -
            
            
            
            (999,631
            )Proceeds
      from the maturity of securities
            
            
            -
            
            
            
            4,016,000Proceeds
      from sale of fixed assets
            
            
            14,946
            
            
            
            -Purchases
      of fixed assets
            
            
            (8,025
            )
            
            
            (152,997
            )Expenditures
      for intellectual property
            
            
            (330,630
            )
            
            
            (260,986
            )Net
      cash provided by (used in) investing activities
            
            
            (323,709
            )
            
            
            2,602,386CASH
      FLOWS FROM FINANCING ACTIVITIESIssuance
      of common stock (net)
            
            
            24,712
            
            
            
            694,104Proceeds
      from convertible debt
            
            
            3,800,000
            
            
            
            -Borrowings
      on capital lease and short term financing
            
            
            
            
            
            
            14,859Principal
      payments on notes payable
            
            
            (12,979
            )
            
            
            (826
            )Net
      cash provided by financing activities
            
            
            3,811,733
            
            
            
            708,137Effect
      of exchange rate on cash
            
            
            216,577
            
            
            
            62,122Net
      increase (decrease) in cash and cash equivalents
            
            
            8,224,698
            
            
            
            (2,998,809
            )Cash
      and cash equivalents at beginning of period
            
            
            429,726
            
            
            
            5,279,878Cash
      and cash equivalents at end of period
            
            $
            8,654,424
            
            
            $
            2,281,069





NON
      CASH DISCLOSURES:Advance
      on convertible debt
            
            $
            100,000
            
            
            $
            -








The accompanying footnotes are an
integral part of these unaudited condensed consolidated financial
statements.


5


PUREDEPTH,
INC. AND SUBSIDIARIES


Notes
to the Unaudited Condensed Consolidated Financial Statements





Note
1 - Summary of Significant Accounting Policies





Basis
of Presentation





The
accompanying unaudited condensed consolidated financial statements of PureDepth,
Inc. (“the Company") are presented in accordance with the requirements for Form
10-Q and Article 8 of Regulation S-X.  Accordingly, they do not
include all of the disclosures required by accounting principles generally
accepted in the United States of America.   The accompanying
condensed consolidated balance sheet as of January 31, 2008, which has been
derived from the audited consolidated financial statements and the accompanying
unaudited condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission.  The interim period financial statements should be read in
conjunction with the audited consolidated financial statements for the year
ended January 31, 2008 included in the Company's Annual Report on Form 10-KSB
filed with the Commission on April 30, 2008.  Those statements contain a
summary of significant accounting policies.





In the
opinion of management, all adjustments (all of which were of a normal recurring
nature) considered necessary to fairly present the financial position, results
of operations, and cash flows of the Company on a consistent basis, have been
made.





These
results have been determined on the basis of accounting principles generally
accepted in the United States and practices applied consistently with those used
in the preparation of the Company's Annual Consolidated Financial Statements for
the years ended January 31, 2008 and 2007.  Operating results for the
three and nine months ended October 31, 2008 are not necessarily indicative of
the results that may be expected for the year ending January 31,
2009.





Certain
balances in the prior periods have been reclassified to conform to the
presentation adopted in the current period.





Going
Concern





The
accompanying condensed consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which as of October 31, 2008 contemplated continuation of the Company
as a going concern. The report from the Company’s independent auditors on the
financial statements for the year ended January 31, 2008 includes an explanatory
paragraph indicating there is substantial doubt about the Company’s ability to
continue as a going concern.  The Company’s operations have resulted
in operating losses to date and are expected to continue to have operating
losses in the year ending 2009.





On
September 10, 2008, the Company entered into an amendment (the “Amendment”) to
the Patent and Technology License and Technology Transfer Agreement (“License
Agreement”) with International Game Technology (IGT) dated October 13,
2006.  Pursuant to the terms of the Amendment, among other
consideration, the Company received an advance, non-refundable payment of
licensing fees from IGT in the amount of ten million dollars
($10,000,000).  The Company believes that the advance, non-refundable
payment of licensing fees allows the Company to effectively address its going
concern issues for the remainder of the year ending January 31, 2009 and into
the year ending January 31, 2010.  See Note 6 – Deferred Revenue in
this Quarterly Report on Form 10-Q for further information on our deferred
revenue.





In
addition to its receipt of the advance, non-refundable payment of licensing
fees, the Company raised $3.9 million during the nine months ended October 31,
2008 in secured convertible debt from its majority shareholder.  The
Company may continue to consider raising additional funds from a number of
sources, including, but not limited to, additional sales of equity
or convertible debt securities, loans from banks, other financial
institutions or affiliates, or a credit facility.





The funds
from the non-refundable payment of licensing fees under the Amendment and the
secured convertible debt will be used to fund the Company’s operations, continue
the Company’s efforts to fulfill and promote existing customer agreements with
Sanyo Electric Corporation (Sanyo), International Game Technology (IGT) and
Samsung Electronics Company, Ltd (Samsung) and expand the Company’s customer
base to diversify its sources of licensing revenue.  The funds may
also be used to minimize the Company’s current or future debt
obligations.





6




Recently
Issued Accounting Pronouncements




In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.SFAS No. 159 permits entities to choose
to measure many financial instruments and certain other items at fair value.
SFAS No. 159 was effective at the beginning of 2008. The adoption of this
statement did not have a material impact on the Company’s financial condition,
results of operations, or liquidity.




In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which
changes the accounting for business combinations and their effects on the
financial statements. SFAS No. 141(R) will be effective at the beginning of
2009. The adoption of this statement is not expected to have a material impact
on the Company’s financial condition, results of operations, or
liquidity.




In
December 2007, the FASB issued SFAS No. 160, Accounting and Reporting of
Noncontrolling Interests in Consolidated Financial Statements, and amendment of
ARB No. 51. SFAS No. 160 requires entities to report non-controlling
interests in subsidiaries as equity in their consolidated financial statements.
SFAS No. 160 will be effective at the beginning of 2009. The adoption of this
statement is not expected to have a material impact on the Company’s financial
condition, results of operations, or liquidity.




In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement
No. 133.  SFAS No. 161 requires enhanced disclosures
about a company’s derivative and hedging activities including: how and why
derivative instruments are utilized; how derivative instruments and related
hedged items are accounted for under SFAS No. 133 and its related
interpretations; and how derivative instruments and related hedged items affect
a company’s financial position, financial performance and cash
flows.  SFAS No. 161 is effective for financial statements issued
for fiscal years and interim periods beginning after November 15,
2008.  The
adoption of this statement is disclosure related and is not expected to have a
material impact on the Company’s financial condition, results of operations, or
liquidity.




In May 2008, the FASB
issued SFAS No. 162,The
Hierarchy of Generally Accepted Accounting Principles.SFAS No. 162 identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy).  The GAAP hierarchy is
directed to the entities rather than the auditors as entities are responsible
for selecting accounting principles for financial statements that are presented
in conformity with GAAP. The Board concluded that the GAAP hierarchy should
reside in the accounting literature established by the FASB and is issuing this
Statement to achieve that result.  This Statement is effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411,The
Meaning ofPresent Fairly in
Conformity With Generally Accepted Accounting Principles.The adoptionof this statement will
not result in a change to the current practice and is not expected to have a
material impact on the Company’sfinancial condition,
results of operations, or liquidity.





In April
2008, the FASB issued Staff Position No. 142-3, Determination of the Useful Life of
Intangible Assets (“FSP No. 142-3”). FSP No. 142-3 amends the
guidance in FASB Statement No. 142, Goodwill and Other Intangible
Assets, for estimating useful lives of recognized intangible assets and
requires additional disclosures related to renewing or extending the terms of a
recognized intangible asset.  In estimating the useful life of a
recognized intangible asset, FSP No. 142-3 requires companies to consider
their historical experience in renewing or extending similar arrangements
together with the asset’s intended use, regardless of whether the arrangements
have explicit renewal or extension provisions.  FSP No. 142-3 is
effective for fiscal years beginning after December 15, 2008 and is to be
applied prospectively to intangible assets acquired after the effective date.
The disclosure requirements are to be applied prospectively to all intangible
assets. The Company is currently evaluating what effect, if any, the adoption of
FSP 142-3 will have on the Company’s financial condition,
results of operations, or liquidity.




Use
of Estimates




The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires the use of management’s estimates. These estimates are subjective in
nature and involve judgments that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements.  Actual results may differ from these
estimates.








7





Note
2 - Description of Business





PureDepth,
Inc., (PDI) along with its two wholly owned subsidiaries, PureDepth Limited
(PDL) and PureDepth Incorporated Limited (PDIL) develops, markets, licenses, and
supports multi-layer display (MLD) technology.  Unlike other
display-based technologies, the MLD technology was created and designed based on
how humans visualize the world.  Depth is a key component of everyday
visualization and interaction, yet in the world today most of our information is
displayed on technology that can, at best, only provide the visual perception of
depth. Unlike standard two-dimensional (2D) display technologies that utilize
only a single-layer liquid crystal display (LCD), the MLD technology utilizes
two or more LCD panels that are stacked and separated by actual
depth.





The
Company’s technology has application in industries and markets where flat panel
monitors and displays are utilized.  The Company’s goal is to have
their MLD technology become a standard technology for incorporation into these
LCD-based products, which include location-based entertainment devices, computer
monitors, flat panel televisions, mobile devices and other mass market display
devices.





The
accompanying condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America (“U.S. GAAP”).  The condensed consolidated financial
statements include all of the accounts of PureDepth, Inc., a U.S. corporation
based in California, and its wholly-owned subsidiaries, based in Auckland, New
Zealand.








Note
3 - Inventory





The
Company uses a series of subcontractors to manufacture a MLD component part that
is sold to a licensing customer.  The purchases of raw materials, work
in process and finished goods are recorded as inventory until the components are
sold to the licensing customers.  All inventories are located at
subcontractor facilities.   Inventories include materials,
subcontractor expenses and overhead and are stated at the lower of cost or
market.  Cost is determined using the first-in, first out (“FIFO”)
method.  Market is determined based on net realizable
value.  Appropriate consideration is given to obsolescence, excess
quantities, and other factors in evaluation net realizable value.





Inventories:
            
            October
      31,
              2008
            
            
            January
      31,
              2008Raw
      materials
            
            $
            15,679
            
            
            $
            -Work-in-progress
            
            
            75,468
            
            
            
            -Finished
      goods
            
            
            18,761
            
            
            
            -Total
      inventories
            
            $
            109,908
            
            
            $
            -








8




Note
4 - Intellectual Property





Intellectual
property consists of the following:




October
      31,
              2008
            
            
            January
      31,
              2008Acquired
      patent rights
            
            $
            2,299,509
            
            
            $
            2,299,509Software
      development costs
            
            
            70,456
            
            
            
            70,456Patent
      registration costs
            
            
            2,730,512
            
            
            
            2,399,880Less:
      accumulated amortization
            
            
            (2,449,604
            )
            
            
            (2,205,585
            )Intellectual
      property, net
            
            $
            2,650,873
            
            
            $
            2,564,260





Amortization
of intellectual property is included in licensing cost of
sales.   For the three months ended October 31, 2008 and 2007
amortization expense totaled $82,732 and $80,634, respectively and for the nine
months ended October 31, 2008 and 2007 amortization expense totaled $244,019 and
$234,603, respectively.





Amortization
expense for the next five years is summarized in the following
table:




Years
      ending January 31,2009
            
            $
            89,1192010
            
            
            333,1362011
            
            
            333,1362012
            
            
            169,2942013
            
            
            136,526Thereafter
            
            
            1,589,662Total
            
            $
            2,650,873







Note
5 - Notes Payable and Convertible Notes




Notes
Payable





The
Company had the following obligations outstanding:




October
      31,
              2008
            
            
            January
      31,
              2008Notes
      payable excluding imputed interest to date at 10%,payable
      in equal annual installments of $175,000 throughJanuary
      31, 2011 and secured by intellectual property
            
            $
            435,200
            
            
            $
            435,200Other
            
            
            -
            
            
            
            12,979Less:
      current portion
            
            
            (131,480
            )
            
            
            (135,870
            )Total
      long term notes payable
            
            $
            303,720
            
            
            $
            312,309





Future maturities of long term debt excluding imputed interest are as
follows:




Years
      ending January 31,2009
            
            $
            131,4802010
            
            
            144,6282011
            
            
            159,092Total
            
            $
            435,200








9




Secured
Convertible Debt and Related Instruments





On
February 4, 2008 and subsequently amended on July 4, 2008 and August 12, 2008,
the Company executed a Convertible Note Purchase Agreement (“Note Purchase
Agreement” or “notes”) with K One W One Ltd., a majority shareholder and
accredited investor, whereby the Company issued $3.9 million in secured
convertible promissory notes (the “Convertible Notes”). These notes bear an
interest rate of 8% per year, which accrues starting on October 4, 2008, and
mature on February 4, 2009. The Company intends to use the proceeds for general
corporate purposes, including working capital. This financing was a private
placement with an accredited investor and is exempt from registration pursuant
to Section 4(2) of the Securities Act of 1933, as amended. Pursuant to a
Security Agreement dated February 4, 2008, as amended on July 4, 2008 and August
12, 2008, by and between the Company and the Purchaser (the “Security
Agreement”); the Convertible Notes are secured by substantially all of the
assets of the Company, including the Company’s intellectual property. The
principal and interest due on the Convertible Notes are payable on the maturity
date, subject to earlier conversion due to a Qualified Financing event, as
defined in the Convertible Notes. At the option of the holder, principal and
interest due on the Convertible Notes is payable either in cash or in common
stock. The price per share of common stock for any such conversion shall be
equal to an amount equal to 95% of the lower of (i) the average of the daily
volume-weighted average price of the Company’s stock over a period of 10 days
prior to the date of the signing of the Agreement (or, in the case of
Convertible Notes issued on or after July 4, 2008, the date of issuance of such
Convertible Notes), as quoted on the OTCBB or (ii) the average of the daily
volume-weighted average price of the Company’s common stock over a period of ten
trading days prior to the maturity date, as quoted on the OTCBB.





The Notes
contain customary negative covenants for loans of this type, including
limitations on the Company’s ability to incur indebtedness, issue securities,
and dispose of assets. As of October 31, 2008, the Company is not in
default.





Additionally,
the Convertible Notes were issued with embedded and potentially detachable
derivatives which included the conversion feature and warrants (contingent upon
the conclusion of a Qualified Event).





The
Company applied the guidance in SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” (“SFAS No. 133”) and EITF Issue 00-19
“Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company’s Own Stock”, (“EITF 00-19”) in evaluating whether the
debt conversion feature for the secured convertible term note issued to the
holder is an embedded derivative that should be separated from the debt host and
accounted for as a derivative at fair value.  The Company determined
that the Convertible Notes did not meet the definition of conventional
convertible debt in paragraph 4 of EITF 00-19 and EITF 05-02, since the
conversion price is variable.  The Company evaluated the embedded
conversion feature pursuant to paragraphs 12-32 of EITF 00-19, and determined
that conversion feature did not require liability classification. Accordingly,
the value assigned to the embedded conversion feature of the Debentures followed
the guidance of the EITF Issue No. 98-5, “Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratio”, and EITF Issue No. 00-27, “Application of Issue No. 98-5 to Certain
Convertible Instruments” of the FASB’s Emerging Issues Task
Force.  The debt discount associated with the embedded conversion
feature is amortized to interest expense over the life of the Debenture or upon
earlier conversion of the Debenture using the effective yield
method.




Contingent
Features





The
Convertible Notes include a provision that results in an automatic conversion in
case the Company concludes a Qualified Financing prior to the Maturity Date.
Pursuant to the terms of the Notes, a “Qualified Financing” shall mean the
Company’s first financing transaction after the Initial Closing in which the
Company issues investment instruments of the Company and receives gross proceeds
of at least $3,000,000 for application to several corporate purposes from an
investor or investors (not including proceeds from the conversion of the
Note(s)); and provided that if the proposed investment instruments offered in
such financing transaction are other than capital stock or other equity
instruments (such as convertible debentures or other debt instruments), the
financing transaction shall require the written consent of K1W1 to be considered
a Qualified Financing for purposes of this Agreement. For the avoidance of
doubt, an investment instrument will not be deemed to be an equity instrument
for the purposes of the preceding sentence if such investment instrument is, by
its terms, convertible into or exchangeable for any type of debt instrument,
whether at the option of the Company or the holder.








10




The value
assigned to the Convertible Notes and the related debt features on issuance as
of October 31, 2008 is the following:




Date
      of Note
            
            Amount
      of Notes
            
            
            Debt
      Features
              Value
      at Issuance
            
            
            Initial
              Carrying
      ValueFebruary
      4, 2008
            
            $
            1,000,000
            
            
            $
            52,632
            
            
            $
            947,368March
      14, 2008
            
            
            2,000,000
            
            
            
            105,263
            
            
            
            1,894,737July
      5, 2008
            
            
            400,000
            
            
            
            21,053
            
            
            
            378,947August
      12, 2008
            
            
            500,000
            
            
            
            26,315
            
            
            
            473,685Total
            
            $
            3,900,000
            
            
            $
            205,263
            
            
            $
            3,694,737





The
amortized debt discount associated with the embedded conversion feature was
recorded to interest expense in the amount of $63,973 and $137,178 for the three
and nine months ended October 31, 2008, respectively.





If the
aggregate principal amount owing under the Convertible Notes is converted, the
Company will issue 12,786,625 shares of Common Stock, which may be adjusted
based upon the conversion purchase price formula pursuant to the terms of the
Convertible Note.  If the Notes are not converted, the principal and
accrued interest will be due on February 4, 2009.





Warrant





Pursuant
to the Note Purchase Agreement, the Company granted the note holder a warrant
which would become exercisable for shares of its common stock if and only if a
Qualified Financing takes place prior to termination of the Warrant.  The
Warrant will expire on February 4, 2011 or immediately prior to a change in
control pursuant to the terms of the Warrant.  If the warrants are
exercisable due to a Qualified Financing, the Warrants would permit the
Purchasers to purchase Common Stock at an exercise price of an amount equal to
95% of the lower of (i) the average of the daily volume-weighted average price
of the Company’s stock over a period of 10 days prior to signing of the Note
Purchase Agreement, as quoted on the OTCBB or (ii) the average of the daily
volume-weighted average price of the Company’s common stock over a period of ten
trading days prior to the maturity date, as quoted on the OTCBB.





Because a
Qualified Financing has not yet taken place and because the warrants are only
exercisable upon a Qualified Financing, the warrant’s exercise price and number
of shares are not yet determinable. As such, the warrants have not been
measured.  If and when a Qualified Financing does occur, the warrants
will be measured and recognized at that time.








Note
6 - Deferred Revenue





Deferred
revenue represents payments from customers of non-refundable licensing fees that
are ultimately expected to be recognized as revenue, but for which not all
revenue recognition criteria have been met.  As the revenue
recognition criteria is met, deferred revenue is amortized in accordance with
the terms of the license agreement on the greater of the straight line basis
over the life of the agreement or the units of production method.








Note
7 - Stockholders’ Deficit





Stock
warrants





The
following table summarizes common stock warrant activity for:




Nine
      Months Ended
              October
      31, 2008
            
            
            Twelve
      Months Ended
              January
      31, 2008Warrants
            
            
            Weighted
      Average
              Exercise
      Price
            
            
            Warrants
            
            
            Weighted
      Average
              Exercise
      PriceOutstanding
      at beginning of period
            
            
            17,290,468
            
            
            
            $1.15
            
            
            
            19,404,660
            
            
            
            $1.12Issued
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            (205,202
            )
            
            
            $0.87Expired
            
            
            -
            
            
            
            -
            
            
            
            (1,908,990
            )
            
            
            $0.87Outstanding
      at end of period
            
            
            17,290,468
            
            
            
            $1.15
            
            
            
            17,290,468
            
            
            
            $1.15Exercisable
      at end of period
            
            
            17,290,468
            
            
            
            $1.15
            
            
            
            17,290,468
            
            
            
            $1.15






11


Included
in the total outstanding warrants for the nine months ended October 31, 2008 and
the twelve months ended January 31, 2008 are A-warrants to purchase 9,147,613
shares of common stock at $1.20 per share, C-warrants to purchase 1,082,811
shares of common stock at $0.44 per share, and D-warrants to purchase 7,060,044
shares of common stock at $1.20 per share.





The
Company values warrants issued as compensation at the fair value determined on
the date of grant using the Black-Scholes valuation model and the same
assumptions as used for employee stock-based compensation except for expected
terms which are determined by the respective warrant agreement.  See
Stock option plan note for related discussion and assumptions.





Stock
option plan





At
October 31, 2008, the Company had reserved a total of 22,241,260 shares of
common stock for issuance under its 2006 Stock Incentive Plan (the Plan). The
Plan is an amendment of the Second Amended and Restated Executive Share
Option Plan No. 3 (Second Plan).  The Second Plan was as an
amendment of the First Amended and Restated Executive Share Option Plan No. 3
(First Plan), which was assigned by DVIL in connection with the 2005
restructuring. The First Plan, in turn, was a successor plan to the
Executive Share Option Plan Number 3 of DVIL. The predecessor options were
denominated in New Zealand dollars; options granted following the
assignment are exercisable in U.S. dollars.  Options granted in each
successor plan were designed to replace, without modification of terms, options
of the predecessor plan. Awards under the successor plans which did result
in either a modification or a new award of executive options were assigned a
grant date fair value which is charged to expense over the expected service
period of the recipient.





Option
awards have generally been granted with an exercise price equal to the market
price of the Company’s stock at the date of grant; the option awards generally
vest over three years with 1/6 vesting at 6 months and 1/12 at quarterly
intervals thereafter.  The options expire in seven years from the date
of grant. Certain option awards included anti-dilution provisions resulting in
the original option grants becoming exercisable for an additional 1,185,022 of
shares of common stock (post merger adjusted additional shares were 2,713,945)
to existing employees as a result of the increase in shares from the private
placement offering.  On December 19, 2006, the stock option agreements
for certain executive officers and directors were amended  pursuant to
which the optionees are required to exercise shares, if at all, in
pre-determined annual allotments and to sell any such exercised shares on a
pre-determined scheduled.  Any portion of the options that are not
exercised pursuant to the exercise schedule set forth in the amendment will
expire. These modifications made the awards less favorable resulting in no
additional stock-based compensation expense.




The fair
value of each option award was estimated on the date of grant using a
Black-Scholes option valuation model that uses the assumptions noted in the
following table. Expected volatilities were based on historical volatility of
similar companies considering characteristics such as industry, stage of life
cycle, size, financial leverage, and other factors. Expected forfeiture rates
were determined by considering the Company’s historical data to estimate option
exercise and employee termination.  The expected dividend yield is
based on our history of having never paid dividends and our expectation that we
will not pay dividends in the near future.  The expected term of our
employee option grants in the nine months ended October 31, 2008 is the
simplified approach as defined by SEC Staff Accounting Bulletin No. 107, Share-Based Payment (SAB
107). This approach resulted in expected terms of 3.5 to 5.5 years for stock
options and 1.5 years for stock warrants.  The risk-free rate for
periods within the contractual life of the option is based on the U.S. Treasury
rate in effect at the time of grant.





Significant
      Assumptions
            Nine
      Months Ended
              October
      31, 2008
            Twelve
      Months Ended
              January
      31, 2008Expected
      volatility
            70%
            70%Expected
      forfeiture rate
            30%
            30%Expected
      dividend yield
            0%
            0%Expected
      term (in years)
            3.5
      to 5.5
            3.5
      to 5.0Risk-free
      rate
            2.38%
      to 3.19%
            2.94%
      to 5.03%








12




The
following table summarizes common stock option activity under the plan
for:




Nine
      Months Ended
              October
      31, 2008
            
            
            Twelve
      Months Ended
              January
      31, 2008Option
      Shares
            
            Shares
            
            
            Weighted
      Average
              Exercise
      Price
            
            
            Shares
            
            
            Weighted
      Average
              Exercise
      PriceOutstanding
      at beginning of period
            
            
            12,002,429
            
            
            
            $0.74
            
            
            
            12,815,411
            
            
            
            $0.68Granted
            
            
            7,085,000
            
            
            
            $0.28
            
            
            
            4,177,501
            
            
            
            $1.21Exercised
            
            
            (88,256
            )
            
            
            $0.27
            
            
            
            (2,121,395
            )
            
            
            $0.28Forfeited
      and cancelled
            
            
            (2,301,436
            )
            
            
            $1.37
            
            
            
            (2,869,088
            )
            
            
            $1.48Outstanding
      at end of period
            
            
            16,697,737
            
            
            
            $0.46
            
            
            
            12,002,429
            
            
            
            $0.74Exercisable
      at end of period
            
            
            9,268,890
            
            
            
            $0.45
            
            
            
            8,684,732
            
            
            
            $0.53





The
following table summarizes significant ranges of outstanding and exercisable
options as of October 31, 2008:




Outstanding
            
            
            ExercisableExercise
      Price Range
            
            
            Shares
            
            
            Weighted
              Average
              Life*
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Aggregate
              Intrinsic
              Value
            
            
            Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Aggregate
              Intrinsic
              Value$0.27
      to $0.44
            
            
            
            14,240,670
            
            
            
            
            5.27
            
            
            
            $0.28
            
            
            
            $0.0
            
            
            
            8,226,088
            
            
            
            
            $0.28
            
            
            
            $0.0$0.48
      to $2.07
            
            
            
            1,713,400
            
            
            
            
            5.91
            
            
            
            $1.03
            
            
            
            $0.0
            
            
            
            570,884
            
            
            
            
            $1.12
            
            
            
            $0.0$2.20
      to $2.95
            
            
            
            533,400
            
            
            
            
            5.11
            
            
            
            $2.25
            
            
            
            $0.0
            
            
            
            316,717
            
            
            
            
            $2.26
            
            
            
            $0.0$3.03
      to $3.51
            
            
            
            210,267
            
            
            
            
            4.93
            
            
            
            $3.40
            
            
            
            $0.0
            
            
            
            155,201
            
            
            
            
            $3.40
            
            
            
            $0.0Totals
            
            
            
            16,697,737
            
            
            
            
            5.32
            
            
            
            $0.46
            
            
            
            $0.0
            
            
            
            9,268,890
            
            
            
            
            $0.45
            
            
            
            $0.0


*Average
contractual remaining life in years





The
aggregate intrinsic value in the preceding table represents the total pretax
intrinsic value based on stock options with an exercise price less than the
Company’s closing stock price of $0.19 as of October 31, 2008, which would have
been received by the option holders had those option holders exercised their
options as of that date.  There were no in-the-money stock options
exercisable as of October 31, 2008.  At October 31, 2008, 9,268,890
options were exercisable with a weighted-average exercise price of these options
was $0.45. Of the 22,241,260 shares of common stock reserved for issuance under
its 2006 Stock Incentive Plan, 16,697,737 options were outstanding, 2,798,821
options have been exercised and 2,744,702 options are available for grant at
October 31, 2008.





The
stock-based compensation cost for options issued in the three months ended
October 31, 2008 and 2007 was $190,148 and $376,617,
respectively.  The stock-based compensation cost for options issued in
the nine months ended October 31, 2008 and 2007 was $567,055 and $763,290,
respectively.  The total income tax benefit recognized in the income
statement for stock-based compensation arrangements was zero, due to the
Company's net operating loss carry-forwards and the associated valuation
allowance which results in an effective tax rate of zero. None of the
stock-based compensation cost recognized for option issuances has been
capitalized.  Total unrecorded stock-based compensation cost at
October 31, 2008 associated with employee and director stock options was
approximately $1.5 million and is expected to be recognized over a
weighted-average period of 2.8 years.








Note
8 – Major Customer





One
customer accounted for 100% and 99% of the Company’s licensing revenues in the
three and nine months ended October 31, 2008, respectively.  The same
customer accounted for 100% of the Company’s licensing revenues in the three and
nine months ended October, 31 2007 and the entire ending balance of deferred
revenue at October 31, 2008 and January 31, 2008.





13




Note
9 – Net Loss per Share





Basic net
loss per share is calculated on the basis of the weighted-average number of
common shares outstanding during the reporting periods. Diluted net loss per
share is calculated on the basis of the weighted-average number of common shares
outstanding and taking into account the dilutive effect of all potential common
stock equivalents outstanding. Potentially dilutive common stock equivalents
primarily consist of convertible debt, warrants and employee stock options.
Diluted net loss per share for the three and nine months ended October 31, 2008
and 2007 is equal to basic net loss per share because the effect of all
potential common stock outstanding during the periods, including convertible
debt, warrants and employee stock options is anti-dilutive. The components of
basic and diluted net loss per share were as follows:





Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            October
      31,2008
            
            
            2007
            
            
            2008
            
            
            2007Numerator:Net
      loss per share, basic and diluted
            
            $
            (2,324,981
            )
            
            $
            (2,331,394
            )
            
            $
            (5,325,985
            )
            
            $
            (7,116,714
            )Denominator:Weighted
      average shares outstanding, basic and diluted
            
            
            68,572,235
            
            
            
            67,424,122
            
            
            
            68,498,042
            
            
            
            66,953,379Net
      loss per share, basic and diluted
            
            $
            (0.03
            )
            
            $
            (0.03
            )
            
            $
            (0.08
            )
            
            $
            (0.11
            )





The
Company excluded the following shares from the denominator of the diluted net
loss per share calculation as the effect of including them would have been
anti-dilutive:





Three
      Months Ended
            
            Nine
      Months EndedOctober
      31,
            
            October
      31,2008
            
            
            2007
            
            2008
            
            
            2007Convertible
      notes
            12,786,625
            
            
            -
            
            12,786,625
            
            
            -Warrants
            17,290,468
            
            
            17,290,468
            
            17,290,468
            
            
            17,290,468Employee
      stock options
            19,496,558
            
            
            12,982,912
            
            16,697,737
            
            
            12,982,912








Note
10 - Related Party Transactions




On
February 4, 2008 and subsequently amended on July 4, 2008 and August 12, 2008,
the Company entered into a convertible note purchase agreement (“Note Purchase
Agreement”) with K One W One (“K1W1”) providing for the purchase by K1W1 of
convertible notes (“Notes”) up to of an aggregate principal amount of $3,900,000
or such greater amount as is approved in writing by the Company’s board of
directors and K1W1.  Under the Note Purchase Agreement, upon the
closing, on February 4, 2008, K1W1 purchased an initial Note of $1,000,000
($100,000 of which was previously funded to the Company on January 30, 2008), on
March 14, 2008 K1W1 purchased another Note of $2,000,000, on July 4, 2008 K1W1
purchased another Note of $400,000 and on August 12, 2008 K1W1 purchased another
Note of $500,000.  The Notes are secured by the assets of the Company
pursuant to a security agreement.  The Notes are convertible at a
discount of five percent (5%) into investment instruments issued by the Company
pursuant to and upon a qualified financing.  If such qualified
financing does not occur, upon maturity of the Notes on February 4, 2011 the
Notes may, at K1W1’s option, convert into common stock of the Company at a five
percent (5%) discount from a formula-derived market price.  The Notes
accrue interest at the annual rate of 8%, commencing October 4,
2008.  In addition, pursuant to the Note Purchase Agreement, K1W1
received in the form of a warrant the right to participate in qualified
financing, for a period of three years, in an amount equal to ten percent (10%)
of the aggregate principal under the Notes, and at a discount of five percent
(5%) of the purchase price of the investment instruments issued in such
qualified financing.





14




On April
10, 2008, the Board of Directors approved stock option grants to employees,
directors and to its recently appointed President, Mr. Jonathan McCaman,
totaling an aggregate of 3,385,000 shares of the Company’s common
stock.  The directors as a group were granted options to purchase
1,025,000 shares of Company common stock and the employees as a group were
granted options to purchase 1,610,000 shares of Company common
stock.  The director and employees’ shares vest 1/6 of their
underlying shares on October 10, 2008 and 1/12 of the remaining underlying
shares on a quarterly basis thereafter over a period of two and a half
years.  Mr. McCaman, was granted an option to purchase 750,000 shares
of Company common stock, vesting on a quarterly basis over a period of two
years.  All granted options were issued with an exercise price equal
to the closing price of the Company’s common stock on April 10, 2008 as reported
by the OTC Bulletin Board, $0.27 per share.  Each option will also be
subject to the terms and conditions of the Company’s 2006 Stock Incentive Plan
and form of stock option agreement, which each individual will be required to
sign as a condition of receiving the option.





On April
29, 2008 the Company and Mr. McCaman entered into an amendment to Mr. McCaman’s
employment agreement in connection with his appointment as President of the
Company.  The amendment provided that Mr. McCaman’s base salary was
increased to $210,000 effective as of March 1, 2008 and that he was eligible for
an executive incentive bonus, in an amount up to $50,000 per quarter, to be
based upon key performance indicators (“KPI’s”) to be mutually determined by Mr.
McCaman and the Board’s Compensation Committee, for the first two quarters,
within 30 days of signing of this Amendment, and thereafter on a schedule
determined by the parties.  On July 7, 2008 the Company paid Mr.
McCaman a $25,000 executive incentive bonus determined and approved by the
Board’s Compensation Committee for the three months ended April 30,
2008.  In addition, the amendment provided for the grant of a stock
option to purchase 750,000 shares of the Company’s common stock, vesting over
two years.  The Board of Directors previously approved Mr. McCaman’s
750,000 stock option grant as part of the stock options granted on April 10,
2008.  Pursuant to the amendment and subject to the approval of the
Board, each quarter Mr. McCaman was to be eligible for additional grants of
stock options to purchase up to 150,000 shares of the Company’s common stock, to
be based upon KPI’s to be mutually determined by Mr. McCaman and the Board’s
Compensation Committee, for the first two quarters, within 30 days of signing of
this Amendment, and thereafter on a schedule determined by the
parties.  On July 7, 2008 the Board of Directors approved a 75,000
stock option grant to Mr. McCaman for the three months ended April 30,
2008.  The exercise price of each of the options granted pursuant to
the foregoing was equal to the closing price of the Company’s common stock on
the option grant date as reported by the OTC Bulletin Board.  These
options will vest quarterly over three (3) years, and will be subject to the
terms and conditions of the Company’s 2006 Stock Incentive Plan and form of
stock option agreement.  The amendment further provided that in the
event of a “Change of Control,” as defined in the amendment, all of Mr.
McCaman’s then-unvested options shall immediately vest.  Mr. McCaman’s
employment agreement was further amended on September 12, 2008.





On June 9, 2008,the Companyentered into a variation to
employment agreement and a consultancy agreement with Ms. Kristin Bowman, Senior
Vice President, Customer and Business Development of PureDepth Incorporated
Limited, the Company’s New Zealand subsidiary (“PDIL”), and a director of the
Company, relating to her separation from employment with the
Company.  The terms of the variation to employment agreement, which
amend her Employment Agreement dated March 31, 2005,weregenerally effective as of
April 17, 2008 and provide for a reduction in Ms. Bowman’s work hours to 8 hours
per week, with a corresponding reduction in her salary, and the remainder of her
previously scheduled weekly work hours taken as vacation pay until her accrued
vacation pay is exhausted.  The agreement also providedfor the resignation of Ms.
Bowman’s position with,PDIL effective June 14,
2008.  Ms. Bowmandidnot resign as a director of
the Company.   The terms of the consultancy agreementwere effective after the
effective date of Ms. Bowman’s resignation on June 14, 2008 and call for Ms.
Bowman to consult with PureDepth’s executive management team without charge for
up to 20 hours per calendar quarter with any additional hours to be charged at a
rate of USD$150 per hour until January 31, 2009, after which she will be
entitled to $150 per hour for all consultancy to the Company or it subsidiaries.
The agreement may be terminated by either party with six months
notice.  Pursuant to the consultancy agreement, Ms. Bowman’s option
agreement was also amended to provide thatin the event Ms. Bowman ceases
to serve as a director, officer, employee or consultant of the Company, she will
have until the earlier of (i) 365 days from the date of such termination or
(ii) March 31, 2011 to exercise all or any part of her vested
options.








15




On August
27, 2008, the Board of the Company appointed Andrew L. Wood (‘Andy”) as Chief
Executive Officer (CEO) and director of the Company effective September 8, 2008
and entered into an executive employment agreement with Mr. Wood providing for
his future compensation and benefits.  Mr. Wood will earn an annual
base salary of $250,000 per year, will participate in a performance-based
compensation (“Bonus”) plan, was granted options to purchase 3,400,000 shares of
the Company’s common stock (the “Option”) and will be provided customary and
usual fringe benefits generally available to employees of the Company, subject
to the terms and conditions of the Company’s benefit plan documents and
policies.  Mr. Wood’s participation in the Bonus plan is based on
criteria of such performance objectives (the “Goals”) defined by Mr. Wood and
the Compensation Committee of the Board during the first month following Mr.
Wood’s commencement of employment.  Although there is no minimum
guaranteed bonus, Mr. Wood will be eligible to earn an aggregate annual bonus of
up to one hundred twenty five thousand dollars ($125,000), payable at Mr. Wood’s
election in either cash, a common stock award under the Company’s 2006 Stock
Incentive Plan (the “Stock Plan”) or a combination of both, in connection with
the achievement of the goals.  Mr. Wood’s option will vest monthly
over four (4) years with the measuring period beginning on August 27, 2008 so
long as Mr. Wood continues to be employed by the Company or any of its
subsidiaries.  The exercise price of the option granted was the
closing price of the Company’s common stock on September 24, 2008, the date of
grant, as reported by the OTC Bulletin Board.  Mr. Wood’s termination
benefits are as follows:  In connection with a termination by the
Company of Mr. Wood’s employment Without Cause (as defined in the Agreement and
which may include a voluntary resignation by Mr. Wood in certain circumstances
following a Material Adverse Change (as defined in the Agreement)), the Company
shall pay Mr. Wood an amount equal to his then effective base salary for a
period of six (6) months, payable in equal installments in accordance with the
Company’s regular payroll schedule; and if such termination Without Cause takes
place on or within twelve (12) months following the effective date of a Change
of Control (as defined in the Agreement), Mr. Wood shall also become vested in
50% of the shares subject to any options to purchase Company common stock then
held by him.  Receipt of the foregoing termination benefits will be
contingent upon Mr. Wood’s execution of a general release of
claims.





Pursuant
to bonus arrangements approved by the Board of Directors on September 4, 2008,
upon the Company’s execution of the amendment to the Patent and Technology
License and Technology Transfer Agreement with International Game Technology on
September 10, 2008 and its receipt of a prepaid royalty payment in connection
therewith on September 11, 2008, Mr. McCaman was paid a cash bonus of $100,000
and was granted an option to purchase 50,000 shares of the Company’s common
stock.  The exercise price of the option was equal to the closing
price of the Company’s common stock on the option grant date as reported by the
OTC Bulletin Board, and the option is fully vested as of the date of
grant.





On
September 12, 2008, the Company and Mr. McCaman entered into a second amendment
to Mr. McCaman’s employment agreement in connection with his resignation as
President of the Company effective September 12, 2008.  The amendment
provided that Mr. McCaman’s base annual salary will remain at $210,000 and that
effective beginning September 1, 2008, Mr. McCaman will be eligible for an
executive incentive bonus in an amount up to 12.5% of his then current annual
base salary per fiscal quarter, with payment of any such bonus to be based upon
the achievement of key performance indicators to be mutually determined by Mr.
McCaman and the Board’s Compensation Committee on a schedule determined by the
parties.  Pursuant to the bonus arrangements in the prior agreement
which are being replaced by the amendment, Mr. McCaman was paid $25,000 in
respect of the three months ended July 31, 2008.  Also pursuant to the
prior agreement and acknowledged in the amendment, Mr. McCaman was granted on
September 24, 2008 an option to purchase 75,000 shares of the Company’s common
stock (the “Bonus Option”).  The Bonus Option will vest quarterly over
three (3) years, subject to the certain acceleration of vesting described
below.  The Bonus Option will be subject to the terms and conditions
of the Company’s 2006 Stock Incentive Plan and form of stock option
agreement.  Pursuant to the amendment, all unvested options which were
initially granted to Mr. McCaman on or prior to October 1, 2008, including the
Bonus Option, will immediately vest in the event of a “Change of Control” (as
defined in the employment agreement).  Any options which are initially
granted to Mr. McCaman after October 1, 2008 will vest with respect to 50% of
the shares subject to such options in the event that Mr. McCaman is terminated
without Cause (as defined in the employment agreement, and which for these
purposes may include a voluntary resignation by Mr. McCaman in certain
circumstances following a Material Adverse Change (as defined in the Agreement)
on or within twelve months following the effective date of a Change of Control.
The grant of any such subsequent options will be at the sole discretion of the
Board of Directors (or Compensation Committee thereof), and Mr. McCaman waived
any rights to equity of the Company (other than options then held by him and the
Bonus Option) with respect to the prior terms of his employment
agreement.








16




Note
11 - Subsequent Events





On
November 10, 2008, the Company entered into a Deed of Variation of Leases and
Rent Reviews (the “Agreement”) with Lionel Cranston Joyce and Kevin George
Ogles, as trustees of the First Five Trust (the “Landlord”) for its New Zealand
Research and Development premises at 24 Morrin Road, Panmure,
Auckland.  The Agreement amends each of the Deed of Lease dated May
31, 2006 (the “First Lease”) and the Deed of Lease dated May 31, 2006 (the
“Second Lease” and together with the First Lease, the “Lease”), the initial
terms of which were to expire on October 31, 2008.  Pursuant to the
Agreement, the renewal terms of each Lease have been revised to provide for two
renewal terms of three years.  The first renewal term, during which
the annual rent payable under the First Lease will be USD$22,650 (plus GST) in
respect of the First Lease and USD$21,000 (plus GST) in respect of the Second
Lease, will commence on November 1, 2008 and expire on October 31,
2011.  The second term will, if exercised, commence on November 1,
2011 and expire October 31, 2014.  The
Company may cancel the lease agreement without further liability during the
period of any renewed lease term upon the giving of six months notice in writing
to the Landlord.The Agreement also amends the Leases to provide
that there will be a rent review in each of 2008, 2010 and 2012, and releases K
One W One Limited from the covenants in the Leases and the Agreement and all and
any claims existing or arising later in respect thereto.





On
November 13, 2008, the Company sold and issued to Dr. David Teece 294,117 shares
of the Company’s Common Stock, $0.001 par value per share at a purchase price of
$0.17 per share or an aggregate purchase price of approximately
$50,000.   The per share purchase price is equal to ninety
percent (90%) of the average of the daily volume-weighted average price of the
Company’s common stock, as quoted on the OTCBB, over the ten (10) trading days
prior to November 13, 2008, the date of this transaction.  The 294,117
shares sold and issued to Dr. Teece have not been registered under the
Securities Act of 1933 and Dr. Teece has been represented to the Company as an
accredited investor as defined by Rule 501 under the Securities
Act.





On
November 25, 2008, Mr. John Stringer resigned as a member of the Board of
Directors and as the Chairman of the Compensation Committee.





On
November 25, 2008, Dr. David Teece was appointed by the Board of Directors to
fill the resulting vacancy on the Board.  Dr. Teece will receive cash
compensation for his services as a member of the Board according to the
Company’s director compensation policy approved by the Board on April 5,
2007.   In addition, Dr. Teece received an option grant to
purchase an aggregate of 375,000 shares of the Company’s common stock pursuant
to the Company’s 2006 Stock Incentive Plan, as amended, with an exercise price
of $0.18, which was equal to the closing price of the Company’s common stock on
November 25, 2008, the grant date of the option, as reported by the OTC Bulletin
Board.  The shares subject to the option will vest over three years
subject to Dr. Teece’s continued service to the Company, with one-sixth of the
shares subject to the option vesting six months from November 25, 2008, and
one-twelfth of the shares subject to the option vesting each three months
thereafter.





On
November 25, 2008, the Board of Directors appointed Mr. Mark Kalow as the
Chairman of the Compensation Committee.  Mr. Kalow will receive
director compensation for his role as Chairman of the Compensation Committee
according to the Company’s director compensation policy approved by the Board on
April 5, 2007.  Mr. Kalow will also continue to serve as the Chairman
of the Audit Committee.








17




Item
2 - Management’s Discussion and Analysis of Financial Condition
and Results
of Operations




Special
Note Regarding Forward-Looking Information




This Quarterly Report of PureDepth,
Inc. on Form 10-Q contains certain “forward-looking statements” All statements
in this Quarterly Report other than statements of historical fact are
“forward-looking statements” for purposes of these provisions, including any
statements of the plans and objectives for future operations and any statement
of assumptions underlying any of the foregoing. Statements that include the use
of terminology such as “may,” “will,” “expects,” “believes,” “plans,”
“estimates,” “potential,” or “continue,” or the negative thereof or other and
similar expressions are forward-looking statements. Forward-looking statements
in this Quarterly Report include, but are not limited to, statements regarding
expanding the use of our technologies in existing and new markets; demand for
and future revenues from the sale of visual display products incorporating our
technologies; growth opportunities in the visual display market; opportunities
to incorporate our technologies in markets outside the traditional consumer
product markets; the rate of adoption and sales of MLD visual displays;
diversification of sources of licensing revenue; our expected profit margin from
our MLD product sales; the future impact of our critical accounting policies,
including those regarding revenue recognition, allowance for doubtful accounts,
accounting for income taxes, and stock-based compensations; statements regarding
the sufficiency of our cash reserves; and our expected rate of return on
investments. Actual results may differ materially from those discussed in these
forward looking statements due to a number of factors, including: the rate of
growth of the markets for MLD visual displays that include our technologies; the
extent to which our expectations regarding new licensing markets are realized;
whether our competitors are able to develop and sell alternative 3-D or MLD
visual display technologies to our partners; the accuracy of our identification
of critical accounting policies and the accuracy of the assumptions we make in
implementing such policies; the accuracy of our estimates regarding our taxable
income and cash needs for the next twelve months; the accuracy of our
calculations of royalties due to our licensors; and fluctuations in interest
rate and foreign currencies.  These forward-looking statements involve
risks and uncertainties, and it is important to note that our actual results
could differ materially from those projected or assumed in such forward-looking
statements. Among the factors that could cause actual results to differ
materially are the factors detailed under the heading “Risk Factors” as well as
elsewhere in this Quarterly Report on Form 10-Q. All forward-looking statements
and risk factors included in this document are made as of the date hereof, based
on information available to us as of the date hereof, and we assume no
obligation to update any forward-looking statement or risk factor. You should
consider the factors affecting results and risk factors listed from time to time
in our filings with the Securities and Exchange Commission (SEC), including our
Annual Report on Form 10-KSB, our Quarterly Reports on Form 10-Q, our Current
Reports on Form 8-K and amendments to such reports.  Such filings are
available on our website, free of charge, at www.puredepth.com,
but the information on our website does not constitute part of this Quarterly
Report.




Company
and Fiscal Year




As used
herein, unless the context otherwise requires, PureDepth, Inc., together with
its New Zealand subsidiaries PureDepth Limited and PureDepth Incorporated
Limited, are referred to in this Quarterly Report on Form 10-Q as the “Company,”
“we,” “us” and “our.” References herein to year ending 2009, and years ended
2008 and 2007 mean the fiscal year ending January 31, 2009, and the fiscal years
ended January 31, 2008 and January 31, 2007, respectively.











18




Management’s
Discussion and Analysis





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the unaudited condensed
consolidated financial statements and related notes included under Item 1 of
this Part I entitled “Financial Statements” and the above section entitled
“Special Note Regarding Forward-Looking Statements”.





PureDepth,
Inc. is a technology and licensing company focusing on the visual display
experience by delivering award-winning Multi-Layer Display (MLD)
technology.  We derive revenues primarily from the licensing of our
technology to our product partners and LCD manufacturing partners and, to a
lesser extent, from sales of prototype MLD-enabled display devices and MLD
components that we manufacture. Licensees are and will be responsible for the
manufacture and sale of display-based products incorporating our technology and
related software.  In connection with our licensing arrangements, we
may also derive revenues from the sale of software tools and drivers for
market-specific applications and from various support services, including
engineering consulting services, technical services for implementation and
optimization of our technology and software support and training.





Our
efforts are primarily focused on fulfilling the requirements of and supporting
existing customer agreements with Sanyo Electric Corporation
(Sanyo),  International Game Technology (IGT) and Samsung Electronics
Company, Ltd (Samsung).  At the same time, we will continue to seek to
diversify our sources of licensing revenue. We have identified the following
target markets in North America, Asia and Europe that we believe are appropriate
for our MLD technology: location-based entertainment devices, computer monitors,
public information display systems, mobile devices, flat-panel televisions and
other mass market display devices.  Our existing license agreements
pertain to products for the location-based entertainment devices, mass market
display devices and mobile devices.  Our goal is to expand our
business by working with partner companies to develop MLD-based products and
developing demand and a presence for such devices in our identified target
markets.





Our
primary operating costs relate to compensation for employees, including stock
options and other incentives; ongoing research and development of our
technology; legal services including patent applications and defense of
currently-held patents; and rental of premises in both Redwood City, CA and
Auckland, New Zealand. Other than our research and development expenses, no
significant capital equipment purchases are expected during the year ending
2009.





Our
critical research and development activities include: further enhancing our
existing MLD technology and related software; developing, manufacturing and
testing prototype MLD-enabled display devices for our existing licensee partners
and potential licensee partners; designing and customizing features to the
specification of potential licensee partners; and patent defense and application
for our existing and new technology developments. Our goal is to enhance our
existing technology based upon research and development in optics, LCD
technology, backlighting, and component technologies.





We
maintain two facilities, our U.S. corporate headquarters in Redwood City,
California and our research and development center in Auckland, New
Zealand.  Our facility lease in New Zealand expired in October 2008,
we subsequently entered into a new agreement to provide for two renewal terms of
three years with the first term commencing on November 1, 2008 and expiring on
October 31, 2011.  The second term will, if exercised, commence on
November 1, 2011 and expire October 31, 2014.  We signed a four year
lease in a new location in Redwood City, California which started in February
2008.  Due to our reduction in headcount and our cost reduction
efforts, we subsequently subleased the new office space to a sub lessee for a
two year term commencing in June 2008 at terms similar to our
obligations.  In May 2008 we signed a new two year lease in a new
location in Redwood City, California and we relocated our U.S. corporate
headquarters to this new location.





We have
reduced the number of worldwide employees from a high of 46 employees during the
year ending 2008 to a level of 28 full time employees at October 31,
2008.  During the three months ended October 31, 2008, we hired a
Chief Executive Officer (“CEO”) to fill the vacant CEO position.  The
new CEO along with four continuing employees are located at our U.S. corporate
headquarters in Redwood City, California and the remaining 23 employees are
located at our research and development facility in Auckland, New
Zealand.  We believe the current level of employees is adequate to run
our operations and support our existing customer agreements. We will continue to
monitor our staffing levels in both the U.S. corporate headquarters and our New
Zealand research and development facility and if necessary, make changes in
relation to our business strategy and customer activity.





19





The
report from our independent auditors on our financial statements for the year
ending 2008 includes an explanatory paragraph indicating there is substantial
doubt about our ability to continue as a going concern.  Our
operations have resulted in operating losses to date and are expected to
continue to have operating losses in the year ending 2009.





On
September 10, 2008 we entered into an amendment to the Patent and Technology
License and Technology Transfer Agreement with International Game Technology
(IGT) dated October 13, 2006.  Pursuant to the amendment, we have
agreed to an automatic renewal term of ten years after expiration of the initial
five year term of the original license agreement.  Upon execution of
the amendment, IGT made an advance, non-refundable payment of licensing fees to
us in the amount of $10 million.  Among other additional terms, IGT
agreed to modify the royalty schedule for the extended term and redefined the
existing limited worldwide license rights of the Company’s technology and
patents to develop, manufacture, market, sell, and distribute products for use
in wager-based gaming.  We believe that the advance, non-refundable
payment of licensing fees allows us to effectively address our going concern
issues for the remainder of the year ending January 31, 2009 and into the year
ending January 31, 2010.





In
addition to our receipt of the advance, non-refundable payment of licensing
fees, we raised $3.9 million during the nine months ended October 31, 2008 in
secured convertible debt from our majority shareholder.  We may also
continue to consider raising additional funds from a number of sources,
including, but not limited to, additional sales of equity
or convertible debt securities, loans from banks, other financial
institutions or affiliates, or a credit facility. If additional funds are raised
by the issuance of debt or other equity instruments, we may become subject to
certain operational limitations, and such securities may have liquidation rights
senior to those of the then existing holders of common stock





The funds
from the non-refundable payment of licensing fees under the Amendment and the
secured convertible debt will be used to fund the our operations, continue our
efforts to fulfill and promote existing customer agreements with Sanyo Electric
Corporation (Sanyo), International Game Technology (IGT) and Samsung
Electronics Company, Ltd (Samsung) and expand our customer base to diversify our
sources of licensing revenue.  The funds may also be used to minimize
the Company’s current or future debt obligations.





Results
of Operations





For the
three months ended October 31, 2008, we reported net losses of $2.3 million
which is consistent when compared to the $2.3 million reported in the three
months ended October 31, 2007. For the nine months ended October 31, 2008, we
reported net losses of $5.3 million representing a decrease in our net loss of
$1.8 million when compared to the $7.1 million reported in the nine months ended
October 31, 2007.  Our net losses are primarily derived from total
operating expenses and will continue to be so until our licensing revenues
become significant.  Our operations have not generated net income to
date and are not expected to do so in the year ending 2009.





Licensing
Revenue and Cost of Licensing




Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            Change
            
            
            October
      31,
            
            
            Change($
      in thousands)
            
            2008
            
            
            2007
            
            
            $
            
            
            %
            
            
            2008
            
            
            2007
            
            
            $
            
            
            %Licensing
      revenue
            
            $
            214
            
            
            $
            188
            
            
            $
            26
            
            
            
            14
            %
            
            $
            591
            
            
            $
            563
            
            
            $
            28
            
            
            
            5
            %Cost
      of licensing
            
            
            83
            
            
            
            81
            
            
            
            2
            
            
            
            2
            %
            
            
            244
            
            
            
            235
            
            
            
            9
            
            
            
            4
            %Gross
      margin - $
            
            $
            131
            
            
            $
            107
            
            
            $
            24
            
            
            
            
            
            
            $
            347
            
            
            $
            328
            
            
            $
            19Gross
      margin - %
            
            
            61
            %
            
            
            57
            %
            
            
            
            
            
            
            
            
            
            
            59
            %
            
            
            58
            %





We are a
party to patent and technology license and technology transfer agreement as
recently amended (collectively, the “IGT Agreement”) with International Game
Technology (IGT) that involves the manufacture and distribution of products by
IGT, incorporating MLD technology for sale in the wagering-based gaming segment
of the location-based entertainment display device market. This agreement grants
IGT certain rights of exclusivity for the development and sale of MLD-based
products in the wagering-based gaming market. In aggregate, we have received
advance, non-refundable payments of license fees of $13.75 million under the
terms of the agreement.  Substantially all of our licensing revenue
for the three and nine months ended October 31, 2008 consisted of the
amortization of these advance non-refundable payments which began in October
2006.  The increase in the amount of licensing revenue in the three
months and nine months ended October 31, 2008 when compared with the
corresponding periods in the prior year is due to the receipt of the additional
$10.0 million in advance, non-refundable payments of license fees during the
three months ended October 31, 2008.  The balance of the advance on
licensing revenues is recorded as deferred revenue and will continue to be
earned over the remaining term of the agreement.




20


Our
patent and technology licensing agreements provide royalties to us when our
customers sell or ship products incorporating our MLD
technology.   Except for advanced, non-refundable payments, we do
not recognize licensing revenues until our customers sell or ship their products
incorporating MLD technology.  Therefore, a majority of our potential
licensing revenue is dependent upon our customers’ sales and marketing
programs.  In the nine months ended October 31, 2008 we recognized a
nominal amount of licensing revenue from customer shipments in addition to the
amortization of the IGT advance, non-refundable payments.  We will
recognize additional licensing revenue from IGT and may receive additional
licensing revenue from other customers in the remainder of year ending 2009;
however, we have no control over the timing or success of our customers’ sales
or marketing programs.





Cost of
licensing is primarily the amortization of capitalized costs related to our
patents.  The increase in cost of licensing is the result of
additional capitalized patent costs being amortized.  Cost of
licensing is not expected to grow proportionately with revenues as our costs
related to intellectual property (including legal fees, registration costs and
ongoing maintenance costs) are generally capitalized and amortized on a
straight-line basis over the expected statutory lives of the related patents, of
up to 20 years.





Services
Revenue and Cost of Services




Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            Change
            
            
            October
      31,
            
            
            Change($
      in thousands)
            
            2008
            
            
            2007
            
            
            $
            
            
            %
            
            
            2008
            
            
            2007
            
            
            $
            
            
            %Services
      revenue
            
            $
            -
            
            
            $
            32
            
            
            $
            (32
            )
            
            
            (100
            %)
            
            $
            110
            
            
            $
            67
            
            
            $
            43
            
            
            
            64
            %Cost
      of services
            
            
            -
            
            
            
            32
            
            
            
            (32
            )
            
            
            (100
            %)
            
            
            87
            
            
            
            58
            
            
            
            29
            
            
            
            50
            %Gross
      margin - $
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            
            -
            %
            
            $
            23
            
            
            $
            9
            
            
            $
            14Gross
      margin - %
            
            
            -
            
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            21
            %
            
            
            13
            %





We had no
services revenue in the three months ended October 31, 2008.  Our
services revenue in the nine months ended October 31, 2008 consisted entirely of
billings for technical and professional services provided to IGT.  We
offer professional services to IGT and our other licensees in order for them to
develop, test, and promote MLD applications in their products.  We
believe that services revenues will continue as relationships with new and
existing partners evolve, but will continue to represent a small portion of our
total revenues.





Cost of
services represents direct labor and overhead costs of providing the respective
services.   We expect cost of services to fluctuate with changes in
services revenues and the related gross margins to improve as the volume of
services revenues increase.





Product
Sales Revenue and Cost of Product Sales




Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            Change
            
            
            October
      31,
            
            
            Change($
      in thousands)
            
            2008
            
            
            2007
            
            
            $
            
            
            %
            
            
            2008
            
            
            2007
            
            
            $
            
            
            %Product
      sales revenue
            
            $
            180
            
            
            $
            77
            
            
            $
            103
            
            
            
            134
            %
            
            $
            232
            
            
            $
            207
            
            
            $
            25
            
            
            
            12
            %Cost
      of product sales
            
            
            230
            
            
            
            65
            
            
            
            165
            
            
            
            254
            %
            
            
            291
            
            
            
            185
            
            
            
            106
            
            
            
            57
            %Gross
      margin - $
            
            $
            (50
            )
            
            $
            12
            
            
            $
            (62
            )
            
            
            
            
            
            $
            (59
            )
            
            $
            22
            
            
            $
            (81
            )Gross
      margin - %
            
            
            (28
            %)
            
            
            16
            %
            
            
            
            
            
            
            
            
            
            
            (25
            %)
            
            
            11
            %





Product
sales represent sales of MLD components and prototypes of MLD-enabled display
devices to existing and potential licensing customers. We design and manufacture
MLD components and MLD prototypes specifically for sale to these customers, who
use them in their manufacturing process or to develop, test and promote MLD
applications in their products.  The increase in product sales revenue
is due to an increase in MLD component sales to an IGT subassembly vendor who
manufactured and sold MLD products during the three months ended October 31,
2008.  Our entire product sales revenue in the three and nine months
ended October 31, 2008 was derived from component sales to the IGT subassembly
vendor.  We expect product sales revenue of our MLD component and
prototypes of MLD-enabled display devices will fluctuate and may increase as our
customers launch and market their MLD products and as relationships with new and
existing partners evolve, but will continue to represent a small portion of our
overall revenues in the year ending 2009.





21





Cost of
product sales represents materials, sub-contractor services, direct labor and
overhead costs of assembling the components or prototypes at subcontractor’s
facilities or at our research and development facility in Auckland, New
Zealand.  We have minimal to negative margins on our product sales as
we acquire small quantities of materials at higher costs than we would have paid
had we been able to buy in bulk and because the engineering for prototype
MLD-enabled display devices has, to date, required the use of non-standard parts
and manual or unique assembly.  As the engineering and material
standards for form factors are finalized, we expect the cost of materials and
associated labor to decline. In addition, we intend to outsource more of the
assembly with the expectation of further reducing our costs. As a result of
these factors, we expect to see our cost of product sales as a percentage of
product revenues decline in the year ending 2009.





Operating
Expenses




Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            Change
            
            
            October
      31,
            
            
            Change($
      in thousands)
            
            2008
            
            
            %
              of
      Total
            
            
            2007
            
            
            %
              of
      Total
            
            
            $
            
            
            %
            
            
            2008
            
            
            %
              of
      Total
            
            
            2007
            
            
            %
              of
      Total
            
            
            $
            
            
            %Depreciation
            
            $
            32
            
            
            
            2
            %
            
            $
            30
            
            
            
            1
            %
            
            $
            2
            
            
            
            7
            %
            
            $
            97
            
            
            
            2
            %
            
            $
            69
            
            
            
            1
            %
            
            $
            28
            
            
            
            41
            %Research
      and development
            
            
            560
            
            
            
            27
            %
            
            
            701
            
            
            
            30
            %
            
            
            (141
            )
            
            
            (20
            %)
            
            
            1,613
            
            
            
            32
            %
            
            
            1,870
            
            
            
            25
            %
            
            
            (257
            )
            
            
            (14
            %)Sales
      and marketing
            
            
            581
            
            
            
            28
            %
            
            
            505
            
            
            
            21
            %
            
            
            76
            
            
            
            15
            %
            
            
            784
            
            
            
            15
            %
            
            
            1,401
            
            
            
            19
            %
            
            
            (617
            )
            
            
            (44
            %)General
      and administrative
            
            
            887
            
            
            
            43
            %
            
            
            1,151
            
            
            
            48
            %
            
            
            (264
            )
            
            
            (23
            %)
            
            
            2,609
            
            
            
            51
            %
            
            
            4,127
            
            
            
            55
            %
            
            
            (1,518
            )
            
            
            (37
            %)Total
      operating expenses
            
            $
            2,060
            
            
            
            100
            %
            
            $
            2,387
            
            
            
            100
            %
            
            $
            (327
            )
            
            
            (14
            %)
            
            $
            5,103
            
            
            
            100
            %
            
            $
            7,467
            
            
            
            100
            %
            
            $
            (2,364
            )
            
            
            (32
            %)





Included
in our operating expenses are stock-based compensation costs related to the
granting of options to employees and directors.  For the three months
ended October 31, 2008 and 2007, our stock-based compensation totaled $0.2
million and $0.4 million, respectively.  For the nine months ended
October 31, 2008 and 2007, our stock-based compensation totaled $0.6 million and
$0.8 million, respectively.  We intend to continue to offer stock
options as part of compensation packages to motivate and retain
employees.  As a result, stock-based compensation on existing and new
grants will continue to be recognized.  In the nine months ended
October 31, 2008, we expensed stock-based compensation of approximately $148,000
in research and development, $11,000 in sales and marketing, and $408,000 in
general and administrative operating expense categories.





Depreciation.The
increase in depreciation is primarily the result of depreciation on capitalized
purchases of fixed assets in prior periods that are being depreciated over their
respective useful lives of 24 to 36 months.  Depreciation expense is
not expected to increase proportionately with revenue or total operating
expenses as it is unlikely we will need to make significant purchases of fixed
assets in the foreseeable future.





Research and
development.Research and development expenses consist
primarily of personnel salary and benefits, travel, materials, consultant fees
and stock-based compensation.  The decrease in research and
development expenses for the three and nine months ended October 31, 2008 is
primarily due to cost cutting measures implemented at the end of the year ended
2008 for travel, materials, consultants and general operating
costs.  Decreases of $0.2 million and $0.5 million in the three and
nine months ended October 31, 2008, respectively, in travel, materials,
consultants, and project expenses were offset by increases of $26,000 and $0.2
million, respectively, in personnel salary and benefits and stock-based
compensation as we used our employees to administer our research and development
projects in place of outside consultants.  Patent legal costs
increased $8,000 and $31,000 in the three and nine months ended October 31,
2008, respectively, due to a new patent issuance and additional patent legal
reviews related to potential and existing licensing
arrangements.  Other fluctuations in research and development expenses
during the three and nine months ended October 31, 2007 were consistent or
slightly below the amounts in the corresponding prior year periods.





We expect
research and development expenses to be maintained at approximately this level
for the remainder of the year ending 2009 as we are focused on meeting the
immediate needs of our existing customers and maintaining our
technology.  We expect that our long term research and development
activities beyond these two objectives will be more fully understood as we
determine how best to accelerate our strategy with the recently received
funding.





22




Sales and
marketing.Sales and marketing expenses consist primarily of
personnel salary and benefits, travel, tradeshows, consultant fees and
stock-based compensation.  For the three months ended October 31, 2008
our sales and marketing expenses consisted primarily of non-recurring consulting
fees paid for customer support and marketing services.  The decrease
in sales and marketing expenses for the nine months ended October 31, 2008 is
due to the reduction in employees and cost cutting measures implemented at the
end of the year ended 2008 with additional cost cutting efforts and staff
reductions in the three months ended April 30, 2008.  As of October
31, 2008, we had no full-time sales and marketing employees.  For the
nine months ended October 31, 2008 the net decrease of $0.6 million from the
corresponding period of the prior year is the net result of approximately $1.1
million in decreases in personnel salary, travel, stock-based compensation and
other marketing expenses offset by $0.5 million in non-recurring consultant fees
paid in the three months ended October 31, 2008.





We expect
sales and marketing expenses to be a smaller percentage of overall operating
costs for the remainder of year ending 2009.  We expect that sales and
marketing activities will consist primarily of outside services and be narrowly
focused on opportunities with our current customers or identified potential
customers with near term revenue opportunities.  We also expect that
all sales and marketing costs will be minimized until we more fully understand
how we will accelerate our strategy with the recently received
funding.





General and
administrative. General and administrative expenses
consist primarily of personnel salary and benefits, travel, capital raising
costs, insurance, stock-based compensation, and professional fees related to our
public company filing requirements.  The decrease in general and
administrative expenses for the three and nine months ended October 31, 2008 of
$0.3 million and $1.5 million from the prior year corresponding periods is
primarily due to staff reductions, the past vacancy in our CEO position and
other executive level positions, general cost cutting measures, relocation to a
smaller corporate office in Redwood City, California and the resolution of
matters related to our registration statement and other of our public filing
requirements at the end of the year ended 2008.  Fluctuations in other
general and administrative expenses for the three and nine months ended October
31, 2008 were consistent with the prior year corresponding periods.





As a
public company we have certain unavoidable expenses related to our public filing
requirements, legal obligations, insurance needs, and other necessary
expenditures to fulfill our fiduciary and regulatory
requirements.  These unavoidable expenses could increase depending on
our need to rely upon external professionals for these services.  We
may also experience increased legal and capital raising cost associated with any
capital raising activities we may continue to undertake in the remainder of the
year ending 2009.  We anticipate that any unavoidable increases in
general and administrative expenses in the remainder of year ending 2009 may be
offset with our ongoing cost cutting measures.





Other
Income and Expense






Three
      Months Ended
            
            
            Nine
      Months EndedOctober
      31,
            
            
            Change
            
            
            October
      31,
            
            
            Change($
      in thousands)
            
            2008
            
            
            2007
            
            
            $
            
            
            %
            
            
            2008
            
            
            2007
            
            
            $
            
            
            %Interest
      income
            
            $
            45
            
            
            $
            29
            
            
            $
            16
            
            
            
            55
            %
            
            $
            55
            
            
            $
            177
            
            
            $
            (122
            )
            
            
            (69
            %)Interest
      expense
            
            
            (106
            )
            
            
            (14
            )
            
            
            (92
            )
            
            
            (657
            %)
            
            
            (240
            )
            
            
            (42
            )
            
            
            (198
            )
            
            
            (471
            %)Foreign
      exchange loss
            
            
            (285
            )
            
            
            (78
            )
            
            
            (207
            )
            
            
            (265
            %)
            
            
            (349
            )
            
            
            (145
            )
            
            
            (204
            )
            
            
            (141
            %)Other
      expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
      other income(expense), net
            
            $
            (346
            )
            
            $
            (63
            )
            
            $
            (283
            )
            
            
            (449
            %)
            
            $
            (534
            )
            
            $
            (10
            )
            
            $
            (524
            )
            
            
            (5,240
            %)





Other
income and expense consists of interest income, interest expense, foreign
exchange gain or loss and other miscellaneous income or
expense.  Interest income is earned on our cash
balances.  Interest income was higher in the three months ended
October 31, 2008 due to the receipt of advance, non-refundable payments of
license fees resulting in larger cash resources.  We expect interest
income to increase in the remainder of year ending 2009 based on our larger cash
resources.   Interest expense is incurred on our notes payable
and convertible debt.  Included in interest expense is the
amortization of the debt discount associated with the embedded conversion
feature of our convertible notes and is amortized over the life of the debenture
or upon earlier conversion of the debenture using the effective yield
method.  The increase in interest expense relates to our issuance of
secured convertible notes in the three and nine months ended October 31, 2008
for the aggregate principal amount of $3.9 million.  We expect
interest expense to increase in the year ending 2009 as a result of the
continuation of and increases in the aggregate principal outstanding under the
Convertible Notes or due to potential additional funding arrangements with
interest requirements.  Our foreign exchange gains and losses result
from transactions with our New Zealand subsidiaries, with our overseas customers
and translation of our New Zealand subsidiaries into U.S.
dollars.   The increase in the foreign exchange loss is due to
the fluctuations in the international exchange rates with our subsidiaries in
New Zealand and our overseas transactions in Asia.  We anticipate the
foreign exchange loss will increase for the year ending 2009, but will not
represent a significant amount in our total expenses.  Other expense
was immaterial for the three and nine months ended October 31, 2008 and 2007 and
is expected to be immaterial in the year ending 2009.




23


Liquidity
and Capital Resources





We have
funded our operations from inception through October 31, 2008 primarily through
the sale and exercise of common stock and warrants, the use of advance,
non-refundable payments of licensing fees and the issuance of secured
convertible notes.  In the nine months ended October 31, 2008, net
cash provided by operating activities was $4.5 million and an additional $3.8
million was provided by financing activities.  Our investing
activities used cash of $0.3 million and consisted primarily of purchases of
fixed assets and expenditures for intellectual property.  Our
operating activities and asset purchasing activities were primarily funded by
available cash of $0.4 million, the receipt of $10.0 million in advance,
non-refundable payments of license fees and the issuance of $3.8 million in
secured convertible notes during the nine months ended October 31,
2008.  Our ending cash balance at October 31, 2008 was $8.7
million.





Our
available funds pursuant to the advance, non-refundable payments of license fees
and the secured convertible debt will be used to fund our operations, continue
our efforts on fulfilling and promoting the existing customer agreements with
Sanyo Electric Corporation (Sanyo), International Game Technology (IGT) and
Samsung Electronics Company, Ltd (Samsung) and expand our customer base to
diversify our sources of licensing revenue. The funds may also be used to
minimize our current or future debt obligations.





We have
issued options to purchase 7,085,000 shares of our commons stock to employees
and directors during the nine months ended October 31, 2008 pursuant to our 2006
Stock Incentive Plan.  As of October 31, 2008, we had options to
purchase 16,697,737 shares of our common stock outstanding under our 2006 Stock
Incentive Plan with a weighted exercise price of $0.46.  A total of
9,268,890 of the shares underlying such outstanding options are exercisable at
October 31, 2008.  We had no in-the-money options at October 31,
2008.   We also have outstanding warrants to purchase 17,290,468
shares of common stock at a weighted average exercise price of
$1.15.





Subject
to approval of our Board of Directors, the 2006 Stock Incentive Plan allows
option holders to exercise options using a “cashless exercise,” whereby vested
shares would be used as payment for the exercise of options.  While
the exercise of stock options for cash will generally increase immediate working
capital, the approval of a cashless exercise by our Board of Directors would
impact directly on the extent of this working capital and our ability to use
existing options as a capital resource.





Provision
for State and Federal Income Taxes





From
inception through October 31, 2008, we have incurred net losses for federal and
state tax purposes. We have also incurred foreign net losses in respect of our
predecessor entity and two foreign subsidiaries.





We have
not recorded a tax benefit for domestic tax losses because of the uncertainty of
realization. We adhere to SFAS No. 109 Accounting for Income Taxes(“SFAS 109”), which requires an asset and liability approach to financial
accounting and reporting for income taxes. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be
realized. Under paragraph 17e of SFAS 109, deferred tax assets are reduced by a
valuation allowance if the weight of the available positive and negative
evidence suggests that it is more likely than not some portion or all of the
deferred tax asset will not be realized.




We have
generated net losses since our inception, and since our current projections are
based upon predictions that cannot ensure sustained profitability in future
years, we have provided a full valuation allowance against the deferred tax
assets at October 31, 2008 and 2007.




As a
result of the adoption of FIN 48, there was no impact to our consolidated
financial position, results of operations or cash flows for the three and nine
months ended October 31, 2008.  In accordance with FIN 48, we
recognize interest and penalties related to unrecognized tax benefits as a
component of income taxes.  At October 31, 2008 no interest or
penalties related to unrecognized tax benefits had been
recorded.  There was no change to our unrecognized tax benefits for
the three and nine months ended October 31, 2008.





24


We are
subject to taxation in the U.S. and California. Our subsidiaries are subject to
taxation in New Zealand.  All of our tax years in the U.S. will be
open to examination by the federal and California tax authorities because the
statute of limitations are open and due to our overall net operating loss
carryforward position.  Our subsidiaries are subject to examination by
foreign tax authorities for all tax years.





Obligations





Our
obligations as of October 31, 2008 consisted of operating leases for facilities,
a settlement agreement obligation accounted for as a note payable and secured
convertible notes.  At October 31, 2008, minimum lease payments
required under the operating leases amounted to $0.7 million and are payable
through 2012. The note payable has a balance, including future interest, of
approximately $0.5 million and is payable in equal annual installments of
$175,000 through 2010. The aggregate principal amount of the secured convertible
notes at October 31, 2008 totaled $3.9 million and is convertible at a discount
of five percent (5%) into investment instruments issued by us pursuant to and
upon a qualified financing.  If such qualified financing does not
occur, upon maturity one year from the date of issuance the secured convertible
notes may, at the holder’s option, convert into our common stock at a five
percent (5%) discount from a formula-derived market price.  The
secured convertible notes will accrue interest at the annual rate of 8%,
commencing October 4, 2008.  In addition, pursuant to the secured
convertible note purchase agreement, each note holder has received in the form
of a warrant the right to participate in qualified financing, for a period of
three years, in an amount equal to ten percent (10%) of the aggregate principal
under the secured convertible notes, and at a discount of five percent (5%) of
the purchase price of the investment instruments issued in such qualified
financing.  The secured convertible notes are secured by our
assets.





We intend
to fund our obligations from our ongoing operations, existing cash resources,
subleasing agreements, and other capital raising activities.





We
anticipate that our existing licensing contracts will require limited capital
investment and will be supported by our current staff levels.





Off-Balance
Sheet Arrangements





We
do not have any off-balance sheet arrangements.





Critical
Accounting Policies





There
have been no significant changes in our critical accounting policies included in
our Annual Report on Form 10-KSB for the year ended 2008.




The
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America, (“U.S. GAAP”). The preparation of these financial statements in
accordance with U.S. GAAP requires us to utilize accounting policies and make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingencies as of the date of the financial
statements and the reported amounts of revenue and expenses during a fiscal
period. We have described our accounting policies in Note 1 to our condensed
consolidated financial statements included in the Form 10-KSB under Item 7
of  Part II entitled “Financial Statements”.  The SEC
considers an accounting policy to be critical if it is both important to a
company’s financial condition and results of operations and it requires
significant judgment and estimates on the part of management in its
application.




We have
discussed the selection and development of the critical accounting policies with
the audit committee of our board of directors, and the audit committee has
reviewed our related disclosures in this Quarterly Report on Form 10-Q. Although
we believe that our judgments and estimates are appropriate and correct, actual
results may differ from those estimates.  See also the section
entitled “Risk Factors” for certain matters which may affect our future results
of operations.




Revenue
Recognition.  We evaluate revenue recognition for transactions
to sell products and services and to license technology, trademarks and know-how
using the criteria set forth by the SEC in Staff Accounting Bulletin 104,
Revenue Recognition (SAB 104). For revenue transactions that involve software or
software-related products, we recognize revenue under the guidance established
by Statement of Position No. 97-2, Software Revenue Recognition (SOP
97-2).  Both SAB 104 and SOP 97-2 state that revenue is recognized
when each of the following criteria is met: persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
seller’s price to the buyer is fixed or determinable, and collectibility is
reasonably assured.  If we make different judgments or utilize
different evidence in relation to the revenue recognition criteria, the amount
and timing of our revenue could be materially affected.




25


Licensing.
Licensing revenue is primarily derived from royalties received from licensees of
our intellectual property rights, including patents, trademarks and know-how.
Royalties are recognized when all revenue recognition criteria have been met.
Judgments are made as to whether collectibility can be reasonably assured based
on the licensee’s recent payment history and credit worthiness.





Deferred revenue related to agreements
involving both an exclusive license for a term and a provision for royalty
payments per units beyond a minimum threshold will be recognized as follows: the
initial payment amount will be either (a) recognized equally over the term or
(b) based upon customer license usage, whichever cumulative figure is
higher.





If we
were to make different judgments or utilize different evidence in relation to
licensing revenue agreements, collectibility and the amount of deferred revenue
related to the agreements and the terms, the amount and timing of our revenue
could be materially affected.




Research
and Development Costs.Research and
development costs are recognized in the period incurred in accordance with SFAS
No. 2 Accounting for Research and Development Costs. Research and development
expenses primarily include prototype development costs, contractor fees, and
administrative expenses directly related to research and development
support.  If we make different judgments in relation to the nature of
research and development costs, the amount of research and development costs and
operating expenses could be affected.





Intellectual
Property.  Intangible assets (intellectual property) consist of
acquired technology and patents, and internally developed patents and software
costs.  All of the acquired technology was transferred to the Company
from its predecessor company and are recorded at the predecessor’s original
cost.  Acquired technology is amortized on a straight-line basis over
the life of the original agreement.





The costs
of internally developing intellectual property that are not specifically
identifiable, have indeterminate lives, or are inherent in a continuing business
and related to an entity as a whole have been expensed as incurred pursuant to
the requirements of SFAS No. 142, Goodwill and Other Intangible Assets. Legal
fees, registration costs, and ongoing maintenance costs relating to intellectual
property are capitalized as incurred and are amortized on a straight line basis
over the estimated remaining statutory lives of the patents, ranging from one to
twenty years. We evaluate the recoverability of our intellectual property
periodically and take into account events or circumstances that warrant revised
estimates of useful lives or that indicate that impairment exists. No
impairments of intellectual property have been identified during the periods
presented.




Our
impairment analysis contains judgments, uncertainties and estimates in order to
estimate future cash flows and fair values, if we were to make different
judgments and estimates, the outcome of the impairment analysis could be
materially affected.





Foreign
Operations and Foreign Currency.  We have two wholly-owned
subsidiaries incorporated in New Zealand. Our direct subsidiary, PureDepth Ltd.,
is the holding entity for the intellectual property portfolio, which is subject
to an exclusive license with us for its use, exploitation and future
development. Our indirect subsidiary, PureDepth Incorporated Ltd., undertakes
the operations in respect of any future research and development of the
intellectual property portfolio on our behalf. This activity is governed by a
development agreement with us pursuant to which an annual development fee of
cost plus 7.5% is calculated at the end of each quarter.  Income and
expenditures relating to the license and future development of the intellectual
property are inter-company transactions and are eliminated on consolidation.
Therefore, these amounts are not shown in the financial statements. We
(including our subsidiaries) use the U.S. dollar as our functional currency. We
determined that the cash flow, sales price, sales market, expense, financing and
intercompany transaction indicators had reached a significant level where under
SFAS 52 each of the entities would be best represented by the U.S. dollar as the
functional currency.  Our currency decisions contain judgments and
uncertainties that if we were to make different judgments, the outcome could
have a material affect to our operating results and fiscal period ending
balances.





Accounting
for Income Taxes.  In preparing our consolidated financial
statements, we are required to make estimates and judgments that affect our
accounting for income taxes. This process includes estimating actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences, including
differences in the timing of recognition of stock-based compensation expense,
result in deferred tax assets and liabilities, which are included in our
consolidated balance sheets. We also assess the likelihood that our deferred tax
assets will be recovered from future taxable income and, to the extent that we
believe that recovery is not likely, we have established a valuation
allowance.





26


During
year ended 2008, we adopted the provisions of Financial Accounting Standards
Board (“FASB”) Interpretation No. 48, “Accounting for Uncertain Income Taxes –
An Interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
entity’s financial statements in accordance with FASB Statement No. 109,
“Accounting for Income Taxes” (“FAS 109”) and prescribes a recognition threshold
and measurement attributes for financial statement disclosure of tax positions
taken or expected to be taken on a tax return.  There was no impact to
our consolidated financial position, results of operations or cash flows for the
year ended 2008.




Significant
judgment is required in determining the provision for income taxes, deferred tax
assets and liabilities and the valuation allowance against our deferred tax
assets. Our financial position and results of operations may be materially
affected if actual results significantly differ from these estimates or the
estimates are adjusted in future periods.




Stock-Based
Compensation.  We follow the provisions of Statement of
Financial Accounting Standards No. 123(R), Share-Based Payment(SFAS
123R). SFAS 123R requires measurement of all employee and non-employee
stock-based compensation awards using a fair-value method and recording of such
expense in the consolidated financial statements over the requisite service
period.  We estimate our stock-based compensation using the
Black-Scholes option-pricing model.  The Black-Scholes option-pricing
model requires judgmental assumptions including expected option life,
volatility, and forfeiture rates.  If we make or utilize different
assumptions used in the Black-Scholes option-pricing model, the amount of
stock-based compensation expense could be materially affected.











27




Item
3 – Qualitative and Quantitative Disclosures about Market Risk




The
primary objectives of our investment activity are to preserve principal, provide
liquidity and maximize income without significantly increasing the risk. Some of
the securities we invest in are subject to market risk. To minimize this risk,
we maintain our portfolio of cash equivalents and short term investments in
money market funds, and certificates of deposit.  Since our results of
operations are not dependent on investment performance, we believe that such
risks would not have a significant impact on our results from
operations.





Transactions
with our New Zealand research facility and with suppliers and manufacturers in
Asia are denominated in local currencies and thus, we are subject to foreign
currency exchange fluctuations associated with re-measurement to U.S. dollars.
Such fluctuations have not been significant historically. We are prepared to
hedge against any fluctuations in foreign currencies should such fluctuations
have a material economic impact on us, although we have not engaged in hedging
activities to date.







Item
4T - Controls and Procedures




Evaluation
of Disclosure Controls and Procedures





Under the
supervision and with the participation of our management, including our
principal executive and principal financial officer, we have evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”)), as of October 31, 2008.  Disclosure controls and
procedures are designed to ensure that information required to be disclosed in
reports filed or submitted under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in SEC rules and
forms and that such information is accumulated and communicated to management,
including the principal executive and principal financial officer, to allow
timely decisions regarding required disclosures.  Based on that
evaluation, and in light of the previously identified material weaknesses in our
internal control over financial reporting, as of January 31, 2008, relating to
ineffective control environment for inadequate segregation of duties and
information technology access as described in the our Annual Report on Form
10-KSB, our principal executive officer and our principal financial officer have
concluded that our disclosure controls and procedures were not effective as of
October 31, 2008.





Changes
in Internal Control over Financial Reporting





We
continue to improve our internal control over financial reporting and disclosure
controls and procedures related to our financial reporting.  One of
the two material weaknesses identified by management in our Annual Report on
Form 10-KSB for the year ended 2008 relating to inadequate controls to monitor
management override was remediated as of April 30, 2008 with the implementation
of a formal whistle blower policy and an employee notification and
acknowledgment process.  Other than the foregoing, there has been no
change in our internal control over financial reporting that occurred during the
three months ended October 31, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.





Inherent
Limitations of Any Control System





We do not
expect that our disclosure controls and procedures or our internal control over
financial reporting will prevent all error and all fraud. A control system, no
matter how well designed 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. 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.











28




PART
II – OTHER INFORMATION





Item
1 - Legal Proceedings




We are not currently involved in any
legal proceedings.







Item
1A - Risk Factors





The Risk
Factors included in our Annual Report on Form 10-KSB for the year ended 2008
have not materially changed, other than the following:





·
            The
      Risk Factor entitled “WE
      HAVE OBTAINED FINANCING, AND MAY CONTINUE TO CONSIDER ADDITIONAL
      FINANCING, THAT WILL DILUTE SHAREHOLDINGS, AND OUR FAILURE TO OBTAIN
      ADDITIONAL FINANCING AS AND IF NEEDED WILL RESTRICT OUR OPERATIONS AND MAY
      CAUSE US TO CEASE OPERATIONS ALTOGETHER”has been updated to
      reflect our recent receipt of an advance, non-refundable payment of
      certain license fees.





You
should carefully consider the risks described below before making an investment
decision. If any of the following risks actually occur, our business, financial
condition or results of operations could be materially and adversely affected.
In such case, the trading price of our common stock could decline, and you may
lose all or part of your investment.




WE
HAVE OBTAINED FINANCING, AND MAY CONTINUE TO CONSIDER ADDITIONAL FINANCING, THAT
WILL DILUTE SHAREHOLDINGS, AND OUR FAILURE TO OBTAIN ADDITIONAL FINANCING AS AND
IF NEEDED WILL RESTRICT OUR OPERATIONS AND MAY CAUSE US TO CEASE OPERATIONS
ALTOGETHER.





Because
our cash balance and cash flow may not be sufficient to fund our future
long-term operating expenses and the growth of our business, we may continue to
consider additional financing or funding in order to finance our future
losses.  Additional financing could be sought from a number of sources,
including, but not limited to, additional sales of equity
or convertible debt securities, loans from banks, other financial
institutions or our affiliates, or a credit facility.  In addition,
additional funding could be sought from new or existing license partners in the
form of royalty advances or other prepayment. In the nine months ended October
31, 2008, we entered into a Note Purchase Agreement with K1W1, our majority
stockholder, which was subsequently amended on July 4, 2008 and August 12, 2008,
pursuant to which we issued K1W1 notes in the aggregate principal amount of
$3,900,000.  The notes will be convertible at a discount of five
percent into the investment instruments we would issue pursuant to and upon any
subsequent qualified financing.  If such qualified financing does not
occur, upon maturity one year from the date of issuance the notes may, at K1W1’s
option, convert into our common stock at a five percent discount from a
formula-derived market price, which will dilute existing
shareholders.  In addition, pursuant to the Note Purchase Agreement,
K1W1 received a three-year warrant to purchase a number of the instruments that
are issued in the qualified financing equal to 10% of the aggregate principal
under the Notes divided by the discounted price at which such Notes convert in a
qualified financing.  If this warrant is exercised, the resulting issuance
of instruments would also dilute the existing shareholders, including those
investors which participated in the qualified financing.  In September
2008, we entered into an amendment to the Patent and Technology License and
Technology Transfer Agreement with International Game Technology dated October
13, 2006, pursuant to which we received an advance, non-refundable payment of
licensing fees in the amount of $10,000,000.





We cannot
be certain that any additional financing or funding will be available on terms
favorable to us, or if such financing or funding will be available to us at all.
If additional funds are raised by the issuance of our equity securities, such as
through the issuance of stock, convertible securities, or the issuance and
exercise of warrants, then the ownership interest of our existing stockholders
would be further diluted. If additional funds are raised by the issuance of debt
or other equity instruments, we may become subject to certain operational
limitations, and such securities may have liquidation rights senior to those of
the then existing holders of common stock.





Ultimately, if no additional financing
or funding is obtained as and when needed, we may be required
to significantly reduce our level of operations, including by
slowing our growth, delaying  hiring, abandoning certain product
development including product development on which we may have already spent
considerable resources and otherwise reducing expenses, or eventually, if
necessary, cease operations altogether.  Further, if we do not
enter into a qualified financing resulting in the conversion of the notes issued
to K1W1, or do not satisfy the payment obligations under the notes, K1W1 may
elect to exercise its remedies with respect to its security interest described
below under the heading “We have granted our lender a security interest in our
assets and a default of our obligations under our outstanding convertible notes
could result in the seizure or forced sale of our assets.”





29


WE
HAVE GRANTED OUR LENDER A SECURITY INTEREST IN OUR ASSETS, AND A DEFAULT OF OUR
OBLIGATIONS UNDER OUR OUTSTANDING CONVERTIBLE NOTES COULD RESULT IN THE SEIZURE
OR FORCED SALE OF OUR ASSETS.





Our obligations under the Note
Purchase Agreement and Security Agreement, under which the Company raised
$3,900,000, are secured by a first priority security interest in substantially
all of our assets, including patents and intellectual property.  If
there is an event of default under the loan and/or security agreements,
including of the Company’s fault to meet its payment obligations, is liquidated
or becomes insolvent, K1W1 would be entitled to exercise the remedies available
to a secured lender under applicable law and/or pursuant to the applicable loan
and security agreements, including its ability to exercise its rights associated
with the security interests in the Company’s assets.  See the description
of the Note Purchase Agreement transaction in “Note 5 – Notes Payable –
Convertible Notes” of the Notes to the condensed consolidated financial
statements included with this Quarterly Report.





WE
ARE NOT CURRENTLY PROFITABLE AND MAY NEVER BECOME PROFITABLE.





We have a
history of losses and expect to incur substantial losses and negative operating
cash flow for the foreseeable future. In fact, we expect that our expenses will
increase significantly in absolute dollars in future periods.  As a
result, we will need to generate significant revenue in order to achieve and
maintain profitability. Currently, we have limited sources of revenue. Even if
we succeed in developing and commercializing our current and additional
products, we expect that we will continue to incur substantial losses for the
foreseeable future. In sum, we may never achieve or maintain profitability. Our
failure to achieve or maintain profitability will likely negatively impact the
value of our securities.




WE
HAVE A LIMITED OPERATING HISTORY UPON WHICH TO BASE AN INVESTMENT
DECISION.




We are an
early-stage company with a limited operating history upon which to evaluate the
viability of our business and long-term prospects for success. Accordingly,
potential investors should carefully consider the risks, expenses and unforeseen
difficulties generally encountered in the operation and development of an
early-stage business, including the risks and uncertainties frequently
encountered by companies whose business and viability is dependent upon new
technologies.





IF
OUR PARTNERS ARE UNABLE TO INNOVATE, DEVELOP AND MARKET ATTRACTIVE NEW PRODUCTS
INTO WHICH OUR TECHNOLOGY CAN BE INCORPORATED, OUR BUSINESS MAY BE ADVERSELY
AFFECTED.




We do not
manufacture, market or sell visual display consumer products, other than
prototypes, and expect to derive a substantial portion of our future revenues
from the licensing of our MLD technology to our partners for their incorporation
into innovative new products for sale.  We expect that these revenues
will generally be based on royalty payments calculated on a per unit sold or
shipped basis.  Accordingly, our licensing revenues depend on the
success of our licensees in launching products in volume that incorporate our
technology. We cannot control these manufacturer’s product development or
commercialization efforts or predict their success. The process of
developing and marketing new products is generally complex and uncertain, and
involves a number of risks including, without limitation, the
following:




▪
            our
      partners may be unable to obtain adequate funding and resources necessary
      for investments in new products and
  technologies;




▪
            our
      partners’ investments and commitment of significant resources may not
      result in successful new products or
  technologies;




▪
            our
      partners may misunderstand their customers’ product needs and
      desires;




▪
            our
      partners may not be able to successfully anticipate the new products and
      technologies which will gain market acceptance, especially since the
      industry in which they operate is characterized by rapid changes,
      including technological changes;





▪
            our
      partners’ technology may become obsolete earlier than expected due to
      rapid advancements in technology and changes in consumer preferences,
      and




30





▪
            delays
      in being first to market with new technologies and products may prevent
      our partners from successfully competing with their
  rivals.




If our
partners fail to develop and market innovative new products, or if any of the
risks described above materialize, our licensing revenues from our arrangements
with these partners will decline and our business may be negatively and
adversely affected.




OUR
LICENSING ARRANGEMENTS HAVE LENGTHY SALES CYCLES THAT MAKE IT DIFFICULT TO PLAN
OUR EXPENSES AND FORECAST RESULTS.




Our
technology is generally incorporated in our partners’ products at the design
stage.  However, their decision to use our technology often requires
significant expenditures by us for engineering, prototype manufacturing and
sales consultation without any assurance of success, and often precedes volume
sales of products incorporating our technology, if any, by a year or
more.  If a partner decides at the design stage not to incorporate our
technology into their products, we may not have another opportunity for a design
win with respect to that customer's product for many months or years, if at all.
Our sales cycle can take up to 24 months to complete and because of this
lengthy sales cycle, we may experience a delay between increasing expenses for
research and development and our sales and marketing efforts and the generation
of volume licensing revenues, if any, from these expenditures. Moreover, the
value of any design win will largely depend on the commercial success of our
product and LCD manufacturing partners' products. There can be no assurance that
we will continue to achieve licensing wins or that any licensing win will result
in future revenues.




A
SMALL NUMBER OF PARTNERS ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES AND
ACCOUNTS RECEIVABLE IN ANY PERIOD, AND IF ANY ONE OF THEM FAILS TO SHIP PRODUCTS
INCORPORATING OUR TECHNOLOGY OR FAILS TO PAY US, OUR OPERATING RESULTS WILL
SUFFER.




We
currently have licensing arrangements only with IGT, Sanyo, Samsung, and DRS,
and expect to derive a majority of our revenues for the year ending 2009 in the
form of deferred revenue resulting from prepaid royalties under our licensing
agreement with IGT.  We are not expecting significant additional
revenue from Samsung, Sanyo or DRS, or revenues resulting in cash, during the
year ending 2009 as we cannot control our other partner’s product development or
commercialization efforts.  If for any reason our partners do not ship
products incorporating our technology, we will not receive additional licensing
revenues and our operating results will suffer.




At any
given time, the majority of our accounts receivable will be comprised of amounts
due from a small number of these partners.  Generally, we do not
require collateral from our partners.   If any of our partners do
not pay us, our operating results will be harmed.





EVEN
WITH SIGNIFICANT CAPITAL SPENDING IN THE FUTURE TO KEEP PACE WITH TECHNOLOGICAL
CHANGES, WE MAY NOT BE ABLE TO DEVELOP NEW TECHNOLOGIES THAT ARE ACCEPTED BY THE
MARKET.




Advances
in technology typically lead to a decline in sales volumes for products made
with older technologies and may even lead to those products becoming obsolete.
As a result, we will likely be required to make significant expenditures to
enhance our existing technology or to develop or acquire new technologies to be
incorporated into our partners’ products, including technologies that may cause
our MLD technology to obsolesce. We may not be able to successfully enhance our
technology or develop new technologies that keep pace with technological changes
through our own research and development efforts or through our acquisition of
technology licenses. This may be true even after we have spent significant
amounts of capital. Furthermore, even if we are successful in enhancing,
developing or acquiring any particular technology, we may not be able to
effectively market and license our technology to our partners, or our partners
may not be able to effectively commercialize or market the resulting MLD based
products into which our technology has been incorporated.





31


THE
AVERAGE SELLING PRICES OF DISPLAYS USING OUR TECHNOLOGY MAY DECLINE OVER TIME
AND NEGATIVELY AFFECT OUR OPERATING RESULTS.




The
average selling prices of displaysusing
our technology are expected to continually decline over time as a result of,
among other factors, technology advances, cost reductions and increased
competition. Although we may initially be able to take advantage of higher
selling prices that may be associated with the new MLD-based products that our
partners may bring to market, we cannot provide assurance that we will be able
to maintain licensing royalty rates with our partners in the face of market
competition for these products. If we are unable to effectively anticipate and
counter the price erosion that accompanies our partners’ products and may affect
our licensing royalty rates, our profit margins will be negatively
affected.





WE
OPERATE IN A HIGHLY COMPETITIVE ENVIRONMENT AND OUR OPERATING RESULTS MAY BE
ADVERSELY AFFECTED IF WE CANNOT COMPETE EFFECTIVELY.




Our
ability to compete successfully depends on factors both within and outside our
control, including: the end-product pricing of our partners and its impact on
our licensing royalty rates, the performance and reliability of our technology
and the products of our partners which incorporate our technology, our
successful and timely investment in technology development, the success or
failure of our partners in marketing their brands and the products into which
our technology is incorporated, component and raw material supply costs for our
prototypes and our partners’ products, market acceptance of alternative
technologies and general economic and industry conditions. Some prospective
customers for our partners’ products may perceive the quality of certain
products utilizing our competitors’ technologies to be equivalent or superior to
MLD-based products. Our competitors from time to time may have greater
financial, sales and marketing, manufacturing, research and development or
technological resources than us. In particular, competitors with greater
resources may be able to license or manufacture competitive products on a larger
scale or with greater cost efficiencies than us. Alternatively, because
innovation in our industry often creates wide scale change in technologies and
resulting products, our competitors may develop superior technologies and obtain
exclusive rights to those technologies. The number of our competitors may
increase in the future. If any technology that is competing with ours is or
becomes more reliable, higher performing, less expensive or has other advantages
over our technology, then the demand for our technology and related products and
services would decrease.  Any of the foregoing factors could harm our
business





OUR
BUSINESS MAY BE ADVERSELY AFFECTED IF ALTERNATIVE VISUAL DISPLAY PANEL
TECHNOLOGIES ERODE FUTURE SALES OF PRODUCTS BASED ON OUR MLD TECHNOLOGY.




The
successful marketing and sale of currently available alternative visual display
panel technologies, or the introduction of new alternative visual display panel
technologies, including those that may be currently under development by our
competitors and us, may erode future sales of MLD technology and may have a
material adverse effect on our business.





GOVERNMENTAL REGULATION MAY LIMIT OUR
ACTIVITIES OR INCREASE OUR COST OF OPERATIONS.




Our
business and operations are subject to various forms of government regulation in
the various countries in which we do business, including required
business/investment approvals, export regulations based on national security or
other reasons, and other export/import regulations such as tariffs. Currently,
we design our technology and products to meet rigid governmental requirements.
However, because the final product will generally be produced and manufactured
by our partners, the actual approval process is the responsibility of the
partner for the specific market. Many of the products manufactured by our
licensees and the prototypes we manufacture are subject to certain environmental
and recycling laws and regulations relating to the disposal of electronics.
These laws are constantly subject to revision and amendment. If we or our
partners cannot comply with these regulations without great cost, our financial
performance may suffer.





GENERAL ECONOMIC CONDITIONS MAY
ADVERSELY AFFECT OUR SALES AND PROFITABILITY.




For the
most part, purchases of the products into which our technology is incorporated
are discretionary. As a result, demand for consumer electronics products, which
we believe will account for a significant proportion of our worldwide operating
revenue will likely be affected by general economic trends in the countries or
regions in which the products into which our technology is incorporated are
sold. Similarly, demand for business use products and for components we may
manufacture that go into products of third parties will also likely be affected
by general economic trends in the various markets in which we sell our products.
In sum, economic downturns and resulting declines of demand in our major markets
and those of our product and LCD manufacturing partners, including North
America, Asia, and Europe, may adversely affect our sales and operating
results.







32


AS
WE MATERIALLY RELY ON A LIMITED NUMBER OF THIRD-PARTY SUPPLIERS FOR KEY RAW
MATERIALS AND COMPONENTS, AND ANY DISRUPTION IN THEIR SUPPLY WILL NEGATIVELY
AFFECT OUR BUSINESS.




Our
development and sale of MLD prototype products depend in part on obtaining
adequate supplies of quality raw materials and components, which are in many
cases with non-standard or customized specifications, on a timely basis.
Similarly, our third party licensors also depend on adequate supplies of quality
raw materials and components to manufacture MLD products, including without
limitation, polarized and/or laminated film.  In general, most of the
raw materials as well as key components of these MLD products are sourced from
two or three suppliers for each key component. The high volume, lower cost
manufacturers of these materials generally will not sell in smaller quantities,
nor will they generally build non-standard or customized materials. We, and our
third-party licensors, may experience shortages in the supply of these and other
components or raw materials as a result of, among other things, anticipated
capacity expansion in the MLD and competitive industries. If we or our
third-party licensors are unable to obtain adequate supplies of high quality raw
materials or components at a reasonable cost or in a timely manner, or are
unable to make alternative arrangements for such supplies, our operating results
could be negatively impacted.





OUR
BUSINESS MATERIALLY RELIES ON PATENT RIGHTS THAT MAY BE NARROWED IN SCOPE OR
FOUND TO BE INVALID OR OTHERWISE UNENFORCEABLE.




Our success will
materially depend on our ability to obtain, defend and enforce our patent rights
worldwide. The coverage claimed in a patent application can be significantly
reduced before a patent is issued. Consequently, our pending or future patent
applications may not result in the issuance of patents. Patents issued to us may
be subjected to further proceedings limiting their scope and may not provide
significant proprietary protection or a competitive advantage. Our patents also
may be challenged, circumvented, invalidated or deemed unenforceable. In
addition, because (i) patent applications in various countries publish at
different times, (ii) it is difficult to monitor patent applications that may be
filed in other countries by third parties, and (iii) the publication of
discoveries in scientific or patent literature often lags behind actual
discoveries, we generally cannot be certain that (i) we were the first creator
of inventions covered by our pending patent applications, (ii) that we or any of
our licensors will be entitled to any rights in purported inventions claimed in
pending or future patent applications, or (iii) that we were the first to file
patent applications on such inventions.





FAILURE
TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD IMPAIR OUR COMPETITIVENESS AND
HARM OUR BUSINESS AND FUTURE PROSPECTS.




We
believe that developing new products and technologies that can be differentiated
from those of our competitors is critical to the success of our business. We
intend to take active measures to obtain international protection of our
intellectual property by obtaining patents and undertaking monitoring activities
in our major markets. Nevertheless, we may not be able to effectively deter
competitors from improper use of our proprietary technologies. For instance, our
competitors may misappropriate our intellectual property, disputes as to
ownership of intellectual property may arise, and our intellectual property may
otherwise become known or independently developed by our competitors. Our
technology may be accessible in markets, such as Asia, where the practical legal
protections for intellectual property may be considerably less than in North
America or Europe. As a result, we may have to litigate to enforce and protect
our intellectual-property rights to determine their scope, validity or
enforceability. Intellectual property litigation is particularly expensive,
could cause a diversion of financial resources and the time and attention of our
management, and may not prove successful. The loss of intellectual property
protection, or the inability to secure or enforce intellectual property
protection, could materially harm our business and ability to
compete.














33




IF
WE INFRINGE THE RIGHTS OF THIRD PARTIES, WE COULD BE PREVENTED FROM SELLING
PRODUCTS, FORCED TO PAY DAMAGES, OR FORCED TO DEFEND AGAINST LITIGATION, WHICH
WOULD ADVERSELY AFFECT OUR BUSINESS.




If our
products, methods, processes or other technologies infringe the proprietary
rights of other parties, we could incur substantial costs and we may have
to:




▪
            obtain
      licenses, which may not be available on commercially reasonable terms, if
      at all;




▪
            abandon
      an infringing implementation or
product;





▪
            redesign
      our products or processes to avoid
infringement;




▪
            stop
      using the subject matter claimed in the patents held by
      others;




▪
            pay
      damages; or




▪
            defend
      litigation or administrative proceedings which may be costly whether we
      win or lose, and which could result in a substantial diversion of our
      valuable management resources.




WE RELY UPON TRADE SECRETS AND OTHER
UNPATENTED PROPRIETARY KNOW-HOW TO MAINTAIN OUR COMPETITIVE POSITION IN OUR
INDUSTRY, AND ANY LOSS OF OUR RIGHTS TO, OR UNAUTHORIZED DISCLOSURE OF, OUR
TRADE SECRETS OR OTHER UNPATENTED PROPRIETARY KNOW-HOW COULD NEGATIVELY AFFECT
OUR BUSINESS.




We also
rely upon trade secrets, unpatented proprietary know-how and continuing
technological innovation in our business. We typically enter into
confidentiality agreements with each of our employees and consultants upon the
commencement of an employment or consulting relationship, whereby each employee
or consultant agrees to maintain the confidentiality of our trade secrets and
certain other proprietary information on a perpetual basis. However, these
agreements may be breached and in certain circumstances we may not be able to
enforce them. Moreover, even if we can enforce such an agreement, we may not
have an adequate remedy for any such breach. The mere disclosure of our trade
secrets or other know-how as a result of such a breach could adversely and
irreparably affect our business.




OUR
BUSINESS WILL SUBJECT US TO POTENTIAL PRODUCT-LIABILITY CLAIMS THAT COULD
ADVERSELY AFFECT OUR OPERATING RESULTS, FINANCIAL CONDITION AND BUSINESS
REPUTATION.




We
currently manufacture only prototype MLD visual display products for sale to and
use by our partners.We may in the future
manufacture various products or components for incorporation into our partners’
products. We cannot be certain, however, that our prototypes, components we may
manufacture and products incorporating our technology will be defect-free and
will not be recalled at some later date. Furthermore, although we maintain
insurance against product-liability claims, we cannot be certain that such
insurance can adequately satisfy the liabilities that may ultimately be
incurred. In addition, insurance may not continue to be available on terms
acceptable to us. A large-scale product recall or a successful product-liability
claim against us could result in significant costs or have a negative impact on
our reputation, which may in turn lead to a decrease in sales, adversely
affecting our results of operations.





WE
RELY ON KEY ENGINEERS, SENIOR MANAGEMENT AND OTHER PERSONNEL, AND THE LOSS OF
THE SERVICES OF ANY SUCH PERSONNEL OR THE INABILITY TO ATTRACT AND RETAIN
SUITABLE REPLACEMENTS MAY NEGATIVELY AFFECT OUR BUSINESS.




Our
success depends to a significant extent upon the continued service of our
research and development and engineering personnel, and on our ability to
continue to attract, retain and motivate qualified researchers and engineers,
especially during periods of rapid growth. The loss of the services of any of
our key research and development and engineering personnel or senior management,
without adequate and timely replacement, could result in delays in product
development, loss of customers, partners and sales, and a diversion of
management resources, each of which could have a material adverse effect on our
business.  The current cash position of the Company, and our publicly
identified need for funding, may increase the risk of loss of employees,
including without limitation, loss resulting from employee concerns about their
job security or loss resulting from other companies identifying the employees as
suitable and susceptible hire candidates.




34


IF
WE ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL, OUR ABILITY TO GROW OUR
BUSINESS MAY BE HARMED.




As we
attempt to grow our business, we will need to hire additional qualified
personnel with expertise in software development, testing, research, technology
development and manufacturing, as well as sales and marketing. We believe that
attracting and retaining qualified personnel will be critical to our success. In
this regard, we compete for qualified individuals with numerous other
enterprises. Competition for individuals with the expertise we require in
Redwood City, California and in Auckland, New Zealand is intense, and we may not
be able to attract and retain qualified personnel.




WE
EXPECT TO HAVE SIGNIFICANT INTERNATIONAL OPERATIONS, WHICH WILL POSE UNIQUE
RISKS TO OUR BUSINESS.




We expect
that a substantial portion of our operational activity and the operational
activity of our partners will be conducted outside of the United States and
particularly in Asia. There are a number of risks inherent for us and our LCD
product and LCD manufacturing partners in doing business in overseas markets,
including the following:




▪
            unexpected
      legal or regulatory changes;




▪
            unfavorable
      political or economic factors;




▪
            difficulties
      in recruiting and retaining personnel;▪
            labor
      disputes, including strikes;▪
            less
      developed technological infrastructure, which can affect our production or
      other activities or result in lower customer acceptance of our products
      and services;




▪
            potentially
      adverse tax consequences; or




▪
            social,
      political or economic turmoil due to terrorism, war, or other
      factors.




Our
failure to adequately address these risks may harm our business.





WE
MAY BE UNABLE TO SUCCESSFULLY MANAGE AND SUSTAIN OUR GROWTH, WHICH COULD HARM
OUR BUSINESS.




Since the
founding of DVIL, we have experienced, and expect to continue to experience,
growth in the scope and complexity of our operations. This growth may strain our
managerial, financial, manufacturing and other resources, impairing our ability
to effectively execute our business plans. The materialization of these risks
could adversely affect our operating results.




OUR
MAJORITY STOCKHOLDER POSSESSES A CONTROLLING PORTION OF THE VOTING POWER OF OUR
COMMON STOCK, WHICH COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON
STOCK.




As
of December 12, 2008, K1W1, our majority stockholder, possessed beneficial
ownership of 36,664,355 shares of our common stock, or approximately 53% of our
outstanding common stock, including 884,349 shares of common stock issuable
upon exercise of warrants.  This represents a significant and controlling
portion of the outstanding voting power of our securities, and enables K1W1 to
control our management and affairs through the election and removal of our
entire Board of Directors, and all other matters requiring stockholder approval,
including any future merger, consolidation or sale of all or substantially all
of our assets. This concentrated control could discourage others from initiating
any potential merger, takeover or other change-of-control transaction that may
otherwise be beneficial to our stockholders. As a result, the return on an
investment in our common stock through the market price of our common stock or
ultimate sale of our business could be adversely affected.





35


SINCE
TRANSFER RESTRICTIONS HAVE ELAPSED ON CERTAIN SHARES OF OUR OUTSTANDING COMMON
STOCK, AND AS OUR SECURITY REGISTRATIONS HAVE BECOME EFFECTIVE, THE AVAILABILITY
OF SHARES MAY DEPRESS THE MARKET PRICE OF OUR COMMON STOCK.





In the year ending 2008, the
number of shares available for resale on the OTC Bulletin Board increased and
may continue to increase in the future.As of December 12, 2008
shares of our
outstandingcommon stock totaling
68,572,235 areeligible for resale without
registration under Rule 144 of the Securities Act, subject to the limitations of
that rule.  Additionally, we have registered on Form S-8 22,241,260
shares of our common stock for issuance upon exercise of options granted under
our 2006 Stock Incentive Plan, including most recently 8.5 million shares
pursuant to a Form S-8 filed on September 5, 2007.  In connection with
our prior private placements and other arrangements with certain of our security
holders, we have registered on Form SB-2/A, 21,463,423 shares of our outstanding
common stock and 16,406,119 shares underlying outstanding warrants to purchase
our common stock.  Any increase in the number of shares available on
the market resulting from the above factors may have an adverse effect on the
trading price of the stock.





TRADING
OF OUR COMMON STOCK ON AN ILLIQUID MARKET MAY RESULT IN LOWER MARKET
PRICES.




Trading
of our common stock is conducted on the OTC Bulletin Board. This has an adverse
effect on the liquidity of our common stock, not only in terms of the number of
shares that can be bought and sold at a given price, but also through delays in
the timing of transactions and reductions in security analysts’ and the media’s
coverage of our operations and our common stock. This may result in lower prices
for our common stock than might otherwise be obtained and could also result in a
larger spread between the bid and asked prices for our common
stock.





THERE
IS CURRENTLY LITTLE TRADING VOLUME IN OUR COMMON STOCK, WHICH WILL MAKE IT
DIFFICULT TO SELL SHARES OF OUR COMMON STOCK.




In general, there has
not been substantial trading activity in shares of our common stock. The small
trading volume will likely make it difficult for our stockholders to sell their
shares as and when they choose. Furthermore, small trading volumes generally
depress market prices. As a result, our stockholders may not always be able to
resell shares of our common stock publicly at times and prices that they feel
are fair or appropriate.





WE
MAY NOT SUCCEED IN EFFORTS TO HAVE OUR COMMON STOCK LISTED ON THE NASDAQ GLOBAL
MARKET OR A SECURITIES EXCHANGE.




We plan
to seek listing of our common stock on a national securities exchange. However,
we cannot assure you that we will be able to meet the initial listing standards
of any stock exchange.





THERE
HAS BEEN ONLY A LIMITED PUBLIC MARKET FOR OUR COMMON STOCK TO DATE.




To date,
there has been only a limited public market for our common stock on the OTC
Bulletin Board. Our common stock is currently not listed on any national
exchange. If an active trading market for our common stock does not develop, the
market price and liquidity of our common stock will be materially and adversely
affected.





BECAUSE
WE BECAME PUBLIC BY MEANS OF A REVERSE MERGER, WE MAY NOT BE ABLE TO ATTRACT THE
ATTENTION OF MAJOR BROKERAGE FIRMS.




Additional
risks may exist as a result of our becoming a public reporting company through a
reverse merger transaction, as opposed to a traditional initial public offering.
Because we did not engage in a more traditional and publicized initial public
offering, security analysts of major brokerage firms may not provide us research
coverage. In addition, there is no incentive to brokerage firms to recommend the
purchase of our common stock. The failure of brokerage firms to provide analyst
coverage will be likely to slow the dissemination of awareness and knowledge of
our business. As a result, the trading price of our common stock may be
adversely affected.








36




OUR
CERTIFICATE OF INCORPORATION GRANTS THE COMPANY’S BOARD OF DIRECTORS WITH THE
POWER TO DESIGNATE AND ISSUE ADDITIONAL SHARES OF COMMON AND/OR PREFERRED
STOCK.




Our
authorized capital consists of 200,000,000 shares, of which 190,000,000 shares
are designated as common stock, par value $0.001 per share, and 10,000,000
shares are designated as preferred stock, par value $0.001 per share. Pursuant
to authority granted by our certificate of incorporation, our Board of
Directors, without any action by the stockholders, may designate and issue
shares in such classes or series (including classes or series of common stock
and/or preferred stock) as it deems appropriate and establish the rights,
preferences, and privileges of such shares, including dividends, liquidation and
voting rights. The rights of holders of classes or series of common stock or
preferred stock that may be issued could be superior to the rights of the common
stock offered hereby. Our Board of Directors’ ability to designate and issue
shares could impede or deter an unsolicited tender offer or takeover proposal.
Further, the issuance of additional shares having preferential rights could
adversely affect other rights appurtenant to the shares of common stock offered
hereby. Any such issuances will dilute the percentage of ownership interest of
our stockholders and may dilute our book value.




WE
ARE SUBJECT TO THE SARBANES-OXLEY ACT AND THE REPORTING REQUIREMENTS OF FEDERAL
SECURITIES LAWS, WHICH CAN BE EXPENSIVE.




As a
public reporting company, we are subject to the Sarbanes-Oxley Act of 2002, as
well as the information and reporting requirements of the Securities Exchange
Act of 1934 and other federal securities laws. The costs of compliance with the
Sarbanes-Oxley Act and of preparing and filing annual, quarterly and current
reports and other information with the SEC, will cause our expenses to be higher
than they would be had we remained privately held.




WE HAVE NEVER PAID DIVIDENDS ON OUR
CAPITAL STOCK AND DO NOT INTEND TO DO SO FOR THE FORESEEABLE
FUTURE.




We have
never paid dividends on our capital stock and we do not anticipate that we will
pay any dividends for the foreseeable future. Accordingly, any return on an
investment in us will be realized, if at all, only when an investor sells shares
of our common stock.














37




Item
2 - Unregistered Sales of Equity Securities and Use of Proceeds





None








Item
3 - Defaults upon Senior Securities





None








Item
4 - Submission of Matters to a Vote of Security Holders





None








Item
5 - Other Information





None

















38




Item
6 - Exhibits




EXHIBIT
INDEX




Exhibit
      No.
            
            Description
            
            Filed
      with this
              Quarterly
      Report2.1
            
            Agreement
      and Plan of Merger dated March 16, 2006 by and among PureDepth, Inc.,
      PureDepth Technologies, Inc. and Diamond One, Inc.*(1)3.1
            
            Certificate
      of Incorporation*(1)3.2
            
            Certificate
      of Merger relating to the merger of PureDepth, Inc. (California) with and
      into PureDepth Technologies, Inc. *(1)3.3
            
            Certificate
      of Merger relating to short-form merger of PureDepth, Inc. (f/k/a Diamond
      One, Inc.) with and into PureDepth, Inc. (f/k/a PureDepth Technologies,
      Inc.)*(1)3.4
            
            Certificate
      of Designation of Series A Convertible Preferred Stock *(1)3.5
            
            Bylaws
      of the Company *(1)4.1
            
            Form
      of A-Warrant *(1)4.2
            
            Form
      of B-Warrant *(1)4.3
            
            Form
      of Agent/C-Warrant*(1)4.4
            
            Form
      of D-Warrant *(2)10.1
            
            Employment
      Agreement with Fred Angelopoulos dated March 31, 2005 *(1)10.2
            
            Employment
      Agreement with Kristin Bowman dated March 31, 2005*(1)10.3
            
            Letter
      Offer Agreement with David Hancock dated May 30, 2006*(1)10.4
            
            Master
      License Agreement between PureDepth Limited and PureDepth, Inc. *(1)10.5
            
            Agreement
      dated May 16, 2005 by and among the Company, DRS Electronic Systems, Inc.
      and DRS Laurel Technologies (++)*(1)10.6
            
            Exclusive
      Sales and Distribution License Agreement by and among the Company, Sanyo
      Sales and Marketing Corporation and SANYO Electric System Solutions Co.,
      Ltd. (++)*(1)10.7
            
            2006
      Stock Option Plan (as amended) (13)10.8
            
            Form
      of Stock Option Agreement *(4)10.9
            
            Director
      Contract - John Floisand *(4)10.10
            
            Director
      Contract - Tom Marcus *(4)




10.11
            
            Executive
      Employment Agreement - O’Callahan *(5)10.12
            
            Executive
      Employment Agreement - Angelopoulos *(6)10.13
            
            Form
      of Directors and Officers Indemnity Agreement*(7)10.14
            
            Amendment
      of Stock Option Agreement – David Hancock *(7)10.15
            
            Amendment
      of Stock Option Agreement – Fred Angelopoulos *(7)10.16
            
            Amendment
      of Stock Option Agreement – Mark Yahiro *(7)10.17
            
            Patent
      and Technology License and Technology Transfer Agreement (++) *(8)




39


10.18
            
            Executive
      Employment Agreement – McCaman *(9)10.19
            
            Separation
      Agreement – Angelopoulos *(10)10.20
            
            Waiver
      Agreement with K1W1 *(11)10.21
            
            Executive
      Employment Agreement – Credelle *(13)10.22
            
            Executive
      Employment Agreement – Marcus *(14)10.23
            
            Samsung
      License Agreement (++)*(15)10.24
            
            Office
      Lease – Twin Dolphin Drive, California*(16)10.25
            
            Amendment
      No. 2 of Stock Option Agreement – Yahiro *(17)10.27
            
            Secured
      Note Purchase Agreement*(18)10.28
            
            Security
      Agreement*(18)10.29
            
            IGT
      Patent and Technology License and Technology Transfer Agreement(++)*(19)10.30
            
            Amendment
      to Executive Employment Agreement – McCaman*(18)10.31
            
            Sublease
      Agreement – Twin Dolphin Drive, California*(18)10.32
            
            Office
      Lease – 230 D Twin Dolphin Drive, Redwood City, California*(20)10.33
            
            Variation
      to Employment Agreement – Bowman *(21)10.34
            
            Consultancy
      Agreement - Bowman*(21)10.35
            
            Amendment
      no. 1 to Convertible Note Purchase Agreement and Security Agreement*(22)10.36
            
            Amendment
      no. 2 to Convertible Note Purchase Agreement and Security Agreement*(23)10.37
            
            Amendment
      no 1. to Exclusive Sales and Distribution License Agreement by and among
      the Company, Sanyo Sales and Marketing Corporation and SANYO Electric
      System Solutions Co., Ltd. (++) *(26)10.38
            
            Executive
      Employment Agreement – Andrew L. Wood *(24)10.39
            
            Amendment
      No. 2 to Executive Employment Agreement – Jonathan J. McCaman *(24)10.40
            
            Amendment
      No 1. to the IGT Patent and Technology License Transfer Agreement
      (++)
            
            X10.41
            
            Deed
      of Variation of Leases and Rent Reviews dated November 10, 2008 (amending
      Deeds of Lease dated May 31, 2006) *(25)14.1
            
            Code
      of Business Conduct and Ethics *(18)16.1
            
            Letter
      of Comiskey & Company P.C. dated April 13, 2006 *(3)16.2
            
            Letter
      of Mark Bailey & Company *(12)31.1
            
            Section
      302 Certification of Chief Executive Officer
            
            X31.2
            
            Section
      302 Certification of Chief Financial Officer
            
            X32.1
            
            Section
      906 Certification of Chief Executive Officer and Chief Financial
      Officer
            
            X







40









(++)
            Confidential
      treatment has been obtained as to certain portions of this exhibit
      pursuant to Rule 406 of the Securities Exchange Act of 1933, as
      amended.*(1)
            Previously
      filed with the Commission in the Company’s SB-2 filed on May 30,
      2006*(2)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on August 3, 2006*(3)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on April 14, 2006*(4)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on September 12, 2006*(5)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on November 7, 2006*(6)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on November 16, 2006*(7)
            Previously
      filed with the Commission in the Company’s Annual Report on Form 10-KSB
      filed on May 31, 2007*(8)
            Previously
      filed with the Commission in the Company’s Quarterly Report on Form 10-QSB
      filed on December 15, 2006*(9)
            Previously
      filed with the Commission in the Company’s Quarterly Report on Form 10-QSB
      filed on June 14, 2007*(10)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on October 26, 2007*(11)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on August 8, 2007*(12)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K/A
      filed on June 20, 2007*(13)
            Previously
      filed with the Commission in the Company’s SB-2/A filed on August 28,
      2007*(14)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K/A
      filed on September 19, 2007*(15)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K/A
      filed on October 15, 2007*(16)
            Previously
      filed with the Commission in the Company’s Quarterly Report on Form 10-QSB
      filed on December 14, 2007*(17)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on December 27, 2007*(18)
            Previously
      filed with the Commission in the Company’s Annual Report on Form 10-KSB
      filed on April 30, 2008*(19)
            Previously
      filed with the Commission in the Company’s Quarterly Report on Form
      10-QSB/A filed on December 5, 2007*(20)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on May 27, 2008*(21)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on June 11, 2008*(22)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on October 7, 2008*(23)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on August 15, 2008*(24)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on September 15, 2008*(25)
            Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on November 10, 2008*(26)
            Previously
      filed with the Commission in the Company’s Quarterly Report on Form 10-Q
      filed on September 15, 2008

















41




SIGNATURES





In
accordance with the requirements of the Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




PUREDEPTH,
      INC.Date: December
      12, 2008
            By:
            /s/ Andrew
      L. WoodMr.
      Andrew L. Wood
              Chief
      Executive Officer and Director











By:
            /s/ Jonathan
      J. McCamanMr.
      Jonathan J. McCaman
              Chief
      Financial Officer and Secretary
              (Principal
      Accounting and Financial Officer)








42