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
      1934For
      the quarterly period ended October
      31, 2009or
 
 [   ]
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      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.)
 
 303 Twin
Dolphin Drive, Suite 600, Redwood City, California 94065
 (Address
      of principal executive offices) (Zip
Code)
 
 (650)
      632-4651
 (Registrant’s
telephone number, including area code)
 
 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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted electronically and posted pursuant to Rule 405 of regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files). 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
November 30, 2009, 68,991,352 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
              
              15Item
      3
              Quantitative
      and Qualitative Disclosures about Market Risk
              
              25Item 4T
              Controls
      and Procedures
              
              25PART
      II - OTHER
      INFORMATIONItem
      1
              Legal
      Proceedings
              
              26Item 1A
              Risk
      Factors
              
              26Item
      2
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              34Item
      3.
              Defaults
      Upon Senior Securities
              
              34Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              
              34Item 5.
              Other
      Information
              
              34Item
      6.
              Exhibits
              
              35Signatures
              
              39
 
 
 2
 PART
I – FINANCIAL INFORMATION
 Item
1 - Financial Statements
 
 PUREDEPTH,
INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 
 October
      31,
                2009
              
              
              January
      31,
                2009ASSETSCurrent AssetsCash and cash equivalents
              
              $
              3,952,934
              
              
              $
              7,275,435Restricted
      cash
              
              
              26,271
              
              
              
              15,000Accounts
      receivable, net
              
              
              287,625
              
              
              
              93,415Inventory
              
              
              153,815
              
              
              
              118,355Other current assets
              
              
              241,518
              
              
              
              210,398Total current assets
              
              
              4,662,163
              
              
              
              7,712,603Property and Equipment, net
              
              
              403,709
              
              
              
              265,934Other AssetsIntellectual
      property, net
              
              
              2,453,905
              
              
              
              2,230,313Other
      assets
              
              
              -
              
              
              
              45,949Total
      Assets
              
              $
              7,519,777
              
              
              $
              10,254,799
 
 LIABILITIES
      AND STOCKHOLDERS’ DEFICITCurrent LiabilitiesAccounts
      payable
              
              $
              593,508
              
              
              $
              286,369Accrued expenses
              
              
              508,275
              
              
              
              237,980Accrued interest
              
              
              334,618
              
              
              
              100,618Deferred revenue – current portion
              
              
              939,757
              
              
              
              939,757Convertible
      debt, net of discount
              
              
              -
              
              
              
              3,897,849Other
      current liabilities
              
              
              266,173
              
              
              
              13,646Total current liabilities
              
              
              2,642,331
              
              
              
              5,476,219Long Term LiabilitiesDeferred
      revenue
              
              
              10,315,246
              
              
              
              11,020,063Convertible
      debt - See Note 6
              
              
              3,900,000
              
              
              
              -Other
      long term liabilities
              
              
              -
              
              
              
              15,000Total
      Liabilities
              
              
              16,857,577
              
              
              
              16,511,282Commitments
      and contingenciesStockholders' DeficitPreferred
      stock, $0.001 par value, 10,000,000 authorized and no outstanding
      shares
              
              
              -
              
              
              
              -Common stock, $0.001 par value, 190,000,000 sharesauthorized,
      68,991,352 and 68,991,352 issued and outstanding
              
              
              68,991
              
              
              
              68,991Additional
      paid in capital
              
              
              35,581,123
              
              
              
              35,225,671Accumulated
      other comprehensive loss
              
              
              (100,289
              )
              
              
              (922,600
              )Accumulated
      deficit
              
              
              (44,887,625
              )
              
              
              (40,628,545
              )Total
      stockholders' deficit
              
              
              (9,337,800
              )
              
              
              (6,256,483
              )Total
      Liabilities and Stockholders' Deficit
              
              $
              7,519,777
              
              
              $
              10,254,799
 
 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
      31,2009
              
              
              2008
              
              
              2009
              
              
              2008RevenueLicensing
              
              $
              385,099
              
              
              $
              213,895
              
              
              $
              960,977
              
              
              $
              590,895Services
              
              
              -
              
              
              
              -
              
              
              
              225,430
              
              
              
              110,052Product
      sales
              
              
              323,397
              
              
              
              180,000
              
              
              
              700,697
              
              
              
              231,750Total
      revenue
              
              
              708,496
              
              
              
              393,895
              
              
              
              1,887,104
              
              
              
              932,697Cost
      of licensing
              
              
              45,833
              
              
              
              82,732
              
              
              
              132,046
              
              
              
              244,019Cost
      of services
              
              
              -
              
              
              
              -
              
              
              
              205,513
              
              
              
              87,473Cost
      of product sales
              
              
              278,271
              
              
              
              230,116
              
              
              
              644,823
              
              
              
              290,532Total
      cost of revenue
              
              
              324,104
              
              
              
              312,848
              
              
              
              982,382
              
              
              
              622,024Gross
      margin
              
              
              384,392
              
              
              
              81,047
              
              
              
              904,722
              
              
              
              310,673Operating ExpensesDepreciation
              
              
              22,955
              
              
              
              32,192
              
              
              
              63,012
              
              
              
              96,545Research and development
              
              
              494,212
              
              
              
              560,233
              
              
              
              1,693,351
              
              
              
              1,613,075Sales and marketing
              
              
              252,932
              
              
              
              581,074
              
              
              
              738,116
              
              
              
              784,138General and administrative
              
              
              717,347
              
              
              
              886,890
              
              
              
              2,536,774
              
              
              
              2,609,144Total
      operating expenses
              
              
              1,487,446
              
              
              
              2,060,389
              
              
              
              5,031,253
              
              
              
              5,102,902Loss
      from operations
              
              
              (1,103,054
              )
              
              
              (1,979,342
              )
              
              
              (4,126,531
              )
              
              
              (4,792,229
              )Other Income ( Expense )Interest income
              
              
              29,738
              
              
              
              44,679
              
              
              
              127,546
              
              
              
              54,811Interest expense
              
              
              (78,020
              )
              
              
              (105,610
              )
              
              
              (236,284
              )
              
              
              (240,176
              )Foreign exchange gain (loss)
              
              
              105,012
              
              
              
              (285,183
              )
              
              
              229,895
              
              
              
              (348,866
              )Other income
              
              
              -
              
              
              
              475
              
              
              
              -
              
              
              
              475Total
      other income (expense)
              
              
              56,730
              
              
              
              (345,639
              )
              
              
              121,157
              
              
              
              (533,756
              )Loss
      before income taxes
              
              
              (1,046,324
              )
              
              
              (2,324,981
              )
              
              
              (4,005,374
              )
              
              
              (5,325,985
              )Income
      tax provision
              
              
              8,424
              
              
              
              -
              
              
              
              253,706
              
              
              
              -Net
      loss
              
              $
              (1,054,748
              )
              
              $
              (2,324,981
              )
              
              $
              (4,259,080
              )
              
              $
              (5,325,985
              )Net
      loss per share, basic and diluted
              
              $
              (0.02
              )
              
              $
              (0.03
              )
              
              $
              (0.06
              )
              
              $
              (0.08
              )Weighted
      average shares outstanding, basic and diluted
              
              
              68,991,352
              
              
              
              68,572,235
              
              
              
              68,991,352
              
              
              
              68,498,042Comprehensive LossNet
      loss, per statement of operations
              
              $
              (1,054,748
              )
              
              $
              (2,324,981
              )
              
              $
              (4,259,080
              )
              
              $
              (5,325,985
              )Foreign
      exchange gain
              
              
              151,032
              
              
              
              174,122
              
              
              
              822,311
              
              
              
              216,577Comprehensive
      net loss
              
              $
              (903,716
              )
              
              $
              (2,150,859
              )
              
              $
              (3,436,769
              )
              
              $
              (5,109,408
              )
 
 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, 2009
              
              
              October
      31, 2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
              
              $
              (4,259,080
              )
              
              $
              (5,325,985
              )Adjustments
      to reconcile net loss to net cash flows provided by (used in) operating
      activities:Depreciation
      and amortization
              
              
              195,058
              
              
              
              340,564Loss
      on disposal of assets
              
              
              24,094
              
              
              
              1,314Stock-based
      compensation expense
              
              
              355,452
              
              
              
              567,055Amortization
      of debt discount
              
              
              2,150
              
              
              
              137,178Changes
      in operating assets and liabilities:
              
              
              -
              
              
              
              -Restricted
      cash
              
              
              (11,271
              )
              
              
              63,499Accounts
      receivable
              
              
              (194,210
              )
              
              
              (39,569
              )Inventory
              
              
              (35,460
              )
              
              
              (109,908
              )Other
      current assets
              
              
              14,830
              
              
              
              (73,466
              )Accounts
      payable
              
              
              307,139
              
              
              
              (77,497
              )Accrued
      expenses
              
              
              270,295
              
              
              
              (505,361
              )Accrued
      interest
              
              
              234,000
              
              
              
              102,523Deferred
      revenue
              
              
              (704,817
              )
              
              
              9,411,104Other
      liabilities
              
              
              237,527
              
              
              
              28,646Net
      cash provided by (used in) operating activities
              
              
              (3,564,293
              )
              
              
              4,520,097CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      from sale of fixed assets
              
              
              -
              
              
              
              14,946Purchases
      of fixed assets
              
              
              (224,881
              )
              
              
              (8,025
              )Expenditures
      for intellectual property
              
              
              (355,638
              )
              
              
              (330,630
              )Net
      cash used in investing activities
              
              
              (580,519
              )
              
              
              (323,709
              )CASH
      FLOWS FROM FINANCING ACTIVITIESIssuance
      of common stock (net)
              
              
              -
              
              
              
              24,712Proceeds
      from convertible debt
              
              
              -
              
              
              
              3,800,000Principal
      payments on notes payable
              
              
              -
              
              
              
              (12,979
              )Net
      cash provided by financing activities
              
              
              -
              
              
              
              3,811,733Effect
      of exchange rate on cash
              
              
              822,311
              
              
              
              216,577Net
      increase (decrease) in cash and cash equivalents
              
              
              (3,322,501
              )
              
              
              8,224,698Cash
      and cash equivalents at beginning of period
              
              
              7,275,435
              
              
              
              429,726Cash
      and cash equivalents at end of period
              
              $
              3,952,934
              
              
              $
              8,654,424
 
 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. and subsidiaries (“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, 2009, 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, 2009 included in the Company's Annual
Report on Form 10-K filed with the Commission on April 15, 2009.  Those
statements contain a summary of significant accounting policies.
 
 In the
opinion of the Company, the financial statements reflect all adjustments,
consisting only of normal, recurring adjustments necessary for a fair
presentation of the financial position at October 31, 2009, the operating
results for the three and nine months ended October 31, 2009 and 2008 and the
cash flows for the nine months ended October 31, 2009 and 2008.
 
 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, 2009 and 2008.  Operating results for the
three months and nine months ended October 31, 2009 are not necessarily
indicative of the results that may be expected for the year ending January 31,
2010.
 
 As a
result of the Company experiencing losses and net cash used in its operating
activities this quarter, and in each of the last two years, and its anticipating
a loss and additional cash to be used in the next twelve months, the Company has
carefully assessed its anticipated cash needs for the next twelve months. The
Company has adopted an operating plan to manage the costs of its capital
expenditures and operating activities along with its revenues in order to meet
its working capital needs. Although the Company believes that it has sufficient
working capital to conduct its operations and meet its current obligations for
the next twelve months, it makes no assurance that it will be able to do so.
Accordingly, the accompanying consolidated financial statements are presented on
the basis that the Company is a going concern.
 
 Recently
Issued Accounting Pronouncements
 
 In
December 2007, new accounting guidance was issued for accounting for business
combinations and noncontrolling interests in consolidated financial statements
that significantly changed practices regarding business combinations. Among the
more significant changes is the expanding of the definition of a business and a
business combination; it requires the acquirer to recognize the assets acquired,
liabilities assumed and noncontrolling interests (including goodwill), measured
at fair value at the acquisition date; requires acquisition-related expenses and
restructuring costs to be recognized separately from the business combination;
and requires in-process research and development to be capitalized at fair value
as an indefinite-lived intangible asset. This changes the accounting and
reporting for minority interests, reporting them as equity separate from the
parent entity’s equity, as well as requiring expanded disclosures. These changes
are effective for financial statements issued for fiscal years beginning after
December 15, 2008. The Company adopted this accounting guidance effective
February 1, 2009. The implementation did not have a material impact on our
consolidated financial statements.
 
 In March
2008, new accounting guidance was issued for accounting for disclosures about
derivative instruments and hedging activities, which requires additional
disclosures about the objectives of using derivative instruments, the method by
which the derivative instruments and related hedged items, and the effect of
derivative instruments and related hedged items on financial position, financial
performance, and cash flows. The new accounting guidance also requires
disclosure of the fair values of derivative instruments and their gains and
losses in a tabular format. This is effective for financial statements issued
for fiscal years and interim periods beginning after November 15,
2008, with early adoption encouraged.  The Company adopted this
accounting guidance effective February 1, 2009. The implementation did not have
a material impact on our consolidated financial statements.
 
 In April
2008 new accounting guidance was issued for the determination of the useful life
of intangible assets that amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset. The intent is to improve the consistency between
the useful life of a recognized intangible asset and the period of expected cash
flows used to measure the fair value of the asset. The new accounting guidance
was effective for fiscal years beginning after December 15, 2008. The
Company adopted this new accounting guidance effective February 1, 2009. The
implementation did not have a material impact on our consolidated financial
statements.
 
 6
  In
November 2008 new accounting guidance was issued for accounting for defensive
intangible assets that addresses the accounting for assets acquired in a
business combination or asset acquisition that an entity does not intend to
actively use, otherwise referred to as a ‘defensive asset.’ This requires
defensive intangible assets to be initially accounted for as a separate unit of
accounting and not included as part of the cost of the acquirer’s existing
intangible asset(s) because it is separately identifiable. It also requires that
defensive intangible assets be assigned a useful life and is effective for
financial statements issued for fiscal years beginning after December 15,
2008. The Company adopted this new accounting guidance effective February 1,
2009.  The adoption did not have a material impact on its consolidated
financial statements.
 
 In April
2009 new accounting guidance was issued for recognition and presentation of
other-than-temporary impairments. This amends the other-than-temporary
impairment guidance for debt securities to make the guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments in the financial statements. The most significant change is a
revision to the amount of other-than-temporary loss of a debt security recorded
in earnings. The new accounting guidance is effective for interim and annual
reporting periods ending after June 15, 2009. The Company adopted this guidance
effective July 31, 2009.  The adoption did not have a material impact
on its consolidated financial statements.
 
 In April
2009 new accounting guidance was issued for determining fair value when the
volume and level of activity for the asset or liability have significantly
decreased and identifying transactions that are not orderly . This provides
additional guidance for estimating fair value in accordance with fair value
measurements accounting guidance, when the volume and level of activity for the
asset or liability have significantly decreased. This also includes guidance on
identifying circumstances that indicate a transaction is not orderly. This
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions. The new accounting guidance is effective
for interim and annual reporting periods ending after June 15, 2009, and is
applied prospectively. The Company adopted this effective July 31,
2009.  The adoption did not have a material impact on its consolidated
financial statements.
 
 In April
2009 new accounting guidance was issued for interim disclosures about fair value
of financial instruments. This amends previous guidance on disclosures about
fair value of financial instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. This also amends guidance on interim
financial reporting, to require those disclosures in summarized financial
information at interim reporting periods. The new accounting guidance is
effective for interim and annual reporting periods ending after June 15, 2009.
The Company adopted this effective July 31, 2009.   The adoption
did not have a material impact on its consolidated financial statements
 
 On May
28, 2009 new accounting guidance was issued for subsequent events that
established the principles and requirements for the disclosure of subsequent
events. In particular, this set forth:
 
 o
              the
      period after the balance sheet date during which management of a reporting
      entity will evaluate events or transactions that may occur for potential
      recognition or disclosure in the financial
  statements
 
 o
              the
      circumstances under which an entity will recognize events or transactions
      occurring after the balance sheet date in its financial
      statements
 
 o
              the
      disclosures that an entity will make about events or transactions that
      occurred after the balance sheet
date
 
 The
Company adopted this guidance effective July 31, 2009.  The adoption
did not have a material impact on its consolidated financial
statements.
 
 In June
2009 new accounting guidance was issued for Accounting Standards
Codification TM
and the Hierarchy of Generally
Accepted Accounting Principles, replacing previous guidance and
establishing the FASB Accounting Standards Codification TM as
the source of authoritative accounting principles recognized by the FASB to be
applied by nongovernmental entities in the preparation of financial statements
in conformity with US GAAP. The new accounting guidance will be effective for
financial statements issued for interim and annual periods ending after
September 15, 2009, for most entities. On the effective date, all non-SEC
accounting and reporting standards will be superseded. The Company adopted the
new accounting guidance for the quarterly period ended October 31,
2009.  The adoption did not have a material impact on the Company's
financial statements.
 
 In
October 2009, the FASB issued two Accounting Standards Updates providing
guidance on revenue recognition for arrangements that include software elements
and multiple deliverables. Revenue arrangements containing both tangible
products and software elements that function together to deliver a tangible
product’s essential functionality, will not be subject to software revenue
accounting.  Guidance is also provided for allocating revenues among
multiple deliverables in a multi-element arrangement.  This new
guidance is effective for fiscal years beginning on or after June 15, 2010, and
we have elected to adopt prospectively for revenue arrangements entered into, or
materially modified in fiscal year beginning February 1, 2011. The adoption is
not expected to have a material impact on the Company’s financial
statements.
  7
  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.
 
 Subsequent
Events
 
 We
evaluated subsequent events through December 11, 2009, the date this quarterly
report on form 10-Q was filed with the Securities and Exchange Commission
(SEC).
 
 Note
2 - Description of Business
 
 PureDepth,
Inc., (PDI) along with its wholly owned subsidiaries, PureDepth Limited (PDL),
PureDepth Incorporated Limited (PDIL), PureDepth Japan KK (PDKK), and
predecessor parent entity, Deep Video Imaging Limited (DVIL), (collectively, the
Company) develops, markets, licenses, and supports multi-layer display (MLD)
technology. The Company also sells prototype MLD-enabled display devices and
related components that it manufactures. The Company’s technology has
application in industries and markets where LCD monitors and displays are
utilized including location based entertainment, computer monitors,
telecommunications, mobile phones and other hand held devices.
 
 Restructuring
 
 There was
no restructuring activity in the three months ended October 31,
2009.  The following restructuring activity occurred during the first
six months of the fiscal year and all restructuring costs were recognized during
this period.
 
 On
February 8, 2009, and on July 24, 2009 we restructured our operations reducing
our research and development staff in our Auckland, New Zealand office. At
October 31, 2009 we had 8 research and development staff, compared with 23 at
October 31, 2008.  The company incurred a restructuring charge
included in Research and Development Operating Expenses that primarily related
to employee severance in the three and nine months ended October 31, 2009 of $0
and approximately $132,000, respectively.
 
 During
April 2009, our accounting function was transferred from our Redwood City,
California office, to our Auckland, New Zealand office.  On May 15,
2009, the former Chief Financial Officer left the company and a Chief Financial
Officer was retained on a part time basis from a leading financial and
management services firm. We relocated from 230 Twin Dolphin Drive, Suite 230D,
in Redwood City, California, to 303 Twin Dolphin Drive, Suite 600, also in
Redwood City, California. One time severance costs associated with these changes
were recognized in the three and nine months ended October 31, 2009 of $0 and
approximately $127,000, respectively.  In addition, one time
relocation costs were recognized in the three and nine months ended October 31,
2009 of $0 and of approximately $96,000, respectively.  These
severance and relocation costs were included in General and Administrative
Operating Expenses.
 
 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 of net realizable
value.
 
 Inventories:
              
              October
      31,
                2009
              
              
              January
      31,
                2009Work-in-progress
              
              $
              112,182
              
              
              $
              117,677Finished
      goods
              
              
              41,633
              
              
              
              678Total
      inventories
              
              $
              153,815
              
              
              $
              118,355
 
 8
 
 Note
4 - Intellectual Property
 
 Intellectual
property consists of the following:
 
 October
      31,
                2009
              
              
              January
      31,
                2009Patent
      registration costs
              
              $
              3,175,508
              
              
              $
              2,819,828Software
      development costs
              
              
              70,456
              
              
              
              70,456Acquired
      patent rights
              
              
              333,400
              
              
              
              333,400Less:
      accumulated amortization
              
              
              (1,125,459
              )
              
              
              (993,371
              )Intellectual
      property, net
              
              $
              2,453,905
              
              
              $
              2,230,313
 
 Amortization
of intellectual property is included in the cost of
licensing.   For the nine months ended October 31, 2009 and 2008,
amortization expense totaled approximately $132,000 and $244,000,
respectively.  For the three months ended October 31, 2009 and 2008,
amortization expense totaled approximately $46,000 and $83,000,
respectively.
 
 Amortization
expense for the next five years is summarized in the following
table:
 
 Years
      ending January 31,2010
              
              $
              54,7052011
              
              
              186,7952012
              
              
              186,7952013
              
              
              186,7952014
              
              
              186,795Thereafter
              
              
              1,652,020Total
              
              $
              2,453,905
 
 Note
5 – Current Liabilities
 
 Accounts
payable consist of amounts payable to trade creditors.   The bulk of
the increase as of October 31, 2009 was due to the recent purchase of MLD units
for sales evaluation kits, foreign exchange movement, and outsourcing to meet
increased demand for the manufacture of a MLD component part and for design
and prototyping services, outsourcing to expand the scope of our patent
management and outsourcing for other consulting work.
 
 Accrued
expenses consist of accruals for bonuses, restructuring costs, trade and other
creditors.  The bulk of the increase as of October 31, 2009 was due to
accrual of bonuses (not previously accrued), rent for premises not used since
the restructuring last quarter, and accruals resulting from increased
manufacturing to meet demand for the MLD component.  At the end of the
last fiscal year, there was no accrual for bonuses.  Because of the
improved predictability of performance against objectives this quarter, we
started accruing for bonuses in the period in which the performance was
achieved.
 
 Accrued
interest consists of interest payable on the convertible debt and the increase
is the accrual for the nine months through October 31, 2009.
 
 Convertible
debt terms were amended on August 25, 2009 to extend the maturity date to June
30, 2011 and the debt was reclassified to long term liabilities.
 
 Other
current liabilities consist of the provision for corporate taxes.  No
provision was necessary at the end of the last fiscal year. However, in early
2009, the State of California legislature enacted significant California tax law
changes and a provision has been established accordingly, as described in Note
10.
 
 Note
6 - Convertible Notes
 
 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, with interest accrual starting on October 4, 2008,
and were originally due to mature on February 4, 2009.
 
 9
  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.
 
 On
February 4, 2009, Amendment 1 to the Note Purchase Agreement was signed
extending the maturity to February 10, 2010. On August 25, 2009, Amendment 2 to
the Note Purchase Agreement was signed further extending the maturity on these
notes to June 30, 2011. Amendment 2 also provided for conversion prior to
maturity at the holder’s option and provided a change in the conversion terms.
The price per share of common stock for any such conversion shall be the lower
of (i) $0.15 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
conversion date, as quoted on the OTCBB.  The principal and interest
due on the Convertible Notes are payable on the maturity date, subject to
earlier conversion at the option of the holder. If the notes are not converted,
the principal and accrued interest will be due on June 30,
2011.  Assuming, solely for the purposes of providing an estimate,
that the conversion date of the notes was October 31, 2009, the number of shares
of common stock that would have been issuable upon conversion on such date is
approximately 36,757,482.
 
 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, 2009, 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 Financial Accounting Standards Board (“FASB”) guidance 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 since the conversion price is
variable.  The Company evaluated the embedded conversion feature and
determined that conversion feature did not require liability
classification.  The debt discount associated with the embedded
conversion feature was amortized to interest expense over the life 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.
 
 The
initial term of the convertible notes included a conversion feature that
resulted in a debt discount that was amortized over the term and recorded to
interest expense.  The initial term ended on February 4, 2009 and the
remaining debt discount of $2,150 was recognized as interest
expense.  There was no debt discount associated with the amendments on
February 4, 2009, and August 25, 2009.  The August 25, 2009 amendment
set the conversion price per share of common stock equal to an amount equal to
the lower of (i) $0.15 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 conversion date, as quoted on the OTCBB.  On August 25, 2009, the
date of the 2nd
amendment, and as of October 31, 2009, the market price was lower than the $0.15
conversion option, so there was no beneficial conversion feature.
 
 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.
 
 10
  Note
7 - 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
8 - Stockholders’ Deficit
 
 Stock
warrants
 
 The
following table summarizes common stock warrant activity for:
 
 Nine
      months ended
                October
      31, 2009Warrants
              
              
              Weighted
      Average
                Exercise
      PriceOutstanding
      at beginning of period
              
              
              16,063,876
              
              
              $
              1.15Issued
              
              
              -
              
              
              
              -Exercised
              
              
              -
              
              
              
              -Expired
              
              
              (16,063,876
              )
              
              $
              1.15Outstanding
      and exercisable at the end of the period
              
              
              -
              
              
              
              -
 
 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, 2009, 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 No. 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 280,445 of
shares of common stock (post merger adjusted additional shares were 642,277) 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 three months ended October, 31, 2009 is determined
by using the simplified approach in the FASB guidance. This approach resulted in
expected term of 5.0 years for stock options.  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.
 
 11
 
 Three
      Months Ended
              
              
              Nine
      Months EndedOctober
      31,
              
              
              October
      31,Significant
      Assumptions
              
              2009
              
              
              2008
              
              
              2009
              
              
              2008Expected
      volatility
              
              
              70%
              
              
              
              70%
              
              
              
              70%
              
              
              
              70%Expected
      forfeiture rate
              
              
              30%
              
              
              
              30%
              
              
              
              30%
              
              
              
              30%Expected
      dividend yield
              
              
              0%
              
              
              
              0%
              
              
              
              0%
              
              
              
              0%Expected
      term (in years)
              
              
              5.0
              
              
              
              5.0
              
              
              
              5.0
              
              
              4.5
      to 5.0Risk-free
      rate
              
              
              2.46%
              
              
              2.38%
      to 2.91%
              
              
              1.65%
      to 2.46%
              
              
              2.66%
      to 3.19%
 
 The
following table summarizes common stock option activity under the plan
for:
 
 Nine
      Months Ended October 31, 2009Option
      Shares
              
              Shares
              
              
              Weighted
      Ave.
                Exercise
      PriceOutstanding
      at beginning of year
              
              
              13,670,681
              
              
              
              $0.49Granted
              
              
              10,017,280
              
              
              
              $0.14Exercised
              
              
              0
              
              
              
              $0.00Forfeited
      and cancelled
              
              
              (10,642,914
              )
              
              
              $0.49Outstanding
      at end of the period
              
              
              13,045,047
              
              
              
              $0.22Exercisable
      at end of the period
              
              
              5,618,072
              
              
              
              $0.30
 
 The
following table summarizes significant ranges of outstanding and exercisable
options as of October 31, 2009:
 
 Outstanding
              
              
              ExercisableExercise
      Price
                Range
              
              Shares
              
              
              Weighted
                Average
                Life*
              
              
              Weighted
      Average
                Exercise
                Price
              
              
              Aggregate
                Intrinsic
                Value
              
              
              Shares
              
              
              Weighted
                Average
                Exercise
                Price
              
              
              Aggregate
                Intrinsic
                Value$0.09
      to $0.18
              
              
              8,474,950
              
              
              
              6.42
              
              
              
              $0.13
              
              
              
              $49,750
              
              
              
              1,626,007
              
              
              
              $0.14
              
              
              
              $4,458$0.21
      to $0.29
              
              
              4,055,512
              
              
              
              2.24
              
              
              
              $0.28
              
              
              
              $0
              
              
              
              3,644,140
              
              
              
              $0.28
              
              
              
              $0$0.41
      to $1.67
              
              
              484,585
              
              
              
              5.06
              
              
              
              $0.98
              
              
              
              $0
              
              
              
              317,925
              
              
              
              $0.98
              
              
              
              $0$2.07
      to $3.51
              
              
              30,000
              
              
              
              3.99
              
              
              
              $3.41
              
              
              
              $0
              
              
              
              30,000
              
              
              
              $3.41
              
              
              
              $0Totals
              
              
              13,045,047
              
              
              
              5.07
              
              
              
              $0.22
              
              
              
              $49,750
              
              
              
              5,618,072
              
              
              
              $0.30
              
              
              
              $4,458
 
 *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 $0.12 as of October 31, 2009, which would have
been received by the option holders had those option holders exercised their
options as of that date.  There were 237,497 in-the-money stock
options exercisable as of October 31, 2009.  At October 31, 2009,
5,618,072 options were exercisable with a weighted-average exercise price of
$0.30. Of the 22,241,260 shares of common stock reserved for issuance under its
2006 Stock Incentive Plan, 13,045,047 options were outstanding, 2,798,821
options have been exercised, 125,000 have been granted to a third party service
provider and 6,272,392 options are available for grant at October 31,
2009.
 
 The
stock-based compensation cost for options issued in the nine months ended
October 31, 2009 and 2008 was $355,452 and $567,055,
respectively.  The stock-based compensation cost for options issued in
the three months ended October 31, 2009 and 2008 was $88,449 and $190,148,
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, 2009 associated with employee and director stock options was
approximately $0.7 million and is expected to be recognized over a
weighted-average period of 2.2 years.
 
 12
  Note
9 – Major Customer
 
 One
customer accounted for 61% and 73% of the Company’s licensing revenues in the
three and nine months ended October 31, 2009.  The same customer
accounted for 100% and 99% of the Company’s licensing revenues in the three and
nine months ended October 31, 2008 and the entire ending balance of deferred
revenue at October 31, 2009 and January 31, 2009.
 
 Note
10 – Provision for Income Taxes
 
 In early
2009, the State of California legislature enacted significant California tax law
changes. As a result of the enacted legislation, the Company expects that, based
upon its current projected taxable income for the year, its tax obligation in
the year 2010 will be approximately $291,000 due to a change in treatment of net
operating losses and deferred revenue. We recorded a provision for the three and
nine months ended October 31, 2009 of approximately $8,000 and $254,000,
respectively, for income taxes related to this expected payment.
 
 Note
11 – 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 months and nine months ended October
31, 2009 and 2008 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
      31,2009
              
              
              2008
              
              
              2009
              
              
              2008Numerator:Net
      loss
              
              $
              (1,054,748
              )
              
              $
              (2,324,981
              )
              
              $
              (4,259,080
              )
              
              $
              (5,325,985
              )Denominator:Weighted
      average shares outstanding, basic and diluted
              
              
              68,991,352
              
              
              
              68,572,235
              
              
              
              68,991,352
              
              
              
              68,498,042Net
      loss per share, basic and diluted
              
              $
              (0.02
              )
              
              $
              (0.03
              )
              
              $
              (0.06
              )
              
              $
              (0.08
              )
 
 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
    31,2009
              
              
              2008
              
              
              2009
              
              
              2008Convertible
      notes
              
              
              36,757,482
              
              
              
              12,786,625
              
              
              
              36,757,482
              
              
              
              12,786,625Warrants
              
              
              -
              
              
              
              17,290,468
              
              
              
              -
              
              
              
              17,290,468Employee
      stock options
              
              
              13,045,047
              
              
              
              19,496,558
              
              
              
              13,045,047
              
              
              
              16,697,737
 
 13
  Note
12 - Related Party Transactions
 
 On
February 20, 2009, the Board of Directors approved the cancellation of certain
options previously granted to the executive officers and certain of the
Directors of the Company and, effective February 23, 2009, granted new options
to those executive officers and directors.  The Board took this action
in light of the recent trading prices for the Company’s common stock and in
order to provide adequate performance and retention incentives.  The
executive officers and directors included in this option exchange, together with
the number and exercise prices of shares subject to previously outstanding
options which were cancelled and the respective new option grants which were
issued are as follows:
 
 Name
              Title
              Number
      of Shares Subject
                to
      Outstanding Options
                Cancelled
      (1)
              Exercise Price of Shares
                Subject
      to Options
                Cancelled
              Number
      of New Options
                GrantedAndy
      L. Wood
              Chief
      Executive Officer and Director
              3,400,000
              $0.29
              3,400,000John
      Blair
              Director
              375,000
              $0.27
              375,000Kristin
      Bowman
              Director
              375,000
              $0.28
              375,000Mark
      Kalow
              Director
              375,000
              $0.27
      to $3.51
              375,000
 
 (1)
Optionees were required to cancel vested shares subject to outstanding options,
to the extent available.  Any shares subject to an option which were
not cancelled remain outstanding on the initial terms of such
option.
 
 All of
the new options granted will vest monthly over three years from the grant date
and have an exercise price of $0.15, which was the closing price of the
Company’s common stock on the grant date as reported by the OTC Bulletin
Board.  The new options are subject to the terms and conditions of the
2006 Stock Incentive Plan and related form of stock option
agreement.
 
 With
respect to the options granted to Mr. Wood, 100% of the shares subject to such
options will vest in the event the individual’s service is terminated without
cause (which may include a voluntary resignation by Mr. Wood in certain
circumstances following a material adverse change) on or within twelve months
following the effective date of a change in control, subject to certain release
conditions.  Mr. Wood’s employment agreement was amended on February
20, 2009 to provide that the new and any future options granted to Mr. Wood will
have acceleration provisions consistent with the foregoing.  For
purposes of the foregoing, the terms “cause,” “material adverse change” and
“change in control” have the meanings set forth in the employment
agreements.
 
 On April
13, 2009 the Board of Directors approved the cancellation of 375,000 options
previously granted to Director, David Teece at $0.18, and effective April 13,
2009, granted the same number of new options at $0.11. The Board took this
action in light of the recent trading prices for the Company’s common stock and
in order to provide adequate performance and retention incentives.
 
 With
respect to the options granted to the Directors listed above, 100% of the shares
subject to such options will vest if the individual’s service is terminated on
or within twelve months following the effective date of change in
control.  For purposes of the foregoing, the definition of “change in
control” is the same as that used in the employment agreement with Mr.
Wood.
 
 On August
25, 2009, the Company entered into an Amendment No. 2 to Convertible Promissory
Notes (the “Amendment”), which amends each of the  Convertible
Promissory Notes previously issued by the Company to K One W One Limited
(“K1W1”) on February 4, 2008, March 14, 2008, July 4, 2008 and August 12, 2008,
respectively (collectively, the “Notes”), pursuant to the  Convertible
Note Purchase Agreement dated as of February 4, 2008 and Security Agreement
dated as of February 4, 2008, in each case as amended by Amendment No. 1 to
Convertible Note Purchase Agreement and Security Agreement dated July 4, 2008
and Amendment No. 2 to Convertible Note Purchase Agreement and Security
Agreement dated August 12, 2008 and Amendment No. 1 to Convertible Promissory
Notes dated February 3, 2009.  The Amendment restates and extends the
maturity date of each of the Notes to June 30, 2011. The Amendment also allows
K1W1 the option to convert the Note and accrued interest, at or prior to
maturity, at the lower of the 10-day weighted average share price prior to the
conversion date or $0.15. All other terms and conditions of the Notes and the
Convertible Note Purchase Agreement and Security Agreement, as amended, remain
the same.
 
 14
  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-K, 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, and Japanese subsidiary, PureDepth Japan KK, are referred to in this
Quarterly Report on Form 10-Q as the “Company,” “we,” “us” and “our.” References
herein to year ending 2010, and years ended 2009 and 2008 mean the fiscal year
ending January 31, 2010, and the fiscal years ended January 31, 2009 and January
31, 2008, respectively.
 
 
 15
 
 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.
 
 We
continue to execute on our strategy of expanding our presence in the US Casino
market by working with Game Development companies to place potential games
before IGT. In this regard, agreements have been announced with ADI and No 8.
Additional opportunities are being explored. In addition, we continue our
primary focus of expanding our Japan market presence in both the Pachinko and
Pachislot markets, as well as the Amusement and Public Information Display
markets. We believe steady progress is being made to identify the potential
partners to penetrate the markets of Pachinko and Amusement. We continue to
support our existing licensees and are pleased that IGT has now taken MLD
product distribution into over 500 properties worldwide and that Sanyo, along
with its customer, has launched a new Hollywood-titled game on December
8.  In addition, we are pleased to announce that we have introduced
our  MOBILE MLD prototype to selected customers and prospects. This
shows, in our view, excellent visual impact with only 1mm (millimeter) between
the two displays and market-compatible battery performance.  As a
result, our technology and this form factor are under evaluation by several
notable brands.
 
 In the
Japanese market, we are responding to customer input by providing Evaluation
Kits consisting of Hardware, our Software Development Platform, training and
support, to allow for testing of our technology in real-world environments with
fixed time periods associated. In addition we are formulating partnerships with
hardware suppliers to enable both the provision of the hardware component of the
Evaluation Kits as well as full product channel supply.
 
 In
addition, we have continued to progress the strategy that is focused on those
companies that have demonstrated an interest in MLD by filing for their own
patents or launching products in this market space. Several discussions are
underway with regard to these target companies as indicated above.
 
 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 Redwood City, CA, Auckland,
New Zealand and Tokyo, Japan. Other than purchases for research and development
purposes, no significant capital equipment purchases are expected during the
year ending 2010.
 
 Our
critical research and development activities include: further enhancing our
existing MLD technology, developing productized software and content development
pipelines, environments, and tools; developing, manufacturing and testing
prototype MLD-enabled electronic display devices for our existing licensee
partners and potential licensee partners; designing and customizing features to
the specification of potential licensee partners;  patent defense; and
strengthening and leveraging the  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 and software. We currently have 80 granted and allowed
patents in 20 countries and 146 granted, allowed, and applied for
patents.  We are underway with selected companies on discussions with
regard to potential infringement of our backlight patents.  The
outcome of these discussions cannot be guaranteed to be “positive”
however.
 
 We
maintain three facilities, a U.S. office in Redwood City, California, our
research and development center in Auckland, New Zealand and our office in
Tokyo, Japan.  Our facility lease in New Zealand expires on October
31, 2011, and has a provision for a second term which, if exercised, will
commence on November 1, 2011 and expire October 31, 2014. In June 2009, we
exercised our option to provide a six month notice to exit our lease on one of
the units in Auckland by December 23, 2009. In July 2009, we moved our U.S.
office to a new location in Redwood City, California, which we rent
month-to-month.   Our sales office lease in Japan expires on
April 19, 2010.
 
 In July
2009, we reduced our overall headcount in our New Zealand office in order to
better align our cash resources with our strategic plans. This restructuring
impacted our research and development group and was made possible by the
achievement of key milestones on the delivery of substantially improved content
capability and related architecture and supporting software
tools.   In aggregate, we reduced the number of worldwide
employees from a 27 full time employees at January 31, 2009 to 12 at July 31,
2009, and it remains at 12 at October 31, 2009. One of the employees is located
in the U.S., one is located in Tokyo, Japan and the remaining 10 are located in
Auckland, New Zealand. We expect that these reductions, along with our planned
process improvements will produce a significant cost savings for
us.  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 the business and if necessary, will make changes
in relation to our business strategy and customer activity.
  16
  Our
operations have resulted in operating losses to date and are expected to
continue to have operating losses in the year ending 2010.  We believe
that, as a result of the cost reduction actions taken, future losses will be
reduced versus historical performance assuming that there are no unforeseen
circumstances arising.
 
 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.
 
 In
addition to our receipt of the advance, non-refundable payment of licensing
fees, we raised $3.9 million in 2008 in secured convertible debt from our
majority shareholder.  That debt was originally due February 10, 2009
but was first extended to February 10, 2010 and subsequently to June 30, 2011.
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 IGT agreement and
the secured convertible debt will be used to fund our operations, continue our
efforts to fulfill and promote existing customer agreements with Sanyo Electric
Corporation (Sanyo), and International Game Technology (IGT) and expand our
customer base to diversify our sources of licensing revenue.  
  We believe that the advance, non-refundable payment of licensing
fees, along with the actions taken by management referred to above, allows
us to effectively address any going concern issues for the remainder of the year
ended January 31, 2010 and into the year ended January 31, 2011.
 
 Results
of Operations
 
 For the
three months ended October 31, 2009, we reported net losses of $1.1 million,
$1.2 million less than the $2.3 million reported in the three months ended
October 31, 2008.  For the nine months ended October 31, 2009, we
reported net losses of $4.3 million, $1.0 million less than the $5.3 million
reported in the nine months ended October 31, 2008.  However, the loss
this year includes one-time costs in the three and nine months
ended  October 31, 2009 of $0 approximately $488,000,
respectively.  These one-time costs include a substantial reduction of
our research and development staff and the transfer of our accounting function
from California to Auckland, New Zealand.  As a result of these
actions, we expect our operating costs to be significantly lower in the
remainder of the year.  The one-time costs also include expenses to
establish our subsidiary in Japan.  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
2010.
 
 Licensing
Revenue and Cost of Licensing
 
 Three
      Months Ended
              
              Nine
      Months EndedOctober
      31,
              
              Change
              
              October
      31,
              
              Change($
      in thousands)
              2009
              
              2008
              
              $
              
              
              
              %
              
              2009
              
              2008
              
              $
              
              
              
              %Licensing
      revenue
              
              $
              385
              
              
              $
              214
              
              
              $
              171
              
              
              
              80%
              
              
              $
              961
              
              
              $
              591
              
              
              $
              370
              
              
              
              63%Cost
      of licensing
              
              
              46
              
              
              
              83
              
              
              
              (37)
              
              
              
              -45%
              
              
              
              132
              
              
              
              244
              
              
              
              (112)
              
              
              
              -46%Gross
      margin - $
              
              $
              339
              
              
              $
              131
              
              
              $
              208
              
              
              
              
              
              
              $
              829
              
              
              $
              347
              
              
              $
              482Gross
      margin - %
              
              
              88%
              
              
              
              61%
              
              
              
              
              
              
              
              
              
              
              
              86%
              
              
              
              59%
 
 We are a
party to a patent and technology license and technology transfer 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.   Our licensing
revenue for the nine months ended October 31, 2009 consisted primarily of the
amortization of advance non-refundable license fee payments;
however, royalty revenues received were also received from another
customer.   Our revenue from the amortization of the IGT advance
non-refundable license fee payments, as a percentage of our total licensing
revenue for the three and nine months ended October 31, 2009 was 61% and 73%,
respectively. The increase in the amount of licensing revenue in the three
months and nine months ended October 31, 2009 when compared with the
corresponding periods in the prior year is due to an increase in amortization as
a result of the additional $10.0 million in advance, non-refundable payments of
license fees received in September, 2008, and the receipt of royalty revenues
from SANYO.  The balance of the IGT advance on licensing revenues is
recorded as deferred revenue and will continue to be earned through the year
ended 2022, the remaining term of the agreement.
  17
  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.  We expect to continue to recognize increasing licensing
revenue from SANYO and the continued recognition of IGT deferred revenue in the
year ending 2010; however, we have no control over the timing or success of our
customer’s sales or marketing programs.
 
 Cost of
licensing is primarily the amortization of capitalized costs related to our
patents.  In December 2001, DVIL entered into an agreement with BASS
Group LLC, a Florida limited liability company, whereby John and Robert Bass
assigned the rights and interest to three patents granted in the U.S. These
rights were subsequently assigned to PureDepth Limited.  In
consideration of the assignment, PureDepth Limited was required to pay BASS
Group approximately $175,000 per year through 2010.   On January 29,
2009, we entered into a new settlement agreement with The Bass Group, pursuant
to which the original settlement agreement between us and The Bass Group dated
as of December 2001, expired on February 27, 2009 and we made a one-time payment
to The Bass Group of approximately $43,000.  Pursuant to the
agreement, we retained ownership of the patents covered by the original
settlement until they expired on February 27, 2009 and no further amounts are or
will be due the BASS Group. The substantial decrease in cost of licensing for
the three and nine months ending October 31, 2009 compared with the
corresponding periods in the prior year is the result of the termination of the
payments due for these patents acquired from the BASS Group
LLC.    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)
              
              2009
              
              
              2008
              
              
              $
              
              
              %
              
              
              2009
              
              
              2008
              
              
              $
              
              
              
              %Services
      revenue
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              
              0%
              
              
              $
              225
              
              
              $
              110
              
              
              $
              115
              
              
              
              105%Cost
      of services
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              0%
              
              
              
              206
              
              
              
              87
              
              
              
              119
              
              
              
              137%Gross
      margin - $
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              
              -
              
              
              $
              19
              
              
              $
              23
              
              
              $
              (4)Gross
      margin - %
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              8%
              
              
              
              21%
 
 Our
services revenue in the three and nine months ended October 31, 2009 and 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 had no service revenue in the three months ended October
31, 2009 and 2008.  The increase in revenue in the nine months ended
October 31, 2009 is the result of services performed on two major design and
prototyping contracts with IGT, compared to one in the same period last year,
and of providing software training. 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 provided in the nine months ended October 31, 2008 represents direct
labor and overhead costs of providing the respective services.   Cost
of services provided in the nine months ended October 31, 2009 primarily
represents outsourcing costs.   We have strengthened our relationships
with outsourcing vendors, reduced the number of employees from the same period
last year, and increased our managed outsourcing.  We expect cost of
services to fluctuate with changes in services revenue and the related gross
margins to improve as the volume of services revenue increases.
 
 18
 
 Product
Sales Revenue and Cost of Product Sales
  Three
      Months Ended
              
              
              Nine
      Months EndedOctober
      31,
              
              
              Change
              
              
              October
      31,
              
              
              Change(
      $ in thousands)
              
              2009
              
              
              2008
              
              
              $
              
              
              
              %
              
              
              2009
              
              
              2008
              
              
              $
              
              
              
              %Product
      sales revenue
              
              $
              323
              
              
              $
              180
              
              
              $
              143
              
              
              
              79%
              
              
              $
              701
              
              
              $
              232
              
              
              $
              469
              
              
              
              202%Cost
      of product sales
              
              
              278
              
              
              
              230
              
              
              
              48
              
              
              
              21%
              
              
              
              645
              
              
              
              291
              
              
              
              354
              
              
              
              122%Gross
      margin - $
              
              $
              45
              
              
              $
              (50)
              
              
              $
              95
              
              
              
              
              
              
              $
              56
              
              
              $
              (59)
              
              
              $
              115Gross
      margin - %
              
              
              14%
              
              
              
              (28%)
              
              
              
              
              
              
              
              
              
              
              
              8%
              
              
              
              (25%)
 
 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
for the three and nine months ended October 31, 2009 compared with the
corresponding periods in the prior year is due to an increase in MLD component
sales to an IGT subassembly vendor who manufactures MLD
products.   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 2010.
 
 Cost of
product sales represents materials, sub-contractor services, direct labor and
overhead costs of assembling the components or prototypes at subcontractor’s
facilities, and product warranty costs.  Because of the recent
increase in sales volume, a product warranty reserve has been established and
approximately $33,000 was charged to the cost of product sales this quarter. In
the nine months ended October 31, 2008, we had negative margins on our product
sales as we acquired 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 required the use of non-standard parts and
manual or unique assembly.   In the nine months ended October 31,
2009, the engineering and material standards for form factors have been improved
and economies of scale have been realized.  As a result of these
factors, we expect to see our cost of product sales as a percentage of product
revenues continue to decline in the fiscal year ending 2010.
 
 Operating
Expenses
  Three
      Months Ended
              
              Nine
      Months EndedOctober
      31,
              
              Change
              
              October
      31,
              
              Change(
      $ in thousands)
              
              2009
              
              % of
      Total
              
              2008
              
              % of
      Total
              
              $
              
              %
              
              2009
              
              % of
      Total
              
              2008
              
              % of
      Total
              
              $
              
              %Depreciation
              
              $
              23
              
              
              2%
              
              $
              32
              
              
              2%
              
              $
              (9
              )
              
              (28%
              )
              $
              63
              
              
              1%
              
              $
              97
              
              
              2%
              
              $
              (34
              )
              
              (35%
              )Research
      and development
              
              
              494
              
              
              33%
              
              
              560
              
              
              27%
              
              
              (66
              )
              
              (12%
              )
              
              1,693
              
              
              34%
              
              
              1,613
              
              
              32%
              
              
              80
              
              
              5%Sales
      and marketing
              
              
              253
              
              
              17%
              
              
              581
              
              
              28%
              
              
              (328
              )
              
              (56%
              )
              
              738
              
              
              15%
              
              
              784
              
              
              15%
              
              
              (46
              )
              
              (6%
              )General
      and administrative
              
              
              717
              
              
              48%
              
              
              887
              
              
              43%
              
              
              (170
              )
              
              (19%
              )
              
              2,537
              
              
              50%
              
              
              2,609
              
              
              51%
              
              
              (72
              )
              
              (3%
              )Total
      operating expenses
              
              $
              1,487
              
              
              100%
              
              $
              2,060
              
              
              100%
              
              $
              (573
              )
              
              (28%
              )
              $
              5,031
              
              
              100%
              
              $
              5,103
              
              
              100%
              
              $
              (72
              )
              
              (1%
              )
  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, 2009 and 2008, our stock-based compensation totaled $88,449
and $190,148, respectively.  For the nine months ended October 31,
2009 and 2008, our stock-based compensation totaled $355,452 and $567,055,
respectively.  The decrease of stock-based compensation is primarily
the result of staff reductions and the issuance of stock options at a lower
exercise price. 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, 2009, we expensed
stock-based compensation of approximately $108,000 in research and development,
$3,000 in sales & marketing, and $244,000 in general and administrative
operating expense categories.
 
 Depreciation.
Depreciation represents the depreciation expense on our fixed
assets.  The decrease in depreciation expense for the three and nine
months ended October 31, 2009 compared with the corresponding periods in the
prior year is primarily the result of fully amortizing leasehold improvements in
our Auckland, New Zealand location in the last quarter of last
year.  It is unlikely we will need to make significant purchases of
fixed assets in the foreseeable future and accordingly, the depreciation expense
is not expected to change proportionately with revenue or total operating
expenses.
  19
  Research and
development. Our research and development activities include
the following: research, patent development and management, prototype
development, product design development and development of software applications
and the development of content tools. Research and development expenses consist
primarily of personnel salary, benefits and stock-based compensation, consultant
and contractor fees, materials, and travel.
 
 There was
no restructuring activity in the three months ended October 31,
2009.  The following restructuring activity occurred during the first
six months of the fiscal year and all restructuring costs were recognized during
this period.  On February 8, 2009, and on July 24, 2009 we
restructured our operations reducing our research and development staff in our
Auckland, New Zealand office. During the three months ended July 31, 2009, we
completed a major engineering milestone in the release of a new version of the
software that drives the MLD screens, improving 3-D imaging and allowing for
easier development of content that could utilize the capabilities of the MLD.
Because of the completion of this milestone and after assessing the likely
timeframe required to execute its market strategies management concluded that we
needed fewer resources in research and development and would focus its efforts
primarily on the Japanese market.  At October 31, 2009 we had 8 research
and development staff, compared with 23 at October 31, 2008.  The
Company incurred a restructuring charge included in research and development
expenses that primarily related to employee severance in the three and nine
months ended October 31, 2009 of $0 and approximately $132,000,
respectively.  As a result of this restructuring, there was a 57%
reduction in salary and stock based compensation in the three months ended
October 31, 2009 compared with the three months ended October 31,
2008.
 
 During
the three and nine months ended October 31, 2009, we expanded the scope of our
patent management activities beyond patent issuance to address patent strategy,
patent infringement, and market opportunities.  We utilize the
services of specialized consultants with in depth knowledge and experience in
our industry to manage our patents.  In the same periods last year,
patent management was handled in-house and the main focus was on the issuance of
new patents.
 
 Research
and development costs increased by approximately $80,000 in the nine months
ended October 31, 2009 compared to the same period last year.  Cost
savings from a reduction in salaries and a favorable movement in foreign
exchange rates were exceeded by the increased costs for patent management,
payment of scheduled bonuses, severance and contract labor.  Our
research and development work is conducted in New Zealand and the costs incurred
are primarily in New Zealand dollars.
 
 Research
and development costs decreased by approximately $66,000 in the three months
ended October 31, 2009 compared to the same period last year.  This
was primarily due to reduction in salaries that was partly offset by the
increased costs for patent management, bonuses, and contract labor. In the same
quarter last year there was no cost for bonuses.  Because of the
improved predictability of performance against objectives this quarter, we
started accruing for bonuses in the period in which the performance was
achieved.  In addition, as part of the July 24, 2009 restructuring
program, we are accruing retention bonuses that will be payable early next
fiscal year.  As a result of the restructuring actions taken, we
expect research and development expenses to be significantly lower in the
remainder of the year.  Our focus will be on refining the
productization of our platform capability for easier adoption by our
partners.  Also, we will continue to proactively manage, expand and
protect our intellectual property assets.
 
 Sales and
marketing. During the latter part of fiscal year 2009, we re-evaluated
our strategy and shifted our focus to expanding our initial presence in the
Pachinko and Pachislot market in Japan, and developing technical and commercial
approaches for potential licensees in the newly identified public information
display markets in Japan.  We hired a country manager and formed a
Japanese subsidiary, PureDepth Japan K.K., in April 2009.  During the
first six months of the current fiscal year we incurred one-time costs to
establish our subsidiary in Japan of approximately $156,000.  During
the three months ended October 31, 2009, our costs consisted primarily of the
operation of our sales office in Japan. During the first six months of the
previous fiscal year we curtailed our marketing efforts in the United States and
our costs consisted primarily of severance costs and outside
consultants.  During the three months ended October 31, 2008, our
costs consisted primarily of a $0.5 million in non-recurring consultant
fees.
 
 General and
administrative.  General and administrative expenses
consist primarily of personnel salary and benefits, stock-based compensation,
travel, insurance, rent and professional fees related to our public company
filing requirements.
 
 During
the three months ended April 30, 2009, our accounting function was transferred
from our Redwood City, California office, to our Auckland, New Zealand
office.  In May 2009, the former Chief Financial Officer left the
company and a Chief Financial Officer was retained on a part time basis from a
leading financial and management services firm. We relocated from 230 Twin
Dolphin Drive, Suite230D, in Redwood City, California, to 303 Twin Dolphin
Drive, Suite 600, also in Redwood City, California. One time severance and
relocation costs associated with these changes totaled $127,000 and $96,000
respectively.
 
 General
and administration costs decreased in the nine months ended October 31, 2009 by
approximately $72,000 compared to the same period last year.  This was
primarily due to a reduction in salaries, audit and accounting costs, and a
favorable movement in foreign exchange rates, which were partly offset by costs
for temporary contract staff and severance costs.
 
 General
and administration costs decreased in the three months ended October 31, 2009 by
approximately $170,000 compared to the same period last year.  This
was primarily due to a reduction in salaries, audit, accounting and legal costs
that were partly offset by costs for temporary contract staff.  As a
result of the restructuring action taken so far this year, we expect general and
administrative expenses to be significantly lower in 2010.
  20
  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 due to the
reduction of inside legal and technical employees and our reliance of external
professionals.  We may also experience increased legal and capital
raising costs associated with any capital raising activities we may undertake in
the fiscal year ended 2010.  We anticipate that the overall cost
savings measures we have progressively introduced will help us maintain or
offset increases in our general and administrative expenses in the fiscal year
ending 2010, as we have re-balanced our costs in support of our strategy. A
portion of our general and administrative costs is incurred in New Zealand
dollars and may be impacted by currency fluctuations.
 
 Other
Income and Expense
  Three
      Months Ended
              
              Nine
      Months EndedOctober
31,
              
              Change
              
              October
31,
              
              Change($
      in thousands)
              2009
              
              2008
              
              2009
              
              
              2009
              
              2009
              
              2008
              
              2009
              
              
              2009Interest
      income
              
              $
              30
              
              
              $
              45
              
              
              $
              (15
              )
              
              
              (33%
              )
              
              $
              127
              
              
              $
              55
              
              
              $
              72
              
              
              
              133%Interest
      expense
              
              
              (78
              )
              
              
              (106
              )
              
              
              28
              
              
              
              (26%
              )
              
              
              (236
              )
              
              
              (240
              )
              
              
              4
              
              
              
              (2%
              )Foreign
      exchange gain (loss)
              
              
              105
              
              
              
              (285
              )
              
              
              390
              
              
              
              (137%
              )
              
              
              230
              
              
              
              (349
              )
              
              
              579
              
              
              
              (166%
              )Total
      other income(expense), net
              
              $
              57
              
              
              $
              (346
              )
              
              $
              403
              
              
              
              (116%
              )
              
              $
              121
              
              
              $
              (534
              )
              
              $
              655
              
              
              
              (123%
              )
 
 Other income and expense consists of interest income, interest
expense and foreign exchange gain or loss.  Interest income is earned
on our cash and cash equivalents.  Interest income was higher in the
nine months ended October 31, 2009, compared with the corresponding period in
the prior year as a result of the investment of advanced licensing payments
received in the later part of last year, in certificates of deposit and cash
equivalents.  Interest income was lower in the three months ended
October 31, 2009, compared with the corresponding period in the prior year as a
result of a reduction in interest rate.  We expect interest income to
fluctuate in the fiscal year ended 2010, depending on the amount and timing of
any capital raised, advanced licensing payments received or royalty payments
received and the rate at which we use such funds to pay our ongoing operating
expenses.   Interest expense during the nine months ended October
31, 2009 is comparable with the corresponding period in the prior
year.  During the same period last year, weighted average principal
outstanding was lower, resulting in a lower interest
expense.  However, this was offset by the amortization of the debt
discount and payment of interest on the Bass loan.  The Bass loan
settled late last year, and the extensions of the K1W1 loans this year did not
result in a debt discount.    Our foreign exchange gains and
losses result from transactions with our New Zealand and Japanese subsidiaries,
with our overseas customers and translation of our overseas subsidiaries into
U.S. dollars.   The increase in the foreign exchange gain for the
three and nine months ended October 31, 2009 compared with the corresponding
periods in the prior year is due to fluctuations in the international exchange
rates.
 
 Liquidity
and Capital Resources
 
 We have
funded our operations from inception through October 31, 2009 primarily through
the sale and exercise of common stock and warrants, the sale of convertible
notes and the use of advance, non-refundable payments of licensing
fees.  In the nine months ended October 31, 2009, net cash used by
operating activities was $3.6 million and an additional $0.6 million was used
for investment in fixed assets and intellectual property. In the nine
months ended October 31, 2008, net cash provided by operating activities was
$4.5 million.  An additional $3.8 million was provided by financing
activities and $0.3 million was used for the purchases of fixed assets and
expenditures for intellectual property.  Our operating and asset
purchasing activity during the nine months ended October 31, 2009 was primarily
funded by available cash of $7.3 million at January 31, 2009.  Our
operating and asset purchasing activities in the nine months ended October 31,
2008 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.  We expect the
cash balance of $4.0 million at October 31, 2009 to be adequate to fund our
operations in the fiscal year ending 2010.
 
 We have
issued options to employees and directors pursuant to our 2006 Stock Incentive
Plan. As of October 31, 2009, we had 13,045,047 options outstanding under our
2006 Stock Incentive Plan with a weighted exercise price of
$0.22.   In July 2009, the remaining 7,060,044 warrants with a
weighted average exercise price of $1.20 expired without exercise.  We
have no warrants outstanding as of October 31, 2009.
 
 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.
 
 21
  Provision
for State and Federal Income Taxes
 
 From
inception through October 31, 2009, 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 New Zealand subsidiaries.
 
 We have
not recorded a tax benefit for domestic tax losses because of the uncertainty of
realization. We adhere to 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. 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, 2009.
 
 We
recognize interest and penalties related to unrecognized tax benefits as a
component of income taxes.  For the three months and nine months ended
October 31, 2009, no interest or penalties related to unrecognized tax benefits
had been recorded.  There was no change to our unrecognized tax
benefits for the three months and nine months ended October 31,
2009.
 
 We are
subject to taxation in the U.S. and California. Our subsidiaries are subject to
taxation in New Zealand and Japan.  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, 2009 consisted of operating leases for facilities
and secured convertible notes.  The convertible notes were originally
due February 4, 2009. On February 4, 2009, an extension was signed to February
10, 2010.  On August 25, 2009, an extension was signed to June 30,
2011.  The aggregate principal amount and of the secured convertible
notes and interest accrued at October 31, 2009, totaled approximately $4.2
million and is convertible into our common stock at the note holder’s sole
option during the term of the notes.  The conversion into our common
stock is at the lower of the 10-day weighted average share price prior to the
conversion date or $0.15.  In the event of a qualified financing, the
aggregate principal amount of the secured convertible notes is convertible at a
discount of five percent (5%) into investment instruments issued by
us.  If the notes have not been converted at the maturity date, the
note holder has the option of payment of the principal and interest in either
cash or common stock.   In addition, pursuant to the secured
convertible note purchase agreement, the 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 accrue interest at the
annual rate of 8%, commencing October 4, 2008.  The secured
convertible notes are secured by our assets.  At October 31, 2009,
minimum lease payments required under the operating leases amounted to $0.1
million and are payable through 2010.
 
 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.
 
 22
  Critical
Accounting Policies
 
 There
have been no significant changes in our critical accounting policies included in
our Annual Report on Form 10-K for the year ended 2009.
 
 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-K under Item 8
of  Part II entitled “Financial Statements and Supplementary
Data”.  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 in the FASB guidance.  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 collectability 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.
 
 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 collectability 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, collectability 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. 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 is 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. 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.
 
 23
  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 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 condensed 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 condensed 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.
 
 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 measure of all employee and non-employee
stock-based compensation awards using a fair-value method and record such
expense in the condensed 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.
 
 
 
 24
  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
. 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, 2009.  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, 2009, relating to
ineffective control environment for inadequate segregation of duties and
information technology access as described in the our Annual Report on Form
10-K, our principal executive officer and our principal financial officer have
concluded that our disclosure controls and procedures were not effective as of
October 31, 2009.
 
 Changes
in Internal Control over Financial Reporting
 
 There has
been no change in our internal control over financial reporting that occurred
during the three months ended  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.
 
 
 25
 
 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-K for the year ended 2009 have
not materially changed except for the deletion of the Risk Factor beginning with
“ WE MAY NOT SUCCEED IN EFFORTS
TO HAVE OUR COMMON STOCK LISTED ON THE NASDAQ GLOBAL MARKET OR A SECURITIES
EXCHANGE.”This risk factor has been deleted because we do not
presently plan to seek listing of our common stock on a national securities
exchange.
 
 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.
 
 IF
OUR STRATEGY IS NOT SUCCESSFUL, OR IF EXPANSION OPPORTUNITIES ARISE THAT REQUIRE
CASH INVESTMENT, WE WILL NEED TO SEEKADDITIONAL FINANCING TO FUND ONGOING
OPERATING LOSSES OR EXPANSION, 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 .
 
 Our
strategy and related plans have not been sufficiently implemented for us to make
an assessment of their ultimate potential outcome. Should they fail, or if they
do not achieve the desired result, we will likely not attract sufficient sources
of revenues to achieve or maintain profitability. Our failure to achieve or
maintain profitability will require us to seek additional funding to fund these
operating losses.
 
 The
implementation of our strategy is dependent upon having sufficient resources to
make necessary investments, including investments in prototypes or support that
may be required by new potential customers, and cover operating losses until we
can achieve profitability. We do not believe we have sufficient cash to fully
execute our strategy and achieve profitability if we are required to pay the
$3,900,000, plus interest to K1W1 when it is due in June 2011. We have
negotiated a second extension of the Note Purchase Agreement and Security
Agreement with K1W1 to June 2011 from its previous due date of February 2010,
and our plans are to again negotiate the conversion of the notes when due, or an
extension for at least another year. If K1W1 do not convert the notes, or agree
to an extension of the loan when due, we will likely need to seek additional
funding.
 
 Opportunities
to expand our business through investment, acquisition or merger may arise. We
do not now have, and we do not expect in the near future to have, sufficient
cash to fund such expansion. Should we determine these expansion plans will be
in the best interests of the shareholders we would likely seek to finance these
expansion plans through additional funding.
 
 We
expect that if our strategy is not successful, it will be necessary for us to
obtain additional financing or other funding in order to fund our operations
some time in our year ending 2011. If an expansion opportunity arises we may
need to secure additional financing, irrespective of the success of our
strategy. We cannot, however, be certain that any such 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.
 
 26
 
 Ultimately,
if no additional financing or funding is obtained as and when needed, or if our
current strategy is not successful, we may be required to significantly
reduce our level of operations, including by further slowing our
growth, delaying  hiring, abandoning certain product development
including product development on which we may have already spent considerable
resources and otherwise further reducing expenses, or eventually, if
necessary, enter in to a strategic transaction or 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.”
 
 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 we 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
this Quarterly report on Form 10-Q under Item 2 Part I entitled “Management
Discussion and Analysis of Financial Condition and Results of
Operations”.
 
 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.  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.
 
 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
 
 ▪
              delays
      in being first to market with new technologies and products may prevent
      our partners from successfully competing with their
  rivals.
 
 27
  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. In addition, our customers may
develop products that require government approval which may delay their time to
market. 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 and Sanyo, and expect to
derive a majority of our revenues for the year ending 2010 in the form of the
recognition of deferred revenue resulting from prepaid royalties under our
licensing agreement with IGT and royalties from Sanyo unit sales under our
agreement with them.  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.
 
 THE
AVERAGE SELLING PRICES OF DISPLAYS USING OUR TECHNOLOGY MAY DECLINE OVER TIME
AND NEGATIVELY AFFECT OUR OPERATING RESULTS.
 
 The
average selling prices of displays using 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.
 
 28
 
 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.
 
 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 licensees 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.
 
 29
 
 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, patent applications in various countries
are published at different times,  it is difficult to monitor patent
applications that may be filed in other countries by third parties, and the
publication of discoveries in scientific or patent literature often lags behind
actual discoveries, we generally cannot be certain that we were the first
creator of inventions covered by our pending patent
applications,  that we or any of our licensors will be entitled to any
rights in purported inventions claimed in pending or future patent applications,
or 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.
 
 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.
 
 30
 
 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.
 
 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 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.
 
 31
  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 October 31, 2009, K1W1, our majority stockholder, possessed beneficial
ownership of 35,780,006 shares of our common stock, or approximately 52% of our
outstanding common stock.  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.
 
 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.
 
 Pursuant
to and in accordance with the limitations of Rule 144 of the Securities Act, all
of the shares of our common stock that were issued pursuant to our private
placements are eligible for resale on the OTC Bulletin Board. Certain of these
shares, were also registered for resale under our currently effective
registration statement on Form S-1/A.   Additionally, we have
registered on Form S-8 approximately 22 million 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 in
September, 2007. The 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 our common stock.
 
 LIMITED
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.  Our
common stock is not listed on any national exchange, and we have no current
plans to seek listing on a national securities exchange.  Accordingly,
there is a limited public market for our common stock.  These factors
have 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.  In general, there has not been substantial trading activity in
shares of our common stock.  Low trading volumes generally depress
market prices and could also result in a larger spread between the bid and asked
prices for our common stock.  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.
 
 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.
  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.
 
 32
 
 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.
 
 OUR
CERTIFICATE OF INCORPORATION GRANTS OUR 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, cause our expenses to be higher than
they would be had we remained privately held.  We estimate the current
annual cost for compliance with Sarbanes-Oxley is approximately $100,000,
including internal resources to maintain documentation and testing of our
financial controls, but excluding other costs of being a public
company.
 
 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.
 
 
 33
  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
 
 The
Annual Meeting of Stockholders was held on October 13, 2009 for the following
purposes: (1) to elect five directors to serve until the 2010 Annual
Meeting of Stockholders, or until their successors are duly elected and
qualified, and (2) to ratify the appointment of Stonefield Josephson, Inc.
as our independent registered public accounting firm for the year ending January
31, 2010.
 
 The
following persons were elected as directors of the Company to serve until the
2010 Annual Stockholders’ Meeting, or until their successors are duly elected
and qualified, with the votes indicated below:
 
 Director
              
              Votes
                For
              
              Votes
                WithheldJohn
      Blair
              
              35,780,006
              
              0Kristin
      Bowman
              
              35,780,006
              
              0Mark
      Kalow
              
              35,780,006
              
              0David
      Teece
              
              35,780,006
              
              0Andrew
      Wood
              
              35,780,006
              
              0
 
 The
proposal to ratify the appointment of Stonefield Josephson, Inc. as our
independent registered public accounting firm for the fiscal year ending January
31, 2010 was approved and ratified by a vote of 35,780,006 shares for and no
shares against.
 
 Item
5 - Other Information
 
 None.
 
 34
 
 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)
 
 35
 
 10.16
              
              Amendment
      of Stock Option Agreement – Mark Yahiro * (7)10.17
              
              Patent
      and Technology License and Technology Transfer Agreement (++) * (8)10.17
              
              Patent
      and Technology License and Technology Transfer Agreement (++) * (8)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
      (++)10.41
              
              Deed
      of Variation of Leases and Rent Reviews dated November 10, 2008 (amending
      Deeds of Lease dated May 31, 2006) * (25)10.42
              
              Amendment
      no 2. to Exclusive Sales and Distribution License Agreement by and among
      the Company, Sanyo Sales and Marketing Corporation and SANYO Electric
      System Solutions Co., Ltd. (++)10.43
              
              Amendment
      No. 2 to Convertible Promissory Notes * (27)
 
 36
  
 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 dated December 11,
      2009
              
              X31.2
              
              Section
      302 Certification of Chief Financial Officer dated December 11,
      2009
              
              X32.1
              
              Section
      906 Certification of Chief Executive Officer and Chief Financial Officer
      dated December 11, 2009
              
              X
 
 
 37
  
 (++)
              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*
      (27)
              Previously
      filed with the Commission in the Company’s Current Report on Form 8-K
      filed on August 28, 2009
 
 
 38
  
 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
      11, 2009
              By:
              /s/ Andrew
      L. WoodMr.
      Andrew L. Wood
                Chief
      Executive Officer and Director
 
 By:
              /s/ Joseph
      A. MoranMr.
      Joseph A. Moran
                Chief
      Financial Officer
                (Principal
      Accounting and Financial Officer)
 
 
 39