**United
      States**


**Securities
      and Exchange Commission**


**Washington,
      D.C. 20549**





**FORM
      10-K**





x  ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15( d )
      OF THE
      SECURITIES EXCHANGE ACT OF 1934


For
      the
      fiscal year ended December 31, 2006.


OR


o TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15( d )
      OF THE
      SECURITIES EXCHANGE ACT OF 1934


For
      the
      transition period from   to





Commission
      File Number: 000-19828





**SPATIALIGHT,
      INC.**


(Exact
      name of registrant as specified in its Charter)











**New
                York**
            **16-1363082******(State
                or other jurisdiction of incorporation or
                organization)
            (I.R.S.
                Employer Identification
                No.)




Five
      Hamilton Landing, Suite 100, Novato, California 94949


(Address
      of principal executive
      offices)               
 (zip code)





(415)
      883-1693


(Issuer’s
      telephone number including area code)





Securities
      registered pursuant to Section 12(b) of the Exchange Act: None


Securities
      registered pursuant to Section 12(g) of the Exchange Act:





Common
      Shares, $.01 par value


(Title
      of
      Class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes o
      No x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.


Yes o
      No x





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 o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
      be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-K
      or any amendment to this Form 10-K. o





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


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


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


Yes o
      No x





The
      aggregate market value for the registrant’s voting shares held by non-affiliates
      of the registrant, based upon the $2.30 per share closing sale price of the
      common shares on June 30, 2006, as reported on the Nasdaq Capital Market, was
      approximately $74,860,908. Common shares held by each officer and
      employee-directors and by each person who owns 5% or more of the outstanding
      common shares have been excluded because such persons are deemed to be
      affiliates. This determination of affiliate status is not necessarily a
      conclusive determination for other purposes.





As
      of
      March 14, 2007, registrant had 47,773,092 common shares
      outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE





None.





SPATIALIGHT,
          INC.
 FORM
          10-K
          ANNUAL REPORT
 
 TABLE
          OF
          CONTENTS
 
 PART
                      I
                  PageITEM
                      1
                  Business
                  3ITEM
                      1A
                  Risk
                      Factors
                  8ITEM
                      1B
                  Unresolved
                      Staff Comments
                  17ITEM
                      2
                  Properties
                  17ITEM
                      3
                  Legal
                      Proceedings
                  18ITEM
                      4
                  Submission
                      of Matters to a Vote Of Security Holders
                  18PART
                      IIITEM
                      5
                  Market
                        for Registrant’s Common Equity, Related Shareholder Matters and Issuer
                        Purchases of Equity Securities
                  18ITEM
                      6
                  Selected
                      Consolidated Financial Data
                  20ITEM
                      7
                  Management’s
                        Discussion and Analysis of Financial Condition and Results
                        of
                        Operations
                  21ITEM
                      7A
                  Quantitative
                      and Qualitative Disclosures About Market Risk
                  38ITEM
                      8
                  Consolidated
                      Financial Statements and Supplementary Data
                  39ITEM
                      9
                  Changes
                      in and Disagreements with Accountants On Accounting and Financial
                      Disclosure
                  76ITEM
                      9A
                  Controls
                      and Procedures
                  76ITEM
                      9B
                  Other
                      Information
                  79PART
                      IIIITEM
                      10
                  Directors,
                      Executive Officers and Corporate Governance
                  80ITEM
                      11
                  Executive
                      Compensation
                  82ITEM
                      12
                  Security
                      Ownership of Certain Beneficial Owners and Management and Related
                      Shareholder Matters
                  88ITEM
                      13
                  Certain
                      Relationships and Related Transactions and Director
                      Independence
                  89ITEM
                      14
                  Principal
                      Accountant Fees and Services
                  90PART
                      IVITEM
                      15
                  Exhibits
                      and Financial Statement Schedules
                  90
 
  2
  **PART
          I**
 
 *This
          annual report on Form 10-K contains certain forward-looking statements
          within
          the meaning of Section 21E of the Securities and Exchange Act of 1934,
          as
          amended, and is subject to the safe harbor provisions created by that statute.
          In this report, the words “anticipates,” “believes,” “expects,” “future,”
“intends,” and similar expressions identify forward-looking statements. Such
          statements are subject to risks and uncertainties, including, but not limited
          to, those discussed herein which are specific to the Company’s business, and in
          particular, those contained in “Item 1A - Risk Factors” that could cause actual
          results to differ materially from those projected. You are cautioned not
          to
          place undue reliance on these forward-looking statements, which speak only
          as of
          the date hereof. We undertake no obligation to publicly update or revise
          these
          forward-looking statements to reflect events or circumstances after the
          date of
          this report or to reflect the occurrence of unanticipated events and thus
          you
          should not assume that silence by management over time means that actual
          events
          are bearing out as estimated in such forward-looking
          statements.*
 
 **Item
          1.**  **Business.**
 
 **Description
          of Business**
 
 We
          are in
          the business of manufacturing high-resolution liquid crystal on silicon
          (LCoS)
          microdisplays. Our current customers and prospective customers are original
          equipment manufacturers (OEMs) engaged in the businesses of manufacturing
          high
          definition televisions or manufacturing light engines for incorporation
          into
          high definition televisions and 3-dimensional near-to-eye display devices.
          Our
          products are also suitable for incorporation into other potential display
          applications including front projection systems, head mounted devices,
          rear
          projection computer monitors, wireless communication devices, portable
          games and
          digital assistants. Currently we are working with OEMs of high definition
          televisions, light engines for incorporation into high definition televisions,
          near-to-eye head mounted display devices, and micro-projectors for mobile
          electronics applications.
  We
          were
          incorporated under the laws of the State of New York in 1989. Our executive
          offices are located at Five Hamilton Landing, Suite 100, Novato, California
          94949. Our internet address is www.spatialight.com .
          Our
          annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports
          on
          Form 8-K, and amendments to those reports are available at our internet
          address
          without charge under “Investors - SEC reports” as soon as reasonably practicable
          after we electronically file with or furnish such material to the
          SEC.
  
 **Technology
          and Products under Development**
 
 Our
          LCoS
          microdisplays are high-resolution liquid crystal displays. They are constructed
          with a silicon chip, a layer of liquid crystals and a glass cover plate
          in
          contrast to the more common construction of liquid crystals sandwiched
          between
          two glass plates. Our displays are also known as, and commonly referred
          to as,
          liquid crystal on silicon (LCoS), liquid crystal displays (LCD), active
          matrix
          liquid crystal displays and spatial light modulators.
 
 We
          currently manufacture our T-3 LCoS Set which consists of three of our
          proprietary SpatiaLight imagEngineTM LCoS microdisplays and has a 1920 pixels by
          1080 pixels configuration. We previously have manufactured and continue
          to have
          in inventory our T-1 LCoS Set model which has a 1280 pixels by 960 pixels
          configuration. Although we believe we can sell our T-1 LCoS Set model,
          we are
          focusing on manufacturing the T-3 model of our LCoS Sets (as opposed to
          the T-1
          Sets) because we believe that the market demand for that higher resolution
          product will be significantly greater. The following table summarizes our
          sales
          revenue percentage by product for the past three years
 
 2006
                  
                  
                  2005
                  
                  
                  2004LCoS
                      (T-3) sets
                  
                  
                  96
                  %
                  
                  77
                  %
                  
                  5
                  %LCoS
                      (T-1) sets
                  
                  
                  -
                  
                  
                  4
                  %
                  
                  42
                  %Light
                      engine display units
                  
                  
                  -
                  
                  
                  1
                  %
                  
                  51
                  %Other
                      (primarily supporting electronics)
                  
                  
                  4
                  %
                  
                  18
                  %
                  
                  2
                  %Total
                  
                  
                  100
                  %
                  
                  100
                  %
                  
                  100
                  %
 
 The
          image
          on a microdisplay can be projected onto a screen or other surface for individual
          or group viewing or used in a portable application that is viewed through
          a
          magnifying device similar to a viewfinder. Potential microdisplay applications
          include:
  3
  
 ·
              large-screen
                  front and rear-projection television systems, in both high definition
                  television format and standard television
                  formats; ·
              near-to-eye
                  display devices for 3-dimensional viewing
                  purposes; ·
              large-screen
                  rear-projection computer monitors in a variety of
                  resolutions; ·
              video
                  projectors for applications such as
                  presentations; ·
              head-mounted
                  displays which are used for virtual reality systems, defense, aerospace
                  and gaming applications; and ·
              other
                  potential applications such as point of purchase displays, optical
                  computing and data storage. 
 Our
          technology uses liquid crystals and silicon chips. An advantage of these
          materials is that processes for working with them are already known and
          they may
          be produced more quickly than competing technologies that offer comparable
          quality. By using existing manufacturing processes at our manufacturing
          facility
          in South Korea, which commenced producing products for commercial sale
          in
          limited quantities in the second quarter of 2005, we believe we will be
          able to
          obtain economies of scale.
 
 A
          typical
          liquid crystal display consists (along with other associated materials
          and
          processes) of liquid crystal material sandwiched between two pieces of
          glass,
          polarizers, color filters, a data signal and a light source. As the data
          signal
          is applied across the sandwich of the liquid crystals, the electric field
          created by this data signal causes the liquid crystals to tilt. This tilting,
          combined with the polarizers, makes each pixel change from opaque to
          transparent, thereby controlling either the transmission or reflection
          of light
          from each pixel.
 
 Departing
          from typical liquid crystal displays utilizing circuitry on two pieces
          of glass,
          we design integrated circuits that control individual reflective pixels
          on a
          silicon substrate. This silicon substrate is manufactured using a conventional
          complementary metal oxide semiconductor (CMOS) process. This processed
          silicon
          substrate, also known as a silicon backplane, then has the liquid crystal
          material and a cover glass applied to it. When the data signal is sent
          to the
          circuitry in the silicon, the liquid crystals again tilt from opaque to
          transparent states. When polarizers are added and light is reflected from
          the
          pixels on the silicon, images can be viewed directly or, using standard
          optical
          techniques, projected into larger images on a screen.
 
 As
          is
          common with all LCDs, the images produced are inherently black and white.
          The
          varying of the electrical signal to each pixel produces gray scaling (various
          shades of gray going from black to white). Utilizing this gray scaling,
          there
          are three basic techniques for achieving color displays: (1) optically
          combining
          different colors of light, (2) sequential color systems and (3) color filters.
          We believe our displays can be adapted for use in all of these types of
          color
          display processes.
 
  **Customers
          and Potential Customers**
 
 *LG
          Electronics, Inc.*
 
 In
          March
          2007, LG Electronics (LGE) verbally informed us of their intent to discontinue
          the production of rear projection television (RPTV) (both LCoS and DLP).
          We do
          not expect significant further sales to LGE, we are currently in negotiations
          with LGE related to an appropriate exit strategy, and are currently assessing
          the impact of this communication on our business.
  In
          July
          2004, we entered into an agreement with LGE providing for us to sell our
          T-3
          LCoS Sets to LGE. There have been a number of subsequent modifications
          to our
          arrangements with LGE, most significantly with respect to a number of product
          specifications, as well as in timing of deliveries and quantities. The
          changes
          in the timing of deliveries and quantities to be delivered were, in part,
          a
          result of our attempts to respond to these product specification change
          requests
          and agreements.
  In
          August
          2005, we received a firm purchase order from LGE for its purchase from
          us of an
          aggregate minimum quantity of 9,300 LCoS Sets for the period July through
          December 2005, thereby reducing the initial purchase commitment set forth
          in our
          July 2004 agreement. We subsequently agreed with LGE, through a series
          of
          communications, that the initial purchase order for 9,300 LCoS Sets could
          be
          filled over a period of time that would extend beyond April 2006. While
          we
          continued to ship product throughout 2006, as noted above we do not expect
          to
          have significant shipments to LGE in 2007.
  LGE
          commenced an initial consumer market rollout in Australia of a limited
          quantity
          of 71-inch LCoS televisions incorporating our LCoS Sets during the first
          quarter
          of 2006. The LG Electronics 71” LCoS television has received very positive
          feedback in Australia. LGE communicated to its U.S. distributors in the
          first
          quarter of 2006 that it had postponed its plans to introduce its 71” and 62”
LCoS televisions into the U.S. marketplace. LGE had attributed this postponement
          to uncertainty regarding the timetable for the availability of sufficiently
          large supplies of our LCoS Sets to enable a significant product launch.
          We
          believe that delays in LGE’s initial product rollouts had been based upon
          revisions to our delivery schedule caused by LGE’s product specification changes
          and our problems in ramping up production that have occurred over time.
          However,
          our recent production deliveries to LGE have been of acceptable quantity
          and
          quality starting in the second quarter of 2006. In our manufacturing process
          we
          have recently made a transition from 100% testing of certain characteristics
          to
          sample testing. This removed a bottleneck and facilitates the production
          ramp
          up. LGE had previously informed us of their intent to expand distribution
          of
          product to the US and other markets. This has not occurred to date. LGE
          has been
          emphasizing flat panel TV’s and de-emphasizing their projection TV products. As
          noted above we do not expect to have significant shipments to LGE in
          2007.
  4
  In
          2005
          and 2006, the majority of our product deliveries, which were in small
          quantities, were made to LGE. The loss of LGE as a customer could materially
          harm our future sales and results of operations; and our substantial dependence
          on one customer is subject to risks set forth under “Item 1A Risk Factors”.
  *Business
          in Taiwan*
  To
          date,
          we have delivered limited quantities of our T-3 LCoS Sets to a Taiwanese
          customer, ThinTek Optronics Corporation. A substantial portion of these
          product
          deliveries took place in 2005 and the first quarter of 2006. ThinTek has
          ordered
          quantities sufficient for pilot programs and sample products, but not enough
          to
          enable them to launch mass production of LCoS high definition televisions.
          On
          July 19, 2006, one of the parent organizations of ThinTek, United Microdisplay
          Optronics (UMO), announced that it was acquiring ThinTek. The acquisition
          was
          effective October 1, 2006. We understand that as part of this acquisition,
          ThinTek’s and UMO’s business models are under evaluation, and may tend to a more
          vertically integrated approach. For this reason, we have chosen to deal
          directly
          with a TV maker, Jiangxi Greatsource Display Tech Co., Ltd. (KHD) (in China),
          rather than ThinTek going forward.
  *Business
          in China*
  To
          date,
          we have delivered limited quantities of our microdisplay products to our
          Chinese
          customers. A substantial portion of these product deliveries occurred in
          2004,
          with a smaller quantity delivered in 2005 and none in 2006. The quantities
          of
          our products delivered to our Chinese customers are sufficient only for
          engineering testing and pilot program purposes. To date, our Chinese customers
          have not ordered quantities of our products that would enable them to launch
          commercial sales of LCoS high definition televisions.
  We
          have
          continuing business relationships with customers and prospective customers
          in
          China. Current Chinese prospective customers are at different stages in
          the
          development and product introduction processes, and their efforts are
          progressing at a slower rate than we originally anticipated. One of our
          original
          Chinese customers, Skyworth Display Limited, is selling televisions utilizing
          our display units incorporating our T-1 LCoS Sets into the Chinese educational
          market. However, we do not intend to sell any additional display units
          incorporating our T-1 LCoS Sets beyond those we currently have in inventory
          to
          Skyworth. Skyworth may, although we have no assurance that it will, elect
          to
          transition to products incorporating our T-3 LCoS Sets. We cannot provide
          assurance concerning the quantities of our products that we will sell to
          our
          Chinese customers and prospective customers in the future.
  We
          have
          provided sample product to Jiangxi Greatsource Display Tech Co., Ltd. (KHD),
          a
          Chinese manufacturer of LCoS light engines and televisions that has received
          significant financing from the Chinese government. We supported KHD pilot
          evaluation runs with our personnel at their plant in China. Evaluations
          have
          identified a variety of non-SpatiaLight related product issues, mostly
          of driver
          board electronics origin, that are being addressed by KHD. KHD sent a delegation
          to review the capabilities of the SpatiaLight Korea, Inc. (SLK) facility,
          which
          has successfully occurred. KHD demonstrated an 85” commercial product at the
          January 2007 Consumer Electronics Show (CES) show employing our imagers.
          For a
          more detailed discussion of our business in Taiwan and China, see Item
          7
“Management’s Discussion and Analysis of Financial Condition and Results of
          Operations.”
  *Prospective
          Customers*
  We
          are
          currently continuing to develop working relationships with prospective
          customers, located primarily in South Korea, Japan and other parts of the
          Pacific Rim region. These prospective customers fall into the following
          categories: 1) television manufacturers, 2) light engine suppliers, 3)
          head
          mounted display manufacturers, and 4) mobile electronics display device
          manufacturers. We have provided samples of our LCoS Sets to certain of
          these
          prospective customers, but we do not have any formal agreements with these
          parties as of December 31, 2006. While we have made significant progress
          with
          respect to product integration and negotiating purchase orders with certain
          of
          these prospective customers, we cannot provide assurance that we will receive
          any purchase orders that will be binding on any of these companies for
          their
          purchase of our products in the near future. Even assuming that we receive
          purchase orders that are binding on the prospective customers, these orders
          and
          our sales to these customers and to our existing customers are subject
          to
          certain contingencies described under “Item 1A Risk Factors”.
   5
  
 **Marketing,
          Sales and Distribution**
 
 Our
          primary target for our product development efforts has been for high definition
          rear projection television. More recently we have taken steps to broaden
          the
          addressed market and have been developing single panel, field sequential
          color
          operation LCoS displays for applications such as head mounted displays
          and
          micro-projectors. These efforts have been facilitated by working with end
          system
          suppliers such as Deocom of South Korea in the case of head mounted displays,
          and with an international consortium of firms on the development of a
          micro-projector product.
 
 *Application
          and Markets*
 
 We
          are
          currently working with a number of OEM customers and prospective customers,
          located primarily in South Korea, Japan, Taiwan and China, to use our
          microdisplay products in their high definition television end product
          applications. We do not believe that designing, selling and distributing
          end
          products for these diverse markets is in our own best interests. In high
          volume
          applications, we currently are and expect to continue custom designing
          our
          microdisplay products to fit a specific manufacturer’s need for a specific
          product. Our LCoS Sets can be incorporated into a wide variety of products
          such
          as high definition televisions, rear-projection computer monitors, video
          projectors and head mounted displays. While our primary emphasis has previously
          been on high definition rear projection televisions (RPTV) we are now working
          with a number of customers who are active in new display market segments
          other
          than RPTV.
 
 Our
          current strategy is to focus our resources and expertise on original equipment
          design (OED) of LCoS Sets and to work closely with high definition television
          OEMs, light engine OEMs, and OEMs of products such as head mounted displays
          and
          micro-projectors to market end products utilizing our microdisplays. We
          are
          therefore dependent upon these OEMs for the manufacturing, marketing and
          selling
          of these end products.
 
 We
          have
          cooperatively worked with Foreal Spectrum (Foreal) of San Jose, California
          to
          develop an LED illumination/LCoS imager based light engine. A prototype
          of this
          engine was jointly demonstrated at the SpatiaLight suite in the MGM Grand
          during
          the January 2007 CES show. A second generation prototype will be available
          shortly that will address many issues existing in the first prototype.
          We expect
          that this product with its long life and other positive characteristics
          will be
          of interest to China TV makers as well as other commercial display
          makers.
 
 We
          have
          recently signed a Joint Market Agreement with Foreal for the LCoS/ LED
          based
          light engine developed by Foreal. Full production volumes amongst the four
          customers targeted by the two companies are expected to be in the vicinity
          of
          twenty thousand sets per month.
 
 We
          have
          also recently signed a Purchase Agreement with Deocom to supply LCoS imagers
          for
          use in head mounted displays (HMD). This agreement anticipates immediate
          shipments of samples for prototype and pre-production runs, followed by
          mass
          production later this year. We expect this market to grow significantly
          over
          time.
 
 In
          January 2007, we entered into a Joint Development Agreement between SpatiaLight,
          SI Infocomm, and SCRAM Technologies for the development of a micro-projector
          prototype with the intent to produce this in volume starting in the fourth
          quarter of 2007.
 
 *Segment
          and Geographical Information*
 
 For
          the
          year ended December 31, 2006, 92% of our revenue was derived from LGE,
          located
          in South Korea. This customer made up 100% of our outstanding accounts
          receivable balance at December 31, 2006. For the year ended December 31,
          2005,
          73% and 12% of our revenue was derived from LGE and Thintek Optronics Corp,
          located in Taiwan, respectively. These two customers made up 84% of our
          outstanding accounts receivable balance at December 31, 2005. The remaining
          15%
          of revenue in 2005 was derived from the sales of our LCoS Sets and related
          components to customers located in Hong Kong, China and the United States.
          For
          the year ended December 31, 2004, 47% and 43% of our revenue was derived
          from
          Skyworth TV Holding, Ltd. and Shanghai China Display Co., Ltd, both located
          in
          China. These two customers made up 90% of our outstanding accounts receivable
          balance at December 31, 2004. The remaining 10% of revenue in 2004 was
          derived
          from the sales of our LCoS Sets and related components to customers located
          in
          Hong Kong, Taiwan and South Korea.
 
 *Manufacturing
          and Supply*
 
 We
          completed construction of our South Korean manufacturing facility in January
          2005. This facility serves as our central commercial manufacturing base.
          The
          facility began producing products for commercial sale in limited quantities
          in
          the second quarter of 2005. The facility is designed with the capacity,
          on full
          employment, to produce up to 28,000 LCoS Sets per month. The facility has
          been
          designed for expansion to a capacity of 120,000 LCoS Sets per month in
          several
          phases. We believe that the facility can be expanded in an efficient manner
          in
          the event that such expansion becomes necessary based upon increased or
          perceived increased demand for our products from our customers.
  6
  
 We
          completed the process of relocation of all of our manufacturing operations
          to
          South Korea in February of 2006. As part of the transition to full-scale
          manufacturing, we experienced a variety of manufacturing problems, most
          of which
          were due to environmental factors at our facility in Petaluma, California
          such
          as dust particles, temperature and humidity. At our manufacturing facility
          in
          South Korea, it appears that we are no longer experiencing the production
          problems attributable to the environmental issues specified above. However,
          early in the second quarter of 2006, we experienced certain other production
          problems, some of which we believe were principally attributable to flaws
          in the
          silicon wafers used for our backplane that we obtained from our supplier.
          Our
          supplier has transferred our wafer fabrication production line to a newer
          facility and processes have been slightly modified. Subsequent production
          verified improvement and increased stability.
 
 In
          addition, we had, until recently, been testing all of our microdisplays
          for
          certain characteristics. We have now obtained solid statistics on a reasonable
          volume of product and have moved, as of July 31, 2006, to a sampling test
          mode
          for these characteristics. The testing of all of our microdisplays for
          certain
          characteristics had been providing a bottleneck to our LCoS Set delivery
          to LGE,
          which is now removed. While many issues have been addressed as indicated,
          the
          manufacturing process of our LCoS Sets is a complex process, and future
          problems
          could have a material negative impact upon our results of operations as
          set
          forth under “Risk Factors.”
 
 We
          currently obtain silicon backplanes, a vital component in our LCoS Sets,
          from
          Taiwan Semiconductor Manufacturing Company, located in Taiwan. We are working
          to
          qualify a second supply source for our silicon backplanes. Historically,
          the
          supply of silicon backplanes from suppliers fluctuates and we may be subject
          to
          problems of availability, although we have not experienced any such problems
          to
          date.
 
 Other
          key
          components include coated glass and flex circuitry. We currently obtain
          glass
          from Oerlikon (formerly Unaxis Optics), located in Liechtenstein. Our flex
          circuits are obtained from multiple sources located in Asia and the United
          States. We are subject to some supply fluctuations and there may be availability
          problems that arise. In all cases, we are attempting to find and qualify
          additional supply sources to mitigate supply risk, but this process is
          not
          complete.
 
 We
          do not
          currently have any long-term agreements with any of our suppliers. Any
          termination of a relationship with one or more of our suppliers could have
          a
          material adverse effect on our ability to meet our anticipated commitments
          to
          customers while we identify and qualify replacement manufacturers or sources
          of
          supply. We could become dependent on a manufacturer for components of our
          LCoS
          Sets and any termination of our relationship with such a manufacturer could
          adversely affect our ability to manufacture our products.
 
 **Competition**
 
 Microdisplays
          are a subset of the display market (including television and video display).
          This display market subset consists of (1) reflective microdisplays produced
          on
          silicon backplanes, (2) transmissive microdisplays and (3) emissive
          microdisplays. Companies competing in the reflective microdisplay market
          include
          Sony, JVC, Aurora, Syntax-Brillian, and eLCOS. These companies are all
          producing
          different forms of a liquid crystal display on a silicon backplane. Sony
          and JVC
          have high definition televisions incorporating the LCoS technology in the
          consumer market. A major competitor in the reflective microdisplay market,
          although not using liquid crystals in the display, is Texas Instruments,
          which
          is producing a micro-mechanical structure of moving mirrors on a silicon
          backplane, a technology known as digital light processing, or DLP. Texas
          Instruments has had significant success selling its DLP products to its
          customers in the rear projection television market and the business front
          projector market.
 
 In
          the
          market for head mounted displays and microprojectors, and other near-to-eye
          products, current competitors would include LCoS type displays from DisplayTech
          and Kopin as well as micro electrical mechanical systems (MEMS) based displays
          such as those supplied by Texas Instruments or Microvision.
 
 Rapid
          and
          significant technological advances have characterized the microdisplay
          market.
          There can be no assurance that we will be able to effect any such technological
          advances or that we will have sufficient funds to invest in new technologies,
          products or processes. Although we believe that our displays have specifications
          and capabilities, which equal or exceed that of commercially available
          LCD,
          cathode ray tube (CRT) and DLP based display products, the manufacturers
          of
          these products may develop further improvements of their existing technology
          that would eliminate or diminish our anticipated advantage. In addition,
          numerous competitors have substantially greater financial, technical, marketing,
          distribution and other resources than we have. We may also face an aggressive,
          well-financed competitive response that may include misappropriation of
          our
          intellectual property or predatory pricing.
 
 Our
          ability to compete will depend in part upon many factors, including the
          quality
          of the display images, manufacturing, capacity, delivery, pricing and technical
          specifications. In addition, there will be factors within and outside of
          our
          control, including customer support and the success and timing of product
          introduction and distribution by our customers. Our competitors may succeed
          in
          developing technologies and products that are equally or more efficient
          than any
          which we are developing, which will render our technology, displays and
          other
          products obsolete and non-competitive.
  7
  
 **Patents
          and Intellectual Property**
 
 We
          currently have five U.S. patents and we have other U.S. and international
          patent
          applications pending. The scope of the issued patents includes physical
          structure design of the metal layers used for light blocking in the silicon
          die
          (or backplane), several silicon die (or backplane) circuitry designs, and
          a dual
          panel system design. The applications are in the area of light engine level
          system enhancements and drive circuitry concepts. Our currently issued
          patents
          will all expire between 2011 and 2017. There can be no assurance respecting
          the
          degree of protection offered by these patents or as to the likelihood that
          pending patents will be issued. Our competitors, in both the United States
          and
          foreign countries, many of which have substantially greater resources and
          have
          made substantial investments in competing technologies, may seek to apply
          for
          and obtain patents that will prevent, limit or interfere with our ability
          to
          make and sell our products or intentionally infringe upon our patents.
          We may
          undertake to expand our intellectual property portfolio by continuing to
          file
          new patent applications and/or by purchasing or licensing existing patents
          currently owned by other companies.
 
 The
          defense and prosecution of patent suits is both costly and time-consuming,
          even
          if the outcome is favorable to us. This can be particularly true in foreign
          countries. In addition, there is an inherent unpredictability regarding
          obtaining and enforcing patents in foreign countries. An adverse outcome
          in the
          defense of a patent suit could subject us to significant liabilities to
          third
          parties, require disputed rights to be licensed from third parties, or
          require
          us to cease selling our products.
 
 We
          also
          rely on unpatented proprietary technology and there can be no assurance
          that
          others may not independently develop the same or similar technology or
          otherwise
          obtain access to our proprietary technology. To protect our rights in these
          areas, we require all employees and technology consultants, advisors and
          collaborators to enter into confidentiality agreements. However, these
          agreements may not provide meaningful protection for our trade secrets,
          know-how
          or other proprietary information in the event of any unauthorized use,
          misappropriation or disclosure of such trade secrets, know-how or other
          proprietary information. To date, we have no experience in enforcing our
          confidentiality agreements.
 
 **Research
          and Development**
 
 The
          display industry has undergone and continues to undergo rapid and significant
          technological change. We expect display technologies to continue to develop
          rapidly, and our success will depend significantly on our ability to attain
          and
          maintain a competitive position. Rapid technological development may result
          in
          our products or processes becoming obsolete before we recoup a significant
          portion of related research and development, acquisition and commercialization
          costs.
 
 We
          incurred research and development expenses of approximately $1,067,000
          in 2006,
          $3,586,000 in 2005, and $2,306,000 in 2004. Research and development expenses
          are those costs incurred for personnel and experimental materials for the
          design
          and development of new products. We believe that the development of new
          products
          will be required to allow us to compete effectively and to achieve greater
          revenues than we have derived to date. As of December 31, 2006, we had
          11
          employees in the U.S. whose significant duties included research and
          development. We intend to continue our product development programs, focusing
          on
          increasing the display specifications including resolution, color and
          manufacturing processes. We believe that such developments will be required
          to
          exploit future markets.
 
 **Employees**
 
 As
          of
          December 31, 2006, we had 19 full-time employees and one part-time employee
          located in California. Full-time employment is divided among two functional
          areas with 11 in research and development and nine in management/ finance/
          administration. As of December 31, 2006, we had 12 full-time employees
          classified as management/ finance/ administration in South Korea. We have
          eight
          engineers and 73 employees classified as manufacturing in South Korea.
          We
          consider our relations with our employees to be good.
 
 **Item
          1A. Risk Factors.**
 
 **We
          are confronted by serious liquidity concerns.**
 
 As
          of the
          date hereof, we have very limited financial resources. Our operations to
          date
          have consumed substantial amounts of cash and will continue to require
          substantial amounts of cash in the future. In order to remain competitive,
          we
          must continue to make significant investments including further investments
          in
          research and development, equipment, and expansion of our facilities and
          production activities. Our $10,000,000 of Senior Secured Convertible Notes,
          issued in November 2004, are scheduled to mature on November 30, 2007.
          The
          Senior Secured Convertible Notes are convertible, at the option of their
          holders, into our common shares at the conversion price of $9.72 per share.
          The
          last sale price of our common shares on the NASDAQ Capital Market on March
          14,
          2007, was $0.66 per share and we do not expect the Noteholders to exercise
          their
          conversion rights. As a result, we will be required to repay to the Noteholders
          the entire $10,000,000 principal amount of the notes on that maturity date.
  8
  
 Taking
          into account our current financial condition, we will require significant
          additional financing to satisfy our increasing working capital requirements
          in
          2007 and thereafter. The report of our independent registered public accounting
          firm, Odenberg, Ullakko, Muranishi & Co. LLP, dated March 15, 2007 included
          in this Annual Report on Form 10-K raises substantial doubt with respect
          to our
          ability to continue as a going concern.
 
 In
          the
          past, we have maintained our financial condition and liquidity primarily
          through
          private sales of our common shares (both registered and unregistered),
          convertible note financing, and the payment of exercise prices on our warrants
          and options. We have no assurance that outstanding stock options and warrants
          will be exercised in the future to any significant extent. Reliance on
          private
          equity purchase agreements and public offerings and exercises of derivative
          securities to finance our current and future operations entails the additional
          risks of our inability to sell our common shares or other securities and
          an
          insufficient number of derivative securities being exercised owing to the
          prevailing market prices of our underlying common shares. Additionally,
          any
          additional sales of our common stock may have a dilutive effect on the
          value of
          our outstanding shares. In the event that we are unable to obtain further
          financing on satisfactory terms, or at all, or if we are unable to generate
          sales sufficient to offset our costs, or if our costs of development and
          operations are greater than we anticipate, we may be unable to increase
          the size
          of our business at the rate desired or may be required to delay, reduce,
          or
          cease certain or all of our operations, any of which could materially harm
          our
          business and financial results.
 
 **Certain
          of the holders of the Senior Secured Convertible Notes issued by us in
          November
          2004 have made claims of default.**
 
 Holders
          of $9,000,000 principal amount of our Senior Secured Convertible Notes,
          issued
          in November 2004, have alleged that we have defaulted in the payment of
          the
          installment of interest due November 30, 2005. One of these holders has
          also
          alleged that we have defaulted in our failure to maintain the effectiveness
          of
          the registration statement relating to the shares of common stock issuable
          upon
          conversion of the Senior Secured Convertible Notes and that we have defaulted
          under the terms of the Senior Secured Convertible Notes by entering into
          certain
          types of debt financing transactions. These holders have demanded the immediate
          redemption of the principal amount of their Senior Secured Convertible
          Notes
          plus a redemption premium and other amounts. We do not believe that we
          have
          defaulted in the payment of interest on the Senior Secured Convertible
          Notes. We
          also believe that the registration statement has remained effective, that
          we
          have not entered into any debt financing transactions that would constitute
          a
          breach or failure in any material respect, and that we are otherwise in
          compliance with the relevant provisions of the Senior Secured Convertible
          Notes.
          At this date, we cannot predict what actions, if any, will be undertaken
          by any
          of the holders of the Senior Secured Convertible Notes, but we will contest
          any
          adverse actions as we believe that these allegations lack merit and would
          not
          entitle the holders of the Senior Secured Convertible Notes either to call
          such
          notes or to other remedies that they are seeking.
 
 **We
          have experienced significant manufacturing difficulties during the past
          year
          that have resulted in our manufacturing and shipping LCoS Sets in only
          limited
          commercial quantities. If we encounter further difficulties in manufacturing
          our
          products in larger quantities we may have difficulty meeting customer demands
          and our operating results could be significantly harmed by such difficulties.**
 
 We
          have
          experienced difficulties in manufacturing LCoS Sets during the past year.
          See
“Management’s Discussion and Analysis of Financial Condition and Results of
          Operations - Status of Business with LG Electronics, Inc.” Although we believe
          that we have developed solutions to the past problems that allow us to
          achieve
          higher production and shipment volumes, because the manufacture of our
          LCoS Sets
          involves highly complex processes, technical problems may continue to arise
          as
          we manufacture our LCoS Sets and we cannot assure satisfactory manufacturing
          yields on a continuing basis or that we will be able to adequately ramp
          up
          volume production of our LCoS Sets.
 
 Current
          and anticipated future purchase orders, which we cannot assure, will require
          us
          to produce greater quantities of LCoS Sets than we have produced in the
          past.
          Unanticipated future problems in manufacturing our LCoS Sets could cause
          additional production delays that might lead our current and prospective
          customers to seek other sources, which would negatively affect our operating
          results.
 
 Although
          we believe that we will be able to mass produce our LCoS Sets, other companies,
          including some with substantially greater resources than us, have found
          great
          difficulty manufacturing LCoS products. We do not have reliable information
          about why other companies have failed to be able to manufacture similar
          liquid
          crystal microdisplays and can therefore make no assurances that we will
          not
          encounter similar problems.
  9
  
 We
          currently obtain silicon backplanes, a vital component in our microdisplays,
          from a company in Taiwan, which is subject to potential instability because
          of
          Taiwan’s troubled relations with China. Unless we obtain an alternative source,
          any disruption or termination of our silicon backplane manufacturing source’s
          operation in Taiwan could significantly harm our operations. Early in the
          second
          quarter of 2006, the silicon wafers that we received from our supplier
          contained
          flaws that have materially harmed our manufacturing yields. See Item 1
“Business
          - Manufacturing and Supply.”
 
 The
          design and manufacture of LCoS Sets are highly complex processes that are
          sensitive to a wide variety of factors, including the level of contaminants
          in
          the manufacturing environment, variations in temperature and humidity,
          impurities in the materials used, and the performance of personnel and
          equipment. We have built and equipped a manufacturing plant in South Korea
          where
          we currently manufacture our LCoS Sets in limited quantities. We believe
          that
          these arrangements provide us with strong quality controls and effectively
          protect our proprietary technology in our products, but the risks discussed
          above associated with the highly complex processes of manufacturing these
          liquid
          crystal microdisplays remain applicable.
 
 **Although
          we have commenced producing LCoS Sets in our manufacturing facility in
          South
          Korea, which serves as our principal facility for manufacturing our LCoS
          imagers, we may encounter difficulties in conducting our manufacturing
          operations and difficulties in maintaining our quality controls over the
          manufacturing and production processes in a foreign country, any of which
          would
          be likely to cause significant harm to our business.**
 
 Our
          manufacturing operations were completely relocated from California to South
          Korea and the relocation of our manufacturing operations in South Korea
          may
          cause us to encounter one or more potential problems in our operations
          that
          could harm our business because of cultural or language differences, problems
          may arise in the training of, or communications with, our employees or
          the
          general operation of our manufacturing facility. These cultural or language
          differences may also create misunderstandings or the creation of inefficiencies
          in our operations. Furthermore, the geographic separation between our corporate
          offices in the United States and our principal manufacturing operation
          in South
          Korea could result in managerial or supervisory problems, which could lead
          to
          decreased quality controls and consequently materially harm our business.
 
 **We
          have been largely dependent on one customer, LG Electronics Inc., for our
          future
          revenues, and failure to expand our customer base or receive additional
          orders
          from our existing customer base will make us vulnerable to substantial
          loss of
          potential revenues.**
 
 In
          2005
          and 2006, almost all of our revenue has been derived from LG Electronics,
          Inc.
          (LGE). In March 2007, we were verbally informed by LGE of their intent
          to
          discontinue the production of rear projection televisions (both LCoS and
          DLP).
          We do not expect significant further sales to LGE. If we cannot diversify
          our
          customer base and derive increased revenues through additional purchase
          orders
          and product deliveries from customers other than LGE, we will be vulnerable
          to a
          substantial decline in anticipated revenues. Any such events could have
          a
          material adverse effect on our business, operations and financial condition
          and
          the value of our common shares could decline substantially.
 
 **We
          are the subject of an investigation by the staff of the SEC regarding the
          circumstances surrounding our filing of certain consents of BDO Seidman,
          LLP
          without requisite authorization and transactions in our securities by our
          former
          Chief Executive Officer.**
 
 We
          have
          been advised by the staff of the SEC that it is conducting an investigation
          into
          the circumstances surrounding our filing of certain consents of BDO Seidman
          LLP,
          our former independent accountant, without requisite authorization. The
          consents
          would have allowed us to incorporate by reference the reports of BDO Seidman
          LLP
          on our consolidated financial statements for the years ended December 31,
          2002
          and 2003 into two of our registration statements on Form S-3 (File Nos.
          333-122391 and 333-122392) and each of the prospectuses constituting a
          part of
          such registration statements. Our current independent registered accounting
          firm, Odenberg, Ullakko, Muranishi & Co. LLP (OUM), has since provided us
          with a new report with respect to each of the three years ended December
          31,
          2004 and we were not requested to amend or restate the financial statements
          contained in our annual reports on Form 10-K for any of the three fiscal
          years
          ended December 31, 2004 in connection with the issuance of OUM’s new report. We
          have also received notice that the SEC is investigating transactions in
          our
          securities by Mr. Robert Olins, our former Chief Executive Officer, Secretary,
          Treasurer and a Director. We have been cooperating and intend to continue
          to
          cooperate with the SEC in connection with these matters. In addition, the
          audit
          committee of our Board of Directors has concluded a review and investigation
          of
          these matters. As of this date, we cannot determine whether we or our management
          will be adversely affected by these investigations. See “Management’s Discussion
          and Analysis of Financial Condition and Results of Operations - Certain
          Developments” for further information concerning the circumstances underlying
          the SEC investigation and the audit committee investigation and report
          with
          respect to these matters.
 
 **We
          may be subject to lawsuits relating to our use of a registration statement
          that
          did not contain an authorized consent of BDO Seidman LLP.**
 
 As
          part
          of amendment numbers 5 and 6 to a registration statement (File No. 333-122391)
          registering shares for resale by certain selling shareholders and as part
          of
          amendment numbers 3 and 4 to a “shelf” registration statement (File No.
          333-122392), we filed a consent of BDO Seidman LLP to incorporate by reference
          their report on our consolidated financial statements for the fiscal years
          ended
          December 31, 2002 and 2003. Although we received the requisite authorized
          consents from BDO Seidman LLP to the incorporation by reference of their
          report
          on the consolidated financial statements into these registration statements
          when
          initially filed and subsequent amendments thereto (and BDO Seidman LLP
          has not
          withdrawn these consents), we did not receive the requisite authorization
          from
          BDO Seidman LLP to file its consent as an exhibit to the penultimate and
          final
          amendments to the registration statement before it was declared effective.
          These
          amendments were filed with the SEC on July 27, 2005. Subsequently, our
          current
          independent registered public accountants, OUM, re-audited our consolidated
          financial statements for fiscal years 2003 and 2002. OUM has given its
          consent
          to incorporate by reference into the registration statement its report
          related
          to the 2002 and 2003 financial statements. See “Management’s Discussion and
          Analysis of Financial Condition and Results of Operations - Certain
          Developments.”
  10
  
 Following
          the filing in July 2005 of amendments containing the unauthorized consents
          referred to above, the staff of the SEC declared both of the registration
          statements effective and shares of our common stock were sold. In August
          2005,
          we filed post-effective amendment number 1 to both of these registration
          statements (those post-effective amendments were subsequently withdrawn
          and
          replaced by additional post-effective amendments), which disclosed the
          filing of
          the unauthorized consents.
 
 Because
          both registration statements were used to sell common shares after the
          Staff of
          the SEC declared the registration statements effective, it is conceivable
          that
          there may be litigation against us or our officers or directors under Section
          11
          of the Securities Act of 1933, as amended (the “Securities Act”). Although we do
          not believe that the filing of an invalid consent constitutes a materially
          misleading statement or an omission to disclose a material fact within
          the
          meaning of Section 11 of the Securities Act, a contrary determination could
          result in a liability for us.
 
 At
          present, we are unable to ascertain the exact amount of damages, if any,
          to
          which we could potentially be subject under a Section 11 claim instituted
          by any
          persons who directly purchased shares pursuant to those registration statements.
          Furthermore, at this date, we cannot ascertain the amount of damages, if
          any,
          for which we could be liable for claims instituted by any subsequent purchasers
          who could trace the shares purchased by them to those registration statements.
          In August 2005, we sold 500,000 common shares to three institutional purchasers
          for $5.40 per share pursuant to the “shelf” registration statement referenced
          herein. Each of those investors has since represented to us in writing,
          in
          connection with a separate transaction, that they have disposed of all
          of those
          shares. One of those institutional investors has represented to us that
          it sold
          those shares at a sale price at or higher than its purchase price from
          us. We
          believe, based upon discussions with the other two investors, that they
          sold
          their shares at a sale price of not lower than $4.25 per share. Therefore,
          we
          believe that the maximum amount of potential damages pursuant to Section
          11
          claims from direct purchasers, which we would fully contest, would be $391,000,
          or the difference between the two investors’ purchase price and lowest believed
          resale price, multiplied by the 340,000 shares that they purchased and
          then
          resold.
 
 In
          addition to any damage claims, which may be material to our financial condition,
          any lawsuit alleging securities law violations could require us to expend
          significant financial and managerial resources **.** Any
          such
          lawsuit could also result in further volatility in the market price of
          our
          common shares **.** Nothing
          set forth in the foregoing statement constitutes an express or implied
          admission
          by us of any liability under Section 11 of the Securities Act or otherwise.
 
 **We
          may be subject to lawsuits relating to certain sales of our securities
          by our
          former Chief Executive Officer.**
 
 Our
          Audit
          Committee determined that Robert A. Olins, our former Chief Executive Officer,
          Secretary, Treasurer and a Director failed to report the sale of an aggregate
          of
          70,556 of our common shares in August 2005 and February 2006 at sales prices
          ranging from $5.30 to $3.00. Pursuant to Section 16 of the Securities Exchange
          Act of 1934, as amended (the “Exchange Act”), Mr. Olins has filed delinquent
          reports and disgorged $22,273 in “short-swing profits” that he realized from the
          sales. We have been advised by the SEC that they are investigating the
          transactions in our securities by Mr. Olins and an entity which he controls,
          and
          have received and responded to a request from the SEC requesting documentation
          relating to all transactions by Mr. Olins and the entity which he controls.
          We
          have no knowledge of any other transactions by Mr. Olins, or this entity,
          that
          would be a violation of the Securities Act or the Exchange Act. If the
          SEC
          determines that these or other transactions by Mr. Olins were a violation
          of the
          Securities Act, it is conceivable that such transactions could be imputed
          to us
          and the SEC could seek to impose remedies against us, or private individuals
          could file litigation against us for damages. See “Management’s Discussion and
          Analysis of Financial Condition and Results of Operations - Certain
          Developments”.
 
 We
          are
          unable to estimate the probability of liability or the amount of any penalties
          or damage claims that might arise, which may be material to our financial
          condition. We believe that Mr. Olins will disgorge any “short swing profits” if
          it is determined that he or the entity he controls engaged in transactions
          that
          violated Section 16 of the Exchange Act. Any action by the SEC or lawsuit
          alleging securities law violations could require us to expend significant
          financial and managerial resources and could also result in further volatility
          in the market price of our common shares **.** Nothing
          set forth in the foregoing statement constitutes an express or implied
          admission
          by us of any liability under the Securities Act, the Exchange Act or otherwise.
  11
  
 **The
          obligations arising from our Senior Secured Convertible Notes restrict
          our
          future financing alternatives and may result in financial difficulties
          for us in
          the future.**
 
 The
          Senior Secured Convertible Notes issued in November 2004 bear a 10% rate
          of
          interest per annum and are not prepayable, in whole or in part, prior to
          their
          maturity on November 30, 2007. Therefore, we do not have the ability to
          refinance the 2004 Senior Secured Convertible Notes with debt obligations
          bearing more favorable terms to us or out of the proceeds of an equity
          financing
          until their maturity date. We do have the right to force the conversion
          of the
          Senior Secured Convertible Notes into our common shares in the event that
          our
          common shares trade at or above $14.58 (150% of the $9.72 conversion price
          of
          the Senior Secured Convertible Notes) for twenty consecutive trading days.
          The
          last sale price of our common shares on March 14, 2007, was $0.66 per share
          and
          it is not likely that we will be able to exercise our conversion right
          prior to
          the maturity of the Senior Secured Convertible Notes.
 
 The
          Senior Secured Convertible Notes are secured by virtually all of our assets,
          other than those located in South Korea, and it may therefore be difficult
          for
          us to obtain future debt financing. However, the terms of the Senior Secured
          Convertible Notes allow us to subordinate the liens on accounts receivable,
          certain contract rights and inventory (the “Subject Property”) securing the
          Senior Secured Convertible Notes, to liens on the Subject Property securing
          certain other debt permitted, subject to certain conditions, by the Senior
          Secured Convertible Notes.
 
 In
          addition, the issuance of any additional debt securities, except certain
          types
          of bank debt permitted under the Senior Secured Convertible Notes, will
          require
          the consent of the holders of a majority in interest of our Senior Secured
          Convertible Notes, to the extent that such notes remain issued and outstanding
          at the time of issuance of any additional debt securities. The prohibition
          against incurring debt may negatively affect our ability to engage in capital
          expenditures and to maintain and expand our manufacturing operations.
 
 If
          we
          default in meeting our obligations under the Senior Secured Convertible
          Notes,
          the indebtedness which they evidence may become immediately due and payable,
          and
          the holders of the Senior Secured Convertible Notes may be entitled to
          foreclose
          on any of our assets securing the notes. As noted earlier, certain of the
          holders of our Senior Secured Convertible Notes have alleged that we have
          defaulted in meeting our obligations under the Senior Secured Convertible
          Notes
          and have demanded the immediate repayment of principal and liquidated damages.
          In the event these holders pursue their claims, and a court determines
          that we
          have defaulted in our obligations, we will have to seek financing from
          third
          parties to satisfy the holders’ claims. The Senior Secured Convertible Notes are
          convertible into our common shares and the issuance of such shares (including
          any shares issued in payment of interest on such notes) may have a dilutive
          effect on the value of our outstanding common shares.
 
 **We
          have a history of losses and expect to incur losses in the future and therefore
          cannot assure you that we will achieve profitability.**
 
 We
          have
          incurred operating losses to date and have experienced cash shortages.
          For the
          fiscal year ended December 31, 2006 and 2005, we incurred net losses of
          approximately $19 million and $14 million, respectively. In addition, we
          had an
          accumulated deficit of approximately $101 million as of December 31, 2006.
          We
          expect additional losses as we continue spending for commercial scale production
          and other business activities as well as further research and development
          of our
          products. As a result, we will need to generate substantial sales to support
          our
          costs of doing business before we can begin to recoup our operating losses
          and
          accumulated deficit and achieve profitability.
 
 **We
          may be subject to liability if we default on our obligations to raise additional
          capital as required in the purchase documents related to our private placement
          of common shares in August 2006.**
 
 Under
          the
          terms of the Securities Purchase Agreement dated August 9, 2006, as amended
          on
          October 25, 2006 (the “August 2006 Financing”), we must raise an additional
          $4,200,000 before April 15, 2007 (such date being the “Additional Financing
          Deadline”) or commence a subscription rights offering to our stockholders to
          purchase our common shares having an aggregate value of at least $14,200,000
          (which amount may be reduced on a dollar for dollar basis for any financing
          we
          complete before the Additional Financing Deadline). Because of our existing
          covenants with the holders of our Senior Secured Convertible Notes, which
          requires us to seek their consent before we agree to enter into additional
          material indebtedness, we will most likely try to raise the $4,200,000
          through
          the sale of additional common shares. We can offer no assurance that we
          will
          successfully raise $4,200,000 nor can we offer any assurance that we will
          issue
          subscription rights to our stockholders in the future. In connection with
          the
          August 2006 Financing, we also agreed, for a period of one year following
          the
          closing of the August 2006 Financing, to refrain from, directly or indirectly,
          offering or selling any debt security that is, at any time during the life
          of
          the debt security and under any circumstance, convertible into or exchangeable
          for our common shares, unless we receive prior written consent from a majority
          of the purchasers of the August 2006 Financing.
 
 In
          the
          event that we default upon the foregoing obligations, the purchasers of
          securities in our August 2006 Financing are entitled to contractual damages
          and
          may also request that we specifically perform our obligations under the
          purchase
          agreement giving rise to our obligations. At present, we are unable to
          quantify
          the amount of contractual damages to which the purchasers would be entitled,
          and
          we are unable to estimate the likelihood that a court would grant any
          purchaser’s application that we specifically perform our obligations.
  12
  
 **We
          are subject to lengthy development periods and product acceptance cycles,
          which
          may significantly harm our business.**
 
 Our
          business model requires us to develop microdisplays that perform better
          than
          existing technologies, manufacture our LCoS Sets in bulk, and sell the
          resulting
          LCoS Sets to OEMs who will then incorporate them into their products. OEMs
          make
          the determination during their product development programs whether to
          incorporate our LCoS Sets and/or display units in their products. This
          requires
          us to invest significant amounts of time and capital in designing our LCoS
          Sets
          before we can be assured that we will generate any significant sales to
          our
          customers or even recover our investment. If we fail to recover our investment
          in the LCoS Sets, it could seriously harm our financial condition. In addition,
          the acceptance of new technologies developed by our competitors could limit
          the
          time period that our products may be demanded by our customers.
 
 **We
          incur substantial operational and research and development costs in connection
          with products and technologies that may not be successful.**
 
 We
          currently have 11 full-time engineering personnel based in California working
          on
          microdisplays. We currently have eight full-time engineering and 73 full-time
          manufacturing personnel based in South Korea. This staffing creates significant
          operational and research and development costs that may not be recouped.
          Even if
          our current LCoS Sets become accepted and/or successful, we must continue
          to
          employ, and may increase in number, our engineering and manufacturing personnel
          to develop future generations of our microdisplays because of the rapid
          technological changes in our industry. As a result, we expect to continue
          incurring significant operational and research and development costs.
 
 **Geopolitical
          conditions or potential military conflicts between the United States or
          South
          Korea and North Korea may negatively impact our business.**
 
 We
          commenced producing products in our principal manufacturing operations
          in South
          Korea during the second quarter of 2005, and our largest customer, LGE,
          resides
          in South Korea. South Korea and North Korea are technically at war with
          each
          other, despite the mutually agreed upon existence of the Demilitarized
          Zone and
          the relative absence of physical conflict for several decades. Any escalation
          in
          the existing conflict between these countries or any commencement, or perceived
          commencement, of a military conflict between the United States or South
          Korea
          and North Korea, may limit our ability to effectively operate our manufacturing
          facility in South Korea and may also substantially limit our ability to
          sell
          products into South Korea because of the negative economic, physical or
          other
          destructive impact that such a conflict could have on our most important
          customer. Any such disruptions to our manufacturing operations and/or ability
          to
          consummate sales to a substantial customer could adversely affect the
          development of our business and our financial condition. The recent escalation
          in tension between the United States and North Korea, as a result of North
          Korea’s attempts to test certain of their missiles and nuclear devices, has not
          impacted our operations in South Korea, but we can provide no assurances
          that
          continued tension will not negatively affect our operations.
 
 **If
          the high definition projection television market does not continue to develop
          and if other potential markets for our products do not materialize, then
          our
          business will likely be significantly harmed.**
 
 High
          definition television programming has only recently become available to
          consumers, and widespread market acceptance, although anticipated, is uncertain
          at this time. The market demand for high definition televisions is considered
          contingent upon widespread acceptance of high definition television programming.
          Current trends in cable and satellite programming as well as availability
          of Blu-ray
          DiscTM and
          HD-DVD high definition pre-recorded media support the transition to high
          definition television. Our current sales and marketing efforts are focused
          on
          OEMs of high definition televisions and OEMs of light engines designed
          for
          incorporation into high definition projection televisions. Therefore, if
          the
          market for high definition televisions continues to grow and develop, but
          that
          the projection TV format (as opposed to flat panel display formats such
          as LCD
          TV and Plasma TV) does not maintain a large market share, then we will
          have
          difficulty selling our products for this application, which will have an
          adverse
          effect on our results of operations.
 
 Various
          potential target markets for our products, including projectors, monitors,
          and
          portable microdisplays, are uncertain and may be slow to develop. In addition,
          companies in those markets could utilize competing technologies. For us
          to
          succeed in selling our products in these potential markets we must offer
          end-product manufacturers higher quality and less expensive microdisplay
          products than our competitors, and the manufacturers themselves will also
          have
          to develop commercially successful products using our products. In the
          event
          that we attempt to market and sell our products in these potential target
          markets, and we are not able to succeed in selling our products into these
          potential markets, then our results of operations and overall business
          may be
          negatively affected.
  13
  
 **If
          our products do not become widely accepted by our customers or the end-users,
          our business could be significantly harmed.**
 
 Our
          LCoS
          Sets may not be accepted by a widespread market **.** Even
          if
          we successfully obtain customer orders, our customers may determine not
          to
          introduce or may terminate products utilizing the technology for a variety
          of
          reasons, including the following:
 
 ·
              superior
                  technologies developed by our competitors; ·
              price
                  considerations; and ·
              lack
                  of anticipated or actual market demand for the products. 
 **We
          cannot assure you that we will obtain additional purchase orders from our
          current or prospective customers, or, if we do, that such orders will generate
          significant revenues.**
 
 Even
          though in the past we have received purchase orders for our LCoS Sets and/or
          display units from LGE and from certain Chinese and Taiwanese OEMs, and
          may
          receive additional purchase orders from prospective customers, sales to
          manufacturers in the electronics industry are subject to severe competitive
          pressures, rapid technological change and product obsolescence. In addition,
          purchase orders received from our customers other than LGE are for limited
          quantities. Customers may, at any time, cancel purchase orders or commitments
          or
          reduce or delay orders, thereby increasing our inventory and overhead risks.
          Therefore, despite the purchase orders received from current customers
          and other
          purchase orders that we may receive from prospective customers, we cannot
          assure
          you that these orders will result in significant revenues to us.
 
 **If
          our customers’ products are not successful, our business would be materially
          harmed.**
 
 We
          do not
          currently sell any products to end-users. Instead, we design and manufacture
          various product solutions that our customers may incorporate into their
          products. As a result, our success depends almost entirely upon the widespread
          market acceptance of our customers’ products. Any significant absence of, or
          slowdown in the demand for our customers’ products would materially harm our
          business.
 
 Our
          dependence on the success of the products of our customers exposes us to
          a
          variety of risks, including our need to:
 
 ·
              maintain
                  customer satisfaction with our design and manufacturing services; ·
              match
                  our design and manufacturing capacity with customer demand and
                  maintain
                  satisfactory delivery schedules; ·
              anticipate
                  customer order patterns, changes in order mix, and the level and
                  timing of
                  orders that we can meet; and ·
              adjust
                  to the cyclical nature of the industries and markets we serve. 
 Our
          failure to address these risks may cause us to lose sales or our sales
          to
          decline.
 
 **The
          high definition television industry is highly competitive, which may result
          in
          lost sales or lower gross margins.**
 
 We
          serve
          the highly competitive high definition television industry that is characterized
          by price erosion, rapid technological change and competition from major
          domestic
          and international companies. This intense competition could result in downward
          pricing pressures, lower sales, reduced margins and lower market share.
 
 Companies
          competing in the LCoS microdisplay market include Sony Corporation and
          Victor
          Company of Japan, Limited (“JVC”). A major competitor of ours in the reflective
          microdisplay market is Texas Instruments, which, rather than using liquid
          crystals in the display, is producing a micro-mechanical structure of moving
          mirrors on a silicon backplane, a technology known as digital light processing,
          or DLP. Texas Instruments has had significant success selling its DLP products
          to its customers in the business front projector market and the rear projection
          high definition television market. Some of our competitors, including Texas
          Instruments, Sony, and JVC, have greater market recognition, larger customer
          bases, and substantially greater financial, technical, marketing, distribution
          and other resources than we possess. As a result, they may be able to introduce
          new products and respond to customer requirements more quickly and effectively
          than we can.
 
 Rapid
          and
          significant technological advances have characterized the microdisplay
          market.
          There can be no assurance that we will be able to effect any significant
          technological advances or that we will have sufficient funds to invest
          in new
          technologies or products or processes. Although we believe that our displays
          have specifications and capabilities, which equal or exceed that of commercially
          available liquid crystal displays (“LCD”), cathode ray tube (“CRT”) and DLP
          based display products, the manufacturers of these products may develop
          further
          improvements of their existing technology that would eliminate or diminish
          our
          anticipated advantage. The acceptance of our LCoS Sets and/or display units
          will
          be dependent upon the pricing, quality, reliability and useful life of
          these
          products compared to competing technologies, as to which there can be no
          assurance.
  14
  Our
          competitive position also may suffer if one or more of our customers decide
          to
          design and manufacture their own microdisplay products, to contract with
          our
          competitors, or to use alternative technologies. In addition, customers
          in the
          television manufacturing industry typically develop a second source. Second
          source suppliers may win an increasing share of our customers’ product demands.
 
 Our
          ability to compete successfully depends on a number of factors, both within
          and
          outside our control. These factors include:
 
 ·
              our
                  success in designing and manufacturing new display technologies; ·
              our
                  ability to address the needs of customers; ·
              the
                  quality, performance, reliability, features, ease of use, pricing,
                  and
                  diversity of our display products; ·
              foreign
                  currency fluctuations, which may cause a foreign competitor’s products to
                  be priced significantly lower than our displays; ·
              the
                  quality of our customer services; ·
              the
                  efficiency of our production sources; and ·
              the
                  rate at which customers incorporate our displays into their own
                  products. 
 **Fluctuations
          in the exchange rate of the United States dollar and foreign currencies
          could
          have a material adverse effect on our financial performance and profitability.**
 
 A
          portion
          of our costs is denominated in foreign currencies, including the Korean
          Won and
          the Euro. As a result, changes in the exchange rates of these currencies
          or any
          other applicable currencies to the U.S. Dollar will affect our costs of
          goods
          sold and operating margins, and could result in exchange losses. We cannot
          fully
          predict the impact of future exchange rate fluctuations on our profitability.
          From time to time, we may engage in exchange rate hedging activities in
          an
          effort to mitigate the impact of exchange rate fluctuations, although we
          have
          not engaged in any such hedging activities to date. We cannot offer assurance
          that any hedging technique we may implement will be effective. If it is
          not
          effective, we may experience reduced operating margins.
 
 **Our
          operating results are subject to significant fluctuations.**
 
 Our
          results of operations have varied significantly from quarter-to-quarter
          and are
          likely to vary significantly in the future, making it difficult to predict
          our
          future operating results. Accordingly, we believe that quarter-to-quarter
          comparisons of our operating results are not meaningful and should not
          be relied
          upon as an indicator of our future performance. Some of the factors that
          cause
          our operating results to fluctuate include:
 
 ·
              introductions
                  of displays and market acceptance of new generations of displays; ·
              timing
                  of expenditures in anticipation of future orders; ·
              changes
                  in our cost structure; ·
              availability
                  of labor and components; ·
              pricing
                  and availability of competitive products and services; ·
              the
                  timing of orders; ·
              the
                  volume of orders relative to the capacity we can contract to produce; ·
              evolution
                  in the life cycles of customers’ products; and ·
              changes
                  or anticipated changes in economic conditions. 
 **The
          market price of our common stock is highly volatile.**
 
 The
          market price of our common stock has been highly volatile, reflecting among
          other things reported losses, receipts of additional financing and investors'
          perceptions about our business prospects. Some research has shown that
          similar
          volatility in other companies correlates with initiation of class action
          securities lawsuits although to date we have not been a defendant in any
          such
          lawsuit. The trading price of our common shares in the future could continue
          to
          be subject to wide fluctuations in response to various factors, including:
 
 ·
              quarterly
                  variations in our operating results; ·
              actual
                  or anticipated announcements of technical innovations or new product
                  developments by us or our competitors; ·
              public
                  announcements regarding our business developments; ·
              changes
                  in analysts' estimates of our financial performance; ·
              sales
                  of large numbers of shares of our common stock by our shareholders; ·
              general
                  conditions in the electronics industry; and ·
              worldwide
                  economic and financial conditions.  15
  In
          addition, the stock market has experienced significant price and volume
          fluctuations that have particularly affected the market prices for many
          high-technology companies and that often have been unrelated to the operating
          performance of these companies. These broad market fluctuations and other
          factors may adversely affect the market price of our common stock.
 
 **Future
          offerings of our common stock, or securities convertible into or exercisable
          for
          our common stock, could cause the market price of our common stock to decrease
          significantly, even if our business operations are performing well.**
 
 We
          could
          issue up to 108,134,848 additional shares of common stock under our current
          “Shelf” Registration Statement (Registration Number 333-137100) (subject to the
          number of authorized shares available), based on the price of our common
          stock
          on March 14, 2007 or $0.66 per share. This is more than double of the total
          number of shares of our common stock that were issued and outstanding as
          of
          March 14, 2007. Sales of these shares into the public market, or the perception
          that future sales of these shares could occur, might adversely affect the
          prevailing market price of our common stock in the near future. Furthermore,
          market perceptions regarding the likelihood that we will be required to
          issue
          and sell additional shares of our common stock in the near future to fund
          our
          ongoing operations, thereby diluting the ownership interests of current
          owners
          of our common stock, could have a material adverse effect on the market
          price of
          our common stock.
 
 **Our
          common stock may not be liquid.**
 
 Shares
          of
          our common stock are currently traded on The NASDAQ Capital Market. Our
          stockholders may find that it is more difficult to sell shares of our common
          stock than shares that are listed on The NASDAQ Global Market or The New
          York
          Stock Exchange. The trading volume of our common stock has historically
          been
          adversely affected by their limited marketability, but such volume has
          increased
          significantly in recent periods. Nevertheless, any substantial sales of
          our
          common stock may result in a material reduction in their market price,
          reflecting the volatility of the trading market for shares of our common
          stock.
 
 **If
          we lose our key personnel or are unable to attract and retain additional
          personnel, our ability to compete could be harmed.**
 
 Our
          development and operations depend substantially on the efforts and abilities
          of
          our senior management and qualified technical personnel. Our products require
          sophisticated production, research and development and technical support.
          The
          competition for qualified management and technical personnel is intense.
          The
          loss of services of one or more of our key employees or the inability to
          add key
          personnel could have a material adverse affect on us particularly since
          currently we do not have any insurance policies in place to cover that
          contingency. Our success will depend upon our ability to attract and retain
          highly qualified scientific, marketing, manufacturing, financial and other
          key
          management personnel. We face intense competition for the limited number
          of
          people available with the necessary technical skills and understanding
          of our
          products and technology. We cannot assure you that we will be able to attract
          or
          retain such personnel or not incur significant costs in order to do so.
 
 **Our
          future success depends on our ability to protect our proprietary technology
          and
          our registered intellectual property.**
 
 We
          believe that our success depends in part on protecting our proprietary
          technology. We rely on a combination of patent, copyright, trademark and
          trade
          secret laws, as well as confidentiality and assignment of inventions agreements
          from our employees, consultants, advisors and other contractual provisions,
          to
          establish and protect our intellectual property rights. If we are unable
          to
          protect our intellectual property from use by third parties, our ability
          to
          compete in the industry will be harmed, however, policing unauthorized
          use of
          our products and technology is difficult. Despite our efforts to protect
          our
          proprietary rights, we face the following risks:
 
 ·
              pending
                  patent applications may not be issued; ·
              patents
                  issued to us may be challenged, invalidated, or circumvented; ·
              unauthorized
                  parties may obtain and use information that we regard as proprietary
                  despite our efforts to protect our proprietary rights; ·
              others
                  may independently develop similar technology or design around any
                  patents
                  issued to us; ·
              breach
                  of confidentiality agreements; ·
              intellectual
                  property laws may not protect our intellectual property; and ·
              effective
                  protection of intellectual property rights may be limited or unavailable
                  in some foreign countries, such as China, in which we may operate.
                  Specifically, although we consider the following unlikely because
                  of the
                  complex technological structure of our products, one or more of
                  our
                  current or prospective Chinese, Korean or Taiwanese customers,
                  or their
                  respective employees or other persons including our competitors,
                  that have
                  or gain access to our products for testing purposes, may seek to
                  misappropriate or improperly convert to their own use our intellectual
                  property and a lack of adequate remedies and impartiality under
                  the
                  Chinese, Korean, Taiwanese and other foreign legal systems may
                  adversely
                  impact our ability to protect our intellectual property. 
 16
 There
          can
          be no assurance that we will have adequate remedies or the resources to
          pursue
          those remedies in the event any of the foregoing materializes. Failure
          to
          protect our intellectual property would limit our ability to produce and
          market
          our products in the future, which would materially adversely affect our
          revenues
          generated by the sale of such products.
 
 In
          addition, third parties could assert that our products and technology infringe
          their patents or other intellectual property rights. As a result, we may
          become
          subject to future patent infringement claims or litigation, the defense
          of which
          is costly, time-consuming and diverts the attention of management and other
          personnel.
 
 **The
          material weaknesses identified by our management and our independent registered
          public accounting firm with respect to our internal controls over financial
          reporting may have a materially negative impact on our business.**
 
 In
          accordance with the rules prescribed by the SEC and the Sarbanes-Oxley
          Act of
          2002, we must periodically assess the effectiveness of our internal controls
          over financial reporting. During our preparation of our Annual Report on
          Form
          10-K for the fiscal years ended December 31, 2006 and 2005, our management
          and
          our independent registered public accounting firm identified several material
          weaknesses in our internal controls over financial reporting. As of this
          date,
          the material weaknesses identified include the fact that our Audit Committee
          does not have a member who is deemed a “financial expert” as defined by the
          rules promulgated by the SEC, although a member of our audit committee
          has the
          level of financial sophistication that the rules of the National Association
          of
          Securities Dealers require. We lack qualified financial executive management
          to
          perform independent secondary reviews over complex and non-routine accounting
          matters. Additionally, we did not maintain a formal policy relating to
          the
          updating of standard costs and reviewing variances with actual costs, which
          affects the accounting for inventory. We may need to incur significant
          additional expenses to achieve compliance and we may incur other costs
          in
          connection with regulatory enforcement actions, any of which could negatively
          impact our business.
 
 **Political,
          economic and regulatory risks associated with international operations
          may limit
          our ability to do business abroad.**
 
 A
          substantial number of our customers, manufacturers and suppliers are located
          outside of the United States, principally in the Far East. Our international
          operations are subject to political and economic conditions abroad, and
          protectionist trade legislation in either the United States or foreign
          countries, such as a change in the current tariff structures, export or
          import
          compliance laws, or other trade policies, any of which could adversely
          affect
          our ability to manufacture or sell displays in foreign markets and to purchase
          materials or equipment from foreign suppliers. Certain of our current purchase
          order agreements with customers are governed by foreign law and therefore
          are
          subject to uncertainty with regard to their enforceability.
 **Although
            we have a 50 year 100% land lease payment exemption from the South Korean
            government for our South Korean facility, we could lose this land lease
            payment
            exemption in the event we lose our “high technology”
certification.**
 
 In
            September 2004, we entered into a fifty year term lease with the Gyeongnam
            provincial government for 8.3 acres of undeveloped land in Jinsa, Gyeongnam
            province in South Korea. We leased the land for the purpose of constructing
            a
            state-of-the-art manufacturing facility with the anticipated capacity
            to meet
            mass production-scale demand from our customers and prospective customers.
            We
            have received a 100% land lease payment exemption because the land has
            been
            designated a “free economic zone” by the South Korean national government and
            the South Korean government also certified us as a “high technology” company.
            Under our agreement with the Gyeongnam provincial government we could
            lose our
            land lease payment exemption in the event that we lose our “high technology”
certification, which could increase the costs of operating the facility
            and
            format negatively impact our business. Additionally if we were to lose
            the
            lease, we might be required to donate the building to the South Korean
            government.
  **We
            have federal net operating losses which may expire before we can utilize
            them.**
  At
            December 31, 2006, the Company had a federal net operating loss carryforward
            of
            approximately $67.1 million. Section 382 of the Internal Revenue Code
            imposes an
            annual limitation on the utilization of net operating loss carryforward
            following a “change of ownership.” The amount of the limitation is based on a
            statutory rate of return and the value of the corporation at the time
            of the
            change of ownership. Private placements and other sales of equity securities
            by
            the Company can cause a change of ownership either individually or in
            the
            aggregate. If a change of ownership occurs and an annual limitation is
            imposed,
            a portion of these carryforwards may expire before the Company is able
            to
            utilize them.
 **We
          do not pay cash dividends.**
 
 We
          have
          never paid any cash dividends on our common shares and do not anticipate
          that we
          will pay cash dividends in the near future. Moreover, under the terms of
          our
          November 2004 Financing, we are prohibited from paying cash dividends while
          the
          Senior Secured Convertible Notes issued in the November 2004 Financing
          remain
          outstanding. Instead, we intend to apply any future earnings, as to which
          there
          can be no assurances, to the satisfaction of our obligations, and development
          and expansion of our business.
 
 **Item
          1B.**  **Unresolved
          Staff Comments.**
 
 None.
 
 **Item
          2.**  **Properties.**
 
 Our
          headquarters are located at Five Hamilton Landing, Suite 100, Novato,
          California. Our premises, which were designed and built-out to our
          specifications, encompass our corporate offices, quality assurance and
          testing
          facilities and optics laboratories. The facility aggregates 14,000 square
          feet
          and the lease continues through August 2009. We also leased “clean room” space
          in California where we manufactured components of our LCoS Sets in limited
          quantities through the end of 2005. In September 2004, we entered into
          a fifty
          year term lease with the Gyeongnam provincial government for 8.3 acres
          of
          undeveloped land in Jinsa, Gyeongnam province in South Korea. We leased
          the land
          for the purpose of constructing a state-of-the-art manufacturing facility
          with
          the anticipated capacity to meet mass production-scale demand from our
          customers
          and prospective customers. We have received a 100% land lease payment exemption
          because the land has been designated a “free economic zone” by the South Korean
          national government and the South Korean government also certified us as
          a “high
          technology” company. Under our agreement with the Gyeongnam provincial
          government we could lose our land lease payment exemption in the event
          that we
          lose our “high technology” certification. We completed construction of our South
          Korean manufacturing facility in January 2005. The South Korean facility
          (approximately 25,000 sq. feet) has commenced to serve as our central commercial
          manufacturing base. For a more detailed discussion of our South Korean
          manufacturing facility, see Item 7. Management’s Discussion and Analysis of
          Financial Condition and Results of Operations. We believe that our current
          facilities are adequate to fulfill our business commitments for the immediate
          foreseeable future.
  17
  
 **Item
          3.**  **Legal
          Proceedings.**
 
 We
          are
          not currently involved in any material legal proceedings. We are a party
          to
          routine claims and lawsuits from time to time in the ordinary course of
          business. While the outcome of such ordinary course proceedings cannot
          be
          predicted with certainty, we believe that the resolution of any such matters
          individually or in the aggregate will not have a material adverse effect
          on our
          business, financial condition or results of operations.
 
 We
          have
          received notices alleging events of default under the terms of the Senior
          Secured Convertible Notes (but for which we are not yet subject to legal
          proceedings) which we are contesting as more fully described under Item
          7 -
“Management’s Discussion and Analysis - Senior Secured Convertible Debt
          Financing” and Note 3 to the Consolidated Financial Statements.
 
 We
          have
          received notice of an investigation by the SEC into the circumstances related
          to
          our filing of an unauthorized consent by BDO Seidman LLP in connection
          with
          certain registration statements and transactions in our common stock by
          Mr.
          Robert Olins, our former Chief Executive Officer and a former Director,
          and an
          entity he controls. No legal proceeding has been commenced against us and
          we are
          cooperating with the SEC in their investigation. See “Management’s Discussion
          and Analysis of Financial Condition and Results of Operations - Certain
          Developments.”
 
 In
          connection with his departure, Don Suh, our former Chief Executive Officer,
          has
          filed a claim against the Company alleging that the Company violated the
          Sarbanes-Oxley Whistleblower laws and is asking for severance of $250,000
          plus a
          year’s worth of benefits. We do not believe that his assertions have merit but
          cannot predict the ultimate outcome of any potential litigation.
 
 **Item
          4.**  **Submission
          of Matters to a Vote of Security Holders.**
 
 There
          were no matters submitted to a vote of our security holders during the
          fourth
          quarter of fiscal 2006.
 
 **PART
          II**
 
 **Item
          5.**  **Market
          for Registrant’s Common Equity, Related Stockholders Matters and Issuer
          Purchases of Equity Securities.**
 
 Trading
          in our common shares has been conducted on The Nasdaq Capital Market since
          May
          24, 2000, under the symbol “HDTV.” Because we are traded on the Capital Market,
          our securities may be less liquid, receive less coverage by security analysts
          and news media and generate lower prices than might otherwise be obtained.
 
 The
          following table sets forth, for the calendar quarters indicated, the range
          of
          high and low quotations for our common shares, as reported by Commodity
          Systems,
          Inc.
 
 
 Fiscal
                    2006High
                
                LowFirst
                    Quarter
                
                $
                3.71
                
                $
                2.09Second
                    Quarter
                
                
                3.99
                
                
                2.00Third
                    Quarter
                
                
                3.10
                
                
                2.00Fourth
                    Quarter
                
                
                2.45
                
                
                1.32
 Fiscal
                    2005High
                
                
                LowFirst
                    Quarter
                
                $
                9.15
                
                $
                4.45Second
                    Quarter
                
                
                6.98
                
                
                4.45Third
                    Quarter
                
                
                6.46
                
                
                3.90Fourth
                    Quarter
                
                
                4.77
                
                
                3.11
 
 
 The
          quotations listed above reflect inter-dealer prices, without retail mark-up,
          markdown or commission and may not represent actual
          transactions.
  18
  
 As
          of
          March 14, 2007, there were approximately 496 holders of record of our common
          shares and the closing price per share was $0.66 as reported on the Nasdaq
          Capital Market. The common shares represent the only class of securities
          outstanding as of the date of this filing.
 
 To
          date,
          we have not paid a dividend on our common shares. The payment of future
          dividends is subject to our earnings and financial position and such other
          factors, including contractual restrictions, as the Board of Directors
          may deem
          relevant. Under the terms of the November 2004 Financing which is more
          fully
          described under Item 7 “Overview,” we are prohibited from paying cash dividends
          while the 2004 Senior Secured Convertible Notes issued in the November
          2004
          Financing remain outstanding. It is therefore unlikely that dividends will
          be
          paid in the foreseeable future.
 
 Performance
          Graph
 
 The
          following graph compares the cumulative 5-year total return to shareholders
          on
          SpatiaLight, Inc.'s common stock relative to the cumulative total returns
          of the
          S & P 500 index, and a customized peer group of four companies that
          includes: Brillian Corp., Kopin Corp., Microvision Inc and Universal Display
          Corp. An investment of $100 (with reinvestment of all dividends) is assumed
          to
          have been made in the company's common stock, in the peer group, and the
          index
          on December 31, 2001 and its relative performance is tracked through December
          31, 2006.
 
  
 Dec-01
                
                Dec-02
                
                Dec-03
                
                Dec-04
                
                Dec-05
                
                Dec-06SpatiaLight,
                    Inc.
                
                $
                100.00
                
                $
                35.57
                
                $
                76.71
                
                $
                127.86
                
                $
                49.57
                
                $
                19.29S
                    & P 500
                
                
                100.00
                
                
                77.90
                
                
                100.24
                
                
                111.15
                
                
                116.61
                
                
                135.03Peer
                    Group
                
                
                100.00
                
                
                36.63
                
                
                61.45
                
                
                40.68
                
                
                45.07
                
                
                46.69
 
 The
          stock
          price performance included in this graph is not necessarily indicative
          of future
          stock price performance.
 
 Securities
          Authorized for Issuance under Equity Compensation Plans
  The
          following table provides information as of December 31, 2006 regarding
          compensation plans (including individual compensation arrangements) under
          which
          equity securities are authorized for issuance.
   19
   **EQUITY
                      COMPENSATION PLAN INFORMATION****Plan
                      Category**
                  
                  
                  **Number
                      of Securities to Be Issued Upon
                      Exercise of Outstanding Options**
                  
                  
                  **Weighted-Average
                      Exercise Price of
                      Outstanding Options (Excluding Securities Reflected in Column
                      (a))**
                  
                  
                  **Number
                      of Securities Remaining Available For Future Issuance Under
                      Equity
                      Compensation Plans (Excluding Securities Reflected in Column
                      (a)**(a)
                  
                  
                  (b)
                  
                  
                  (c)Equity
                      Compensation Plans (2006 Incentive Plan and 1999 Stock Option
                      Plan)
                      Approved by Security Holders
                  
                  
                  4,849,894
                  
                  $
                  3.42
                  
                  
                  5,204,166Equity
                      Compensation Plans (Outside the 2006 Incentive Plan and 1999
                      Stock Option
                      Plan)
                  
                  
                  870,000
                  
                  $
                  1.50
                  
                  
                  0Total
                  
                  
                  5,719,894
                  
                  
                  
                  
                  
                  5,204,166*For
                      more information see Note 6 to the Consolidated Financial
                      Statements.
  **Item
          6.**  **Selected
          Condensed Consolidated Financial Data.**
 
 The
          selected consolidated financial data as of, and for the periods ended,
          December
          31, 2006, 2005, 2004, 2003, and 2002 presented below have been derived
          from the
          audited Consolidated Financial Statements of SpatiaLight. The selected
          financial
          data should be read in conjunction with our Consolidated Financial Statements
          and notes thereto and Item 7 “Management’s Discussion and Analysis of Financial
          Condition and Results of Operations” included elsewhere herein, in order to
          fully understand factors that may affect the comparability of the financial
          data
          presented below. Certain reclassifications have been made in the prior
          years to
          conform to current year presentation.
   20
 **Statements
                      of Operations:**Year
                      Ended December 31,2006
                  
                  
                  2005
                  
                  
                  2004
                  
                  
                  2003
                  
                  
                  2002Revenue
                  
                  $
                  474,004
                  
                  $
                  237,724
                  
                  $
                  1,160,978
                  
                  $
                  221,252
                  
                  $
                  -Gross
                      margin
                  
                  $
                  (5,387,640
                  )
                  $
                  (1,519,365
                  )
                  $
                  178,696
                  
                  $
                  (487,068
                  )
                  $
                  (286,000
                  )Total
                      operating expenses
                  
                  $
                  10,380,849
                  
                  $
                  11,027,836
                  
                  $
                  9,046,876
                  
                  $
                  8,308,470
                  
                  $
                  6,714,882Net
                          loss before cumulative effect of change in accounting
                          principle
                  
                  $
                  (18,743,069
                  )
                  $
                  (14,024,639
                  )
                  $
                  (9,367,001
                  )
                  $
                  (9,516,377
                  )
                  $
                  (9,027,913
                  )Cumulative
                          effect of change in accounting principle
                  
                  $
                  (223,993
                  )
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -Net
                      loss
                  
                  $
                  (18,967,062
                  )
                  $
                  (14,024,639
                  )
                  $
                  (9,367,001
                  )
                  $
                  (9,516,377
                  )
                  $
                  (9,027,913
                  )Net
                      loss per share - basic and diluted:Net
                        loss per share before cumulative effect of change in accounting
                        principle
                  
                  $
                  (0.46
                  )
                  $
                  (0.39
                  )
                  $
                  (0.27
                  )
                  $
                  (0.34
                  )
                  $
                  (0.37
                  )Cumulative
                        effect of change in accountingprinciple
                  
                  $
                  (0.01
                  )
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -Net
                      loss per share
                  
                  $
                  (0.47
                  )
                  $
                  (0.39
                  )
                  $
                  (0.27
                  )
                  $
                  (0.34
                  )
                  $
                  (0.37
                  )Weighted
                          average shares used in computing net loss per share- basic
                          and
                          diluted
                  
                  
                  40,717,579
                  
                  
                  36,375,068
                  
                  
                  34,154,057
                  
                  
                  28,173,770
                  
                  
                  24,578,226**Balance
                      Sheet Data:**
                  
                  
                  December
                      31,2006
                  
                  
                  2005
                  
                  
                  2004
                  
                  
                  2003
                  
                  
                  2002Cash
                      and cash equivalents
                  
                  $
                  220,256
                  
                  $
                  42,565
                  
                  $
                  9,087,551
                  
                  $
                  6,359,969
                  
                  $
                  575,663Inventory,
                      net
                  
                  $
                  423,075
                  
                  $
                  756,723
                  
                  $
                  1,173,314
                  
                  $
                  779,617
                  
                  $
                  275,959Working
                      capital (deficit)
                  
                  $
                  (12,893,640
                  )
                  $
                  (3,435,696
                  )
                  $
                  7,679,815
                  
                  $
                  6,228,782
                  
                  $
                  (807,891
                  )Total
                      assets
                  
                  $
                  7,675,969
                  
                  $
                  8,081,078
                  
                  $
                  15,258,136
                  
                  $
                  8,349,696
                  
                  $
                  2,058,454Secured
                      convertible notes
                  
                  $
                  10,784,087
                  
                  $
                  10,340,113
                  
                  $
                  9,885,140
                  
                  $
                  1,155,000
                  
                  $
                  4,207,232Total
                      stockholders' equity (deficit)
                  
                  $
                  (7,408,668
                  )
                  $
                  (7,915,226
                  )
                  $
                  1,578,182
                  
                  $
                  5,813,275
                  
                  $
                  (4,373,806
                  )
 
 **Item
          7.**  **Management’s
          Discussion and Analysis of Financial Condition and Results of
          Operations.**
 
 *The
          following discussion and analysis of our financial condition and results
          of
          operations should be read in conjunction with the consolidated financial
          statements and related notes appearing elsewhere in this Report. This discussion
          and analysis contains forward-looking statements that involve risks,
          uncertainties and assumptions as indicated in the introductory paragraphs
          to
          Item 1 of this Report. The actual results could differ materially from
          those
          anticipated in these forward-looking statements as a result of certain
          factors,
          including but not limited to, customers reception of our products, intensity
          of
          competition, quality control during manufacturing and those set forth under
          Risk
          Factors Item 1A.*
  **Overview**
 
 We
          are in
          the business of manufacturing high-resolution LCoS microdisplays. Our current
          customers are original equipment manufacturers (OEMs) engaged in the business
          of
          manufacturing high definition televisions or manufacturing light engines
          for
          incorporation into high definition televisions. Our products are also suitable
          for incorporation into other potential display applications including front
          projection systems, rear projection computer monitors, head mounted displays,
          micro-projectors, wireless communication devices, portable games and digital
          assistants, and we are now currently working with OEMs on some of these
          products.
   21
  *Status
          of Business with LG Electronics, Inc.*
  In
          March
          2007, LG Electronics (LGE) verbally informed us of their intent to discontinue
          the production of rear projection television (RPTV) (both LCoS and DLP).
          We do
          not expect significant further sales to LGE, are currently in negotiations
          with
          LGE related to an appropriate exit strategy, and are currently assessing
          the
          impact of this communication on our business.
  In
          July
          2004, we entered into an agreement with LG Electronics (LGE) providing
          for us to
          sell our T-3 LCoS Sets to LGE. Our supply agreement with LGE provides that
          we
          will be their exclusive supplier of three-chip LCoS microdisplay products
          for
          twelve months beginning from the date that we commenced shipments under
          that
          agreement. Our agreement provides that LGE will have the exclusive right
          in
          South Korea to purchase microdisplay products based on our T-3 LCoS Sets
          from us
          for the twelve months beginning from the date that we commenced shipments
          under
          that agreement. In July 2005, we commenced delivering a limited quantity
          of
          commercial production LCoS Sets to LGE. Under the July 2004 agreement,
          LGE
          agreed to purchase from us a minimum of 21,000 LCoS Sets during an initial
          six-month delivery period, which was originally scheduled to commence in
          January
          2005, subject to LGE's completion of pre-production requirements. Our July
          2005
          product delivery to LGE included a smaller quantity of LCoS Sets than was
          originally contemplated under the July 2004 agreement for the first delivery
          month. We delivered those LCoS Sets in July 2005 based upon our expectation
          that
          in the immediate future we would receive a firm purchase order from LGE.
 
 In
          August
          2005, we received a firm purchase order from LGE for its purchase from
          us of an
          aggregate minimum quantity of 9,300 LCoS Sets for the period July through
          December 2005. In October 2005, we publicly announced that we had received
          the
          formal written qualification letter from LGE stating that we have met certain
          agreed upon technical specifications (which had been the subject of prior
          informal approval in July 2005). We later agreed with LGE to move the initial
          six-month delivery period to November 2005 through April 2006. We subsequently
          agreed with LGE, through a series of communications, that the initial purchase
          order for 9,300 LCoS Sets may be filled over a period of time that extended
          beyond April 2006. This revised schedule had been based primarily upon
          changing
          expectations about our production output capacity and would have allowed
          us to
          conduct a focused ramp up of our LCoS Set production in South Korea.
 
 Although
          we have been have been delivering a limited quantity of production LCoS
          Sets to
          LGE since July 2005, our delivery ramp up has been slower than expected
          due to
          LGE’s product specification changes and problems that we have experienced in
          ramping up our manufacturing volumes. We have addressed our manufacturing
          problems by relocating the final portions of our manufacturing process
          to our
          production facility in South Korea, where we believe that the combination
          of a
          new facility designed to our specifications and highly qualified personnel
          provides us with more exacting controls over the external variables that
          can
          impact our manufacturing process.
 
 Our
          entire manufacturing operations are now conducted at the facility in South
          Korea. The transfer of those specific portions of the process caused a
          delay in
          manufacturing operations early in 2006 while production equipment was physically
          transferred from California to South Korea and South Korean employees were
          being
          trained to use that equipment. The final phase of this transition occurred
          during the first quarter of 2006. We believe that having manufacturing
          take
          place in one location allows us to maintain a higher level of quality controls
          over LCoS Set production, which we expect will improve our ability to produce
          sufficient quantities of LCoS Sets to meet future quantity demands from
          current
          and prospective customers. The potential negative impact upon our results
          of
          operations that could be caused by additional difficulties in manufacturing
          our
          LCoS Sets are described under Risk Factors Item 1A.
 
 LGE
          commenced an initial consumer market rollout in Australia of a limited
          quantity
          of 71-inch LCoS televisions incorporating our LCoS Sets during the first
          quarter
          of 2006. While we continued to ship product throughout 2006, as noted above,
          LGE
          intends to discontinue production of RPTVs and therefore we do not expect
          significant shipments in 2007 or beyond.
  In
          2005
          and 2006, the majority of our product deliveries, which were in small
          quantities, were made to LGE. Since the third quarter of 2006, we have
          been in a
          position to supply LGE’s requirements with quality product meeting all agreed
          upon specifications. The loss of LGE as a customer could significantly
          harm our
          future sales and results of operations; and our historical substantial
          dependence on one customer is subject to risks set forth under Item 1A
          Risk
          Factors.
 
 *Status
          of Business in Taiwan*
  To
          date,
          we have delivered limited quantities of our T-3 LCoS Sets to a Taiwanese
          customer, ThinTek. A substantial portion of these product deliveries occurred
          in
          2005. ThinTek has ordered quantities sufficient for pilot programs and
          sample
          products, but not enough to enable them to launch mass production of LCoS
          high
          definition televisions. We have continuing business relationships with
          customers
          and prospective customers in Taiwan, including ThinTek. We made small shipments
          of T-3 LCoS Sets to ThinTek during 2005 and the first quarter of 2006.
          On July
          19, 2006, one of the parent organizations of ThinTek, United Microdisplay
          Optronics (UMO), announced that it was acquiring ThinTek. The acquisition
          was
          effective October 1, 2006. We understand that as part of this acquisition,
          ThinTek’s and UMO’s business models are under evaluation, and may tend toward a
          more vertically integrated approach. For this reason, we have chosen to
          deal
          directly with a TV maker, Jiangxi Greatsource Display Tech Co., Ltd. (KHD)
          (in
          China), rather than ThinTek going forward.
   22
  *Status
          of Business in China*
  To
          date,
          we have delivered limited quantities of our microdisplay products to our
          Chinese
          customers. A substantial portion of these product deliveries occurred in
          2004,
          with a smaller quantity delivered in 2005 and none in 2006. The quantities
          of
          our products delivered to our Chinese customers are sufficient only for
          engineering testing and pilot program purposes. To date, our Chinese customers
          have not ordered quantities of our products that would enable them to launch
          commercial sales of LCoS high definition televisions.
  We
          have
          provided sample product to Jiangxi Greatsource Display Tech Co., Ltd. (KHD),
          a
          Chinese manufacturer of LCoS light engines and televisions that has received
          significant financing from the Chinese government. We supported KHD pilot
          evaluation runs with our personnel at their plant in China. Evaluations
          have
          identified a variety of non-SpatiaLight related product issues, mostly
          of driver
          board electronics origin, that are being addressed by KHD. KHD sent a delegation
          to review the capabilities of the SpatiaLight Korea, Inc. (SLK) facility,
          which
          has successfully occurred. KHD demonstrated an 85” commercial product at the
          January 2007 CES show employing our imagers. At this time, we do not have
          any
          purchase orders from KHD. We cannot provide assurance concerning the quantities
          of our products that we will sell to our Chinese customers and prospective
          customers in the future.
  *Market
          Strategy for Taiwan and China*
  Although
          our Chinese and Taiwanese customers' progression from product prototyping
          to
          mass production has been far slower than we had anticipated, we remain
          positive
          about our business prospects in China and Taiwan and the potential for
          China and
          Taiwan to become large markets for us. We currently believe that Chinese
          and
          Taiwanese television manufacturers tend to apply a market strategy of following
          the successful business models of global television manufacturing leaders,
          rather than acting as leaders themselves in terms of introducing new
          technologies to the marketplace. We therefore believe that if the LCoS
          technology gains greater acceptance in the high definition television
          marketplace, and if industry leaders, such as Sony, JVC and LGE, present
          their
          LCoS based televisions to the worldwide consumer markets in a prominent
          fashion,
          it will then be more likely that the Chinese and Taiwanese television
          manufacturers will follow these business models and ramp up their own lines
          of
          LCoS high definition televisions. We believe that our present course of
          continuing to transact business with major Chinese and Taiwanese television
          manufacturers is positioning us to be a leading LCoS supplier in China
          and
          Taiwan in the future.
  *Other
          Business Development*
  We
          are
          currently continuing to develop working relationships with prospective
          customers, located primarily in South Korea, Japan and other parts of the
          Pacific Rim region. These prospective customers fall into the following
          categories: 1) television manufacturers, 2) light engine suppliers, 3)
          head
          mounted display manufacturers, and 4) mobile electronics display device
          manufacturers. We have provided samples of our LCoS Sets to certain of
          these
          prospective customers, but we do not have any formal agreements with these
          parties as of December 31, 2006. While we have made significant progress
          with
          respect to product integration and negotiating purchase orders with certain
          of
          these prospective customers, we cannot provide assurances that we will
          receive
          any purchase orders that will be binding on any of these companies for
          their
          purchase of our products in the near future. Even assuming that we receive
          purchase orders that are binding on the prospective customers, these orders
          and
          our sales to these customers and to our existing customers are subject
          to
          certain contingencies described under Risk Factors in Item 1A.
 
 We
          have
          recently signed a Joint Market Agreement with Foreal for the LCoS/ LED
          based
          light engine developed by Foreal. Full production volumes amongst the four
          customers targeted by the two companies are expected to be in the vicinity
          of
          twenty thousand sets per month.
 
 We
          have
          also recently signed a Purchase Agreement with Deocom to supply LCoS imagers
          for
          use in head mounted displays (HMD). This agreement anticipates immediate
          shipments of samples for prototype and pre-production runs, followed by
          mass
          production later this year. We expect this market to grow significantly
          over
          time.
 
 In
          January 2007, we entered into a Joint Development Agreement between SpatiaLight,
          SI Infocomm, and SCRAM Technologies for the development of a micro-projector
          prototype with the intent to produce this in volume starting in the fourth
          quarter of 2007.
 
 *Manufacturing
          of LCoS Sets*
  We
          completed construction of our South Korean manufacturing facility in January
          2005. The South Korean facility has commenced to serve as our central commercial
          manufacturing base. The facility began producing products for commercial
          sale in
          limited quantities in the second quarter of 2005. The facility is designed
          with
          the capacity, on full employment, to produce up to 28,000 LCoS Sets per
          month.
          The facility has been specially designed for expansion to a capacity of
          120,000
          LCoS Sets per month in several expansion phases. We believe that the facility
          can be expanded in an efficient manner in the event that such expansion
          becomes
          necessary based upon increased or perceived increased demand for our products
          from our customers.
  23
  
 During
          2006, we installed additional manufacturing and related equipment in the
          facility and trained our operators and supervisors in key processes and
          equipment familiarization. We completed the process of moving all of our
          manufacturing operations to South Korea in the first quarter of 2006, which
          included physically moving all manufacturing equipment that remained in
          California as of the end of 2005. As part of the transition process, we
          experienced some manufacturing problems as the line was set up and restarted
          in
          Korea. The manufacturing problems have occurred during the alignment coating,
          glue application and cell lamination portions of our manufacturing process.
          We
          addressed our manufacturing problems in the transition of these portions
          of our
          manufacturing process to our production facility in South Korea, and we
          believe
          that the combination of a new facility designed to our specifications and
          highly
          qualified personnel provides us with more exacting controls over the external
          variables that can impact our manufacturing process. In addition to addressing
          some continuing specification change request issues with LGE, we completed
          the
          transition of these key processes to the South Korean plant. Since the
          third
          quarter of 2006, we have been in position to manufacture adequate quantities
          of
          high quality product meeting all agreed upon specifications. While we cannot
          provide any assurances against unexpected delays, we believe our manufacturing
          facility in South Korea can now successfully manufacture on a basis consistent
          with the anticipated demand for our products. Potential unexpected difficulties
          with our manufacturing process in South Korea could have a material negative
          impact upon our results of operations as set forth under Risk Factors in
          Item
          1A.
 
 *Business
          Strategy*
  In
          reviewing the risk factors for our business, it is clear that there are
          some
          overriding concerns and issues. One of these is the high level of focus
          and
          reliance in recent periods on one customer, LGE. Another factor is that
          our
          product focus has been on the high definition rear projection television
          (RPTV)
          application. While we certainly continue to work for success with the RPTV
          product, we also need to manage the risks inherent in this
          situation.
  For
          these
          reasons, we have taken the following initiatives:
  ·
              Find
                  additional Tier 1 customers for the RPTV product (strong focus
                  on adding
                  at least one other customer). ·
              Complete
                  an agreement with at least one and preferably two China TV
                  manufacturers. ·
              Improve
                  the competitiveness of LCoS based microdisplay products by working
                  with
                  firms involved in LED and laser diode light sources (instead of
                  the
                  standard high pressure mercury arc lamp light
                  source). ·
              Engage
                  in new product development for applications other than RPTV (including
                  Near-To-Eye (NTE) displays such as Head Mounted Displays (HMD)
                  and
                  micro-projector products). 
 We
          are
          currently offering one core product, our T-3 LCoS Set, with a 1920 pixels
          by
          1080 pixels configuration, to our customers and prospective customers,
          all of
          whom are located primarily in Asia. Our LCoS Set is comprised of three
          of our
          proprietary SpatiaLight imagEngineTM LCoS microdisplays. They are constructed
          with a silicon chip, a layer of liquid crystals and a glass cover plate
          in
          contrast to the more common construction of liquid crystals sandwiched
          between
          two glass plates. Our displays are also known as, and commonly referred
          to as,
          liquid crystal on silicon (LCoS), liquid crystal displays (LCD), active
          matrix
          liquid crystal displays and spatial light modulators. For applications
          such as
          large screen RPTV, the LCoS cell (T3P) is designed for a three panel
          configuration for maximum brightness. We are working to find a solution
          using
          the LGE light engine platform that will allow other customers quick market
          entry. We are focusing on manufacturing the T-3 model of our LCoS Sets
          (as
          opposed to our old T-1 LCoS Set with a resolution of 1280 pixels by 960
          pixels)
          for projection TV applications because we believe that the market demand
          for the
          higher resolution product will be significantly greater. A new smaller
          diagonal
          product (T4P) which will still maintain the high resolution of 1920 pixels
          by
          1080 pixels completes development, we will introduce that to allow lower
          price
          points in conjunction with smaller screen sizes (50” to 60” for T4P as opposed
          to 60” + for T3P).
  We
          are
          also working cooperatively with firms such as Foreal Spectrum (Foreal)
          of San
          Jose, California, to jointly provide a solid state light source based LCoS
          light
          engine solution. The long lifetime of these solid state light sources is
          attractive to both the consumer and commercial display maker when compared
          to
          the standard high pressure mercury arc lamp. In the case of laser diode
          sources,
          the low angular divergence of the light source facilitates the optical
          system
          design enabling thin cabinets with form factors approaching those of plasma
          TV’s
          at much lower weight.
  We
          have
          recently signed a Joint Market Agreement with Foreal for the LCoS/ LED
          based
          light engine developed by Foreal. Full production volumes amongst the four
          customers targeted by the two companies are expected to be in the vicinity
          of
          twenty thousand sets per month.
  24
  
 We
          have
          previously announced a Memorandum of Understanding (MOU) working with Deocom
          of
          South Korea on Head Mounted Displays using initially our T-3 imager in
          a full HD
          mode. We expect our cooperative efforts to lead to some product sales in
          the
          short term and a growing commercial and consumer market. We have also recently
          signed a Purchase Agreement with Deocom to supply LCoS imagers for use
          in head
          mounted displays (HMD). This agreement anticipates immediate shipments
          of
          samples for prototype and pre-production runs, followed by mass production
          later
          this year. We expect this market to grow significantly over time.
 
 We
          have
          also announced an MOU between SpatiaLight, SI InfoComm and SCRAM Technologies
          for the joint development of a micro-projector, a new category of product
          targeted at mobile electronics driven applications.
  We
          believe we have a solid core technology that can be used to meet the needs
          of a
          number of large and potentially high growth market segments. We believe
          that the
          manufacturing competence we have established at SpatiaLight Korea gives
          us a
          base from which to supply our current and future customers. To help us
          match
          these technical possibilities and capabilities successfully with market
          needs,
          we have established a new business development function operating out of
          Seoul,
          South Korea, that has already paid dividends in some of the agreements
          mentioned
          above.
 
 *Recent
          Equity Financing*
  February
          2007 Financing
  On
          February 23, 2007, when the price of our common stock was $1.31, we sold
          to five
          institutional buyers that participated in the November 2006 Financing,
          an
          aggregate of 2,190,477 of our common shares at a purchase price of $1.05
          per
          share. In addition, we issued 600,000 common shares, valued at $786,000,
          as a
          fee to obtain a one-time waiver of contractual prohibitions under the November
          2006 Financing against offering shares of our common stock for less than
          $1.30
          per share. We received aggregate proceeds of $2.3 million, before issuance
          costs, from the sale of these shares, which will be used for working capital
          and
          other corporate purposes. We made the sale pursuant to our “shelf” registration
          statement on Form S-3 (File No. 333-137100), which was declared effective
          by the
          SEC on February 14, 2007.
 
 November
          2006 Financing
  On
          November 29, 2006, when the price of our common stock was $1.76, we issued
          and
          sold 2,400,000 of our common shares in a private placement to three
          institutional investors (the “November 2006 Financing”). The transaction
          included the issuance of warrants to purchase 4,872,000 common shares with
          an
          exercise price of $1.75 per share exercisable within five years from the
          date of
          issuance. The purchase price of the common shares was $1.25 per share.
          The
          common shares and warrants were sold pursuant to an exemption from registration
          under Section 4(2) of the Securities Act of 1933, as amended. We received
          approximately $3.0 million in proceeds, before cash-based issuance costs
          of
          $180,000, from the sale of these shares, which was used for working capital
          and
          other general corporate purposes, including the repayment of certain short-term
          debt obligations. We have not yet filed a registration statement on Form
          S-3
          relating to the resale of these shares issued and
          issuance of the shares issuable upon the exercise of the warrants in the
          November 2006 Financing. Since this registration statement will be filed
          more
          than 30 days after, and will be declared effective more than 90 calendar
          days
          after November 29, 2006, we may be required to pay partial liquidated damages
          of
          $60,000 per month, subject to a maximum amount of $720,000 from December
          29,
          2006 until the registration statement is declared effective. Once
          the
          registration statement is declared effective, we are required to maintain
          effectiveness of the registration statement until all shares covered by
          it have
          been sold or may be sold without volume restrictions pursuant to Rule 144(k).
 
 September
          2006 Financing
  On
          September 26, 2006, when the price of our common stock was $2.20, we sold
          270,270 of our common shares in a private placement to certain institutional
          investors (the “September 2006 Financing”) that have previously purchased our
          common shares in private transactions on several occasions and are currently
          stockholders of our Company. The purchase price of the common shares was
          $1.85
          per share. The transaction included the issuance of warrants to purchase
          89,189
          common shares with an exercise price of $2.25 per share exercisable within
          five
          years from the date of issuance. We received $500,000 in gross proceeds,
          before
          cash-based issuance costs of $17,500, from the sale of these shares, which
          were
          used for working capital and other general corporate purposes. We
          have
          not yet filed a registration statement on Form S-3 relating to the resale
          of
          these shares issued and the issuance of shares issuable upon the exercise
          of the
          warrants in the September 2006 Financing. Since this registration statement
          will
          be filed more than 30 days after, and will be declared effective more than
          90
          calendar days after September 26, 2006, we
          may be
          required to pay partial liquidated damages of $10,000 when each of these
          dates
          occur and an additional 1% or $5,000 for each month thereafter to a
          contractually defined maximum of 12% of the aggregate purchase price or
          $60,000
          from October 26, 2006 until the registration statement becomes effective.
          Once
          the registration statement is declared effective, we are required to maintain
          effectiveness of the registration statement until the shares covered by
          the
          registration statement have been sold or may be sold without volume restrictions
          pursuant to Rule 144(k).
  25
 
 August
          2006 Financing
  On
          August
          9, 2006, when the price of our common stock was $2.60, we issued 761,500
          of our
          common shares in a private placement to an institutional investor (“August 2006
          Financing”). The purchase price of the common shares was $2.25 per share. We
          received approximately $1.7 million in gross proceeds, before issuance
          costs,
          from the sale of these shares, which were used for working capital and
          other
          general corporate purposes. The
          common shares were sold pursuant to an exemption from registration under
          Section
          4(2) of the Securities Act of 1933, as amended. We
          paid
          $110,000 to our former Executive Vice President of Strategic Planning to
          facilitate this transaction, which were costs directly related to the
          transaction, and recorded as a reduction of the gross proceeds. We are
          required
          under a registration rights agreement to file a registration statement
          for the
          resale of the shares within 30 calendar days from the closing date and
          have the
          registration statement declared effective no later than 90 calendar days
          after
          the closing date. The registration rights agreement provides that if we
          do not
          meet the above deadlines, we may be required to pay an amount equal to
          1.5% of
          the aggregate purchase price or $25,700 as partial liquidated damages when
          each
          of these dates occur and an additional $25,700 for every 30 days thereafter
          for
          up to six months. After six months, the percentage increases to 2.5% or
          $42,800
          for each additional 30 days with no contractual maximum. Once the registration
          statement is effective, we are required to maintain effectiveness of the
          registration statement until the shares covered by the registration statement
          have been sold or may be sold without volume restrictions pursuant to Rule
          144(k). The institutional investor has waived any claim for liquidated
          damages
          based on the failure to file a registration statement within the time required
          until a reasonable time after the effectiveness of our universal shelf
          registration statement on Form S-3 (Registration No. 333-137100), which
          was
          declared effective by the SEC on February 14, 2007.
 
 As
          part
          of the August 2006 Financing, we agreed to file a “shelf” registration
          statement covering subscription rights of at least $20,000,000 (the “Required
          Rights Offering”) to be offered to the holders of our common stock unless we
          raised at least $10,000,000
          in additional financing between August 9, 2006 and 30 days after the effective
          date of the registration statement. On October 25, 2006, these requirements
          were
          amended to (i) extend the Additional Financing Deadline by 30 days if we
          raised
          at least $1,000,000 in additional financing; (ii) extend the Additional
          Financing Deadline by 30-60 days if we raised between $3,000,000 and $5,000,000
          in additional financing; (iii) extend the Additional Financing Deadline
          by 60
          days and reduce the Required Rights Offering pro rata if we raised more
          than
          $5,000,000 in additional financing. As of March 15, 2007, we have raised
          $5,800,000 in additional financing, the Required Rights Offering has been
          decreased to $14,200,000 and the Additional Financing Deadline has been
          extended
          to May 15, 2007.
 
 Because
          of our existing covenants with the holders of our Senior Secured Convertible
          Notes, which requires us to seek their consent before we agree to enter
          into
          additional material indebtedness, we will most likely try to raise the
          above-mentioned monies through the sale of additional common shares. We
          can
          offer no assurance that we will successfully raise all or any part of the
          $4,200,000 mentioned above, nor can we offer an assurance that we will
          issue
          subscription rights to our shareholders in the future. At present, we are
          considering all of our options and have not definitively determined how
          or
          whether we will raise all or a part of the $4,200,000 which would allow
          us to
          avoid our obligation to make an offering of subscription rights to purchase
          our
          common shares. In connection with the August 2006 Financing, we have also
          agreed, for a period of one year following the closing of the August 2006
          Financing, to refrain from, directly or indirectly, offering or selling
          any debt
          security that is, at any time during the life of the debt security and
          under any
          circumstance, convertible into or exchangeable for our common shares, unless
          we
          receive prior written consent from a majority of the purchasers of the
          August
          2006 Financing.
 
 In
          the
          event we default upon the foregoing obligations, the purchasers of securities
          in
          our August 2006 Financing are entitled to contractual damages and may also
          request that we specifically perform our obligations under the purchase
          agreement giving rise to our obligations. At present, we are unable to
          quantify
          the amount of contractual damages to which the purchasers would be entitled,
          and
          we are unable to estimate the likelihood that a court would grant any
          purchaser’s application that we specifically perform our
          obligations.
 
 June
          2006 Financing
  On
          June
          5, 2006, when the price of our common stock was $2.59, we sold to certain
          institutional buyers, each of which is managed by Wellington Management
          Company,
          LLP, an aggregate of 601,000 of our common shares at a price per share
          of $2.80,
          for an aggregate purchase price of approximately $1.7 million. We made
          the sale
          pursuant to a Post-effective Amendment to a “shelf” registration statement on
          Form S-3 (File No. 333-122392), which was declared effective by the SEC
          before
          this transaction, and which was amended by a registration statement on
          Form S-3
          MEF (File No. 333-134626) filed by us on May 31, 2006. These funds were
          used for
          working capital and other general corporate purposes.
 
 April
          2006 Financing
  On
          April
          7, 2006, when the price of our common stock was $3.89, we sold 750,000
          of our
          common shares at a purchase price of $3.26 per share to three institutional
          purchasers. Those shares were registered in our Post-effective Amendment
          No. 6
          to a Form S-3 “shelf” registration statement (File Number 333-122392). The
          purchase price for those common shares was approximately $2.4 million in
          the
          aggregate. The purchase price was based upon the five-day volume weighted
          average price of our common shares through April 6, 2006, discounted by
          five
          percent. We paid aggregate fees equal to $89,650 to persons who introduced
          us to
          the investors. These funds were used for working capital and other general
          corporate purposes.
  26
 
 March
          2006 Financing
  On
          March
          17, 2006, when the price of our common stock was $2.79, we sold 500,000
          of our
          common shares at a purchase price of $2.18 per share to certain institutional
          investors. Those shares were included in our Post-effective Amendment No.
          6 to
          Form S-3 "shelf" registration statement (File No. 333-122392). The purchase
          price was based upon the five-day volume weighted average price of our
          common
          shares through March 16, 2006, discounted by five percent. We received
          net
          proceeds of approximately $1.1 million, which were used for working capital
          and
          other general corporate purposes.
 
 January
          2006 Financing
  In
          mid-January 2006, when the price of our common stock ranged from $2.62
          to $2.85,
          we issued and sold 1,300,000 of our common shares in a private placement
          to
          three institutional investors. The purchase price of the common shares
          was $2.62
          per share. We received approximately $3.3 million in net proceeds from
          the sale
          of these shares, which were used for working capital and other general
          corporate
          purposes, including the repayment of certain short-term debt obligations.
          We
          were required under a registration rights agreement, to file a registration
          statement for the resale of the shares within 30 calendar days after January
          12,
          2006 and have the registration statement declared effective no later than
          90
          calendar days after January 12, 2006. Once the registration statement is
          declared effective, we
          are
          required to maintain effectiveness of the registration statement until
          the
          shares covered by the registration statement have been sold or may be sold
          without volume restrictions pursuant to Rule 144(k). As
          the
          registration statement was not filed by February 11, 2006 or declared effective
          prior to April 12, 2006, the registration rights agreement required us
          to pay an
          amount equal to 5% of the aggregate purchase price or $170,300 as partial
          liquidated damages when each of these dates occurred and an additional
          $170,300
          for every 30 days thereafter up to six months. After six months, the percentage
          increases to 10% or $340,600 for each additional 30 days. We have included
          $329,602 as liquidated damages in non-cash interest expense from inception
          through May 12, 2006. The registration statement related to these shares
          was
          filed with the SEC on May 5, 2006 and was declared effective on May 12,
          2006.
          Concurrent with the effectiveness of the registration statement, the investors
          of the January financing received an aggregate of 122,725 restricted shares
          in
          settlement of any and all liquidated damages. The shares were issued as
          follows:
          57,725 restricted shares of our common stock were issued on May 18, 2006,
          when
          the market value of our shares was $3.12, resulting in an intrinsic value
          of
          $180,102; 65,000 restricted shares of our common stock were issued on June
          30,
          2006, when the market price of our shares was $2.30, resulting in an intrinsic
          value of $149,500. Of these shares, 57,725 were included in our Form S-3
          (File
          No. 333-137100) filed with the SEC on November 6, 2006 and declared effective
          by
          the SEC on February 14, 2007.
 
 *Senior
          Secured Convertible Debt Financing*
  On
          November 30, 2004, we completed a non-brokered private placement of $10
          million
          of our senior secured notes (the Senior Secured Convertible Notes). The
          Senior
          Secured Convertible Notes accrue interest at 10% per annum, payable quarterly
          in
          cash or our common shares at our option, if certain conditions are met,
          such as
          the availability of an effective registration statement pursuant to which
          resales may be made or the availability of Rule 144(k) for resale of the
          common
          shares underlying our Senior Secured Convertible Notes. The value of the
          shares
          for the purposes of calculating interest payments shall be equal to the
          10-day
          trailing average of the volume weighted average prices of our common shares
          at
          the end of each quarterly interest period. The Senior Secured Convertible
          Notes
          are due November 30, 2007.
 
 The
          Senior Secured Convertible Notes are convertible, at the option of their
          holders, into our common shares at the conversion price of $9.72 per share.
          The
          Senior Secured Convertible Notes are senior to notes that we issued to
          Argyle
          Capital Management Corporation, which is wholly owned by Robert A. Olins,
          our
          former Chief Executive Officer, Secretary, Treasurer and a Director. The
          holders
          of our Senior Secured Convertible Notes have a senior security interest
          in
          substantially all of our assets, except those located in South Korea. However
          the holders of our Senior Secured Convertible Notes have a pledge of the
          issued
          and outstanding shares of SpatiaLight Korea Ltd. In addition, under the
          terms of
          the November 2004 Financing, we are prohibited from using the proceeds
          from the
          financing to repay debt or to pay dividends, and we are prohibited from
          paying
          dividends while the Senior Secured Convertible Notes are outstanding.
  27
 
 We
          were
          required under an amended registration rights agreement, to file a registration
          statement for resale of the shares issuable upon conversion of the Senior
          Secured Convertible Notes and to maintain its effectiveness to allow the
          holders
          of our Senior Secured Convertible Notes to convert their notes and sell
          the
          underlying common shares freely.  We reported in Post-effective Amendment
          No. 2 to our registration statement on Form S-3 relating to the Senior
          Secured
          Convertible Notes (Reg. No. 333-122391), that in late August 2005 we advised
          the
          holders of our Senior Secured Convertible Notes that until the matter concerning
          the filing of an unauthorized consent of our former auditors, BDO Seidman
          LLP,
          is resolved, sales using the prospectus which is the subject of that
          registration statement may result in potential liability. One of the holders
          of
          the Senior Secured Convertible Notes, Portside Growth & Opportunity Fund,
          has claimed that the Post-effective Amendment resulted in an obligation
          for the
          Company to pay each Noteholder liquidated damages in cash equal to 1% of
          the
          purchase price of the notes, and 1% for every 30 days thereafter, until
          the
          matter concerning the consent is resolved.  That amount would equal
          $534,000 and $683,000 as of December 31, 2005 and February 14, 2006 (when
          the
          post-effective amendment to the registration statement was declared effective),
          respectively.  We do not believe that we are contractually obligated to
          make those payments and we have not accrued for the alleged liquidated
          damages.  However, should the Noteholders pursue their claim for liquidated
          damages pursuant to the Registration Rights Agreement and prevail on their
          claim
          in a court of law, the alleged liquidated damages would immediately become
          due
          and payable.  In February 2006, Post-effective Amendment No. 6 to the
          registration statement referenced above was declared effective by the
          SEC.
 
 Portside
          Growth & Opportunity Fund has also claimed the following additional events
          of default under the Senior Secured Convertible Notes: (i) failure to make
          an
          interest payment due in November 2005 on a timely basis; (ii) incurrence
          of
          prohibited indebtedness to our former officers and/or directors of the
          Company;
          (iii) incurrence of prohibited indebtedness by our South Korean subsidiary
          to
          certain banks in South Korea; (iv) granting of a security interest by our
          South
          Korean subsidiary in certain assets located in South Korea; and (v) repayment
          by
          us of indebtedness to our officers or directors and by our South Korean
          subsidiary of indebtedness under bank credit facilities. Smithfield Fiduciary
          LLC, joined in the claim that a default occurred as a result of the failure
          to
          make the November 2005 interest payment in a timely fashion. Each of these
          notices call for us to redeem $9.0 million in the aggregate principal amount
          of
          our Senior Secured Convertible Notes, plus payment of a redemption premium
          of
          $675,000 to each of these holders. Furthermore, the Noteholders claim that
          the
          interest rate on the Senior Secured Convertible Notes has increased from
          10% per
          annum to 12% per annum as a result of the claimed defaults.
 
 We
          believe, after review with outside legal counsel, that these allegations
          lack
          merit and would not entitle the Noteholders to call the notes and other
          remedies
          that they are seeking.  We believe that the Noteholders have undertaken to
          make allegations of events of default that lack merit in an attempt to
          obtain an
          amendment to the terms of the Senior Secured Convertible Notes to reduce
          the
          conversion price, accelerate repayment and increase the interest rate.
          We have
          rejected offers from the Noteholders in this regard, and plan to vigorously
          defend our position. If the Noteholders prevail in calling the Notes, the
          entire
          $10 million debt obligation would become due and payable immediately, including
          the redemption premiums of $1.5 million and liquidated damages of
          $683,000.  We have not accrued the above described redemption premiums or
          liquidated damages as of December 31, 2005 or December 31, 2006.
 
 We
          believe the alleged events of default of which Portside and Smithfield
          have
          given notice lack merit and would not entitle the Noteholders to the remedies
          that they are seeking. Therefore, we believe it is not probable the Noteholders
          would prevail in calling the Notes. As a result, in accordance with FAS
          5,
“ *Accounting
          for Contingencies,”* we have
          continued to classify the Senior Secured Convertible Notes as a long-term
          obligation in our balance sheet at December 31, 2005 and as a short-term
          liability at December 31, 2006, in accordance with the contractual maturity
          date, rather than as a current liability as of December 31, 2005 as FAS
          78,
“ *Classification
          of Obligations That are Callable by the Creditor,”* might
          otherwise require. The redemption premium and liquidated damages of $1.5 million
          and approximately $0.7 million, respectively, have not been accrued in
          the
          consolidated financial statements as of December 31, 2005 or 2006. We refer
          you
          to Note 1 of our Notes to consolidated financial statements contained in
          this
          report for additional information regarding the accounting treatment of
          the
          Senior Secured Convertible Notes.
 
 *Certain
          Developments*
 
 Audit
          Committee Investigations
 
 We
          filed
          an unauthorized consent of BDO Seidman LLP to Amendment Nos. 5 and 6 to
          our
          registration statement on Form S-3 (File No. 333-122391) and to Amendment
          Nos. 3
          and 4 to our registration statement on Form S-3 (File No. 333-122392) in
          order
          to incorporate by reference their report on our consolidated financial
          statements for the fiscal years ended December 31, 2002 and 2003, respectively.
          Although we received the requisite authorized consents from BDO Seidman
          LLP to
          incorporate by reference their report on the consolidated financial statements
          into the registration statements when initially filed and in subsequent
          amendments thereto (and BDO Seidman LLP has not withdrawn these subsequent
          consents), we did not receive the requisite authorization from BDO Seidman
          LLP
          to file its consent as an exhibit to the penultimate and final pre-effective
          amendments to either the registration statements. The penultimate and final
          pre-effective amendments to both the registration statements were filed
          with the
          SEC on July 27, 2005.
 
 The
          Audit
          Committee of our Board of Directors conducted an investigation and review
          of the
          developments pertaining to the BDO Seidman LLP consent issue with the assistance
          of independent counsel.
  28
 
 The
          Audit
          Committee delivered its report, dated October 31, 2005, to our former Chief
          Executive Officer, Robert A. Olins. The Report concluded that the evidence
          does
          not support a finding that any of our employees included the unauthorized
          BDO
          Seidman LLP consents in the amendments to the Registration Statements referred
          to above with fraudulent intent or with specific knowledge that BDO Seidman
          LLP
          had not authorized the filing of these consents. It concluded that the
          evidence
          was consistent with our inclusion of the consents due to lack of communication,
          a series of misunderstandings and/or a failure of inquiry. As to Mr. Olins,
          the
          Report concluded that the Audit Committee found no evidence that Mr. Olins
          was
          informed that BDO Seidman LLP had not authorized the filing of these consents.
          However, it also found no evidence that Mr. Olins inquired or determined
          whether
          BDO Seidman LLP had in fact authorized inclusion of the consents in these
          filings. The Audit Committee Report determined that Mr. Olins, as our Chief
          Executive Officer, did not exercise sufficient diligence in supervising
          the
          filing of the amendments to the Registration Statements, that this was
          a
          particularly serious failing in light of the SEC having highlighted the
          need for
          consents from BDO Seidman LLP, and that as CEO he bears responsibility
          for the
          filings. The Audit Committee also stated its belief that, throughout the
          process
          of preparing and filing the amendments to the registration statements,
          Mr. Olins
          acted with our best interests and the best interests of our shareholders
          in
          mind, and that his lack of diligence was not motivated by self-interest
          and that
          nothing related to this incident personally benefited him financially.
 
 The
          Audit
          Committee recommended three remedial actions. It concluded that the membership
          of the Board of Directors should be supplemented with a financial expert
          within
          the meaning of SEC rules. It also concluded that we must improve our corporate
          governance and disclosure controls, including hiring a full-time Chief
          Financial
          Officer and a Controller (who can be the same person). It further concluded
          that
          by reason of Mr. Olins' responsibility as CEO for supervision of corporate
          filings, he should reimburse us for the sum of $50,000, a portion of the
          costs
          incurred by us by reason of the unauthorized BDO Seidman LLP consents and
          the
          resulting inquiries. In compliance with the Audit Committee Report, in
          December
          2005, Mr. Olins made the $50,000 payment to reimburse the Company. To date,
          our
          Board of Directors has not been supplemented with a financial expert and
          we have
          not hired a fulltime CFO or Controller although on April 28, 2006, we hired
          a
          part-time Director of Accounting and Finance. We have been advised by the
          Staff
          of the SEC that the Staff is conducting an investigation into matters and
          events
          pertaining to the filing of the unauthorized BDO Seidman LLP consents.
          We have
          been cooperating with the Staff with respect to this matter.
 
 Our
          Audit
          Committee, with the assistance of independent legal counsel, conducted
          an
          investigation and review of transactions in the Company’s shares by Robert A.
          Olins, our former Chief Executive Officer, Secretary, Treasurer and a Director
          and determined that he failed to report the sale of an aggregate of 70,556
          of
          our common shares in August 2005 and February 2006 at sales prices ranging
          from
          $5.30 to $3.00. The Audit Committee determined that there was no indication
          that
          Mr. Olins had access to material undisclosed information at the time of
          the
          transactions, that there was no intention to engage in the distribution
          of our
          securities without registration, and that the number of shares involved
          was
          insignificant. Pursuant to Section 16 of the Exchange Act, in July 2006,
          Mr.
          Olins filed the delinquent reports and disgorged $22,273 in “short-swing
          profits” that he realized from the sales.
 
 SEC
          Investigations
 
 We
          have
          been advised by the Staff of the SEC that the Staff is conducting an
          investigation into matters and events pertaining to the filing of the
          unauthorized BDO Seidman LLP consents and transactions in our securities
          by Mr.
          Olins and an entity he controls. We have received and responded to a request
          for
          all information relating to transactions in our securities by Mr. Olins
          and the
          entity he controls. We have been cooperating with the Staff with respect
          to this
          matter but are not aware of any violations of the securities laws except
          as set
          forth under “Audit Committee Investigations” above. At this date, we cannot
          determine whether we or our management will be adversely affected by these
          investigations.
 
 Other
          matters
 
 Both
          of
          the registration statements containing the unauthorized BDO Seidman LLP
          consents
          were declared effective in July 2005. In August 2005, we filed Post-effective
          Amendments number 1 to both of these registration statements (those
          post-effective amendments were subsequently withdrawn and replaced by additional
          post-effective amendments), which disclosed the filing of the unauthorized
          consents. Because both registration statements were used to sell common
          shares
          after the SEC declared the registration statements effective, it is conceivable
          that there may be litigation against us or our officers or directors under
          Section 11 of the Securities Act. Although we do not believe that the filing
          of
          an invalid consent constitutes a materially misleading statement or an
          omission
          to disclose a material fact within the meaning of Section 11 of the Securities
          Act, a contrary determination could result in a liability for us.
 
 At
          present, we are unable to ascertain the exact amount of damages, if any,
          to
          which we could be subject under a Section 11 claim instituted by any persons
          who
          directly purchased shares pursuant to those registration statements.
          Furthermore, at this date, we cannot ascertain the amount of damages, if
          any,
          for which we could be liable for claims instituted by any subsequent purchasers
          who could trace the shares purchased by them to those registration statements.
          In August 2005, we sold 500,000 common shares to three institutional purchasers
          for $5.40 per share pursuant to the “shelf” registration statement referenced
          herein. Each of those investors has since represented to us in writing,
          in
          connection with a separate transaction, that they have disposed of all
          of those
          shares. One of those institutional investors has represented to us that
          it sold
          those shares at a sale price at or higher than its purchase price from
          us. We
          believe, based upon discussions with the other two investors, that they
          sold
          their shares at a sale price of not lower than $4.25 per share. Therefore,
          we
          believe that our maximum damages pursuant to Section 11 claims from direct
          purchasers, which we would fully contest, would be $391,000, or the difference
          between the two investor’s purchase price and lowest believed resale price,
          multiplied by the 340,000 shares that they purchased and then
          resold.
  29
 
 In
          addition to any damage claims, which may be material to our financial condition,
          any lawsuit alleging securities law violations could require us to expend
          significant financial and managerial resources.
 
 **Liquidity
          and Capital Resources**
 
 Through
          December 31, 2006, we have sustained recurring net losses from operations
          and,
          at December 31, 2006, we had a stockholders’ deficit of approximately
          $7,409,000. During 2006, we experienced negative cash flows from operating
          activities of approximately $12,415,000 and a net loss of approximately
          $18,967,000. In the first quarter of 2006, cash was primarily provided
          by the
          net proceeds of approximately $3.3 million that we received from the sale
          of
          1,300,000 of our common shares in mid-January 2006 at a purchase price
          of $2.62
          per share and approximately $1.1 million that we received from the sale
          of
          500,000 of our common shares on March 17, 2006 at a purchase price of $2.18
          per
          share. Additional contributions came from the exercise of employee stock
          options. Additionally, cash for the three months ended March 31, 2006 was
          provided by a Korean Won 1.5 billion (approximately $1.5 million) short-term
          loan obtained in March 2006 that was repaid in early April 2006. See Note
          3 for
          further details of this loan. In the second quarter of 2006, cash was primarily
          provided by the net proceeds of approximately $2.4 million that we received
          from
          the sale of 750,000 of our common shares on April 7, 2006 at a purchase
          price of
          $3.26 per share and approximately $1.7 million that we received from the
          sale of
          601,000 of our common shares on June 6, 2006 at a purchase price of $2.80
          per
          share. The funds from these financings were used to fund our operations
          for the
          second quarter of 2006. In the third quarter of 2006, cash was primarily
          provided by the net proceeds of approximately $1.6 million that we received
          from
          the sale of 761,500 of our common shares on August 9, 2006 at a purchase
          price
          of $2.25 per share and $0.5 million that we received from the sale of 270,270
          of
          our common shares on September 26, 2006 at a purchase price of $1.85 per
          share.
          The funds from these financings were used to fund our operations for the
          third
          quarter of 2006. During the fourth quarter of 2006, cash was provided by
          net
          proceeds of approximately $2.8 million that we received from the sale of
          2,400,000 of our common shares on November 29, 2006 at a purchase price
          of $1.25
          per share. The funds from these financings were used to fund our operations
          for
          the fourth quarter of 2006.
 
 As
          of
          December 31, 2006, we had approximately $220,000 in cash and cash equivalents,
          an increase of approximately $177,000 from the December 31, 2005 amount
          of
          $43,000. Our net working capital deficit at December 31, 2006, was approximately
          $12,894,000, compared to a working capital deficit of approximately $3.4
          million
          at December 31, 2005.
 
 Net
          cash
          used in operating activities totaled approximately $12.4 million and $9.7
          million in 2006 and 2005, respectively. This increase is due primarily
          to
          funding the operations in our South Korean subsidiary without commensurate
          revenues, and increased legal fees associated with the SEC investigations
          and
          2006 financing transactions. Net cash used in investing activities totaled
          approximately $0.5 million and $5.5 million in 2006 and 2005, respectively.
          The
          larger amount in 2005 stemmed from acquiring and building our South Korean
          manufacturing facility during 2005. This facility was operational towards
          the
          end of 2005. Net cash provided by financing activities was approximately
          $13.1
          million and $6.2 million in 2006 and 2005, respectively. Net cash provided
          by
          financing activities in 2006 resulted from the aggregate net proceeds of
          $13.3
          raised in seven separate equity private placement transactions in 2006
          and
          repayment of $0.2 million related to short-term loans during 2006. Net
          cash
          provided by financing activities in 2005 resulted primarily from the aggregate
          net proceeds of $4.6 million raised in two separate equity private placement
          transactions in 2005 and net proceeds of $0.8 million from short-term loans
          during 2005.
 
 As
          of
          December 31, 2006, we had an accumulated deficit of approximately $100.6
          million. We have experienced significant losses in the past and expect
          that
          these losses will continue until we start to generate significant revenues
          from
          the sale of our products. We generated revenue of approximately $474,000
          during
          2006. Although we are expecting to generate revenues from the sale of our
          products in 2007, we expect to operate at a loss during 2007. There can
          be no
          assurance that our business will operate on a profitable basis
          thereafter.
 
 Our
          Audit
          Committee determined that Robert A. Olins, our former Chief Executive Officer,
          Secretary, Treasurer and a Director failed to report the sale of an aggregate
          of
          70,556 of our common shares in August 2005 and February 2006 at sales prices
          ranging from $5.30 to $3.00. Pursuant to Section 16 of the Exchange Act,
          in July
          2006, Mr. Olins has filed the delinquent reports and disgorged $22,273
          in “short
          swing profits” that he realized from the sales. These funds were recorded as an
          increase in additional paid in capital during the third quarter
          2006.
  30
  
 We
          anticipate that our cash expenditures during the first part of 2007 will
          approximate $600,000 per month, or approximately $7.2 million for the year,
          without regard to any revenue in 2007. This is down from our 2006 levels
          due to
          cost cutting measures such as reduced personnel costs, partially as a result
          of
          natural attrition and partially due to reduction in work force in South
          Korea
          due to sales less than anticipated. We expect to meet our immediate cash
          needs
          and fund our immediate working capital requirements with our existing cash
          balances and from additional sources. Those sources include gross proceeds
          of
          approximately $2.3 million that we received from the sale of 2,190,477
          of our
          common shares on February 23, 2007, (as more fully described in Note 11
          to our
          consolidated financial statements);  cash
          payments from our customers; the exercises of stock options and warrants;
          and
          additional sales of our common shares. There can be no assurances with
          respect
          to these potential sources. We believe that our current cash and cash
          equivalents as of December 31, 2006, combined with the proceeds from the
          February 2007 Financing will be sufficient to meet our capital and liquidity
          requirements for our operations through March 2007. We will be required
          to raise
          significant amounts of additional capital to continue to fund our operations
          on
          a going forward basis. To raise additional capital, we
          plan
          to sell the 108 million common shares (subject to the number of available
          authorized shares) that we have available for sale under a currently effective
          “shelf” registration statement (based on the share price on March 14, 2007 of
          $0.66 per share). We also
          believe that we will be required to complete additional equity and/or debt
          financings in 2007. If we are unable to obtain additional funds on reasonable
          terms, we may be unable to continue our operations at current levels, or
          at
          all.
 
 **Off
          Balance Sheet Arrangements**
 
 There
          are
          no off balance sheet arrangements as of December 31, 2006.
 
 **Contractual
          Obligations and Contingent Liabilities and Commitments**
 
 We
          have
          long-term contractual obligations and commitments primarily with regards
          to
          payment of debt and lease arrangements.
 
 The
          following table aggregates our expected contractual obligations and commitments
          subsequent to December 31, 2006:
  **Payments
                      Due By Period**Contractual
                      obligations
                  
                  Less
                      than 1 year
                  
                  1
                      -
                      3 years
                  
                  3-5
                      years
                  
                  over
                      5 years
                  
                  TotalLong-term
                      convertible debt (1)
                  
                  $
                  -
                  
                  $
                  1,188,000
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  1,188,000Senior
                      secured convertible notes (3)
                  
                  
                  10,000,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  10,000,000Short
                      term loans
                  
                  
                  591,070
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  591,070Interest
                      on senior secured convertible notes (2)
                  
                  
                  916,667
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  916,667Operating
                      lease commitments
                  
                  
                  459,040
                  
                  
                  792,419
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,251,459Total
                      contractual cash obligations
                  
                  $
                  11,966,777
                  
                  $
                  1,980,419
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  13,947,196
  (1)
          All
          interest underlying the Notes, at the contractual rate of 6%, has been
          prepaid
          through the issuance of common shares (See Note 3 to consolidated financial
          statements.)
 (2)
          Subject to certain conditions, interest is payable in cash or common shares
          at
          the option of the Company. (See Note 3 to the consolidated financial
          statements.)
 (3)
          The
          holders of $9,000,000 principal amount of these Notes have alleged certain
          events of default under these Notes. As a consequence of these alleged
          defaults,
          these holders have demanded their immediate redemption. We strongly dispute
          that
          any events of default have occurred that would allow the Noteholders to
          call
          their Notes or be entitled to the redemption premiums and liquidated damages
          of
          approximately $1.5 million and $683,000, respectively. See Notes 1 and
          3 to the
          consolidated financial statements for further information.
 
 **Results
          of Operations**
 
 *Three
          years ended December 31, 2006, 2005 and 2004*
 
 *Revenue.* We
          recognized sales revenue of approximately $474,000, $238,000, and $1,161,000
          for
          the years ended December 31, 2006, 2005 and 2004, respectively. Revenue
          in 2004
          was related to deliveries made pursuant to agreements relating to the sale
          of
          our T-1 LCoS Sets and light engines, primarily to customers in China. During
          2005 we changed our focus to the further development, manufacture and sale
          of
          our T-3 LCoS Sets, primarily to LGE. Revenues significantly decreased from
          2004
          to 2005 because of problems that we experienced in the manufacturing of
          our T-3
          LCoS Sets. Revenue in 2006 was related to delivery of our T-3 LCoS Sets,
          primarily to LGE. Revenue during the fourth quarter 2006 decreased from
          its
          trend earlier in the year because LGE significantly decreased its shipment
          releases against its outstanding purchase order with us during the fourth
          quarter 2006. As mentioned earlier, we were verbally informed in March
          2007 by
          LGE that they are intending to discontinue production of RPTV products
          (both
          LCoS and DLP) at this time, continuing their emphasis on flat panel display
          televisions. As a result, we do not expect significant further sales to
          LGE. See
“Status of Business with LG Electronics, Inc.”, “Status of Business in Taiwan”
and “Status of Business in China” under this Item 7 for a more detailed
          description of the agreements relating to the sale of our products.
  31
  
 The
          following table summarizes our sales revenue percentages by product for
          the
          years ended 2006, 2005 and 2004.
  2006
                  
                  
                  2005
                  
                  
                  2004LCoS
                      (T-3) sets
                  
                  
                  96
                  %
                  
                  77
                  %
                  
                  5
                  %LCoS
                      (T-1) sets
                  
                  
                  -
                  
                  
                  4
                  %
                  
                  42
                  %Light
                      engine display units
                  
                  
                  -
                  
                  
                  1
                  %
                  
                  51
                  %Other
                      (primarily supporting electronics)
                  
                  
                  4
                  %
                  
                  18
                  %
                  
                  2
                  %Total
                  
                  
                  100
                  %
                  
                  100
                  %
                  
                  100
                  %
 
 
 *Gross
          Margin.* Gross
          margin changed from a positive of $179,000 in 2004 to a negative $1,519,000
          in
          2005 to a negative $5,388,000 in 2006. During the fourth quarter of 2005
          our
          manufacturing facility in South Korea became operational. Once production
          began,
          our costs associated with this facility became part of our cost of revenue.
          These costs include a certain level of relatively fixed overhead costs,
          including personnel-related costs, to operate and maintain our manufacturing
          facilities. Once these relatively fixed overhead costs are covered, we
          expect to
          experience a contribution margin on additional sales. When we incur these
          costs
          without sufficient revenues from the sale of our products to offset them,
          we
          report negative margins. Our sales have been relatively minor to date,
          and have
          not yet covered the cost of operating our South Korean manufacturing facility.
          The costs of operating our South Korean facility contributed $4.9 million
          to our
          negative gross margin during 2006 versus $0.9 million in 2005, as it became
          operational during the fourth quarter 2005. Due to the addition of these
          costs,
          there is currently no direct correlation between costs and revenue during
          2005
          or 2006. Cost of revenue in 2005 includes a reserve of $351,000, related
          to a
          percentage of our T-1 inventory. Cost of revenue in 2006 includes a reserve
          of
          $444,000 which wrote down the remaining portion of our T-1 inventory and
          the
          remaining light engine inventory. Sales of our T-1 product were minimal
          during
          2005 and we have had no sales of either of these products during 2006.
 
 *Cash-based
          selling, general and administrative expenses.* **** Cash-based
          selling, general and administrative expenses were approximately $7,439,000,
          $7,255,000, and $5,810,000 in 2006, 2005 and 2004, respectively, and include
          professional services, salaries and related taxes and benefits, rent,
          depreciation, travel, insurance, and office expenses. Primary elements
          of the
          changes between the years follow.
 2006Increase/(decrease)
                  
                  
                  2005
Increase/(decrease)Legal
                  
                  $
                  838,000
                  
                  $
                  456,000Auditing
                      and Accounting
                  
                  
                  (137,000
                  )
                  
                  452,000Consulting
                  
                  
                  78,000
                  
                  
                  250,000Rent
                  
                  
                  (203,000
                  )
                  
                  -Wages
                      and related taxes and benefits
                  
                  
                  (399,000
                  )
                  
                  355,000Recruiting
                      expense
                  
                  
                  100,000
                  
                  
                  -Freight
                      and delivery
                  
                  
                  (73,000
                  )
                  
                  162,000Travel
                      and entertainment
                  
                  
                  (63,000
                  )
                  
                  53,000Public
                      relations
                  
                  
                  83,000
                  
                  
                  -Bad
                      debt expense
                  
                  
                  -
                  
                  
                  (350,000
                  )Other
                  
                  
                  (40,000
                  )
                  
                  67,000$
                  184,000
                  
                  $
                  1,445,000
  32
 
 Legal
          fees increased approximately $838,000 compared to 2005 primarily due to
          the
          ongoing SEC investigations as well as correspondence related to our filings
          with
          the SEC and increased legal services incurred for various financing arrangements
          entered into during 2006. Increased legal fees in 2005 were due primarily
          to our
          correspondence related to our filings with the SEC as well as increased
          legal
          services incurred for various financing arrangements entered into during
          2005.
          Accounting related services decreased approximately $137,000 compared with
          2005
          due to audit fees for the one year versus re-audits of earlier years as was
          the case in 2005. Accounting related services increased during 2005 primarily
          due to the re-audit of 2003 and 2002 financial statements by OUM as well
          as
          increased audit fees to cover compliance with the Sarbanes-Oxley Act of
          2002
          (SOX) related compliance and the audit of our South Korean subsidiary in
          2005.
          Consulting services during 2006 increased approximately $78,000 compared
          to 2005
          and included $205,000 in consulting fees to our former Executive Vice President
          of Strategic Planning, $36,000 increased costs to comply with the Sarbanes-Oxley
          Act of 2002 (SOX), partially offset by $163,000 in reduced costs associated
          with
          the implementation of our Navision software system (in the US) during 2005.
          Consulting services during 2005 included increases related to SOX compliance
          efforts and implementation of our Navision software system (in the US)
          as
          compared with 2004. Rent declined during 2006 versus 2005 due to the move
          from
          our rented clean room facilities in California to our South Korean facility.
          This move was completed during the first part of 2006. Wages and related
          taxes
          and benefits decreased approximately $399,000 between 2006 and 2005 due
          to a
          six-person reduction (approximately 23%) in headcount in our US operations.
          Salaries and related taxes and benefits increased by approximately $326,000
          in
          2005 compared to 2004 and primarily relates to administrative wages in
          our new
          South Korean manufacturing facility. This facility incurred an additional
          $364,000 in general and administrative expenses during 2005. Freight expense
          declined in 2006 versus that in 2005 due to reduced shipping activity from
          California to our South Korean facility. There were significant freight
          expenses
          incurred during 2005 to ship equipment and inventory from California to
          South
          Korea as part of the pre-production activities there. Along the same lines,
          travel and entertainment expenses declined in 2006 as compared to 2005
          due to
          reduced travel to our South Korean facility that was incurred in 2005 and
          related to the pre-production activities there. We engaged a public relations
          firm during 2006 to help us perform our investor relations duties. We did
          not
          incur these costs during 2005 due to financial constraints. The cost increases
          in 2005 versus 2004 are partially offset by a reduction in bad debt expense
          of
          $350,000 as compared to 2004. This reserve was created in 2004 and was
          directly
          associated with a particular customer based upon information provided to
          us by
          our Chinese sales representative that this customer was awaiting additional
          pending corporate financing and would likely not be able to pay us for
          our
          product deliveries prior to receiving that additional financing. The associated
          receivable was written off against this reserve during 2005.
 
 *Stock-based
          general and administrative expenses.* Stock-based
          general and administrative expenses were approximately $1,875,000, $186,000,
          and
          $932,000 in 2006, 2005 and 2004, respectively. We adopted Statement of
          Financial
          Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS
          123R”) effective January 1, 2006. SFAS 123R requires the recognition of the
          fair
          value of stock compensation in net income (loss). We recognize the stock
          compensation expense over the requisite service period of the individual
          grantees, which generally equals the vesting period. All of our stock
          compensation is accounted for as an equity instrument. Prior to January
          1, 2006,
          we followed Accounting Principles Board (“APB”) Opinion 25, “Accounting for
          Stock Issued to Employees,” and related interpretations in accounting for our
          stock compensation. We adopted SFAS 123R using the modified prospective
          method.
          Under this method, the provisions of SFAS 123R apply to all awards granted
          or
          modified after the date of adoption. The unrecognized expense of awards
          not yet
          vested at the January 1, 2006 date of adoption is recognized in net income
          (loss) in the periods after the date of adoption using the same valuation
          method
          (i.e. Black-Scholes) and assumptions determined under the original provisions
          of
          SFAS 123, “Accounting for Stock-Based Compensation,” as disclosed in our
          previous filings. Following the provisions of the modified prospective
          method,
          we have not restated our consolidated financial statements for periods
          prior to
          2006 to reflect the adoption of SFAS 123R. Therefore, the results reported
          in
          the consolidated statement of operations for 2006 are not directly comparable
          to
          the results for 2005 and 2004. The amounts incurred relate to common shares,
          options to purchase common shares and warrants issued in exchange for services
          in 2006, 2005 and 2004, and costs of $1,875,000, $186,000, and $332,000,
          respectively, relate primarily to stock and options granted to employees
          and
          directors, and warrants issued in exchange for services. In addition, the
          amounts incurred in 2004 include a $600,000 reduction in a note receivable
          from
          one of our stockholders in exchange for a commitment to invest an additional
          $6,000,000. (See Note 3 to Consolidated Financial Statements.)
  *Research
          and development expenses.* Research
          and development expenses (R&D) were approximately $1,067,000, $3,586,000,
          and $2,306,000 in 2006, 2005 and 2004, respectively. The increase in 2005
          as
          compared to 2004 is due to the pre-production activities of our South Korean
          manufacturing facility. This includes the cost of operating the manufacturing
          facility prior to commencing production as well as supplies and materials
          used
          in these efforts. The facility neared completion towards the end of 2005,
          resulting in significantly reduced R&D expenses during 2006.
  *Interest
          expense* .
          Interest expense was approximately $396,000, $1,108,000, and $157,000,
          in 2006,
          2005, and 2004, respectively. The increase during 2005 is related to the
          November 2004 Senior Secured Convertible Notes of $10,000,000 which bear
          interest at 10% per annum. Approximately $745,000 of the decrease between
          2006
          and 2005 is due to issuing our common shares in lieu of cash to the Senior
          Secured Noteholders for the payment of three quarters’ interest during 2006,
          which is included in non-cash interest expense. This decrease is partially
          offset by interest incurred on the short-term South Korean debt facilities.
          No
          comparable facilities existed in 2004 or the first three quarters of
          2005.
  33
 
 *Non-cash
          interest expense.* Non-cash
          interest expense of approximately $2,856,000, $1,431,000, and $791,000
          in 2006,
          2005 and 2004, respectively, includes approximately $1,086,000, $846,000
          and
          $729,000 for 2006, 2005 and 2004, respectively of expense associated with
          the
          amortization of the beneficial conversion of shares issued to prepay interest
          on
          the notes payable to Argyle Capital Management Corporation, a company
          wholly-owned by Robert A. Olins, former Chief Executive Officer, Secretary,
          Treasurer and a former Director of SpatiaLight. The beneficial conversion
          interest represents the excess market value of the shares received or receivable
          at the market price on the date of receipt over the $0.50 per share conversion
          price. Also included in non-cash interest expense is approximately $444,000
          in
          2006 and 2005 and approximately $37,000 in 2004 representing the amortization
          of
          note discounts and note financing costs of the Senior Secured Convertible
          Notes.
          See Note 3 to the Consolidated Financial Statements for further details.
          Approximately $745,000 of the increase between 2005 and 2006 represents
          expense
          associated with issuing our common shares in lieu of cash to the Senior
          Secured
          Noteholders for the payment of three quarters’ interest. Additionally, 2006
          includes approximately $518,000 representing liquidated damages related
          to the
          registration rights agreements entered into as part of the October 2005,
          January
          2006, September 2006 and November 2006 Financings. Please refer to footnote
          2 in
          the consolidated financial statements for further details.
 
 *Gain
          from revaluation of note purchase option liability.* The gain
          of approximately $754,000 and $412,000 recorded in 2005 and 2004, respectively,
          arises from the revaluation of the additional investment rights (AIR) issued
          with our Senior Secured Convertible Notes in November 2004, which are being
          treated as a derivative and is recorded on the balance sheet as a note
          purchase
          option liability. This AIR expired on August 31, 2005. See Note 3 to
          Consolidated Financial Statements. The gain in 2005 also includes an expired
          Investment Right of $94,500 associated with our August 2005 financing.
          There
          were no corresponding financial instruments during 2006.
 
 *Gain
          on fair value of warrants.* The gain
          of approximately $44,000 and $180,000 arises from the revaluation of the
          warrants issued in connection with the September 2006 and October 2005
          financing. These warrants were being treated as derivatives and were recorded
          on
          the balance sheet at fair value until the shares
          covered by the registration statement have been sold or may be sold without
          volume restrictions pursuant to Rule 144(k) .
          Upon
          our October 1, 2006 adoption of Financial Accounting Standards Board Staff
          Position Emerging Issues Task Force 00-19-2, “Accounting for Registration
          Payment Arrangements”, these warrants have been reclassified to equity and the
          related fair value revaluations have been included in the cumulative effect
          of a
          change in accounting principle (see below).
 
 *Foreign
          currency translation gain.* The gain
          of approximately $91,000 and $59,000 relates to the revaluation of intercompany
          payables recorded in local currency and then revalued at the balance sheet
          date
          to the then-current exchange rate.
 
 *Interest
          and other income.* Interest
          and other income was approximately $145,000, $70,000, and $38,000 in 2006,
          2005,
          and 2004, respectively. Interest was primarily bank interest. Other income
          in
          2006 and 2005 includes approximately $141,000 and $42,000, respectively,
          of
          subsidies from the South Korean government.
 
 *Loss
          before income taxes* .
          Losses
          before income taxes were approximately $18,741,000, $14,022,000, and $9,366,000
          in 2006, 2005 and 2004, respectively. The increase in losses from 2006
          to 2005
          and from 2005 to 2004 is primarily due to costs associated with starting
          up our
          South Korean manufacturing facility coupled with negligible sales, increased
          legal fees related to the SEC investigations and 2006 financings, offset
          by
          non-cash gains from the revaluation of the note purchase option liability
          of
          $754,000 and $412,000 in 2005 and 2004, respectively. Additional factors
          between
          2005 and 2004 include approximately $1,443,000 of increased interest expense
          associated with our $10,000,000 notes ($443,000 of which is non-cash).
 
 *Income
          taxes.* Income
          taxes consist primarily of minimum state tax requirements. See Note 5 to
          the
          Consolidated Financial Statements under Item 8 of this Report.
 
 *Cumulative
          effect of change in accounting principle* .
          Effective October 1, 2006, we adopted Financial Accounting Standards Board
          (FASB) Staff Positon (FSP) Emerging Issues Task Force (EITF) 00-19-2,
“Accounting for Registration Payment Arrangements”. This FASB staff position
          addresses how to account for registration payment arrangements and clarifies
          that a financial instrument subject to a registration payment arrangement
          should
          be accounted for in accordance with other generally accepted accounting
          principles (GAAP) without regard to the contingent obligation to transfer
          consideration pursuant to the registration payment arrangement. The cumulative
          effect of this accounting change increased net loss for 2006 by $223,993,
          or
          $0.01 per share. Please
          see below under Recent
          Accounting Pronouncements and Adoption of New Accounting Pronouncements
          for
          further details.
 
 *Inflation.* Our
          management currently believes that inflation has not had a material impact
          on
          continuing operations.
 
 **Critical
          Accounting Policies and Estimates**
 
 Management’s
          discussion and analysis of our results of operations and liquidity and
          capital
          resources are based on our consolidated financial statements. To prepare
          our
          Consolidated Financial Statements in accordance with accounting principles
          generally accepted in the United States of America, we must make estimates
          and
          assumptions that affect the amounts reported in the consolidated financial
          statements. We regularly evaluate these estimates and assumptions, particularly
          in areas we consider to be critical accounting estimates, where changes
          in the
          estimates and assumptions could have a material impact on our results of
          operations, financial position and, generally to a lesser extent, cash
          flows.
          Senior management and the Audit Committee of the Board of Directors have
          reviewed the disclosures included herein about our critical accounting
          estimates, and have reviewed the processes to determine those
          estimates.
  34
  *Revenue
          Recognition* - We
          evaluate revenue recognition for transactions using the following criteria
          (collectively called the Revenue Recognition Criteria):
 
 ·
              Evidence
                  of an arrangement: Before revenue is recognized, we must have evidence
                  of
                  an agreement with the customer reflecting the terms and conditions
                  to
                  deliver our products. ·
              Delivery:
                  For products, delivery is considered to occur when title and risk
                  of loss
                  have been transferred, which generally occurs upon shipment. ·
              Fixed
                  or determinable fee: We consider a fee to be fixed or determinable
                  if the
                  fee is not subject to refund or adjustment. If a portion of the
                  arrangement fee is not fixed or determinable, we recognize that
                  amount as
                  revenue when the amount becomes fixed or determinable. We do not
                  consider
                  a fee to be fixed and determinable if any amount is due more than
                  180 days
                  from the delivery date. Payment terms of less than 180 days are
                  evaluated
                  based upon the laws or trade practices of the country in which
                  the
                  arrangement is entered into to assess whether the fee is fixed
                  and
                  determinable. ·
              Collection
                  is deemed reasonably assured: Collection is deemed reasonably assured
                  if
                  we expect the customer to be able to pay amounts under the arrangement
                  as
                  those amounts become due. We reduce product revenue for customer
                  returns
                  and sales allowances and record an allowance for doubtful accounts
                  should
                  collectibility become questionable. If it is determined that an
                  account is
                  uncollectible, the account is written off against the allowance. 
 *Inventory
          Valuation -* We
          value
          inventories at the lower of cost (based on the first-in, first-out method)
          or
          market value. We include materials, labor and manufacturing overhead in
          the cost
          of inventories. In determining inventory market values, we give substantial
          consideration to the expected selling price of the product based on historical
          recovery rates. If we assess the market value of our inventory to be less
          than
          costs we write it down to its replacement cost or its net realizable value.
          Our
          estimates may differ from actual results due to the quantity, quality and
          mix of
          products in inventory, consumer and retailer preferences and economic
          conditions.
  *Stock-based
          Payments -* Effective January 1, 2006 we adopted SFAS 123R using the modified prospective
          method and therefore have not restated prior periods’ results for the adoption
          of SFAS 123R. Under the fair value recognition provisions of SFAS 123R,
          we
          recognize stock-based compensation net of an estimated forfeiture rate
          and
          therefore only recognize compensation cost for those shares expected to
          vest
          over the service period of the award. Prior to SFAS 123R adoption, we accounted
          for share-based payments under APB 25 and accordingly, generally recognized
          compensation expense related to stock options with intrinsic value and
          accounted
          for forfeitures as they occurred.
  We
          estimated the fair value of options granted using the Black-Scholes option
          pricing model, except for options granted with a market condition, in which
          case
          a binomial model is used, using the assumptions shown in Note 1, Description
          of
          Business and Summary of Significant Accounting Policies - Stock Based
          Compensation. Calculating stock-based compensation expense under the provisions
          of SFAS 123R requires the input of highly subjective assumptions, including
          the
          expected term of the stock-based awards, stock price volatility, and pre-vesting
          option forfeitures. We estimate the expected life of options granted based
          on
          the simplified method provided in Staff Accounting Bulletin No. 107 for
          "plain
          vanilla" options, except for options granted with a market condition, in
          which
          case a binomial model is used. We estimate the volatility of our common
          stock at
          the date of grant based on the historical volatility of our common stock. 
In addition, we are required to estimate the expected forfeiture rate and
          only
          recognize expense for those shares expected to vest. We estimate the forfeiture
          rate based on historical experience of our stock-based awards that are
          granted,
          exercised and cancelled. If our actual forfeiture rate is materially different
          from our estimate, the stock-based compensation expense could be significantly
          different from what we have recorded in the current period. The assumptions
          used
          in calculating the fair value of stock-based awards represent our best
          estimates, but these estimates involve inherent uncertainties and the
          application of management judgment. As a result, if factors change and
          we use
          different assumptions, our stock-based compensation expense could be materially
          different in the future. As required under SFAS 123R, we will review our
          valuation assumptions at each grant date and, as a result, are likely to
          periodically change the valuation assumptions used to value employee stock-based
          awards granted in future periods. The guidance in SFAS 123R is relatively
          new
          and best practices are not well established. The application of the various
          valuation assumptions may be subject to further interpretation and refinement
          over time. There are significant differences among valuation models and
          there is
          a possibility that we will adopt different valuation models and assumptions
          in
          the future. This may result in a lack of comparability with other companies
          that
          use different models, methods and assumptions and in a lack of consistency
          in
          future periods. See Note 6 - Stockholders’ Equity (Deficit) - Stock Option
          Plans” in the Consolidated Financial Statements for additional
          information.
 
 *Research
          and Development* -
          Research and development costs, including the costs of prototype and
          pre-production LCoS Sets, pre-production display units, and other pre-production
          activities at our South Korean manufacturing facility are charged to expense
          when incurred.
  35
  *Income
          Tax Assets and Liabilities -* In
          establishing our deferred income tax assets and liabilities, we make judgments
          and interpretations based on the enacted tax laws and published tax guidance
          that are applicable to our operations. We record deferred tax assets and
          liabilities and evaluate the need for valuation allowances to reduce the
          deferred tax assets to realizable amounts. The likelihood of a material
          change
          in our expected realization of these assets is dependent on future taxable
          income, our ability to use foreign tax credit carryforwards and carrybacks,
          final U.S. and foreign tax settlements, and the effectiveness of our tax
          planning strategies in the various relevant jurisdictions. Due to our lack
          of
          profitable operating history, potential limitations on usage of operating
          losses
          and general uncertainty, we provided for a 100% valuation allowance against
          our
          deferred tax assets. We are also subject to examination of our income tax
          returns for multiple years by the Internal Revenue Service and other tax
          authorities. We periodically assess the likelihood of adverse outcomes
          resulting
          from these examinations to determine the adequacy of our provision for
          income
          taxes. Changes to our income tax provision or the valuation of the deferred
          tax
          assets and liabilities may affect our annual effective income tax
          rate.
 
 *Impairment
          of Long-Lived Assets* -
          We
          account for the impairment of long-lived assets in accordance with SFAS
          No. 144, *Accounting
          for the Impairment or Disposal of Long-Lived Assets* .
          An
          impairment of a long-lived asset exists when the carrying value of an asset
          exceeds its fair value and when the carrying value is not recoverable through
          future undiscounted cash flows from operations. We review the carrying
          value of
          long-lived assets for impairment when events or changes in circumstances
          indicate that the carrying amount of assets may not be recoverable.
  Considerable
          management judgment is required in determining if and when a condition
          would
          trigger an impairment assessment of our long-lived assets and once such
          a
          determination has been made, considerable management judgment is required
          to
          determine the fair market value of the long-lived asset. In
          determining the fair value of the asset, we consider the associated net
          present
          value of estimated future cash flows. Such estimated future cash flows
          are based
          on assumptions about our expected future operating performance. Our estimates
          of
          future cash flows may differ from actual cash flows due to, among other
          things,
          technological changes, economic conditions or changes to our business
          operations. Impairments would be recognized in operating results to the
          extent
          that the carrying value exceeds this calculated fair value of the long-lived
          assets.
 **Recent
          Accounting Pronouncements and Adoption of New Accounting
          Pronouncements**
 
 In
          September 2006, the Financial Accounting Standards Board (FASB) issued
          Statement
          No. 157, “Fair Value Measurements” (“FAS 157”). This statement defines fair
          value, establishes a framework for measuring fair value under generally
          accepted
          accounting principles (GAAP), and expands disclosures about fair value
          measurements. SFAS No. 157 is effective for financial statements issued
          for
          fiscal years beginning after November 15, 2007, and interim periods within
          those
          fiscal years. The transition adjustment, which is measured as the difference
          between the carrying amount and the fair value of those financial instruments
          at
          the date this statement is initially applied, should be recognized as a
          cumulative effect adjustment to the opening balance of retained earnings
          for the
          fiscal year in which this statement is initially applied. The provisions
          of SFAS
          No. 157 are effective for us beginning January 1, 2008. We are currently
          evaluating the impact of adopting SFAS No. 157 on our consolidated financial
          statements.
 
 In
          September 2006, the Securities and Exchange Commission (SEC) issued Staff
          Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year
          Misstatements when Quantifying Misstatements in Current Year Financial
          Statements.” SAB No. 108 addresses how the effects of prior year uncorrected
          misstatements should be considered when quantifying misstatements in current
          year financial statements and is effective for fiscal years ending after
          November 15, 2006. SAB No. 108 requires companies to quantify misstatements
          using a balance sheet and income statement approach and to evaluate whether
          either approach results in quantifying an error that is material in light
          of
          relevant quantitative and qualitative factors. SAB No. 108 permits existing
          public companies to initially apply its provisions either by (i) restating
          prior
          financial statements as if the “dual approach” had always been used or (ii)
          recording the cumulative effect of initially applying the “dual approach” as
          adjustments to the carrying value of assets and liabilities as of January
          1,
          2006 with an offsetting adjustment recorded to the opening balance of retained
          earnings. The adoption of the provisions of SAB No. 108 on December 31,
          2006 had
          no impact on our consolidated financial statements.
  36
 
 In
          June
          2006, the Financial Accounting Standards Board (FASB) issued Interpretation
          No.
          48, *Accounting
          for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
          109* (“FIN
          48”). This Interpretation clarifies the accounting for uncertainty in income
          taxes recognized in a company’s financial statements in accordance with FASB
          Statement No. 109, *Accounting
          for Income Taxes.* FIN 48
          prescribes a recognition threshold and measurement attribute for the financial
          statement recognition and measurement of a tax position taken or expected
          to be
          taken in a tax return. This Interpretation also provides guidance on
          derecognition, classification, interest and penalties, accounting in interim
          periods, disclosure, and transition. The evaluation of a tax position in
          accordance with FIN 48 is a two-step process. The first step is recognition:
          The
          Company determines whether it is “more-likely-than-not” that a tax position will
          be sustained upon examination, including resolution of any related appeals
          or
          litigation processes, based on the technical merits of the position. In
          evaluating whether a tax position has met the “more-likely-than-not” recognition
          threshold, the company presumes that the position will be examined by the
          appropriate taxing authority that would have full knowledge of all relevant
          information. The second step is measurement: A tax position that meets
          the
“more-likely-than-not” recognition threshold is measured to determine the amount
          of benefit to recognize in the financial statements. The tax position is
          measured at the largest amount of benefit that is greater than 50 percent
          likely
          to be realized upon ultimate settlement. FIN 48 is effective for fiscal
          years
          beginning after December 15, 2006. We are in the process of determining
          the
          impact, if any, of the adoption of FIN 48 on our results of operations
          or
          financial condition.
  In
          June
          2005, the FASB issued Statement No. 154, "Accounting Changes and Error
          Corrections" (SFAS 154), a replacement of APB No. 20, "Accounting Changes"
          and
          FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
          Statements". FAS 154 applies to all voluntary changes in accounting principle
          and changes the requirements for accounting for and reporting of a change
          in
          accounting principle. This statement establishes that unless impracticable,
          retrospective application is the required method for reporting a change
          in
          accounting principle in the absence of explicit transition requirements
          specific
          to the newly adopted accounting principle. It also requires the reporting
          of an
          error correction which involves adjustments to previously-issued financial
          statements similar to those generally applicable to reporting an accounting
          change retrospectively. FAS 154 became effective for accounting changes
          and
          corrections of errors made in our fiscal year beginning on January 1, 2006.
          The
          adoption of FAS 154 has not had a material impact on our results of operations
          or financial condition.
 
 In
          December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” to revise
          SFAS No. 123, “Accounting for Stock-Based Compensation” and supersede APB
          Opinion No. 25, “Accounting for Stock Issued to Employees” and its related
          implementation guidance. It requires companies to recognize their compensation
          costs related to share-based payment transactions in financial statements.
          These
          costs are to be measured based on the fair value of the equity or liability
          instruments issued and are recognized over the period during which an employee
          is required to provide services in exchange for the award - the requisite
          service period (usually the vesting period). We have applied
          SFAS No. 123R beginning January 1, 2006 .
          See
          Note 1 - Description of Business and Summary of Significant Accounting
          Policies
          - Stock Based Compensation for further information.
 
 In
          November 2004, the FASB issued SFAS No. 151, “Inventory Costs, An Amendment Of
          ARB No. 43, Chapter 4” ("SFAS 151"). SFAS 151 amends ARB 43, Chapter 4, to
          clarify that abnormal amounts of idle facility expense, freight, handling
          costs
          and wasted materials (spoilage) be recognized as current period charges.
          It also
          requires that allocation of fixed production overheads to the costs of
          conversion be based on the normal capacity of the production facilities.
          SFAS
          151 became effective for the Company beginning in 2006. The adoption of
          SFAS 151
          has not had a material impact on our results of operations
          or financial position.
 *Adoption
            of New Accounting Pronouncements* -
            Effective October 1, 2006, we adopted Financial Accounting Standards
            Board
            (FASB) Staff Position (FSP) Emerging Issues Task Force (EITF) 00-19-2,
            “Accounting for Registration Payment Arrangements”. This FASB staff position
            addresses how to account for registration payment arrangements and clarifies
            that a financial instrument subject to a registration payment arrangement
            should
            be accounted for in accordance with other generally accepted accounting
            principles (GAAP) without regard to the contingent obligation to transfer
            consideration pursuant to the registration payment arrangement. This
            accounting
            pronouncement further clarifies that a liability for liquidated damages
            resulting from registration statement obligations should be recorded
            in
            accordance with Statement of Financial Accounting Standards No. 5, "Accounting
            for Contingencies *,* " ** when
            the
            payment of liquidated damages becomes probable and can be reasonably
            estimated.
 
 Prior
            to
            adoption of this FSP, we had classified as temporary equity, and as a
            warrant
            liability, as applicable, financial instruments issued in conjunction
            with our
            recent financings until the underlying securities were registered with
            the SEC,
            because the maximum potential liquidated damages may be greater than
            the
            difference in fair values between registered and unregistered shares.
            Our
            adoption of this accounting pronouncement as of October 1, 2006 resulted
            in a reclassification of $1,947,909 of temporary equity and $129,279
            of warrant
            liability to common stock and additional paid in capital as of October
            1, 2006. The
            cumulative effect of this accounting change increased our 2006 net loss by
            $223,993, or $0.01 per share.
 
 We
            also
            adopted Statement of Financial Accounting Standard No. 123(R), “Share-Based
            Payment” (“SFAS 123(R)”), and Statement of Financial Accounting Standard No.
            151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”)
            as of January 1, 2006. The adoption of SFAS 123(R) is discussed above,
            and the
            adoption of SFAS No. 151 did not have a material effect on our results
            of
            operations or financial position.
  37
 
 **Item
          7A.**  **Quantitative and Qualitative Disclosures About Market Risk**
 
 We
          place
          all of our excess cash and cash equivalents in a checking account or money
          market account in the United States. We do not expect any material losses
          from
          our placement of such cash balances, and we believe that our interest rate
          exposure is modest. As of December 31, 2006, our cash and cash equivalents
          totaled $220,256. Of this amount, approximately $3,131 was in South
          Korea.
 
 A
          portion
          of our costs is denominated in foreign currencies, including the South
          Korean
          Won and the Euro. As a result, changes in the exchange rates of these currencies
          or any other applicable currencies to the U.S. dollar will affect our financial
          results, including costs of revenue and operating expenses, and could result
          in
          exchange losses or gains. We cannot fully predict the impact of future
          exchange
          rate fluctuations on our profitability. From time to time, we may engage
          in
          exchange rate hedging activities in an effort to mitigate the impact of
          exchange
          rate fluctuations, although we have not engaged in any such hedging activities
          to date.
 
 The
          November 2006 Financing does not allow us to raise additional capital at
          less
          than $1.30 per share. Depending on the fluctuations in the price of our
          common
          stock, this could limit our ability to raise additional capital, or raise
          the
          costs of obtaining additional capital by paying a fee to obtain a waiver
          from
          the participants in the November 2006 Financing.
  38
 
 **Item
          8.**  **Consolidated
          Financial Statements.**
 
 **REPORT
          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 To
          the
          Board of Directors and Stockholders of
 SpatiaLight,
          Inc.
 
 We
          have
          audited the accompanying consolidated balance sheets of SpatiaLight, Inc.
          and
          its subsidiaries as of December 31, 2006 and 2005, and the related consolidated
          statements of operations, stockholders' equity (deficit) and cash flows
          for each
          of the three years in the period ended December 31, 2006. These financial
          statements are the responsibility of the Company's management. Our
          responsibility is to express an opinion on these financial statements based
          on
          our audits.
 
 We
          conducted our audits in accordance with standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether the
          financial
          statements are free of material misstatement. An audit includes examining,
          on a
          test basis, evidence supporting the amounts and disclosures in the financial
          statements. An audit also includes assessing the accounting principles
          used and
          significant estimates made by management, as well as evaluating the overall
          financial statement presentation. We believe that our audits provide a
          reasonable basis for our opinion.
 
 In
          our
          opinion, the consolidated financial statements audited by us present fairly,
          in
          all material respects, the consolidated financial position of SpatiaLight,
          Inc.
          and its subsidiaries at December 31, 2006 and 2005, and the consolidated
          results
          of their operations and their cash flows for each of the three years in
          the
          period ended December 31, 2006, in conformity with U.S. generally accepted
          accounting principles.
 
 The
          accompanying consolidated financial statements have been prepared assuming
          that
          the Company will continue as a going concern. As discussed in Note 1 to
          the
          consolidated financial statements, the Company has suffered recurring operating
          losses and negative cash flows from operations, and has a negative working
          capital position and a stockholders’ deficit. Management believes that the
          Company's cash resources will not be sufficient to sustain its operations
          beyond
          March 2007 without additional financing. As also described in Notes 1 and
          3, the
          Company's Senior Secured Convertible Notes totaling $10 million mature
          in
          November 2007, and the Company has received notices from certain of its
          Senior
          Secured Convertible Noteholders calling for immediate redemption of their
          convertible notes based on alleged events of default. Management believes,
          after
          reviewing the alleged events of default with outside legal counsel, the
          alleged
          events of default lack merit and would not entitle the Noteholders to call
          the
          Senior Secured Convertible Notes and other remedies they are seeking. If
          the
          Noteholders prevail in calling the convertible notes, the entire debt obligation
          could become due and payable immediately, including the related amounts
          of
          redemption premium and liquidated damages, and the Company would be forced
          to
          refinance or repay the debt obligations or seek other alternative financing.
          Moreover, the Company will be required to repay or refinance the Senior
          Secured
          Convertible Notes in November 2007, and will need to obtain additional
          financing
          to repay the Noteholders. Additionally, as described in Notes 1 and 11,
          the
          Company, based upon discussions in March 2007 with its major customer,
          does not
          expect significant further sales to this customer. Furthermore, as described
          in
          Note 10, the Company is subject to U.S. Securities and Exchange Commission
          investigations relating to the filing of unauthorized consents of its
          predecessor auditor in certain registration statements, and the sale of
          the
          Company’s common stock held by its former Chief Executive Officer, and may
          be subject to certain penalties and claims relating thereto. These factors
          raise
          substantial doubt about the Company's ability to continue as a going concern.
          Management's plans in regard to these matters are also described in Note
          1. The
          accompanying consolidated financial statements do not include any adjustments
          that might result from the outcome of these uncertainties.
 
 As
          discussed in Note 1 to the consolidated financial statements, the Company
          adopted the provisions of Statement of Financial Accounting Standard No.
          123(R),
“Share-Based Payment” and Statement of Financial Accounting Standard No. 151
“Inventory Costs, an Amendment of ARB No. 43, Chapter 4” as of January 1, 2006.
          Additionally, the Company adopted Financial Accounting Standards Board
          Staff
          Position EITF 00-19-2, “Accounting for Registration Payment Arrangements” in the
          fourth quarter of 2006.
 
 We
          have
          also audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the effectiveness of SpatiaLight, Inc.'s
          internal control over financial reporting as of December 31, 2006, based
          on
          criteria established in Internal Control -- Integrated Framework issued
          by the
          Committee of Sponsoring Organizations of the Treadway Commission and our
          report
          dated March 15, 2007 expressed an adverse opinion thereon.
 
 
 */s/
          ODENBERG, ULLAKKO, MURANISHI & CO. LLP*
 
 *San
          Francisco, California*
 *March
          15, 2007*
  39
  SPATIALIGHT,
                      INC.CONSOLIDATED
                      BALANCE SHEETSDECEMBER
                      31, 2006 AND 20052006
                  
                  
                  2005ASSETSCurrent
                      assetsCash
                      and cash equivalents
                  
                  $
                  220,256
                  
                  $
                  42,565Accounts
                      receivable, net of allowance of $0 at December 31, 2006 and
                      2005
                  
                  
                  52,238
                  
                  
                  139,676Inventory,
                      net
                  
                  
                  423,075
                  
                  
                  756,723Prepaids
                      and
                      other current assets
                  
                  
                  307,428
                  
                  
                  255,157Total
                      current assets
                  
                  
                  1,002,997
                  
                  
                  1,194,121Property
                      and
                      equipment, net
                  
                  
                  6,635,851
                  
                  
                  6,813,520Other
                      assets
                  
                  
                  37,121
                  
                  
                  73,437Total
                      assets
                  
                  $
                  7,675,969
                  
                  $
                  8,081,078LIABILITIES,
                      TEMPORARY EQUITY, AND STOCKHOLDERS' EQUITY (DEFICIT)Current
                      liabilitiesSenior
                      secured convertible notes - current portion
                  
                  $
                  9,596,086
                  
                  $
                  -Unsecured
                      short
                      term loans
                  
                  
                  591,070
                  
                  
                  572,025Short
                      term loan from a related party
                  
                  
                  -
                  
                  
                  224,384Accounts
                      payable
                  
                  
                  1,916,249
                  
                  
                  1,665,711Fair
                      value of warrants to purchase common stock
                  
                  
                  -
                  
                  
                  778,270Accrued
                      expenses and other current liabilities
                  
                  
                  1,793,232
                  
                  
                  1,389,427Total
                      current liabilities
                  
                  
                  13,896,637
                  
                  
                  4,629,817Senior
                      secured and related party convertible notes
                  
                  
                  1,188,000
                  
                  
                  10,340,113Total
                      liabilities
                  
                  
                  15,084,637
                  
                  
                  14,969,930Commitments
                      and contingenciesTemporary
                      equity:Common
                      stock, subject to registration, $0.01 par value; 571,431 shares
                      issued and
                      outstanding,net
                      of
                      fair value of warrants of $958,625 and issuance costs of $15,000
                      at
                      December 31, 2005
                  
                  
                  -
                  
                  
                  1,026,374Total
                      liabilities and temporary equity
                  
                  
                  15,084,637
                  
                  
                  15,996,304Stockholders'
                      equity (deficit):Common
                        stock, $.01 par value: 100,000,000 and 50,000,000 sharesauthorized
                      as of December 31, 2006 and December 31, 2005, respectively;
                      44,482,616and
                      36,777,069 shares issued and outstanding at December 31, 2006
                      and 2005,
                      respectively
                  
                  
                  444,826
                  
                  
                  367,771Additional
                      paid-in capital
                  
                  
                  94,756,700
                  
                  
                  76,631,925Prepaid
                      non-cash interest to related party
                  
                  
                  (2,314,266
                  )
                  
                  (3,471,398
                  )Other
                      comprehensive income
                  
                  
                  336,975
                  
                  
                  222,317Accumulated
                      deficit
                  
                  
                  (100,632,903
                  )
                  
                  (81,665,841
                  )Total
                      stockholders' equity (deficit)
                  
                  
                  (7,408,668
                  )
                  
                  (7,915,226
                  )Total
                      liabilities, temporary equity, and stockholders' equity
                      (deficit)
                  
                  $
                  7,675,969
                  
                  $
                  8,081,078See
                      accompanying notes to consolidated financial statements.
 40
   SPATIALIGHT,
                        INC.CONSOLIDATED
                        STATEMENTS OF OPERATIONSYEARS
                        ENDED DECEMBER 31, 2006, 2005 and 20042006
                    
                    2005
                    
                    2004Revenue
                    
                    $
                    474,004
                    
                    $
                    237,724
                    
                    $
                    1,160,978Cost
                        of revenue and manufacturing expenses
                    
                    
                    (5,861,644
                    )
                    
                    (1,757,089
                    )
                    
                    (982,282
                    )Gross
                        margin
                    
                    
                    (5,387,640
                    )
                    
                    (1,519,365
                    )
                    
                    178,696Operating
                        expenses:Selling,
                        general and administrative expenses (including stock-basedexpense
                        of $1,875,330, $186,187 and$931,524
                        for the years 2006, 2005, and 2004, respectively)
                    
                    
                    9,313,910
                    
                    
                    7,441,540
                    
                    
                    6,741,226Research
                        and development expenses
                    
                    
                    1,066,939
                    
                    
                    3,586,296
                    
                    
                    2,305,650Total
                        operating expenses
                    
                    
                    10,380,849
                    
                    
                    11,027,836
                    
                    
                    9,046,876Operating
                        loss
                    
                    
                    (15,768,489
                    )
                    
                    (12,547,201
                    )
                    
                    (8,868,180
                    )Other
                        income (expense):Interest
                        expense:Interest
                        expense
                    
                    
                    (396,194
                    )
                    
                    (1,107,812
                    )
                    
                    (156,693
                    )Non-cash
                        interest expense
                    
                    
                    (2,856,393
                    )
                    
                    (1,430,506
                    )
                    
                    (791,036
                    )Total
                        interest expense
                    
                    
                    (3,252,587
                    )
                    
                    (2,538,318
                    )
                    
                    (947,729
                    )Other
                        income:Gain
                        from revaluation of note purchase option andinvestment
                        right liabilities
                    
                    
                    -
                    
                    
                    754,374
                    
                    
                    412,374Gain
                        from revaluation of warrants
                    
                    
                    43,638
                    
                    
                    180,355
                    
                    
                    -Foreign
                        currency translation gain
                    
                    
                    90,880
                    
                    
                    58,531
                    
                    
                    -Interest
                        and other income
                    
                    
                    145,289
                    
                    
                    69,920
                    
                    
                    38,009Total
                        other income
                    
                    
                    279,807
                    
                    
                    1,063,180
                    
                    
                    450,383Total
                        other income (expenses)
                    
                    
                    (2,972,780
                    )
                    
                    (1,475,138
                    )
                    
                    (497,346
                    )Loss
                        before income tax expense
                    
                    
                    (18,741,269
                    )
                    
                    (14,022,339
                    )
                    
                    (9,365,526
                    )Income
                        tax expense
                    
                    
                    1,800
                    
                    
                    2,300
                    
                    
                    1,475Loss
                        before cumulative effect of change inaccounting
                        principle
                    
                    
                    (18,743,069
                    )
                    
                    (14,024,639
                    )
                    
                    (9,367,001
                    )Cumulative
                        effect of change in accounting principle
                    
                    
                    (223,993
                    )
                    
                    -
                    
                    
                    -Net
                        loss
                    
                    $
                    (18,967,062
                    )
                    $
                    (14,024,639
                    )
                    $
                    (9,367,001
                    )Net
                        loss per share - basic and dilutedNet
                        loss per share before cumulative change inaccounting
                        principle
                    
                    $
                    (0.46
                    )
                    $
                    (0.39
                    )
                    $
                    (0.27
                    )Cumulative
                        effect of change in accounting principle
                    
                    $
                    (0.01
                    )
                    $
                    -
                    
                    $
                    -Net
                        loss per share
                    
                    $
                    (0.47
                    )
                    $
                    (0.39
                    )
                    $
                    (0.27
                    )Weighted
                        average shares used in computingnet
                        loss per share - basic and diluted
                    
                    
                    40,717,579
                    
                    
                    36,375,068
                    
                    
                    34,154,057See
                        accompanying notes to consolidated financial statements
 41
 SPATIALIGHT,
                INC.
 CONSOLIDATED
                  STATEMENTS OF EQUITY (DEFICIT)
 YEARS
                    ENDED DECEMBER 31, 2006, 2005 AND 2004
  **PREPAID**
                      
                      **NOTES**
                      
                      
                      
                      **OTHER****NONCASH**
                      
                      **RECEIVABLE**
                      
                      
                      
                      **COMPRE-****ADDITIONAL**
                      
                      **INTEREST**
                      
                      **FROM**
                      
                      **ACCUM-**
                      
                      **HENSIVE**
                      
                      **COMMON**
                      
                      **TOTAL****COMMON
                          STOCK**
                      
                      **PAID-IN**
                      
                      **RELATED**
                      
                      **STOCK**
                      
                      **ULATED**
                      
                      **INCOME**
                      
                      **STOCK**
                      
                      **STOCKHOLDERS'****SHARES**
                      
                      **AMOUNT**
                      
                      **CAPITAL**
                      
                      **PARTY**
                      
                      **HOLDERS**
                      
                      **DEFICIT**
                      
                      **(LOSS)**
                      
                      **ISSUABLE**
                      
                      **EQUITY
                          (DEFICIT)**Balance,
                          January 1, 2004
                      
                      
                      33,229,191
                      
                      $
                      332,292
                      
                      $
                      61,046,425
                      
                      $
                      -
                      
                      $
                      (1,096,926
                      )
                      $
                      (58,274,201
                      )
                      $
                      -
                      
                      $
                      3,805,685
                      
                      $
                      5,813,275Exercise
                          of stock options and warrants, 132,737shares
                          issued in January 2005
                      
                      
                      1,013,127
                      
                      
                      10,131
                      
                      
                      2,484,387
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      394,185
                      
                      
                      2,888,703Issuance
                          of options to employees and directors
                      
                      
                      -
                      
                      
                      -
                      
                      
                      67,674
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      67,674Issuance
                          of warrant for services
                      
                      
                      -
                      
                      
                      -
                      
                      
                      263,850
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      263,850Issuance
                          of shares for prepayment of relatedparty
                          interest
                      
                      
                      264,036
                      
                      
                      2,640
                      
                      
                      1,541,734
                      
                      
                      (1,544,374
                      )
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -Shares
                          issuable for prepayment of relatedparty
                          interest, 448,768 issued in January 2005
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (3,643,964
                      )
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      3,643,964
                      
                      
                      -Payments
                          on notes receivable from stockholders
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      269,851
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      269,851Reduction
                          of note receivable in exchange forfinancing
                          commitment
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      600,000
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      600,000Accrued
                          interest on notes receivable from stockholder
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (14,387
                      )
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (14,387
                      )Beneficial
                          pricing on conversion feature onconvertible
                          notes
                      
                      
                      -
                      
                      
                      -
                      
                      
                      156,610
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      156,610Issuance
                          of common shares issuable
                      
                      
                      820,082
                      
                      
                      8,201
                      
                      
                      3,797,484
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (3,805,685
                      )
                      
                      -Amortization
                          of related party prepaidnon-cash
                          interest
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      800,063
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      800,063Short
                          swing profit
                      
                      
                      -
                      
                      
                      -
                      
                      
                      25,982
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      25,982Comprehensive
                          loss:Net
                          loss
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (9,367,001
                      )
                      
                      -
                      
                      
                      -
                      
                      
                      (9,367,001
                      )Foreign
                          currency translation adjustments
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      73,562
                      
                      
                      -
                      
                      
                      73,562Total
                          comprehensive loss
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      -
                      
                      
                      (9,293,439
                      )See
                          accompanying notes to consolidated financial statements
  42
 SPATIALIGHT,
            INC.
 CONSOLIDATED
            STATEMENTS OF EQUITY (DEFICIT) (con't)
 YEARS
            ENDED DECEMBER 31, 2006, 2005 AND 2004
  **PREPAID**
                  
                  **NOTES****NONCASH**
                  
                  **RECEIVABLE**
                  
                  
                  
                  **OTHER****ADDITIONAL**
                  
                  **INTEREST**
                  
                  **FROM**
                  
                  **ACCUM-**
                  
                  **COMPRE-**
                  
                  **COMMON**
                  
                  **TOTAL****COMMON
                      STOCK**
                  
                  
                  
                  **PAID-IN**
                  
                  **RELATED**
                  
                  **STOCK**
                  
                  **ULATED**
                  
                  **HENSIVE**
                  
                  **STOCK**
                  
                  **STOCKHOLDERS'****SHARES**
                  
                  **AMOUNT**
                  
                  **CAPITAL**
                  
                  **PARTY**
                  
                  **HOLDERS**
                  
                  **DEFICIT**
                  
                  **INCOME
                      (LOSS)**
                  
                  **ISSUABLE**
                  
                  **EQUITY
                      (DEFICIT)**Balance,
                      December 31, 2004
                  
                  
                  35,326,436
                  
                  $
                  353,264
                  
                  $
                  69,384,146
                  
                  $
                  (4,388,275
                  )
                  $
                  (241,462
                  )
                  $
                  (67,641,202
                  )
                  $
                  73,562
                  
                  $
                  4,038,149
                  
                  $
                  1,578,182Issuance
                      of options below fair market valueto
                      employees
                  
                  
                  -
                  
                  
                  -
                  
                  
                  22,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  22,000Exercise
                      of stock options and warrants
                  
                  
                  369,163
                  
                  
                  3,692
                  
                  
                  532,297
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  535,989Issuance
                      of warrant for services
                  
                  
                  -
                  
                  
                  -
                  
                  
                  164,187
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  164,187Issuance
                      of common shares,net
                          of issuance costs of $103,539 and fair value of investment
                          right
                  
                  
                  499,965
                  
                  
                  5,000
                  
                  
                  2,496,961
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  2,501,961Payments
                      on notes receivable from stockholders
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  249,105
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  249,105Accrued
                      interest on notes receivablefrom
                      stockholder
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (7,643
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (7,643
                  )Issuance
                      of common shares issuable
                  
                  
                  581,505
                  
                  
                  5,815
                  
                  
                  4,032,334
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (4,038,149
                  )
                  
                  -Amortization
                      of prepaid non-cash interest
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  916,877
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  916,877Comprehensive
                      loss:Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (14,024,639
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  (14,024,639
                  )Foreign
                      currency translation adjustments
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  148,755
                  
                  
                  -
                  
                  
                  148,755Total
                      comprehensive loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (13,875,884
                  )See
                      accompanying notes to consolidated financial statements
  43
  SPATIALIGHT,
          INC.
 CONSOLIDATED
            STATEMENTS OF EQUITY (DEFICIT) (con't)
 YEARS
            ENDED DECEMBER 31, 2006, 2005 AND 2004
 **PREPAID**
                  
                  **NOTES****NONCASH**
                  
                  **RECEIVABLE**
                  
                  
                  
                  **OTHER****ADDITIONAL**
                  
                  **INTEREST**
                  
                  **FROM**
                  
                  **ACCUM-**
                  
                  **COMPRE-**
                  
                  **COMMON**
                  
                  **TOTAL****COMMON
                      STOCK**
                  
                  
                  
                  **PAID-IN**
                  
                  **RELATED**
                  
                  **STOCK**
                  
                  **ULATED**
                  
                  **HENSIVE**
                  
                  **STOCK**
                  
                  **STOCKHOLDERS'****SHARES**
                  
                  **AMOUNT**
                  
                  **CAPITAL**
                  
                  **PARTY**
                  
                  **HOLDERS**
                  
                  **DEFICIT**
                  
                  **INCOME
                      (LOSS)**
                  
                  **ISSUABLE**
                  
                  **EQUITY
                      (DEFICIT)**Balance,
                      December 31, 2005
                  
                  
                  36,777,069
                  
                  $
                  367,771
                  
                  $
                  76,631,925
                  
                  $
                  (3,471,398
                  )
                  $
                  -
                  
                  $
                  (81,665,841
                  )
                  
                  222,317
                  
                  $
                  -
                  
                  $
                  (7,915,226
                  )Reclassification
                      from temporary equity of October 2005 Financing shares upon
                      effectiveness
                      of registration statement, including $743,319 market value
                      of warrants
                      issued
                  
                  
                  571,431
                  
                  
                  5,714
                  
                  
                  1,763,979
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,769,693Exercise
                      of stock options
                  
                  
                  50,000
                  
                  
                  500
                  
                  
                  39,745
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  40,245-Stock-based
                      compensation expense
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,875,330
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,875,330-Issuance
                      of common shares and warrants,net
                      of issuance costs of $650,160
                  
                  
                  6,582,770
                  
                  
                  65,828
                  
                  
                  13,232,076
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  13,297,904-Issuance
                      of common shares for interest andliquidated
                      damages charges
                  
                  
                  501,346
                  
                  
                  5,013
                  
                  
                  1,191,372
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,196,385-Short
                      swing profit
                  
                  
                  -
                  
                  
                  -
                  
                  
                  22,273
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  22,273Amortization
                      of prepaid non-cash interest
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,157,132
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,157,132Comprehensive
                      loss:Net
                      loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (18,967,062
                  )
                  
                  -
                  
                  
                  -
                  
                  
                  (18,967,062
                  )Foreign
                      currency translation adjustment
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  114,658
                  
                  
                  -
                  
                  
                  114,658Total
                      comprehensive loss
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (18,852,404
                  )Balance,
                      December 31, 2006
                  
                  
                  44,482,616
                  
                  $
                  444,826
                  
                  $
                  94,756,700
                  
                  $
                  (2,314,266
                  )
                  $
                  -
                  
                  $
                  (100,632,903
                  )
                  $
                  336,975
                  
                  $
                  -
                  
                  $
                  (7,408,668
                  )See
                      accompanying notes to consolidated financial statements
  44
   SPATIALIGHT,
                  INC.CONSOLIDATED
                    STATEMENTS OF CASH FLOWSYEARS
                    ENDED DECEMBER 31, 2006, 2005 AND 20042006
                
                2005
                
                2004Cash
                    flows from operating activities:Net
                    loss
                
                $
                (18,967,062
                )
                $
                (14,024,639
                )
                $
                (9,367,001
                )Adjustments
                    to reconcile net loss to net cash used in operating
                    activities:Allowance
                    for doubtful accounts
                
                
                -
                
                
                -
                
                
                345,030Inventory
                    reserve adjustment
                
                
                444,364
                
                
                351,377
                
                
                (210,000
                )Depreciation
                    and amortization
                
                
                864,064
                
                
                728,383
                
                
                575,391Stock-based
                    general and administrative expenses
                
                
                1,875,330
                
                
                186,187
                
                
                931,524Non-cash
                    interest expense
                
                
                2,856,393
                
                
                1,430,506
                
                
                791,036Gain
                    from revaluation of note purchase option and investment right
                    liabilities
                
                
                -
                
                
                (754,374
                )
                
                (412,374
                )Gain
                    from revaluation of warrants
                
                
                (43,638
                )
                
                (180,355
                )
                
                -Non-cash
                    foreign currency translation gain
                
                
                (90,880
                )
                
                58,531
                
                
                -Accrued
                    interest on notes receivable from stockholder
                
                
                -
                
                
                (7,643
                )
                
                (14,387
                )Gain
                    on sale of fixed assets
                
                
                (3,375
                )
                
                (1,928
                )
                
                -Changes
                    in operating assets and liabilities:Accounts
                    receivable
                
                
                87,438
                
                
                124,377
                
                
                (491,553
                )Inventory
                
                
                (110,716
                )
                
                65,214
                
                
                (183,697
                )Prepaids
                    and other current assets
                
                
                (44,422
                )
                
                714,901
                
                
                (411,437
                )Other
                    assets
                
                
                36,316
                
                
                50,337
                
                
                (22,711
                )Accounts
                    payable
                
                
                343,646
                
                
                1,005,783
                
                
                (261,890
                )Accrued
                    expenses and other current liabilities
                
                
                337,054
                
                
                577,484
                
                
                214,806Net
                    cash used in operating activities
                
                
                (12,415,488
                )
                
                (9,675,859
                )
                
                (8,517,263
                )Cash
                    flows from investing activities:Purchase
                    of property and equipment
                
                
                (622,623
                )
                
                (5,534,882
                )
                
                (795,173
                )Proceeds
                    from the sale of property and equipment
                
                
                84,166
                
                
                -
                
                
                -Construction
                    in progress
                
                
                -
                
                
                -
                
                
                (950,627
                )Net
                    cash used in investing activities
                
                
                (538,457
                )
                
                (5,534,882
                )
                
                (1,745,800
                )Cash
                    flows from financing actitivies:Proceeds
                    from issuance of short-term notes
                
                
                8,856,697
                
                
                987,316
                
                
                -Payment
                    on short-term notes
                
                
                (9,095,383
                )
                
                (190,907
                )
                
                -Proceeds
                    from the issuance of convertible notes
                
                
                -
                
                
                -
                
                
                10,000,000Payments
                    on notes receivable from stockholders
                
                
                -
                
                
                249,105
                
                
                269,851Financing
                    costs for convertible notes
                
                
                -
                
                
                -
                
                
                (217,162
                )Short
                    swing profits
                
                
                22,274
                
                
                -
                
                
                25,982Proceeds
                    from sales of common shares and warrants, net of fees
                
                
                13,306,590
                
                
                4,581,460
                
                
                -Proceeds
                    from exercise of warrants and options
                
                
                40,245
                
                
                535,989
                
                
                2,888,703Net
                    cash provided by financing activities
                
                
                13,130,423
                
                
                6,162,963
                
                
                12,967,374Net
                    increase (decrease) in cash and cash equivalents
                
                
                176,478
                
                
                (9,047,778
                )
                
                2,704,311Effect
                    of exchange rate changes on cash
                
                
                1,213
                
                
                2,792
                
                
                23,271Cash
                    and cash equivalents at beginning of period
                
                
                42,565
                
                
                9,087,551
                
                
                6,359,969Cash
                    and cash equivalents at end of period
                
                $
                220,256
                
                $
                42,565
                
                $
                9,087,551See
                    accompanying notes to consolidated financial statements.
  45
  SPATIALIGHT, INC.CONSOLIDATED
                      STATEMENTS OF CASH FLOWS (con't)YEARS
                      ENDED DECEMBER 31, 2006, 2005 AND 20042006
                  
                  2005
                  
                  2004Supplemental
                      disclosure of cash flow information:Income
                      taxes paid during the period
                  
                  $
                  1,800
                  
                  $
                  2,300
                  
                  $
                  1,475Interest
                      paid during the period
                  
                  $
                  323,711
                  
                  $
                  1,002,740
                  
                  $
                  482Non
                      cash financing activities:Discount
                      on convertible notes due to purchase option liability
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  1,072,248Discount
                      on convertible notes due to beneficial conversion feature
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  156,610Common
                      shares issued or issuable for prepaid interest to related
                      party
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  4,388,275See
                      accompanying notes to consolidated financial
                      statements.
  46
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
  **1.**  **Description
          of Business and Summary of Significant Accounting Policies**
  *Description
          of Business -* We
          are in
          the business of manufacturing high-resolution liquid crystal on silicon
          (LCoS)
          microdisplays. We are currently focused on manufacturing our core product,
          our
          T-3 LCoS Set, to our customers and prospective customers, who are located
          primarily in Asia. The T-3 model has a 1920 pixels by 1080 pixels configuration.
          Our previously manufactured T-1 model has a lower resolution of 1280 pixels
          by
          960 pixels configuration. We are exclusively focusing on manufacturing
          the T-3
          model of our LCoS Sets because we believe that the market demand for that
          higher
          resolution product will be significantly greater. Our current customers
          and
          current prospective customers are original equipment manufacturers (OEMs)
          engaged in the businesses of manufacturing high definition televisions
          or
          manufacturing light engines for incorporation into high definition televisions.
          Our products are suitable for incorporation into other potential applications
          including rear projection computer monitors, wireless communication devices,
          portable games and digital assistants. Currently we are working with OEMs
          of
          high definition televisions, light engines for incorporation into high
          definition televisions, near-to-eye head mounted display devices, and
          micro-projectors for mobile electronics applications.
 
 Our
          principal executive offices are located in Novato, California. We were
          organized
          under the laws of the State of New York in 1989. Our wholly-owned subsidiary,
          SpatiaLight Korea, Inc., was incorporated in 2004 under the laws of South
          Korea.
          Our inactive wholly-owned subsidiary, SpatiaLight Technologies, Inc., was
          incorporated in 2003 under the laws of the State of New York.
  *Basis
          of Consolidation* - The
          consolidated financial statements incorporate the accounts of SpatiaLight,
          Inc.
          and its wholly-owned subsidiaries, SpatiaLight Technologies, Inc. and
          SpatiaLight Korea, Inc. All significant intercompany business and transactions
          have been eliminated in consolidation.
 
 *Going
          Concern -* The
          accompanying consolidated financial statements have been prepared assuming
          we
          will continue as a going concern. We have suffered recurring operating
          losses
          and negative cash flows from operations. As of December 31, 2006, we had
          negative net working capital of $12.9 million and an accumulated deficit
          of
          $100.6 million, with total stockholders’ deficit of $7.4 million.
 
 Our
          total
          cash and cash equivalents at December 31, 2006 was $220,256. As disclosed
          in
          Note 11-Subsequent Events after December 31, 2006, we received approximately
          $2.3 million in gross proceeds from the sale of 2,190,477 of our common
          shares
          in February 2007. We believe these reserves are sufficient to sustain our
          operations and meet our capital and liquidity requirements through March
          2007.
          We plan on raising additional funds through anticipated cash payments from
          customers, additional equity financings and exercises of stock options
          and
          warrants. No assurance can be given that we will receive cash payments
          from
          customers, that we will be able to raise additional equity, or that there
          will be exercises of stock options and warrants. If we do not receive additional
          funds from these or other sources, we will be required to scale back or
          terminate operations and/or seek protection under applicable bankruptcy
          laws.
 
 Additionally,
          as more fully described in Note 3, our Senior Secured Convertible Notes,
          maturing in November 2007, are held by four Noteholders. Two of the Noteholders
          have alleged that certain events of default under the Notes have occurred
          (one
          Noteholder has alleged three events of default, and the other Noteholder
          has
          alleged one event of default), and they have sent us letters asking for
          immediate redemption of the entire principal of their Notes of $9 million
          plus
          redemption premiums of approximately $1.35 million and liquidated damages
          of
          $615,000 and $534,000 at December 31, 2006 and 2005, respectively. We strongly
          dispute that any events of default have occurred that would allow the
          Noteholders to call the Notes, and we plan to vigorously defend our position.
          We
          believe, after review with outside legal counsel, with respect to each
          of the
          three alleged events of default, that it is not probable that the Noteholders
          would prevail in calling the loans based on any of the alleged events of
          default; therefore, in accordance with SFAS 5 “Accounting for Contingencies,” we
          have classified the Notes as short-term and long-term liabilities at December
          31, 2006 and 2005, respectively, in the accompanying consolidated balance
          sheet in accordance with the original contractual terms rather than as
          current
          liabilities as SFAS 78, “ *Classification
          of Obligations That are Callable by the Creditor,”* might
          otherwise require, and have not accrued the redemption premiums and liquidated
          damages. However, should the Noteholders pursue their call for immediate
          redemption of the Notes, and prevail on their claim in a court of law,
          the
          entire $10 million Note obligation would immediately become due and payable
          including redemption premiums of $1.5 million and liquidated damages of
          $683,000
          at December 31, 2006. Moreover, the Company will be required to repay
          or refinance the Notes at their maturity date in November 2007, and will
          need to obtain additional financing to repay the Noteholders.
 
 In
          2006,
          a substantial percentage of our product deliveries, which were in small
          quantities, were made to LGE. In March 2007, we were informed by LGE of
          their
          intent to discontinue production of RPTVs (both LCoS and DLP). We do not
          expect
          significant further sales to LGE. We intend to replace the revenues from
          LGE
          with revenues from sales of our T-3 RPTV model to other customers, as well
          as
          sales of products to manufacturers of head mounted displays and microprojectors.
          Due to the development and ramp up time periods, significant revenue is
          not
          anticipated until at least the second half of 2007.
  47
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Furthermore,
          we are subject to U.S. Securities and Exchange Commission (SEC) investigations
          relating to the unauthorized filing of consents of BDO Seidman, LLP as
          an
          exhibit to certain registration statements, as well as an investigation
          into
          transactions in our securities by our former Chief Executive Officer and
          may be
          subject to penalties and claims relating thereto. These matters are discussed
          in
          Note  10.
 
 These
          matters raise substantial doubt about our ability to continue as a going
          concern. The recoverability of a major portion of the recorded asset amounts
          shown in the accompanying consolidated balance sheet is dependent upon
          our
          continued operations. Our consolidated financial statements do not include
          any
          adjustments relating to the recoverability and classification of recorded
          asset
          amounts or amounts and classifications of liabilities that might be necessary
          should we be unable to continue as a going concern.
 *Adoption
            of New Accounting Pronouncements* -
            Effective October 1, 2006, we adopted Financial Accounting Standards
            Board
            (FASB) Staff Position (FSP) Emerging Issues Task Force (EITF) 00-19-2,
            “Accounting for Registration Payment Arrangements”. This FASB staff position
            addresses how to account for registration payment arrangements and clarifies
            that a financial instrument subject to a registration payment arrangement
            should
            be accounted for in accordance with other generally accepted accounting
            principles (GAAP) without regard to the contingent obligation to transfer
            consideration pursuant to the registration payment arrangement. This
            accounting
            pronouncement further clarifies that a liability for liquidated damages
            resulting from registration statement obligations should be recorded
            in
            accordance with Statement of Financial Accounting Standards No. 5, "Accounting
            for Contingencies *,* " ** when
            the
            payment of liquidated damages becomes probable and can be reasonably
            estimated.
 
 Prior
            to
            adoption of this FSP, we had classified as temporary equity, and as a
            warrant
            liability, as applicable, financial instruments issued in conjunction
            with our
            recent financings until the underlying securities were registered with
            the SEC,
            because the maximum potential liquidated damages may be greater than
            the
            difference in fair values between registered and unregistered shares.
            Our
            adoption of this accounting pronouncement as of October 1, 2006 resulted
            in a reclassification of $1,947,909 of temporary equity and $129,279
            of warrant
            liability to common stock and additional paid in capital as of October
            1, 2006. The
            cumulative effect of this accounting change increased our 2006 net loss by
            $223,993, or $0.01 per share.
 
 We
            also
            adopted Statement of Financial Accounting Standard No. 123(R), “Share-Based
            Payment” (“SFAS 123(R)”), and Statement of Financial Accounting Standard No.
            151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”)
            as of January 1, 2006. The adoption of SFAS 123(R) is discussed under
            “Stock-Based Compensation” below, and the adoption of SFAS No. 151 did not have
            a material effect on our results of operations or financial
            position.
 *Estimates* - The
          preparation of financial statements in conformity with U.S. generally accepted
          accounting principles (GAAP) requires that management make estimates and
          assumptions that affect the reported amounts of assets and liabilities
          and
          disclosure of contingent assets and liabilities at the date of the financial
          statements and the reported amounts of revenues and expenses during the
          reporting period. Actual results could differ from those estimates. Significant
          estimates include those related to accounts receivable reserves and inventory
          reserves and write-downs, which can be affected by a change in the market
          value
          and replacement cost of materials or a change in market price of products
          as
          well as the recoverability of long-lived assets and the valuation of stock
          based
          compensation.
 
 *Cash
          and Cash Equivalents* - We
          consider all highly liquid investments purchased with an original maturity
          of
          three months or less to be cash equivalents. At December 31, 2006 and 2005,
          approximately $220,000 and $43,000, respectively, comprised of checking
          and
          money market accounts, the fair value of which approximates cost, are included
          in cash and cash equivalents. We deposit cash and cash equivalents with
          high
          credit quality financial institutions.
  48
 SPATIALIGHT,
          INC.
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
          31, 2006, 2005 AND 2004
  *Accounts
          Receivable* -
          Accounts receivable are due under negotiated terms. Although we generally
          do not
          require collateral, letters of credit may be required from our customers
          in
          certain circumstances. Senior management reviews accounts receivable on
          a
          quarterly basis to determine if any receivables are uncollectible. In the
          event
          that payment of a customer’s account receivable is doubtful, we would reserve
          the receivable under an allowance for doubtful accounts. If all efforts
          to
          collect a receivable fail, and the receivable is considered uncollectible,
          the
          receivable would be written off against the allowance reserve.
 
 *Inventories
          -* Inventories
          are valued at the lower of cost (based on the first-in, first-out method)
          or
          market value. Materials, labor and manufacturing overhead are included
          in the
          cost of inventories. In determining inventory market values, substantial
          consideration is given to the expected selling price of the product based
          on
          historical recovery rates. If the market value of inventory is assessed
          to be
          less than cost, it is written down to its replacement cost or its net realizable
          value. Estimates may differ from actual results due to the quantity and
          quality
          and mix of products in inventory, consumer and retailer preferences and
          economic
          conditions. There was no lower of cost or market provision recorded in
          2006 or
          2005. Inventory reserves are generally recorded when management determines
          that
          an item is not readily saleable. In 2006 and 2005, we recorded a provision
          on
          our T-1 and light engine inventory of approximately $444,000 and $351,000,
          respectively, as a result of the concentrated focus of our business on
          our T-3
          LCoS Set model. As of December 31, 2006, we have written off 100% of the
          value
          of our remaining T-1 and light engine inventory.
 
 *Property
          and Equipment* -
          Property and equipment are recorded at cost while repairs and maintenance
          costs
          are expensed in the period incurred. Depreciation and amortization is computed
          for financial reporting purposes using the straight-line method over the
          following estimated useful lives.
 
 Category
                  
                  Useful
                      Lives in YearsBuildings
                  
                  
                  40Other
                      equipment and instruments
                  
                  
                  3-10Machinery
                      and manufacturing equipment
                  
                  
                  3-10Office
                      furniture and fixtures
                  
                  
                  3-5Tooling
                  
                  
                  1-5Comuter
                      software and hardware
                  
                  
                  3-5
 
 Leasehold
          improvements are being amortized over the shorter of eight years or the
          term of
          the lease.
 
 *Debt
          Issuance Costs* -
          Debt
          issuance costs related to the 2004 Senior Secured Convertible Notes are
          being
          amortized over the term of the notes using the interest method.
 
 *Revenue
          Recognition* - ** We
          evaluate revenue recognition for transactions using the following criteria
          (collectively called the Revenue Recognition Criteria):
 ·
              Evidence
                  of an arrangement: Before revenue is recognized, we must have evidence
                  of
                  an agreement with the customer reflecting the terms and conditions
                  to
                  deliver our products. ·
              Delivery:
                  For products, delivery is considered to occur when title and risk
                  of loss
                  have been transferred, which generally occurs upon shipment. ·
              Fixed
                  or determinable fee: We consider a fee to be fixed or determinable
                  if the
                  fee is not subject to refund or adjustment. If a portion of the
                  arrangement fee is not fixed or determinable, we recognize that
                  amount as
                  revenue when the amount becomes fixed or determinable. We do not
                  consider
                  a fee to be fixed and determinable if any amount is due more than
                  180 days
                  from the delivery date. Payment terms of less than 180 days are
                  evaluated
                  based upon the laws or trade practices of the country in which
                  the
                  arrangement is entered into to assess whether the fee is fixed
                  and
                  determinable. ·
              Collection
                  is deemed reasonably assured: Collection is deemed reasonably assured
                  if
                  we expect the customer to be able to pay amounts under the arrangement
                  as
                  those amounts become due. We reduce product revenue for customer
                  returns
                  and sales allowances and record an allowance for doubtful accounts
                  should
                  collectibility become questionable. If it is determined that an
                  account is
                  uncollectible, the account is written off against the
                  allowance. 
 *Warranty
          Reserve* - We
          provide for the estimated cost of product warranties at the time revenue
          is
          recognized. As we have limited historical experience in selling our products
          to
          our customers in large volumes, we must exercise considerable judgment
          in
          estimating the expected failure rates. This estimating process is based
          on
          historical experience of similar products in similar industries, as well
          as
          various other assumptions that we believe to be reasonable under the
          circumstances. Should actual product failure rates differ from our estimates,
          revisions to the estimated warranty liability would be required. As of
          December
          31, 2006 and 2005 our warranty reserve represented 1.5% of sales revenue.
          Our
          warranty is limited to the lesser of the end product warranty (the finished
          HDTV) or two years.
  49
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 *Shipping
          and Handling Costs* -
          Shipping and handling costs to date have not been charged to our customers.
          These costs have not been material to date. They have been recorded in
          selling,
          general, and administrative expenses in 2005 and 2004. Beginning in the
          first quarter of 2006, all shipping and handling costs relating to sales
          of our
          products is recorded in cost of revenue. To the extent that such costs
          are
          recouped from the customers, such amounts will be included in revenue.
 
 *Income
          Taxes* - We
          utilize the asset and liability method of accounting for income taxes.
          Deferred
          tax assets and liabilities are recognized for the future tax consequences
          attributable to differences between the financial statement carrying amounts
          of
          existing assets and liabilities and their respective tax bases and operating
          loss and tax credit carryforwards. Deferred tax assets and liabilities
          are
          measured using enacted tax rates expected to apply to taxable income in
          the
          years in which those temporary differences are expected to be recovered
          or
          settled. A valuation allowance is recorded to reduce deferred tax assets
          to an
          amount whose realization is more likely than not. The effect on deferred
          tax
          assets and liabilities of a change in tax rates is recognized in income
          in the
          period that includes the enactment date.
 
 *Research
          and Development* -
          Research and development costs, including the costs of prototype and
          pre-production LCoS Sets, pre-production display units, and other pre-production
          activities at our South Korean manufacturing facility are charged to expense
          when incurred.
 
 *Foreign
          Currency Translation* -
          The
          functional currency of our foreign subsidiary is the local currency, the
          Korean
          Won. We translate the assets and liabilities of our foreign subsidiary
          to U.S.
          dollars at the rate of exchange in effect at the end of the reporting period.
          Revenues and expenses are translated at the average rates of exchange for
          the
          accounting period. Translation adjustments attributable to our foreign
          subsidiary are included in stockholders’ equity (deficit) as a component of
          other comprehensive income (loss).
 
 *Comprehensive
          Loss* -
          Comprehensive loss is comprised of net loss and other comprehensive income.
          The
          only component of other comprehensive income is foreign currency translation
          adjustments in 2006, 2005 and 2004. Other comprehensive income is disclosed
          in
          the statements of stockholders’ equity (deficit).
 
 *Fair
          Value of Financial Instruments* - Our
          financial instruments include cash equivalents, accounts receivable, and
          debt.
          The carrying value of cash equivalents and accounts receivable approximates
          their fair value. The face amount of the convertible notes approximates
          their
          fair value and is offset by the calculated value of the beneficial conversion
          feature, additional investment rights or note purchase option embedded
          in the
          notes, and reimbursement to a noteholder of certain costs.
 
 *Derivative
          Financial Instruments* - Our
          derivative financial instruments consist of a note purchase option (additional
          investment right (AIR)) attached to Senior Secured Convertible Notes and
          warrants issued in connection with our October 2005 financing for the year
          ended
          December 31, 2005 and 2004. The fair value is calculated based on the
          Black-Scholes option-pricing model. We had no derivative financial instruments
          at the end of 2006.
  *Stock-Based
          Compensation* - We
          have stock compensation plans for employees and directors which are described
          in
          Note 6 to our consolidated financial statements in this Annual Report.
          We
          adopted Statement of Financial Accounting Standards No. 123 (revised 2004),
          “ *Share-Based
          Payment* ,”
(“SFAS
          123R”) effective January 1, 2006. SFAS 123R requires the recognition of the
          fair
          value of stock compensation including stock options in net income (loss).
          We
          recognize the stock compensation expense over the requisite service period
          of
          the individual grantees, which generally equals the vesting period of the
          grant
          or, in the case of options granted with a market condition, we use a binomial
          model to calculate a derived service period. All of our stock compensation
          is
          accounted for as an equity instrument. Prior to January 1, 2006, we followed
          Accounting Principles Board Opinion 25, “ *Accounting
          for Stock Issued to Employees,* ”
(“APB
          25”) and related interpretations in accounting for our stock compensation.
          We
          adopted SFAS 123R using the modified prospective method. Under this method,
          the
          provisions of SFAS 123R apply to all awards granted or modified after the
          date
          of adoption. The unrecognized expense of awards not yet vested at the January
          1,
          2006 date of adoption is recognized in net income (loss) in the periods
          after
          the date of adoption using the same valuation method ( *i.e.* Black-Scholes) and assumptions determined under the original provisions
          of SFAS
          123, “ *Accounting
          for Stock-Based Compensation,”* as
          disclosed in our previous filings. Following the provisions of the modified
          prospective method, we have not restated our consolidated financial statements
          for periods prior to 2006 to reflect the adoption of SFAS 123R. Therefore,
          the
          results reported in the Consolidated Statement of Operations for 2006 are
          not
          directly comparable to the results for the prior year.
 
 Under
          the
          provisions of SFAS 123R, we recorded $1,875,330, or $0.05 per share, of
          stock
          compensation, net of estimated forfeitures, in selling, general and
          administrative expenses, in our consolidated statement of operations for
          2006.
          We utilized the Black-Scholes valuation model for estimating the fair value
          of
          the stock compensation granted after the adoption of SFAS 123R, with the
          following weighted-average assumptions:
  50
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Dividend
                      yield
                  
                  -Expected
                      volatility
                  
                  92.8
                      % - 99.02%Risk-free
                      interest rate
                  
                  4.6%
                      - 5.2%Expected
                      lives (in years)
                  
                  5.2
                      - 5.8
 
 The
          dividend yield of zero is based on the fact that we have never paid cash
          dividends and have no present intention to pay cash dividends, and are
          prohibited from paying dividends under the terms of the Senior Secured
          Convertible Notes issued in November 2004 (See Note 3). Expected volatility
          is
          based upon historical volatility of our common stock over the period
          commensurate with the expected life of the options. The risk-free interest
          rate
          is derived from the average U.S. Treasury Constant Maturity Rate during
          the
          period, which approximates the rate in effect at the time of the grant.
          The
          expected term is calculated using the simplified method prescribed by the
          SEC’s
          Staff Accounting Bulletin 107. Our currently unvested options vest over
          two
          years from the date of grant. Our options generally have a 10-year contractual
          term. Based on the above assumptions, the weighted-average fair values
          of the
          options granted under the stock option plans for 2006 was $1.95. As required
          by
          SFAS No. 123R, we now estimate forfeitures of employee stock options and
          recognize compensation cost only for those awards expected to vest. Forfeiture
          rates are determined for four groups of employees - CEO, directors, senior
          management and all other employees - based on historical experience. Estimated
          forfeitures are now adjusted to actual forfeiture experience as
          needed.
 
 During
          the fourth quarter of 2006, we entered into an agreement to grant options
          to
          purchase 950,000 common shares to our former Executive Vice President of
          Strategic Planning in connection with a consulting contract entered into
          between
          the Company and him. The options contain market conditions and were valued
          at
          $59,529 using a binomial model. The following assumptions were used for
          valuing
          this grant: no dividend yields, expected volatility of 81%, risk free rate
          of
          4.74% and expected lives (derived service period) varying from 47 days
          to 379
          days.
  SFAS
          123R
          requires us to present pro forma information for the comparative period
          prior to
          the adoption as if we had accounted for all our employee stock options
          under the
          fair value method of the original SFAS 123. The fair value at date of grant
          for
          options granted has been estimated based on a Black-Scholes pricing model
          with
          the following weighted average assumptions:
 
 2005
                  
                  2004Dividend
                      yield
                  
                  
                  -
                  
                  
                  -Expected
                      volatility
                  
                  
                  87
                  %
                  
                  89
                  %Risk-free
                      interest rates
                  
                  
                  4.1
                  %
                  
                  2.5
                  %Expected
                      lives
                  
                  
                  4.0
                      years
                  
                  
                  3.2
                      years
 
 The
          table
          below shows net loss per share as if the Company had elected the fair value
          method of accounting for stock options.
 
 2005
                  
                  2004Net
                      loss as reported
                  
                  $
                  (14,024,639
                  )
                  $
                  (9,367,001
                  )Add:
                      stock-based employee compensation includedin
                      reported net loss
                  
                  
                  22,000
                  
                  
                  67,674Deduct:
                      total stock-based employee compensationdetermined
                      under fair value method for all awards
                  
                  
                  (3,701,420
                  )
                  
                  (2,723,586
                  )Proforma
                      net loss, as adjusted
                  
                  $
                  (17,704,059
                  )
                  $
                  (12,022,913
                  )Loss
                      per share:Basic
                      and diluted, as reported
                  
                  $
                  (0.39
                  )
                  $
                  (0.27
                  )Basic
                      and diluted, as adjusted
                  
                  $
                  (0.49
                  )
                  $
                  (0.35
                  )
 
 If
          the
          tax deduction realized from the exercise of stock options is less than
          recognized compensation expense, the tax shortfall is recognized in equity
          to
          the extent of available windfall tax benefits realized in the prior year,
          if
          any, otherwise it is recognized within our Consolidated Statements of
          Operations. Under the modified-prospective transition method of
          SFAS No. 123R, we were permitted to calculate a cumulative memo
          balance of windfall tax benefits from post-1995 years for purposes of
          accounting for future tax shortfalls. We elected to apply the long-form
          method
          for determining the pool of windfall tax benefits and have a pool of windfall
          tax benefits.
  51
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 *Stock
          Option Acceleration -* ****** On
          December 6, 2005 **,** our
          Compensation Committee of the Board of Directors approved the acceleration
          of
          the vesting of stock options held by all non-executive employees and certain
          officers under its stock option plans effective December 15, 2005. Options
          held
          by directors were excluded from the vesting acceleration. The closing price
          of
          the Company’s common stock on December 14, 2005, the last trading day before
          approval of acceleration, was $3.40 per share. All above-mentioned unvested
          stock options had exercise prices above $3.40 per share. The accelerated
          options
          are immediately exercisable by employees without any employment-related
          restriction.
  The
          primary purpose of the accelerated vesting was to reduce future compensation
          expense associated with the accelerated stock options upon the planned
          adoption
          of SFAS 123R. We estimate that the acceleration eliminated $0.7 million
          in
          future compensation charges we would otherwise have taken with respect
          to the
          accelerated options. Our Board of Directors believes, based on its consideration
          of the expense savings and the current intrinsic and perceived value of
          the
          accelerated stock options, that the acceleration was in the best interests
          of
          the Company and its shareholders.
 
 *Impairment
          of Long-Lived Assets* -
          We
          account for the impairment of long-lived assets in accordance with SFAS
          No. 144, *Accounting
          for the Impairment or Disposal of Long-Lived Assets* .
          An
          impairment of a long-lived asset exists when the carrying value of an asset
          exceeds its fair value and when the carrying value is not recoverable through
          future undiscounted cash flows from operations. We review the carrying
          value of
          long-lived assets for impairment when events or changes in circumstances
          indicate that the carrying amount of assets may not be recoverable.
  Considerable
          management judgment is required in determining if and when a condition
          would
          trigger an impairment assessment of our long-lived assets and once such
          a
          determination has been made, considerable management judgment is required
          to
          determine the fair market value of the long-lived asset. In
          determining the fair value of the asset, we consider the associated net
          present
          value of estimated future cash flows. Such estimated future cash flows
          are based
          on assumptions about our expected future operating performance. Our estimates
          of
          future cash flows may differ from actual cash flows due to, among other
          things,
          technological changes, economic conditions or changes to our business
          operations. Impairments would be recognized in operating results to the
          extent
          that the carrying value exceeds this calculated fair value of the long-lived
          assets.
 
 *Loss
          per Common Share* - Basic
          loss per common share excludes dilution and is computed by dividing the
          net loss
          by the weighted-average number of common shares outstanding for the period.
          Diluted loss per common share reflects the potential dilution that could
          occur
          if securities or other contracts to issue common shares were exercised
          or
          converted into common shares. Common share equivalents are excluded from
          the
          computation in loss periods, as their effect would be antidilutive.
 
 *Segment
          and Geographical Information* - Our
          chief operating decision-maker is our Chief Executive Officer. The chief
          operating decision-maker reviews only financial information prepared on
          a basis
          substantially consistent with the accompanying consolidated statements
          of
          operations. Therefore, we have determined that we operate in a single business
          segment. All of our assets are located at our facilities in the United
          States at
          December 31, 2006, except for the following:
  52
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 KoreaCash
                  
                  $
                  3,131Accounts
                      receivable
                  
                  
                  45,899Prepaid
                      expenses
                  
                  
                  94,497Deposits
                  
                  
                  3,566Building,
                      net
                  
                  
                  4,485,961Machinery
                      and manufacturing equipment, net
                  
                  
                  761,781Office
                      furniture and fixtures, net
                  
                  
                  121,225Other
                      equipment and instruments, net
                  
                  
                  753,115Inventory,
                      net
                  
                  
                  393,479$
                  6,662,654
 
 The
          following table summarizes our product revenues percentages for the years
          ended
          December 31, 2006, 2005 and 2004.
 2006
                  
                  2005
                  
                  2004LCoS
                      (T-3) sets
                  
                  
                  96
                  %
                  
                  77
                  %
                  
                  5
                  %LCoS
                      (T-1) sets
                  
                  
                  -
                  
                  
                  4
                  %
                  
                  42
                  %Light
                      engine display units
                  
                  
                  -
                  
                  
                  1
                  %
                  
                  51
                  %Other
                      (primarily supporting electronics)
                  
                  
                  4
                  %
                  
                  18
                  %
                  
                  2
                  %Total
                  
                  
                  100
                  %
                  
                  100
                  %
                  
                  100
                  %
  For
          the
          year ended December 31, 2006, 92% of our revenue was derived from LGE,
          located
          in South Korea. LGE made up 100% of our outstanding accounts receivable
          balance
          at December 31, 2006. For the year ended December 31, 2005, 73% and 12%
          of our
          revenue was derived from LGE and ThinTek Optronics Corp, located in Taiwan,
          respectively. These two customers made up 84% of our outstanding accounts
          receivable balance at December 31, 2005. The remaining 15% of revenue in
          2005
          was derived from the sales of our LCoS Sets and related components to customers
          located in Hong Kong, China and the United States. For the year ended December
          31, 2004, 47% and 43% of our revenue was derived from Skyworth TV Holding,
          LTD
          (Skyworth), and Shanghai China Display Co., LTD (China Display), both located
          in
          China. The remaining 10% of revenue in 2004 was derived from the sales
          of our
          LCoS Sets and related components to customers located in Hong Kong, Taiwan
          and
          South Korea.
 
 *Recently
          Issued Accounting Standards -*
 
 In
          September 2006, the Financial Accounting Standards Board (FASB) issued
          Statement
          No. 157, “Fair Value Measurements” (“FAS 157”). This statement defines fair
          value, establishes a framework for measuring fair value under generally
          accepted
          accounting principles (GAAP), and expands disclosures about fair value
          measurements. SFAS No. 157 is effective for financial statements issued
          for
          fiscal years beginning after November 15, 2007, and interim periods within
          those
          fiscal years. The transition adjustment, which is measured as the difference
          between the carrying amount and the fair value of those financial instruments
          at
          the date this statement is initially applied, should be recognized as a
          cumulative effect adjustment to the opening balance of retained earnings
          for the
          fiscal year in which this statement is initially applied. The provisions
          of SFAS
          No. 157 are effective for us beginning January 1, 2008. We are currently
          evaluating the impact of adopting SFAS No. 157 on our consolidated financial
          statements.
 
 In
          September 2006, the Securities and Exchange Commission (SEC) issued Staff
          Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year
          Misstatements when Quantifying Misstatements in Current Year Financial
          Statements.” SAB No. 108 addresses how the effects of prior year uncorrected
          misstatements should be considered when quantifying misstatements in current
          year financial statements and is effective for fiscal years ending after
          November 15, 2006. SAB No. 108 requires companies to quantify misstatements
          using a balance sheet and income statement approach and to evaluate whether
          either approach results in quantifying an error that is material in light
          of
          relevant quantitative and qualitative factors. SAB No. 108 permits existing
          public companies to initially apply its provisions either by (i) restating
          prior
          financial statements as if the “dual approach” had always been used or (ii)
          recording the cumulative effect of initially applying the “dual approach” as
          adjustments to the carrying value of assets and liabilities as of January
          1,
          2006 with an offsetting adjustment recorded to the opening balance of retained
          earnings. The adoption of the provisions of SAB No. 108 on December 31,
          2006 had
          no impact on our consolidated financial statements.
  53
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 In
          June
          2006, the Financial Accounting Standards Board (FASB) issued Interpretation
          No.
          48, *Accounting
          for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
          109* (“FIN
          48”). This Interpretation clarifies the accounting for uncertainty in income
          taxes recognized in a company’s financial statements in accordance with FASB
          Statement No. 109, *Accounting
          for Income Taxes.* FIN 48
          prescribes a recognition threshold and measurement attribute for the financial
          statement recognition and measurement of a tax position taken or expected
          to be
          taken in a tax return. This Interpretation also provides guidance on
          derecognition, classification, interest and penalties, accounting in interim
          periods, disclosure, and transition. The evaluation of a tax position in
          accordance with FIN 48 is a two-step process. The first step is recognition:
          The
          Company determines whether it is “more-likely-than-not” that a tax position will
          be sustained upon examination, including resolution of any related appeals
          or
          litigation processes, based on the technical merits of the position. In
          evaluating whether a tax position has met the “more-likely-than-not” recognition
          threshold, the company presumes that the position will be examined by the
          appropriate taxing authority that would have full knowledge of all relevant
          information. The second step is measurement: A tax position that meets
          the
“more-likely-than-not” recognition threshold is measured to determine the amount
          of benefit to recognize in the financial statements. The tax position is
          measured at the largest amount of benefit that is greater than 50 percent
          likely
          to be realized upon ultimate settlement. FIN 48 is effective for fiscal
          years
          beginning after December 15, 2006. We are in the process of determining
          the
          impact, if any, of the adoption of FIN 48 on our results of operations
          or
          financial condition.
 
 In
          February 2006, the Financial Accounting Standards Board (FASB) issued
          SFAS No. 155, *“Accounting
          for Certain Hybrid Financial Instruments — an amendment of FASB Statements
          No. 133 and 140* ”
          (SFAS 155). SFAS 155 amends SFAS No. 133, *“Accounting
          for Derivative Instruments and Hedging Activities”* (SFAS 133),
          and SFAS No. 140, *“Accounting
          for Transfers and Servicing of Financial Assets and Extinguishments of
          Liabilities”* (SFAS 140).
          This statement also resolves issues addressed in Statement No. 133
          Implementation Issue No. D1, *“Application
          of Statement 133 to Beneficial Interests in Securitized Financial Assets.”* SFAS 155
          permits fair value remeasurement for any hybrid financial instrument that
          contains an embedded derivative that otherwise would require bifurcation
          and
          clarifies which interest-only strips and principal-only strips are not
          subject
          to the requirements of SFAS 133. SFAS 140 is amended to eliminate the
          prohibition on a qualifying special-purpose entity from holding a derivative
          financial instrument that pertains to a beneficial interest other than
          another
          derivative financial instrument. SFAS 155 is effective for all financial
          instruments acquired or issued during fiscal years beginning after
          September 15, 2006 (January 1, 2007 for the Company). We do not
          expect this statement to have a material impact on our consolidated financial
          statements.
  In
          June
          2005, the FASB issued Statement No. 154, "Accounting Changes and Error
          Corrections" (SFAS 154), a replacement of APB No. 20, "Accounting Changes"
          and
          FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
          Statements". FAS 154 applies to all voluntary changes in accounting principle
          and changes the requirements for accounting for and reporting of a change
          in
          accounting principle. This statement establishes that unless impracticable,
          retrospective application is the required method for reporting a change
          in
          accounting principle in the absence of explicit transition requirements
          specific
          to the newly adopted accounting principle. It also requires the reporting
          of an
          error correction which involves adjustments to previously-issued financial
          statements similar to those generally applicable to reporting an accounting
          change retrospectively. FAS 154 became effective for accounting changes
          and
          corrections of errors made in our fiscal year beginning on January 1, 2006.
          The
          adoption of FAS 154 has not had a material impact on our results of operations
          or financial condition.
 
 In
          December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” to revise
          SFAS No. 123, “Accounting for Stock-Based Compensation” and supersede APB
          Opinion No. 25, “Accounting for Stock Issued to Employees” and its related
          implementation guidance. It requires companies to recognize their compensation
          costs related to share-based payment transactions in financial statements.
          These
          costs are to be measured based on the fair value of the equity or liability
          instruments issued and are recognized over the period during which an employee
          is required to provide services in exchange for the award - the requisite
          service period (usually the vesting period). We have applied
          SFAS No. 123R beginning January 1, 2006 .
          See 1 -
          Description of Business and Summary of Significant Accounting Policies
          - Stock
          Based Compensation for further information.
 
 In
          November 2004, the FASB issued SFAS No. 151, “Inventory Costs, An Amendment Of
          ARB No. 43, Chapter 4” ("SFAS 151"). SFAS 151 amends ARB 43, Chapter 4, to
          clarify that abnormal amounts of idle facility expense, freight, handling
          costs
          and wasted materials (spoilage) be recognized as current period charges.
          It also
          requires that allocation of fixed production overheads to the costs of
          conversion be based on the normal capacity of the production facilities.
          SFAS
          151 became effective for the Company beginning with its 2006 fiscal year.
          The
          adoption of SFAS 151 has not had a material impact on our results of operations
          or financial position.
 
 **2.**  **Issuance
          of Securities**
 
 Increase
          in Authorized Shares
 
 On
          July
          6, 2006, we filed an Amendment to our Amended and Restated Certificate
          of
          Incorporation with the Secretary of State of New York that increased the
          number
          of shares of authorized common stock from 50 million to 100 million. Our
          stockholders approved the Amendment to the Certificate of Incorporation
          at our
          2006 Annual Meeting held on June 28, 2006. A principle purpose for authorizing
          the additional shares was to allow for issuance of the shares pursuant
          to
          arrangements to fund working capital and other general corporate
          purposes.
  54
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Short-Swing
          Profits in 2006 and SEC Investigation
 
 Our
          Audit
          Committee determined that Robert A. Olins, our former Chief Executive Officer,
          Secretary, Treasurer and a Director failed to report the sale of an aggregate
          of
          70,556 of our common shares in August 2005 and February 2006 at sales prices
          ranging from $5.30 to $3.00 per share. Pursuant to Section 16 of the Exchange
          Act, in July 2006, Mr. Olins has filed the delinquent reports and disgorged
          $22,273 in “short swing profits” that he realized from the sales. These payments
          are recorded as an increase in additional paid in capital during the third
          quarter 2006. The staff of the SEC is conducting an investigation into
          transactions in our securities by Mr. Olins and an entity he controls.
          See Note
          10 - Commitments and Contingencies.
 
 Exercise
          of Stock Options and Warrants in 2006
 
 During
          2006, 50,000 common shares were issued upon the exercise of employee/director
          stock options. No warrants were exercised during 2006. Total cash received
          from
          option exercises in 2006 was $40,245.
 
 Issuance
          of Shares and Warrants in 2006
 
 On
          November 30, 2006, when the price of our common stock was $1.75, we issued
          143,963 of our common shares in lieu of cash to the Senior Secured Notes
          for the
          payment of one quarter’s interest incurred from these notes. Under the terms of
          the Senior Secured Convertible Notes we can issue our common shares instead
          of
          making cash payments for interest at our option, as long as certain specified
          conditions are met. All of the specified conditions were met as of November
          30,
          2006.
 
 On
          November 29, 2006, when the price of our common stock was $1.76, we issued
          and
          sold 2,400,000 of our common shares in a private placement to three
          institutional investors. The transaction included the issuance of warrants
          to
          purchase 4,872,000 of common shares with an exercise price of $1.75 per
          share
          exercisable within five years from the date of issuance. The purchase price
          of
          the common shares was $1.25 per share. The common shares and warrants were
          sold
          pursuant to an exemption from registration under Section 4(2) of the Securities
          Act of 1933, as amended. We received $3.0 million in proceeds, before issuance
          costs of $180,000, from the sale of these shares, which are and will be
          used for
          working capital and other general corporate purposes, including the repayment
          of
          certain short-term debt obligations. We will be required under a registration
          rights agreement to file a registration statement for the resale of the
          shares
          and shares issuable upon exercise of warrants within 30 calendar days after
          the
          closing date and have the registration statement declared effective no
          later
          than 90 calendar days after closing. The
          registration rights agreement provides that if we do not meet the above
          deadlines, we may be required to pay an amount equal to 2% of the aggregate
          purchase price or $60,000 for every thirty days thereafter to a maximum
          of 24%
          of the aggregate subscription amount or $720,000. Once the registration
          statement is declared effective, we are required to maintain effectiveness
          of
          the registration statement, including shares issuable upon the exercise
          of the
          warrants, until the shares covered by the registration statement have been
          sold
          or may be sold without volume restrictions pursuant to Rule 144(k). Because
          we
          have not filed a registration statement for these shares and shares issuable
          upon exercise of the warrants, we have accrued liquidated damages of $60,000
          as
          of December 31, 2006.
 
 On
          September 26, 2006, when the price of our common stock was $2.20, we sold
          270,270 of our common shares in a private placement to certain institutional
          investors that have previously purchased our common shares in private
          transactions on several occasions and are currently stockholders of our
          Company.
          The purchase price of the common shares was $1.85 per share. The transaction
          included the issuance of warrants to purchase 89,189 common shares with
          an
          exercise price of $2.25 per share exercisable within five years from the
          date of
          issuance. We received $500,000 in gross proceeds, before issuance
          costs of $17,500, from the sale of these shares, which were used for working
          capital and other general corporate purposes. We are required under a
          registration rights agreement to file a registration statement for the
          resale of
          the shares and shares issuable upon the exercise of the warrants within
          30
          calendar days from the closing date and have the registration statement
          declared
          effective no later than 90 calendar days after the closing date. The
          registration rights agreement provides that if we do not meet the above
          deadlines, we may be required to pay an amount equal to 2% of the aggregate
          purchase price or $10,000 as partial liquidated damages when each of these
          dates
          occur and an additional 1% for each month thereafter to a contractually
          defined
          maximum of 12% of the aggregate purchase price or $60,000. Once the registration
          statement is declared effective, we are required to maintain effectiveness
          of
          the registration statement until the shares covered by the registration
          statement have been sold or may be sold without volume restrictions pursuant
          to
          Rule 144(k). Because
          we have not filed a registration statement for these shares and shares
          issuable
          upon exercise of the warrants, we have accrued liquidated damages of
          $20,000 as of December 31, 2006. In
          accordance with EITF 00-19, we classified net stock issuance proceeds as
          temporary equity, and as a warrant liability, because shares issued or
          issuable
          upon exercise of the warrants were subject to registration and potential
          liquidated damages, which may have been greater than the difference in
          fair
          values between registered and unregistered shares, if we were unable to have a
          registration statement declared effective or unable to maintain its
          effectiveness. We recorded the fair value of the warrants at issuance of
          $138,000 as a liability and the remaining net stock proceeds of $345,000
          as
          temporary equity. The fair value of the warrants was calculated using the
          Black-Scholes option pricing model, using the following assumptions: stock
          price
          $2.20, exercise price $2.25, volatility 86%, risk-free interest rate 4.56%,
          remaining contractual life 5 years, and dividend yield of zero. On September
          30,
          2006, the fair value of the warrants was revalued and calculated at $129,000,
          using the Black-Scholes option pricing model, using the following assumptions:
          stock price $2.09, exercise price $2.25, volatility 86%, risk-free interest
          rate
          4.56%, remaining contractual life of five years, and dividend yield of
          zero. The
          decrease of $9,000 was reflected as a gain from revaluation of warrants
          in the
          consolidated statement of operations for the year ended December 31, 2006.
          As
          discussed in Note 1, under Adoption of New Accounting Pronouncements, we
          reclassified the carrying value of the stock from temporary equity, and
          the fair
          value of the warrant liability, to equity on October 1, 2006 upon adoption
          of
          FSP EITF 00-19.
  55
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 On
          August
          31, 2006, when the price of our common stock was $2.27, we issued 109,143
          of our
          common shares in lieu of cash to the Senior Secured Notes for the payment
          of one
          quarter’s interest incurred from these notes. Under the terms of the Senior
          Secured Convertible Notes we can issue our common shares instead of making
          cash
          payments for interest at our option, as long as certain specified conditions
          are
          met. All of the specified conditions were met as of August 31, 2006.
  On
          August
          9, 2006, when the price of our common stock was $2.60, we issued 761,500
          of our
          common shares in a private placement to an institutional investor (“August 2006
          Financing”). The purchase price of the common shares was $2.25 per share. We
          received approximately $1.7 million in gross proceeds, before issuance
          costs,
          from the sale of these shares, which were used for working capital and
          other
          general corporate purposes. We paid $110,000 to our former Executive Vice
          President of Strategic Planning to facilitate this transaction, which were
          costs
          directly related to the transaction, and recorded this amount as a reduction
          of
          the gross proceeds. We are required under a registration rights agreement
          to
          file a registration statement for the resale of the shares within 30 calendar
          days from the closing date and have the registration statement declared
          effective no later than 90 calendar days after the closing date. The
          registration rights agreement provides that if we do not meet the above
          deadlines, we may be required to pay an amount equal to 1.5% of the aggregate
          purchase price or $25,700 as partial liquidated damages when each of these
          dates
          occur and an additional $25,700 for every 30 days thereafter up to six
          months.
          After six months, the percentage increases to 2.5% or $42,800 for each
          additional 30 days with no contractual maximum. Once the registration statement
          is effective, we are required to maintain effectiveness of the registration
          statement until the shares covered by the registration statement have been
          sold
          or may be sold without volume restrictions pursuant to Rule 144(k). The
          institutional investor has waived any claim for liquidated damages based
          on the
          failure to file a registration statement within the time required until
          a
          reasonable time after the effectiveness of our universal shelf registration
          statement on Form S-3 (Registration No. 333-137100).
 We
            classified the net proceeds from the stock issuance as temporary equity
            at
            September 30, 2006 in accordance with EITF 00-19, because the shares
            issued were
            subject to registration and potential liquidated damages if we were unable
            to
            have the registration statement declared effective or unable to maintain
            its
            effectiveness. As discussed in Note 1, under Adoption of New Accounting
            Pronouncements, we reclassified the carrying value of the stock from
            temporary
            equity to equity on October 1, 2006, upon adoption of FSP EITF
            00-19.
 
 As
            part
            of the August 2006 Financing, we agreed to file a “shelf” registration
            statement covering subscription rights of at least $20,000,000 (the “Required
            Rights Offering”) to be offered to the holders of our common stock unless we
            raised at least $10,000,000
            in additional financing between August 9, 2006 and 30 days after the
            effective
            date of the registration statement. On October 25, 2006, these requirements
            were
            amended to (i) extend the Additional Financing Deadline by 30 days if
            we raised
            at least $1,000,000 in additional financing; (ii) extend the Additional
            Financing Deadline by 30-60 days if we raised between $3,000,000 and
            $5,000,000
            in additional financing; (iii) extend the Additional Financing Deadline
            by 60
            days and reduce the Required Rights Offering pro rata if we raised more
            than
            $5,000,000 in additional financing. As of March 16, 2007, we have raised
            $5,800,000 in additional financing, the Required Rights Offering has
            been
            decreased to $14,200,000 and the Additional Financing Deadline has been
            extended
            to May 15, 2007.
 
 Because
            of our existing covenants with the holders of our Senior Secured Convertible
            Notes, which requires us to seek their consent before we agree to enter
            into
            additional material indebtedness, we will most likely try to raise the
            above-mentioned monies through the sale of additional common shares.
            We can
            offer no assurance that we will successfully raise all or any part of
            the
            $4,200,000 mentioned above, nor can we offer an assurance that we will
            issue
            subscription rights to our shareholders in the future. At present, we
            are
            considering all of our options and have not definitively determined how
            or
            whether we will raise all or a part of the $4,200,000 which would allow
            us to
            avoid our obligation to make an offering of subscription rights to purchase
            our
            common shares. In connection with the August 2006 Financing, we have
            also
            agreed, for a period of one year following the closing of the August
            2006
            Financing, to refrain from, directly or indirectly, offering or selling
            any debt
            security that is, at any time during the life of the debt security and
            under any
            circumstance, convertible into or exchangeable for our common shares,
            unless we
            receive prior written consent from a majority of the purchasers of the
            August
            2006 Financing.
 56
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 In
          the
          event we default upon the foregoing obligations, the purchasers of securities
          in
          our August 2006 Financing are entitled to contractual damages and may also
          request that we specifically perform our obligations under the purchase
          agreement giving rise to our obligations. At present, we are unable to
          quantify
          the amount of contractual damages to which the purchasers would be entitled,
          and
          we are unable to estimate the likelihood that a court would grant any
          purchaser’s application that we specifically perform our
          obligations.
 
 On
          June
          5, 2006, when the price of our common stock was $2.59, we sold to certain
          institutional buyers, each of which is managed by Wellington Management
          Company,
          LLP, an aggregate of 601,000 of our common shares at a price per share
          of $2.80,
          for an aggregate purchase price of approximately $1.7 million. We made
          the sale
          pursuant to a post-effective amendment to a “shelf” registration statement on
          Form S-3 (File No. 333-122392), which was declared effective by the SEC
          before
          this transaction, and which was amended by a registration statement on
          Form S-3
          MEF (File No. 333-134626) filed by us on May 31, 2006. As of the date of
          this
          filing, 5,150 of our common shares registered under these “shelf” registration
          statements remain unissued. These funds were used for working capital and
          other
          general corporate purposes.
 
 On
          May
          31, 2006, when the price of our common stock was $3.06, we issued 81,665
          of our
          common shares in lieu of cash to the Senior Secured Notes for the payment
          of one
          quarter’s interest incurred from these notes. Under the terms of the Senior
          Secured Convertible Notes we can issue our common shares instead of making
          cash
          payments for interest at our option, as long as certain specified conditions
          are
          met. All of the specified conditions were met as of May 31, 2006.
 
 On
          April
          7, 2006, when the price of our common stock was $ 3.89, we sold 750,000
          of our
          common shares at a purchase price of $3.26 per share to three institutional
          purchasers. Those shares were registered in our Post-Effective Amendment
          No. 6
          to a Form S-3 “shelf” registration statement (File Number 333-122392), as
          post-effectively amended through February 14, 2006. The purchase price
          for those
          common shares was approximately $2.4 million in the aggregate. The purchase
          price was based upon the five-day volume weighted average price of our
          common
          shares through April 6, 2006, discounted by five percent. We paid aggregate
          fees
          equal to $89,650 to persons who introduced us to the investors. These funds
          were
          used for working capital and other general corporate purposes.
  57
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 On
          March
          17, 2006, when the price of our common stock was $2.79, we sold 500,000
          of our
          common shares at a purchase price of $2.18 per share to certain institutional
          investors. Those shares were included in our Post-Effective Amendment No.
          6 to
          Form S-3 "shelf" registration statement (File No. 333-122392), as
          post-effectively amended through February 14, 2006. The purchase price
          was based
          upon the five-day volume weighted average price of our common shares through
          March 16, 2006, discounted by five percent. We received net proceeds of
          approximately $1.1 million, which were used for working capital and other
          general corporate purposes.
 
 In
          mid-January 2006, when the price of our common stock ranged from $2.62
          to $2.85,
          we issued and sold 1,300,000 of our common shares in a private placement
          to
          three institutional investors. The purchase price of the common shares
          was $2.62
          per share. We received approximately $3.3 million in net proceeds from
          the sale
          of these shares, which were used for working capital and other general
          corporate
          purposes, including the repayment of certain short-term debt obligations.
          We
          were required under a registration rights agreement, to file a registration
          statement for the resale of the shares within 30 calendar days after January
          12,
          2006 and have the registration statement declared effective no later than
          90
          calendar days after January 12, 2006. The latter may be extended to no
          later
          than 120 calendar days if the registration statement is subject to review,
          comments or other actions by the SEC. Once the registration statement is
          declared effective, we
          are
          required to maintain effectiveness of the registration statement until
          the
          shares covered by the registration statement have been sold or may be sold
          without volume restrictions pursuant to Rule 144(k). As
          the
          registration statement was not filed by February 11, 2006 or declared effective
          prior to April 12, 2006, the registration rights agreement required us
          to pay an
          amount equal to 5% of the aggregate purchase price or $170,300 as partial
          liquidated damages when each of these dates occurred and an additional
          $170,300
          for every 30 days thereafter up to six months. After six months, the percentage
          increases to 10% or $340,600 for each additional 30 days. We have included
          $329,602 as liquidated damages in non-cash interest expense from inception
          through May 12, 2006. The registration statement related to these shares
          was
          filed with the SEC on May 5, 2006 and was declared effective on May 12,
          2006.
          Concurrent with the effectiveness of the registration statement, the investors
          of the January financing received an aggregate of 122,725 restricted shares
          in
          settlement of any and all liquidated damages. The shares were issued as
          follows:
          57,725 restricted shares of our common stock were issued on May 18, 2006,
          when
          the market value of our shares was $3.12, resulting in an intrinsic value
          of
          $180,102; 65,000 restricted shares of our common stock were issued on June
          30,
          2006, when the market price of our shares was $2.30, resulting in an intrinsic
          value of $149,500. Of these shares, 57,725 were included in our Form S-3
          Amendment No. 6 (Registration No. 333-137100) filed with the SEC on February
          13,
          2007. This registration statement was declared effective by the SEC on
          February
          14, 2007.
 
 Issuance
          of Shares in 2005
 
 In
          October 2005, we closed a $2.0 million private placement of our common
          shares
          and warrants to purchase our common shares with certain institutional and
          other
          investors. This transaction included the sale of 571,431 common shares
          at a
          purchase price of $3.50 per share and warrants to purchase 228,576 common
          shares
          with an exercise price of $5.00 per share exercisable within five years
          from the
          date of issuance. We received $2.0 million in gross proceeds from this
          transaction, which was used for working capital and other general corporate
          purposes. We did not use a placement agent in this transaction. Three of
          the
          institutional purchasers in this transaction were investors in our November
          2004
          private placement of our Senior Secured Convertible Notes. We were required
          to
          file a registration statement for resale of the shares and shares issuable
          upon
          exercise of the warrants 30 days after October 12, 2005 and have the
          registration statement declared effective no later than 90 days after October
          12, 2005. We are also required to maintain the effectiveness of the registration
          statement (File No. 333-132048) until the shares covered by the registration
          statement have been sold or may be sold without volume restrictions pursuant
          to
          Rule 144(k).
 
 On
          February 27, 2006, we filed a registration statement (File No. 333-132048)
          registering shares issued in our October 2005 financing. Because this
          registration statement was not filed by November 12, 2005, we may be required
          to
          pay $30,000 as liquidated damages to the investors as of November 12, 2005
          and
          every thirty days thereafter through February 27, 2006. Additionally, since
          the
          registration statement was not declared effective by the SEC prior to January
          12, 2006, we may be required to pay $30,000 as liquidated damages to the
          investors on January 12, 2006 and for every thirty days thereafter until
          April
          18, 2006, the date of effectiveness for this registration statement. We
          have
          included $187,215 and $79,000 as liquidated damages in non-cash interest
          expense
          for the periods ended April 18, 2006 and December 31, 2005, respectively.
          Concurrent with the effectiveness of the registration statement, investors
          accounting for 25% of the invested amount in this transaction have waived
          their
          rights to any liquidated damages. In addition, in settlement of any and
          all
          liquidated damages, investors accounting for 50% of the invested amount
          in this
          transaction received an aggregate of 43,850 shares of our common stock
          on June
          5, 2006, when the market price of our stock was $2.77, resulting in an
          intrinsic
          value of $121,465. These shares were included in our amended registration
          statement on Form S-3 MEF (File No. 333-134626) filed by us on May 31,
          2006. We
          continue to maintain an accrual of $65,750 in accrued liabilities on our
          consolidated balance sheet for the investors accounting for the remaining
          25% of
          the invested amount.
  58
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 As
          mentioned above, prior to the issuance of FSP EITF 00-19-2, as further
          described
          in Note 1, Adoption of New Accounting Pronouncements, in accordance with
          EITF 00-19, the fair value of the warrants at inception was accounted for
          as a
          liability, with an offsetting reduction to the carrying value of the common
          stock. We reclassified the warrant liability to equity upon effectiveness
          of the
          related registration statement, on April 18, 2006. The fair value of the
          warrants at inception, of $958,625, was calculated using the Black-Scholes
          option pricing model, using the following assumptions: stock price $4.26,
          exercise price $5.00, volatility 217%, risk free interest rate 3.00%, remaining
          contractual life 5 years and dividend yield of zero. On December 31, 2005,
          the
          fair value of the warrants was revalued and calculated at $778,270, using
          the
          Black-Scholes option pricing model, using the following assumptions: stock
          price
          $3.47, exercise price $5.00, volatility 217%, risk free interest rate 3.00%,
          remaining contractual life 4.87 years and dividend yield of zero. The decrease
          of $180,355 is reflected as a gain from revaluation of warrants in the
          consolidated statement of operations during the year ended December 31,
          2005. On
          April 18, 2006, the fair value of the warrants was revalued and calculated
          at
          $743,319, using the Black-Scholes option pricing model, using the following
          assumptions: stock price $3.48, exercise price $5.00, volatility 178%,
          risk free
          interest rate 3.00%, remaining contractual life 4.52 years and dividend
          yield of
          zero. The decrease of $34,951 is reflected as a gain from revaluation of
          warrants in the consolidated statement of operations during the year ended
          December 31, 2006. In
          accordance with EITF 00-19 we had classified the $1,026,374 value of common
          stock subject to registration (net of $15,000 issuance costs and warrants
          valued
          at $958,625) as temporary equity as of December 31, 2005 related to the
          October
          2005 Financing. The amount had been reclassified to equity upon effectiveness
          of
          the related registration statement, on April 18, 2006.
  On
          August
          5, 2005, we sold 500,000 of our common shares at a purchase price of $5.40
          per
          share to certain institutional investors. Those shares were included in
          our Form
          S-3 “shelf” registration statement (File No. 333-122932), which was declared
          effective by the SEC in July 2005. We received gross proceeds of approximately
          $2.7 million from the transaction, which we used for working capital and
          other
          general corporate purposes. The purchasers in the August 2005 Equity Financing
          had a 30-day right, which expired on September 4, 2005, to purchase an
          additional aggregate of 225,000 of our common shares included in the “shelf”
registration statement at a purchase price of $5.50 per share. On August
          23,
          2005, we filed a post-effective amendment to our “shelf” registration statement
          withdrawing exhibit 23.1, the consent of the independent registered accounting
          firm BDO Seidman LLP. We stated in the post-effective amendment that we
          would
          not make any future sales from the “shelf” registration statement until we
          resolved the matter involving the consent. On August 23, 2005, we reclassified
          the fair value of the Investment Right of $94,500 from equity to a liability
          pursuant to EITF 00-19. The fair value of the Investment Right was calculated
          using the Black-Scholes option pricing model, using the following assumptions:
          stock price $5.24, exercise price $5.50, volatility 138.18%, risk free
          interest
          rate of 3.33%, remaining contractual term of 12 days and dividend yield
          of
          zero.  The Investment Right expired, unexercised, on September 4, 2005, and
          the Investment Right liability was recorded in other income. In February
          2006,
          the SEC declared our Post-Effective Amendment No. 6 to the Shelf Registration
          Statement effective, and we have sold all but 5,150 the balance of the
          securities remaining on the Shelf Registration Statement in compliance
          with the
          federal securities law, through use of the Shelf Registration Statement
          as noted
          above in the section “Issuance of Shares and Warrants in 2006”.
 
 In
          January 2005, 581,505 common shares with a value of $4,038,149 previously
          recorded as common shares issuable were issued. This included 50,500 shares
          valued at $123,625 issued to employees upon exercise of options at the
          end of
          2004, 448,768 shares valued at $3,643,964 related to the prepayment of
          interest
          on the Argyle note mentioned below and 82,237 shares valued at $270,560
          of other
          warrants exercised at the end of 2004.
 
 Exercise
          of Stock Options and Warrants in 2005
 
 During
          2005, employee stock options for 213,606 common shares were exercised for
          $443,989 and warrants for 155,557 common shares were exercised for $92,000.
          Included in the warrant exercise are 105,557 shares issued upon the cashless
          exercise of 250,000 warrants.
 
 Other
          expenses in 2005 totaling $22,000 relate to the valuation of an employee
          stock
          option issued with an exercise price lower than the market price on the
          grant
          date and are included in stock-based general and administrative expenses.
          This
          expense relates to an option granted in 2003.
 
 Issuance
          of Warrant and Option for services in 2005
  59
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 In
          June
          2005, we issued a fully vested warrant to purchase 75,000 of our common
          shares
          to an unaffiliated investment bank for compensation for services provided
          pursuant to a service agreement. A value of $73,387 was assigned to the
          warrant
          using the Black-Scholes pricing model and the following assumptions: stock
          price
          $5.71, exercise price $7.50, historical volatility 65%, risk free interest
          rate
          3%, dividend yield of zero and a contractual life of 12 months. This amount
          is
          included in stock-based general and administrative expenses.
 
 In
          February 2005, we issued a fully vested warrant to purchase 75,000 common
          shares
          as payment to a sales agent. A value of $90,800 was assigned to the warrant
          using the Black-Scholes pricing model and the following assumptions: stock
          price
          $4.66, exercise price $4.50, historical volatility 64%, risk free interest
          rate
          4.28%, dividend yield of zero and a contractual life of 10 months. This
          amount
          is included in stock-based general and administrative expenses.
 
 Issuance
          of Shares in 2004
 
 In
          December 2003, we completed a private placement of 1,000,000 common shares
          that
          were registered with the SEC in a “shelf” Registration Statement at a price of
          $5.00 per share for net proceeds of $4,955,255 received in December 2003.
          Prior
          to December 31, 2003, 300,000 of these shares were issued. The remaining
          700,000
          shares were reflected in common shares issuable at December 31, 2003 and
          were
          issued in January 2004. In addition, 120,082 shares were issued in 2004
          pursuant
          to a warrant exercised in late 2003. The proceeds of approximately $306,000
          had
          been received and were included in common shares issuable as of December
          31,
          2003.
 
 On
          January 7, 2004, we issued 142,360 common shares with a value of $800,063
          as a
          prepayment of interest on the Argyle notes for the interest due for 2004.
          Prepaid interest was computed using the closing price of the shares on
          January
          6, 2004 of $5.62. This amount is fully amortized at December 31, 2004.
          On March
          4, 2004, we issued an additional 71,676 common shares with a value of $338,311
          as a prepayment of interest on the Argyle notes for the period January
          1, 2005
          to June 30, 2005 (see Note 3). Prepaid interest was computed using the
          closing
          price of the shares of $4.72 on March 3, 2004. On December 22, 2004, we
          issued
          an additional 50,000 shares, and 448,768 shares became issuable (and were
          issued
          in January 2005) as a prepayment of interest on the Argyle notes for the
          period
          from July 1, 2005 through December 31, 2008. These shares had a value of
          $4,049,964 based on the closing price of the shares of $8.12 on December
          21,
          2004. Prepaid interest of $2,314,266 and $3,471,398, for the year ended
          December
          31, 2006 and 2005, respectively, is classified as a deduction from stockholders’
equity (deficit).
 
 Exercise
          of Stock Options and Warrants in 2004
 
 During
          2004, employee stock options for 465,083 common shares were exercised for
          $1,158,022 and warrants for 680,781 common shares were exercised for $1,730,681.
          We issued 132,737 of the shares in early January 2005.
 
 Issuance
          of Warrant and Option for Services in 2004
 
 In
          April
          2004, we issued a fully vested warrant to purchase 250,000 common shares
          as
          payment to a sales agent. A value of $210,000 was assigned to the warrant
          using
          a Black-Scholes pricing model and the following assumptions: stock price
          $3.58,
          exercise price $3.75, historical volatility 59%, risk free rate 4%, dividend
          yield of 0% and a contractual life of 13 months. This amount is included
          in
          stock-based general and administrative expenses.
  In
          October 2004, we issued a fully vested option to purchase 10,000 common
          shares
          to a consultant. The option was assigned a value of $53,850 using the
          Black-Scholes option pricing model and the following assumptions: stock
          price
          $5.75, exercise price $5.75, historical volatility 113%, a risk free rate
          of 3%,
          a dividend yield of 0 and a contractual life of 10 years. This amount is
          included in stock-based general and administrative expenses.
 
 Other
          expenses in 2004 totaling $67,674 relate to the valuation of options granted
          to
          employees with an exercise price lower than the market price on the date
          of
          grant, and options granted to a director for additional services. All of
          these
          options were issued in years previous to 2004.
 
 Issuance
          of Shares Under Installment Note
 
 In
          November 2002, Greenpark Limited exercised its warrant to purchase 746,268
          common shares at the exercise price of $2.00 per share, for an aggregate
          purchase price of $1,492,536. Under an installment agreement, Greenpark
          Limited
          was required to make periodic installment payments towards such aggregate
          purchase price. There was a 6% annual interest rate with respect to the
          balance
          of the share purchase price owed to us and all accrued interest is due with
          the final payment. We issued all of the 746,268 shares to Greenpark Limited
          in
          2003. In consideration for the financing commitment by Greenpark Limited
          in the
          November 2004 Financing, we agreed to reduce by $600,000 the amount owed
          by
          Greenpark Limited to us under that certain warrant installment agreement,
          dated
          as of October 14, 2002. This amount was included in stock-based general
          and
          administrative expenses. We received the remaining outstanding balance,
          plus
          accrued interest during 2005.
  60
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 On
          May
          15, 2001, we sold 600,000 common shares under a private stock purchase
          agreement. The shares were sold at a price of $1.75 per share. Cash received
          was
          $262,500. The balance of $787,500 was to be paid in three equal quarterly
          installments of $262,500. An escrow agent held the certificates for the
          shares
          being purchased until all three installments were paid in full. At December
          31,
          2004 the remaining balance was paid and the shares were released from
          escrow.
 
 Short-Swing
          Profits in 2004
 
 In
          September 2004, Robert A. Olins, our former Chief Executive Officer, Secretary,
          Treasurer and a Director, disposed of 11,800 of our common shares at a
          sale
          price of $5.73 per share. Pursuant to the “short-swing profit” provisions of the
          Exchange Act, Mr. Olins subsequently disgorged $25,982 to us for the profit
          that
          he realized from his sale of our common shares. The total aggregate profit
          was
          calculated by using the lowest purchase prices at which Mr. Olins purchased
          11,800 of our common shares during the six months immediately preceding
          September 20, 2004.
 
 Stock-based
          general and administrative expenses discussed above are as follows:
 Year-end
                      December 31,2006
                  
                  2005
                  
                  2004Financing
                      costs related to reduction of stockholder note
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  600,000Stock
                      and options granted to employees and directors
                  
                  
                  1,875,330
                  
                  
                  22,000
                  
                  
                  67,674Common
                      stock and warrants expensed for services
                  
                  
                  -
                  
                  
                  164,187
                  
                  
                  263,850$
                  1,875,330
                  
                  $
                  186,187
                  
                  $
                  931,524
 **3.**  **Short
          Term Loans and Notes Payable**
 
 Short
          Term Loan from a Related Party
 
 During
          March 2006, our wholly-owned subsidiary, SpatiaLight Korea, Inc. borrowed
          KRW
          85,000,000 (approximately US $86,250) from JeWon Yeun, SpatiaLight Korea’s
          former President. This non-interest bearing, unsecured loan was repaid
          in early
          April 2006. Between July and December 2006, we borrowed an aggregate of
          $355,000
          from Herbert Ehrenthal, one of our Directors, and an aggregate of $252,199
          from
          Robert A. Olins, our former Chief Executive Officer, Secretary, Treasurer,
          and a
          Director. The short-term borrowings from Mr. Ehrenthal bear interest at
          8% per
          annum. The short-term borrowings from Mr. Olins are non-interest bearing.
          Each
          of the notes was for $100,000 or less and the notes were on average outstanding
          for less than 2 months at a time. All the notes were fully repaid by early
          December 2006.
 
 On
          December 16, 2005, we borrowed $224,384 from Robert A. Olins, our former
          Chief
          Executive Officer, Secretary, Treasurer and a Director. Mr. Olins obtained
          these
          funds by drawing down on a personal line of credit from a bank, which is
          the
          same bank that we utilize for our domestic commercial banking requirements.
          Based upon discussions among Mr. Olins and other members of our Board of
          Directors, the Board authorized the repayment of the full principal amount
          of
          the loan plus interest at a rate of 8.25% per annum by February 16, 2006,
          the
          maturity date. The Board also authorized the reimbursement to Mr. Olins
          for a
          $30,000 fee that he was required to pay to the bank. The interest rate
          and the
          fee are on the same terms that Mr. Olins obtained from the bank. The unsecured
          loan was repaid by the due date and the fee was reimbursed to Mr.
          Olins.
  61
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Short
          Term Loans
 
 Our
          wholly-owned subsidiary SpatiaLight Korea has revolving credit facilities
          with
          five separate South Korean banks as detailed below (amounts in thousands,
          Korean
          Won, unless otherwise stated):
 
 Bank
                  
                  Shinhan
                      Bank
                  
                  Kyongnam
                      Bank
                  
                  Korea
                      Exchange Bank
                  
                  Pusan
                      Bank
                  
                  Industrial
                      Bank of Korea (4)
                  
                  TotalInterest
                      rate type
                  
                  Variable
                      (1)
                  
                  Variable
                      (2)
                  
                  Fixed
                  
                  Variable
                      (3)
                  
                  FixedInterest
                      rate at 12/31/06
                  
                  
                  7.05
                  %
                  
                  10.20
                  %
                  
                  13.00
                  %
                  
                  11.14
                  %
                  
                  0.00
                  %Maturity
                      date
                  
                  
                  9/22/2007
                  
                  
                  4/28/2007
                  
                  
                  1/10/2007
                  
                  
                  1/10/2007
                  
                  
                  3/23/2007Maximum
                      amount of line
                  
                  
                  200,000
                  
                  
                  200,000
                  
                  
                  200,000
                  
                  
                  100,000
                  
                  
                  -
                  
                  
                  700,000Amount
                      outstanding at 12/31/06
                  
                  
                  199,466
                  
                  
                  198,460
                  
                  
                  57,970
                  
                  
                  99,411
                  
                  
                  -
                  
                  
                  555,308Remaining
                      available
                  
                  
                  534
                  
                  
                  1,540
                  
                  
                  142,030
                  
                  
                  589
                  
                  
                  -
                  
                  
                  144,692Approximate
                      US dollar equivalent
                  
                  $
                  212,312
                  
                  $
                  211,241
                  
                  $
                  61,704
                  
                  $
                  105,813
                  
                  $
                  -
                  
                  $
                  591,070
  (1)
                      Yield ratio of annual bank debenture plus 1.857%(2)
                      Yield ratio of annual industrial financial debenture plus
                      4.0%(3)
                      Pusan Bank's internal market related base rate plus
                      5.56%(4)
                      The IBK facility was terminated in April 2006. See details
                      below.
 
 Interest
          under each of the credit facilities is payable monthly. We are required
          to repay
          funds on the credit facilities by the maturity dates of each of the respective
          credit facilities as noted in the table above. On April 10, 2006, the Korean
          Exchange Bank extended the expiration date on the line of credit from April
          10,
          2006 to October 10, 2006. In early October 2006, the Korean Exchange Bank
          changed the terms of the line of credit to a loan at the same interest
          rate to
          be repaid in three monthly installments with the final payment due January
          10,
          2007. In late October 2006, the Kyongnam Bank extended the expiration date
          of
          the line of credit from October 28, 2006 to April 28, 2007 in exchange
          for an
          increase in the interest rate by 1%.
 
 On
          March
          24, 2006, the Industrial Bank of Korea (IBK) committed itself to extend
          a
          secured line of credit (the “March Facility”) of up to 1.5 billion Korean Won
          (or approximately $1.5 million in U.S. dollars) to SpatiaLight Korea. As
          of
          March 31, 2006, SpatiaLight Korea had drawn down approximately $1.5 million
          on
          the March Facility for working capital purposes and to repay certain of
          its
          outstanding indebtedness. On April 6, 2006, the March Facility was terminated
          by
          repaying all monies borrowed as well as certain prepayment and finance
          charges.
          IBK has released its lien on SpatiaLight Korea’s assets securing the March
          Facility and related personal guarantees made by certain officers. We terminated
          this line of credit as some of the terms of the line might have been precluded
          by our other contractual obligations.
 
 We
          have
          not repaid either the Korean Exchange Bank or the Pusan Bank the amount
          outstanding as of the maturity dates noted above and are in the process
          of
          renegotiating these lines of credit with each of these banks.
 
 Convertible
          Notes
 
 Convertible
          notes at December 31, 2006 consist of the following:
 
 *Argyle
          Notes*
 
 In
          1998,
          we received $1,188,000 in cash in exchange for notes payable in that amount
          to
          Argyle Capital Management Corporation (Argyle), a company owned and controlled
          by Robert A. Olins, our former Chief Executive Officer, Secretary, Treasurer,
          and a former Director. The notes accrue interest at a contractual rate
          of 6% per
          annum, and are secured by substantially all of our assets, although these
          Notes
          are subordinated to the Senior Secured Convertible Notes described below.
          Both
          principal and interest are convertible into our common shares at $0.50
          per
          share. On May 23, 2001, the due date of the notes was extended until December
          31, 2002. On the extension date, the beneficial conversion effect representing
          the excess aggregate value of the common shares receivable upon conversion
          of
          the notes based on the then-current market price of $1.90 per share, over
          the
          aggregate conversion price for such common shares (limited to the original
          proceeds of $1,188,000), was recorded as additional paid-in capital. The
          resulting $1,188,000 discount to the debt arising from the beneficial conversion
          feature was originally being amortized through December 31, 2002. The effective
          interest rate for financial statement purposes due to this discount differs
          from
          the actual contractual interest received or receivable in cash or shares
          by
          Argyle. This discount, along with the contractual 6% interest rate, resulted
          in
          a new effective interest rate of 72% per annum as of the May 23, 2001 extension
          date when compared to the outstanding principal balances. The effective
          rate
          prior to extension had been the 6% per annum contractual rate.
  62
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 On
          September 20, 2002, the due date was extended until March 31, 2004. Accordingly,
          the remaining unamortized discount at the extension date of $198,000 was
          being
          amortized through March 31, 2004, resulting in a new effective interest
          rate of
          17% per annum when compared to the outstanding principal balances. On December
          31, 2003, the due date was extended until June 30, 2005. Accordingly, the
          remaining unamortized discount of $33,000 at the extension date was being
          amortized through June 30, 2005, resulting in a new effective interest
          rate of
          8% per annum when compared to the outstanding principal balances. On November
          30, 2004, the due date was extended until December 31, 2008. The remaining
          unamortized discount of $11,000 at the extension date was amortized through
          June
          30, 2005.
 
 We
          paid
          interest on the Argyle notes by issuing 142,360 common shares with a market
          value of $354,476 in 2003, and 142,360 common shares with a market value
          of
          $800,063 in 2004. The market value of the shares was based on the closing
          price
          of the shares on the day before issuance, and was recorded as interest
          expense. On
          March
          4, 2004, we issued 71,676 common shares with a market value of $338,311
          as a
          prepayment of interest on the Argyle notes of $35,640 for the period January
          1,
          2005 to June 30, 2005. Prepaid interest was computed using the closing
          price of
          the shares of $4.72 on March 3, 2004. In December 2004, we issued 50,000
          common
          shares, and in January 2005, we issued 448,768 common shares, as a prepayment
          of
          interest on the Argyle notes of $249,480 for the period July 1, 2005 through
          December 31, 2008. These shares had a market value of $4,049,964, based
          on the
          closing price of the shares of $8.12 on December 21, 2004. As of December
          31,
          2006, total prepaid interest on the Argyle notes for the period January
          1, 2007
          to December 31, 2008 is $2,314,266, which is classified as a deduction
          from
          stockholders’ equity (deficit). If Argyle elects to convert the notes prior to
          the maturity date (December 31, 2008), Argyle will return shares representing
          unearned interest on those notes at the time of the conversion.
 
 Interest
          expense includes non-cash interest expense of $728,780 in 2004, $845,957
          in 2005
          and $1,085,583 in 2006. The non-cash interest expense results from the
          beneficial conversion price of interest, which is convertible into common
          shares
          at $0.50 per share, and was computed as the excess of the market price
          of the
          shares issued for the interest over the calculated amount of interest due
          for
          the period.
  At
          December 31, 2006, the carrying value of the Argyle notes totaled $1,188,000
          representing the unpaid principal balance *.* In
          December 2006, Argyle, in accordance with the registration rights agreement,
          requested that the shares underlying these notes be registered as soon
          as
          practicable.
 
 *Senior
          Secured Convertible Debt Financing*
 
 On
          November 30, 2004, we completed a non-brokered private placement of $10
          million
          in principal amount of our senior secured notes (the “Senior Secured Convertible
          Notes”). The Senior Secured Convertible Notes accrue interest at 10% per annum,
          payable quarterly, and the interest is payable in cash or common shares,
          at our
          option if certain conditions are met, including the availability of an
          effective
          registration statement pursuant to which resales may be made or the availability
          of Rule 144(k) for resale of the common shares issued upon conversion.
          The value
          of the shares for the purposes of calculating interest payments is equal
          to the
          10-day trailing average of the volume weighted average prices of our common
          stock at the end of each quarterly interest period. The Secured Convertible
          Notes are due November 30, 2007.
 
 The
          Senior Secured Convertible Notes are convertible, at the option of their
          holders, into shares of our common stock at the conversion price of $9.72
          per
          share. The Senior Secured Convertible Notes are senior to notes that we
          issued
          to Argyle Capital Management Corporation (the “Argyle Notes”), which is wholly
          owned by Robert A. Olins, our former Chief Executive Officer, Secretary,
          Treasurer and a former Director, based upon an Intercreditor Agreement.
           This Intercreditor Agreement precludes us from repaying the Arygle Notes
          in cash or other property until the holders of our Senior Secured Convertible
          Notes have been repaid.  The Intercreditor Agreement does not, however,
          preclude us from paying in either cash or shares, interest on the Argyle
          Notes
          provided there has not been an event of default under the Senior Secured
          Convertible Notes, as defined in the agreement.  Under the terms of the
          Intercreditor Agreement, Argyle maintains its rights to convert the Argyle
          Notes
          into shares of our common stock under the conversion terms of the Argyle
          Notes,
          as described above, at any time.  The holders of our Senior Secured
          Convertible Notes have a senior security interest in substantially all
          of our
          assets, except those located in South Korea.  However, the holders of our
          Senior Secured Convertible Notes have a pledge on SpatiaLight Korea’s shares.
 In addition, under the terms of the November 2004 Financing, we are
          prohibited from using the proceeds from the financing to repay debt or to pay
          dividends, and we are prohibited from paying dividends while the Senior
          Secured
          Convertible Notes are outstanding.
 
 We
          were
          required under an amended registration rights agreement, to file a registration
          statement for resale of the shares issuable upon conversion of the Senior
          Secured Convertible Notes and to maintain its effectiveness to allow the
          holders
          of our Senior Secured Convertible Notes to convert their notes and sell
          the
          underlying common shares freely.  We reported in Post Effective Amendment
          No. 2 to our registration statement on Form S-3 relating to the Senior
          Secured
          Convertible Notes (Reg. No. 333-122391), that in late August 2005 we advised
          the
          holders of our Senior Secured Convertible Notes that until the matter concerning
          the filing of an unauthorized consent of our former auditors, BDO Seidman
          LLP,
          is resolved, sales using the prospectus which is the subject of that
          registration statement may result in potential liability. One of the holders
          of
          the Senior Secured Convertible Notes, Portside Growth & Opportunity Fund,
          has claimed that the post-effective amendment resulted in an obligation
          for the
          Company to pay each Noteholder liquidated damages in cash equal to 1% of
          the
          purchase price of the notes, and 1% for every 30 days thereafter, until
          the
          matter concerning the consent is resolved.  That amount would equal
          $534,000 and $615,000 as of December 31, 2005 and February 14, 2006 (when
          the
          post-effective amendment to the registration statement was declared effective),
          respectively.  We do not believe that we are contractually obligated to
          make those payments and therefore we have not accrued for the alleged liquidated
          damages.  However, should the Noteholders pursue their claim for liquidated
          damages pursuant to the registration rights agreement and prevail on their
          claim
          in a court of law, the alleged liquidated damages would immediately become
          due
          and payable.  In February 2006, Post-Effective Amendment No. 6 to the
          registration statement referenced above was declared effective by the
          SEC.
  63
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Portside
          Growth & Opportunity Fund has also claimed the following additional events
          of default under the Senior Secured Convertible Notes: (i) failure to make
          an
          interest payment due in November 2005 on a timely basis; (ii) incurrence
          of
          prohibited indebtedness to our former officers and/or directors of the
          Company;
          (iii) incurrence of prohibited indebtedness by our South Korean subsidiary
          to
          certain banks in South Korea; (iv) granting of a security interest by our
          South
          Korean subsidiary in certain assets located in South Korea; (v) repayment
          by us
          of indebtedness to our officers or directors and by our South Korean subsidiary
          of indebtedness under bank credit facilities. Smithfield Fiduciary LLC,
          joined
          in the claim that a default occurred as a result of certain indebtedness
          incurred as a result of the failure to make the November 2005 interest
          payment
          in a timely fashion. Each of these notices call for us to redeem $9.0 million
          in
          the aggregate principal amount of our Senior Secured Convertible Notes,
          plus
          payment of a redemption premium of $675,000 to each of these holders.
          Furthermore, the Noteholders claim that the interest rate on the Senior
          Secured
          Convertible Notes has increased from 10% per annum to 12% per annum as
          a result
          of the claimed defaults.
 
 We
          believe, after review with outside legal counsel, that these allegations
          lack
          merit and would not entitle the Noteholders to call the notes and other
          remedies
          that they are seeking.  We believe that the Noteholders have undertaken to
          make allegations of events of default that lack merit in an attempt to
          obtain an
          amendment to the terms of the Senior Secured Convertible Notes to reduce
          the
          conversion price, accelerate repayment and increase the interest rate.
 We
          have rejected offers from the Noteholders in this regard, and plan to vigorously
          defend our position. If the Noteholders prevail in calling the Notes, the
          entire
          $10 million debt obligation would become due and payable immediately, including
          the redemption premiums of $1.5 million and liquidated damages of $683000. 
We have not accrued the above described redemption premiums or liquidated
          damages as of December 31, 2005 or December 31, 2006.
 
 In
          consideration for Argyle entering into the Intercreditor Agreement, our
          Board of
          Directors authorized us to enter into an extension and modification agreement
          with Argyle with respect to the Argyle Notes (the Extension Agreement)
          under
          which the due date of the Argyle Notes was extended to December 31,
          2008.
 
 Under
          the
          terms of the November 2004 Financing, Robert A. Olins and Greenpark Limited,
          an
          unaffiliated stockholder, jointly and severally committed, in the event
          that the
          Board of Directors determines that such financing is necessary, to provide
          us
          with up to an additional $6 million in future financing on terms and conditions
          to be determined at the time of any such transaction. That financing commitment
          shall be reduced by any funds that we receive from future sales or exercises
          of
          our equity, debt or derivative securities, including the sale of our common
          shares under the prospectus that we filed with the SEC on January 28, 2005,
          as a
          part of a “shelf” registration process. As of the date of this filing, taking
          into account the October 2005 Private Placement and stock option exercises,
          we
          had received an aggregate total of greater than $6 million, thereby fulfilling
          the commitment by Mr. Olins and Greenpark Limited.
 
 Under
          the
          terms of the November 2004 Financing, the purchasers received the right
          (additional investment rights or AIR) to purchase up to an additional $5
          million
          of senior secured convertible notes subject to the same terms and conditions,
          including the same conversion price as the notes issued in the November
          2004
          Financing. The AIR originally expired on November 30, 2005, but was amended
          on
          December 21, 2004 to expire on August 31, 2005. The fair value of the AIR
          was
          calculated on the November 30, 2004 issuance date at $1,072,248 using the
          Black-Scholes option pricing model (see table below.) This AIR is being
          treated
          as a derivative and has been recorded as a note purchase option liability
          and as
          a discount on the 2004 Senior Secured Convertible Notes. The AIR is not
          a
          hedging derivative. The fair value of the derivative has been recalculated
          on a
          quarterly basis until exercise or expiration to reflect the changing market
          price of the stock, the remaining contractual term, and the changing volatility.
          The objective in entering into the agreement for the AIR was that it was
          required by the lenders in order to complete the financing agreement. Below
          is a
          table reflecting the fair value of the AIR at each period end date and
          the
          Black-Scholes assumptions used to calculate the fair value. The assumptions
          changed from the November 2004 valuation date in that the market price
          of our
          common shares had changed, the contractual life had changed due to the
          December
          21, 2004 amendment, and the volatility changed as a result of the changes
          in
          market price and contractual life. Any reduction in the note purchase option
          liability due to the revaluation of the AIR is recorded as a gain from
          the
          revaluation of the note purchase option liability and is included in other
          income. The remaining value of the note purchase option liability was written
          off upon expiration on August 31, 2005.
  64
 SPATIALIGHT,
          INC.
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
          31, 2006, 2005 AND 2004
 **Fair
                      Value Date***
                  
                  **Fair
                      Value**
                  
                  **Gain
                      Recognized for Quarter**
                  
                  **Cumulative
                      Gain**
                  
                  **Current
                      Stock Price**
                  
                  **Volatility**
                  
                  **Risk-Free
                      Interest Rate**
                  
                  **Contractual
                      Term**November
                      30, 2004
                  
                  $
                  1,072,248
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  8.83
                  
                  
                  67
                  %
                  
                  2.50
                  %
                  
                  1
                      yearDecember
                      31, 2004
                  
                  $
                  659,874
                  
                  $
                  412,374
                  
                  $
                  412,374
                  
                  $
                  8.95
                  
                  
                  52
                  %
                  
                  2.50
                  %
                  
                  8
                      monthsMarch
                      31, 2005
                  
                  $
                  8,639
                  
                  $
                  651,235
                  
                  $
                  1,063,609
                  
                  $
                  5.05
                  
                  
                  49
                  %
                  
                  2.50
                  %
                  
                  5
                      monthsJune
                      30, 2005
                  
                  $
                  2,102
                  
                  $
                  6,537
                  
                  $
                  1,070,146
                  
                  $
                  5.67
                  
                  
                  54
                  %
                  
                  3.00
                  %
                  
                  2
                      monthsSeptember
                      30, 2005
                  
                  $
                  -
                  
                  $
                  2,102
                  
                  $
                  1,072,248
                  
                  $
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  expired*
                      Exercise price for all dates is $9.72 per share and dividend
                      yield for all
                      dates is zero.
  The
          $1,072,248 discount applied to the 2004 Senior Secured Convertible Notes
          gave
          rise to a beneficial conversion feature of $156,610 resulting from the
          excess
          aggregate value of the common shares issuable upon conversion of the 2004
          Senior
          Secured Convertible Notes into common shares over the discounted carrying
          value
          of the 2004 Senior Secured Convertible Notes at the issuance date. The
          resulting
          beneficial conversion feature is treated as an additional discount to the
          2004
          Senior Secured Convertible Notes and an increase in additional paid-in
          capital,
          and is being amortized, along with the original discount related to the
          value of
          the AIR, over the life of the 2004 Senior Secured Convertible Notes. In
          addition, $100,000 of legal fees reimbursed to one of the lenders was recorded
          as a note discount and is being amortized over the life of the notes. Additional
          financing costs of $117,162 were recorded as prepaid expenses and are being
          amortized over the life of the notes. The effective interest rate for financial
          statement purposes due to the discount related to the AIR and beneficial
          conversion feature mentioned above differs from the actual contractual
          interest
          paid or payable in cash or shares to the noteholders. These discounts,
          along
          with the contractual 10% interest rate, results in an effective rate of
          14.4%
          per annum.
  65
 SPATIALIGHT,
          INC.
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
          31, 2006, 2005 AND 2004
  Activity
          in convertible notes payable for 2006 and 2005 is as follows:
 
 **Debt
                      Principal:**
                  
                  **Balance
                      at December 31, 2005**
                  
                  **Addition
                      or New Discount**
                  
                  **(Payment)
                      or Discount Amortization**
                  
                  **Conversion
                      to Equity**
                  
                  **Balance
                      at December 31, 2006**Argyle
                  
                  $
                  1,188,000
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  1,188,000November
                      financing
                  
                  
                  10,000,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  10,000,000November
                      financing discounts for:Beneficial
                      conversion feature
                  
                  
                  (100,060
                  )
                  
                  -
                  
                  
                  52,200
                  
                  
                  -
                  
                  
                  (47,860
                  )Reimbursement
                      of investor's legal fees
                  
                  
                  (63,889
                  )
                  
                  -
                  
                  
                  33,333
                  
                  
                  -
                  
                  
                  (30,556
                  )AIR
                      or note purchase option
                  
                  
                  (683,938
                  )
                  
                  -
                  
                  
                  358,440
                  
                  
                  -
                  
                  
                  (325,498
                  )**Total
                      Convertible Notes**
                  
                  $
                  10,340,113
                  
                  $
                  -
                  
                  $
                  443,973
                  
                  $
                  -
                  
                  $
                  10,784,086**Accrued
                      Interest:**Accrued
                      Argyle 6%
                  
                  $
                  -
                  
                  $
                  71,280
                  
                  $
                  -
                  
                  $
                  (71,280
                  )
                  $
                  -Beneficial
                      interest
                  
                  
                  -
                  
                  
                  1,085,853
                  
                  
                  -
                  
                  
                  (1,085,853
                  )
                  
                  -November
                      financing
                  
                  
                  84,932
                  
                  
                  992,663
                  
                  
                  (247,923
                  )
                  
                  (745,319
                  )
                  
                  84,353**Total
                      Accrued Interest**
                  
                  $
                  84,932
                  
                  $
                  2,149,796
                  
                  $
                  (247,923
                  )
                  $
                  (1,902,452
                  )
                  $
                  84,353**Debt
                      Principal:**
                  
                  
                  **Balance
                      at December 31, 2004**
                  
                  
                  **Addition
                      or New Discount**
                  
                  
                  **(Payment)
                      or Discount Amortization**
                  
                  
                  **Conversion
                      to Equity**
                  
                  
                  **Balance
                      at December 31, 2005**Argyle
                  
                  $
                  1,188,000
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  1,188,000Argyle
                      discount
                  
                  
                  (11,000
                  )
                  
                  -
                  
                  
                  11,000
                  
                  
                  -
                  
                  
                  -November
                      financing
                  
                  
                  10,000,000
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  10,000,000November
                      financing discounts for:Beneficial
                      conversion feature
                  
                  
                  (152,260
                  )
                  
                  -
                  
                  
                  52,200
                  
                  
                  -
                  
                  
                  (100,060
                  )Reimbursement
                      of investor's legal fees
                  
                  
                  (97,222
                  )
                  
                  -
                  
                  
                  33,333
                  
                  
                  -
                  
                  
                  (63,889
                  )AIR
                      or note purchase option
                  
                  
                  (1,042,378
                  )
                  
                  -
                  
                  
                  358,440
                  
                  
                  -
                  
                  
                  (683,938
                  )**Total
                      Convertible Notes**
                  
                  $
                  9,885,140
                  
                  $
                  -
                  
                  $
                  454,973
                  
                  $
                  -
                  
                  $
                  10,340,113**Accrued
                      Interest:**Accrued
                      Argyle 6%
                  
                  $
                  -
                  
                  $
                  71,280
                  
                  $
                  -
                  
                  $
                  (71,280
                  )
                  $
                  -Beneficial
                      interest
                  
                  
                  -
                  
                  
                  845,597
                  
                  
                  -
                  
                  
                  (845,597
                  )
                  
                  -November
                      financing
                  
                  
                  84,932
                  
                  
                  1,002,740
                  
                  
                  (1,002,740
                  )
                  
                  -
                  
                  
                  84,932**Total
                      Accrued Interest**
                  
                  $
                  84,932
                  
                  $
                  1,919,617
                  
                  $
                  (1,002,740
                  )
                  $
                  (916,877
                  )
                  $
                  84,932
 
 The
          maturity date of the Senior Secured Convertible Notes is November 2007.
          Consequently, we have classified the balance related to these notes, of
          $9,596,086 at December 31, 2006 as a current debt in the consolidated balance
          sheet. The $1,188,000 outstanding balance of the Argyle notes continues
          to be
          classified as long-term debt at December 31, 2006 as they are due on December
          31, 2008.
 
 Non-cash
          interest expense is as follows:
 2006
                  
                  2005
                  
                  2004Amortization
                      of Senior Secured Convertible Notes
                  
                  $
                  443,973
                  
                  $
                  443,973
                  
                  $
                  36,998Senior
                      Secured Convertible Notes 10% interest paid in common
                      stock
                  
                  
                  745,319
                  
                  
                  -
                  
                  
                  -Amortization
                      of Argyle note discount
                  
                  
                  -
                  
                  
                  11,000
                  
                  
                  22,000Liquidated
                      damages on the October 2005, January 2006,September
                      2006 and November 2006 financing
                  
                  
                  517,817
                  
                  
                  79,000
                  
                  
                  -Beneficial
                      conversion privileges of interest on Argyle note
                  
                  
                  1,085,853
                  
                  
                  845,597
                  
                  
                  728,780Amortization
                      of prepaid financing costs
                  
                  
                  63,431
                  
                  
                  50,936
                  
                  
                  3,258Total
                      non-cash interest expense
                  
                  $
                  2,856,393
                  
                  $
                  1,430,506
                  
                  $
                  791,036
  66
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 **4.**  **Balance
          Sheet Components**
  Inventory
          as of December 31 consists of the following:
 2006
                  
                  2005Raw
                      materials
                  
                  $
                  531,114
                  
                  $
                  796,770Work-in-progress
                  
                  
                  26,088
                  
                  
                  17,043Finished
                      goods
                  
                  
                  161,285
                  
                  
                  294,287718,487
                  
                  
                  1,108,100Inventory
                      reserve
                  
                  
                  (295,412
                  )
                  
                  (351,377
                  )Total
                      inventory
                  
                  $
                  423,075
                  
                  $
                  756,723
 Property
          and equipment as of December 31, consists of the following:
  2006
                  
                  2005Building
                  
                  $
                  4,735,027
                  
                  $
                  4,360,663Other
                      equipment and instruments
                  
                  
                  2,332,603
                  
                  
                  2,659,653Machinery
                      and manufacturing equipment
                  
                  
                  1,688,943
                  
                  
                  1,141,726Office
                      furniture and equipment
                  
                  
                  463,414
                  
                  
                  590,696Tooling
                  
                  
                  371,700
                  
                  
                  371,700Leasehold
                      improvements
                  
                  
                  165,937
                  
                  
                  175,654Computer
                      software and hardware
                  
                  
                  352,825
                  
                  
                  215,109Total
                      property, plant and equipment
                  
                  
                  10,110,449
                  
                  
                  9,515,201Accumulated
                      depreciation
                  
                  
                  (3,474,598
                  )
                  
                  (2,701,681
                  )Property,
                      plant and equipment, net
                  
                  $
                  6,635,851
                  
                  $
                  6,813,520
  Accrued
          expenses and other current liabilities as of December 31, consist of the
          following:
 
 2006
                  
                  2005Deferred
                      rent
                  
                  $
                  212,886
                  
                  $
                  269,843Accrued
                      compensation
                  
                  
                  446,438
                  
                  
                  184,283Accrued
                      interest on senior secured convertible notes
                  
                  
                  84,932
                  
                  
                  84,932Accrued
                      financing fee
                  
                  
                  149,353
                  
                  
                  -Liquidated
                      damages
                  
                  
                  145,750
                  
                  
                  79,000Accrued
                      legal, accounting and consulting related services
                  
                  
                  706,643
                  
                  
                  741,855Other
                  
                  
                  47,230
                  
                  
                  29,514Total
                      accrued expenses and other current liabilities
                  
                  $
                  1,793,232
                  
                  $
                  1,389,427
 Depreciation
          and amortization expense was $864,064, $728,383, and $575,391 for the years
          ended December 31, 2006, 2005 and 2004, respectively.
 
 Rent
          expense related to operating leases was $557,576, $675,339, and $585,897
          for the
          years ended December 31, 2006, 2005 and 2004, respectively.
 
 We
          lease
          our office space under a non-cancelable operating lease. The lease expires
          in
          August 2009 and is subject to escalations in rent. Rent expense is recorded
          evenly over the lease term. Deferred rent of $212,886, $269,843 and
          $314,611 was recorded as of December 31, 2006, 2005, and 2004,
          respectively.
 
 Future
          lease obligations under non-cancelable operating leases as of December
          31, 2006
          are as follows:
 
 2007
                  
                  $
                  459,0402008
                  
                  
                  471,7682009
                  
                  
                  320,651Total
                  
                  $
                  1,251,459
 In
          September 2004, we entered into a fifty year term lease with the Gyeongnam
          provincial government for 8.3 acres of undeveloped land in Jinsa, Gyeongnam
          province in South Korea. We leased the land for the purpose of constructing
          a
          state-of-the-art manufacturing facility with the anticipated capacity to
          meet
          mass production-scale demand from our customers and prospective customers.
          We
          have received a 100% land lease payment exemption because the land has
          been
          designated a “free economic zone” by the South Korean national government and
          the South Korean government also certified us as a “high technology” company.
          Under our agreement with the Gyeongnam provincial government we could lose
          our
          land lease payment exemption in the event that we lose our “high technology”
certification.
  67
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 **5.**  **Income
          Taxes**
 
 Income
          taxes consist primarily of state minimum taxes. Income tax expense (benefit)
          differed from the amounts computed by applying the U.S. federal income
          tax rate
          of 34% to pretax losses from operations as a result of the
          following:
 2006
                  
                  2005
                  
                  2004Computed
                      tax benefit at federal statutory rate
                  
                  $
                  (6,449,000
                  )
                  $
                  (4,768,000
                  )
                  $
                  (3,185,000
                  )Federal
                      research and development credit
                  
                  
                  (51,000
                  )
                  
                  (81,000
                  )
                  
                  (91,000
                  )Permanent
                      differences:Nondeductible
                      interest
                  
                  
                  971,000
                  
                  
                  486,000
                  
                  
                  269,000Nondeductible
                      SFAS 123R stock option expense
                  
                  
                  638,000
                  
                  
                  -
                  
                  
                  -Foreign
                      earnings taxed at different rates, net of unbenefitted
                      foreign losses
                  
                  
                  (377,000
                  )
                  
                  870,000
                  
                  
                  -Other
                  
                  
                  75,000
                  
                  
                  (306,000
                  )
                  
                  132,000Changes
                      in valuation allowances
                  
                  
                  4,962,000
                  
                  
                  4,967,000
                  
                  
                  3,869,000State
                      tax benefit, net of effect on federal income taxes
                  
                  
                  (10,000
                  )
                  
                  (670,000
                  )
                  
                  (252,000
                  )Other,
                      net
                  
                  
                  242,800
                  
                  
                  (495,700
                  )
                  
                  (740,525
                  )Total
                      tax expense
                  
                  $
                  1,800
                  
                  $
                  2,300
                  
                  $
                  1,475
 
 The
          tax
          effect of temporary differences that give rise to significant portions
          of the
          deferred tax assets at December 31, is presented below:
 2006
                  
                  2005Deferred
                      tax assets:Federal
                      net operating loss carryforwards
                  
                  $
                  27,106,000
                  
                  $
                  24,168,000State
                      income tax effects and credits
                  
                  
                  5,161,000
                  
                  
                  5,186,000Korean
                      income tax effects
                  
                  
                  2,265,000
                  
                  
                  -Accrued
                      expenses
                  
                  
                  17,000
                  
                  
                  28,000Federal
                      research and development credits
                  
                  
                  1,086,000
                  
                  
                  1,031,000Options
                      and warrants
                  
                  
                  806,000
                  
                  
                  883,000Other
                  
                  
                  178,000
                  
                  
                  361,000Gross
                      deferred tax assets
                  
                  
                  36,619,000
                  
                  
                  31,657,000Valuation
                      allowance
                  
                  
                  (36,619,000
                  )
                  
                  (31,657,000Net
                      deferred tax assets
                  
                  $
                  -
                  
                  $
                  -
  The
            provision for income taxes attributable to pretax
            loss from operations follows, for the years ended December 31, 2006,
            2005 and
            2004.
  2006
                  
                  2005
                  
                  2004Loss
                      before income taxes:Domestic
                  
                  $
                  13,413,834
                  
                  $
                  11,485,540
                  
                  $
                  9,228,446International
                  
                  
                  5,553,228
                  
                  
                  2,539,099
                  
                  
                  138,555Total
                  
                  $
                  18,967,062
                  
                  $
                  14,024,639
                  
                  $
                  9,367,001
 
 The
          net
          change in the total valuation allowance was $6,192,000, $4,967,000 and
          $3,869,000 in 2006, 2005 and 2004, respectively. As of December 31, 2006,
          we had
          net operating loss carryforwards of approximately $79.7 million for federal,
          $64.7 million for state tax purposes and $2.3 million for South Korean
          purposes, respectively, which expire in varying amounts from 2007 through
          2026
          for federal purposes and through 2016 for state purposes and 2009 through
          2011
          for South Korean purposes. In addition, as of December 31, 2006, we had
          research
          and development carryforwards of approximately $1,086,000 for federal tax
          purposes, which will begin to expire in 2008 and $1,212,000 for state tax
          purposes, which do not expire.
 
 The
          Company analyzes its deferred tax assets with regard to potential realization.
          The Company has established a full valuation allowance on its deferred
          tax
          assets because management could not conclude that it was more likely than
          not
          that such deferred tax assets would be realized.
 
 Under
          the
          provisions of the Internal Revenue Code, should substantial changes in
          our
          ownership occur, the utilization of net operating loss carryforwards might
          be
          limited.
  68
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Included
          in the net operating loss carryforwards are tax benefits created resulting
          from
          tax deductions in excess of share-based compensation expense recognized
          under
          the fair value recognition provisions of SFAS 123R (windfall tax benefits).
          Although these windfall tax benefits are reflected in the total net operating
          tax loss carryforwards, pursuant to SFAS 123R, deferred tax assets associated
          with these deductions are only recognized to the extent that they reduce
          taxes
          payable. Further, these recognized deductions are treated as direct increases
          to
          stockholders’ equity (deficit) and as a result do not impact the Consolidated
          Statement of Operations. To the extent stock-option related deductions
          are not
          recognized pursuant to SFAS 123R, the unrecognized benefit is not reflected
          on
          the Consolidated Balance Sheet. We
          have elected to continue to reflect our gross net operating loss carryforward
          deferred tax assets and related valuation allowance for the accumulated
          stock
          award tax benefits determined under Accounting Principles Board (“APB”) Opinion
          No. 25, “ Accounting for Stock Issued to Employees ” (“APB 25”). We will track
          these stock award attributes separately and will only realize these attributes
          in accordance with SFAS 123(R). These additional tax benefits of net operating
          loss carryforwards related to the tax benefit from the exercise of stock
          awards
          were $1.6 million in both 2006 and 2005.
  **6.**  **Stockholders’
          Equity (Deficit)**
 
 *Stock
          Option Plans* - In
          2006 the Stockholders approved the 2006 Incentive Plan (the 2006 Plan).
          In 1999
          the Stockholders approved the 1999 Stock Option Plan (the 1999 Plan), which
          in
          turn replaced our 1993 Non-Statutory Employee Stock Option Plan, the 1993
          Non-Statutory Director Stock Option Plan, and the 1991 Stock Option Plan.
          The
          2006 Plan authorizes the issuance of options to purchase up to 5,000,000
          shares
          of our common shares. The 2006 Plan provides for the grant of incentive
          stock
          options, within the meaning of Section 422 of the Internal Revenue Code,
          nonqualified stock options, share appreciation rights, share purchase awards,
          restricted shares, restricted stock units, performance units, and other
          share-based awards. Key employees, directors, and third party service providers
          who are selected by the designated committee are eligible to participate
          in the
          plan. Third party providers include any consultant, agent, advisor, or
          independent contractor who renders services to us, or to any of our subsidiaries
          or affiliates, that are not in connection with the offer and sale of our
          securities in a capital raising transaction and do not directly or indirectly
          promote or maintain a market for our securities. The 1999 Plan authorized
          the
          issuance of options to purchase up to 4,000,000 shares of our common shares.
          It
          also provided for options which may be issued as nonqualified or qualified
          incentive stock options under Section 422A of the Internal Revenue Code
          of 1986,
          as amended.
 
 In
          June
          2002, the Stockholders approved an amendment to the 1999 Stock Option Plan
          to
          increase the maximum number of shares that can be issued pursuant to award
          grants made under the Plan by 1,000,000 common shares, raising the total
          number
          of common shares reserved for issuance thereunder to 5,000,000.
 
 In
          July
          2004, the Stockholders approved an amendment to the 1999 Stock Option Plan
          to
          increase the maximum number of shares that can be issued pursuant to award
          grants made under the Plan by 2,000,000 common shares, raising the total
          number
          of common shares reserved for issuance thereunder to 7,000,000.
 
 Under
          the
          1999 Plan, we may grant options to employees at prices not less than 85%
          of fair
          market value for non-statutory stock options, and to directors at the fair
          market value at the date of grant.
 
 Options
          under the 1999 Plan are granted to Executive Officers at the discretion
          of the
          Board of Directors/Compensation Committee. Options granted to employees
          and
          consultants are at the discretion of the CEO. Options under the 2006 Plan
          are
          granted at the discretion of the Board of Directors/Compensation Committee.
          Options under both plans generally expire 10 years from the date of grant
          and,
          in general, vest and become exercisable 50% at the end of year one and
          50% at
          the end of year two. Changes to the vesting period may be made at the discretion
          of the Board of Directors/Compensation Committee.
  Stock
          option grants to employees are generally issued with an exercise price
          equal to
          the market price on the day before the grant date. To the extent that the
          market price of the common stock exceeds the exercise price of the options,
          the
          Company recognizes deferred compensation for the intrinsic value in accordance
          with APB 25 and FIN 44. The Company amortizes deferred compensation on
          a
          straight-line basis over the vesting period of the option.
  Option
          grants to non-employees are valued at the date of grant using the Black-Scholes
          option-pricing model in accordance with FAS 123. Option grants that do
          not
          include sufficient disincentive for non-performance are accounted for in
          accordance with EITF's 96-18 and 00-18. In such instances, the deferred
          compensation is amortized over the term of the agreement on a straight-line
          basis. Until the awards are fully vested or a measurement date is achieved,
          the
          Company records an adjustment to deferred compensation and consultant expense
          to
          reflect the impact of the fair value, as remeasured at quarter-end, of
          the
          options based on changes to the Company's stock price.
  69
 SPATIALIGHT,
          INC.
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
          31, 2006, 2005 AND 2004
  The
          following is a status of the options under the Plans and outside of the
          Plans
          and a summary of the changes in options outstanding during 2006, 2005 and
          2004:
 **Number
                      of Shares**
                  
                  **Weighted
                      Average Exercise Price**
                  
                  **Weighted
                      Average Remaining Contractual Term (in Years)**
                  
                  **Aggregate
                      Intrinsic Value at December 31, 2006**Outstanding
                      January 1, 2004
                  
                  
                  4,962,333
                  
                  $
                  3.26Options
                      granted under the plan
                  
                  
                  1,122,500
                  
                  $
                  5.39Options
                      exercised
                  
                  
                  (465,083
                  )
                  $
                  2.49Options
                      cancelled
                  
                  
                  (161,250
                  )
                  $
                  4.43Outstanding
                      December 31, 2004
                  
                  
                  5,458,500
                  
                  $
                  3.89Options
                      granted under the plan
                  
                  
                  735,000
                  
                  $
                  5.03Options
                      exercised
                  
                  
                  (213,606
                  )
                  $
                  2.08Options
                      cancelled
                  
                  
                  (97,500
                  )
                  $
                  5.90Outstanding
                      December 31, 2005
                  
                  
                  5,882,394
                  
                  $
                  4.06
                  
                  
                  5.79Options
                      granted under the plan
                  
                  
                  900,000
                  
                  $
                  2.57Options
                      exercised
                  
                  
                  (50,000
                  )
                  $
                  0.80Options
                      cancelled
                  
                  
                  (1,012,500
                  )
                  $
                  8.10Outstanding
                      December 31, 2006
                  
                  
                  5,719,894
                  
                  $
                  3.15
                  
                  
                  5.80
                  
                  $
                  162,270Options
                      vested and exercisableat
                      December 31, 2006
                  
                  
                  5,657,394
                  
                  $
                  3.14
                  
                  
                  5.77
                  
                  $
                  162,270
 
 At
          December 31, 2006, 870,000 of the options outstanding were granted outside
          of
          the 2006 and 1999 Plans. Options exercisable as of December 31, 2006 and
          2005
          totaled 5,657,394 and 5,302,394 options, respectively, at a weighted average
          exercise price of $3.14 and $3.55 per share, respectively. Of the options
          exercisable as of December 31, 2006, 870,000 options were issued outside
          of the
          2006 and 1999 Plans at a weighted average exercise price of $1.50.
 
 Aggregate
          intrinsic value is the sum of the amounts by which the quoted market price
          of
          our stock at December 29, 2006 (the last trading day of 2006), $1.35 per
          share,
          exceeded the exercise price of the options, for those options for which
          the
          quoted market price was in excess of the exercise price
          (“in-the-money-options”). The aggregated intrinsic value of options exercised on
          the dates the options were exercised was $112,865 and $1,512,567 for the
          year
          ended December 31, 2006 and 2005, respectively.
  As
          of
          December 31, 2006, total expected compensation cost of options outstanding
          but
          not yet vested is approximately $57,593. This cost is expected to be recognized
          through June 2008. We recorded no income tax benefits for stock-based
          compensation expense arrangements for the years ended December 31, 2006,
          2005
          and 2004, as we have cumulative operating losses, for which a full valuation
          allowance has been established.
 
 
 The
          weighted average exercise price of options granted during 2006, 2005 and
          2004
          are as follows:
 
 2006
                  
                  2005
                  
                  2004Exercise
                      price equals market price
                  
                  $
                  2.57
                  
                  $
                  5.03
                  
                  $
                  2.18Exercise
                      price is less than market price
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -Exercise
                      price is more than market price
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
  70
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 Additional
          information regarding options outstanding as of December 31, 2006 is as
          follows:
 
 **Options
                      Outstanding**
                  
                  **Options
                      Exercisable**Range
                      of Exercise Prices
                  
                  Outstanding
                      at December 31, 2006
                  
                  Weighted
                      Average Remaining Contractual Life (Yrs.)
                  
                  Weighted
                      Average Exercise Price
                  
                  Number
                      Exercisable
                  
                  Weighted
                      Average Exercise Price$6.01
                      - 9.00
                  
                  
                  10,000
                  
                  
                  8.0
                  
                  $
                  8.35
                  
                  
                  10,000
                  
                  $
                  8.35$5.01
                      - 6.00
                  
                  
                  952,500
                  
                  
                  7.1
                  
                  $
                  5.43
                  
                  
                  952,500
                  
                  $
                  5.43$4.01
                      - 5.00
                  
                  
                  745,000
                  
                  
                  7.8
                  
                  $
                  4.93
                  
                  
                  707,500
                  
                  $
                  4.93$3.01
                      - 4.00
                  
                  
                  489,444
                  
                  
                  5.1
                  
                  $
                  3.60
                  
                  
                  489,444
                  
                  $
                  3.60$2.01
                      - 3.00
                  
                  
                  2,333,750
                  
                  
                  6.9
                  
                  $
                  2.45
                  
                  
                  2,308,750
                  
                  $
                  2.45$1.01
                      - 2.00
                  
                  
                  945,000
                  
                  
                  4.5
                  
                  $
                  1.52
                  
                  
                  945,000
                  
                  $
                  1.52$0.25
                      - 1.00
                  
                  
                  244,200
                  
                  
                  1.4
                  
                  $
                  0.69
                  
                  
                  244,200
                  
                  $
                  0.695,719,894
                  
                  
                  
                  
                  
                  
                  
                  
                  5,657,394
  At
          December 31, 2006, 5,204,166 options were available for future grants under
          the
          2006 and 1999 Plans.
 
 *Warrants
          outstanding and exercisable*
 
 Additional
          information regarding warrants outstanding as of December 31, 2006 is as
          follows:
 
 **Warrants
                      Outstanding and Exercisable**Exercise
                      Price
                  
                  Outstanding
                      at December 31, 2006
                  
                  Remaining
                      Contractual Life (Yrs.)$
                      1.75
                  
                  
                  4,872,000
                  
                  
                  4.9$
                      2.25
                  
                  
                  89,189
                  
                  
                  4.7$
                      2.65
                  
                  
                  323,296
                  
                  
                  1.4$
                      3.29
                  
                  
                  123,465
                  
                  
                  1.6$
                      5.00
                  
                  
                  228,576
                  
                  
                  3.85,636,526
 
 *Diluted
          net loss per share*
  Diluted
          net loss per share does not include the effect of the following potential
          common
          shares at December 31:
 
 2006
                  
                  2005
                  
                  2004Shares
                      issuableunder
                      stock options
                  
                  
                  5,719,894
                  
                  
                  5,882,394
                  
                  
                  5,458,500Shares
                      issuable pursuant to warrants to purchase common shares
                  
                  
                  5,636,526
                  
                  
                  750,337
                  
                  
                  746,761Shares
                      of convertible notes on an "as if converted" basis
                  
                  
                  3,404,807
                  
                  
                  3,404,807
                  
                  
                  3,404,807
 
 The
          weighted average exercise price of stock options outstanding was $3.15,
          $4.06,
          and $3.89 as of December 31, 2006, 2005, and 2004 respectively. The weighted
          average exercise price of warrants was $1.98, $3.96, and $3.12, per share
          as of
          December 31, 2006, 2005 and 2004, respectively.
  71
 SPATIALIGHT,
          INC.
 NOTES
          TO
          CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
          31, 2006, 2005 AND 2004
  **7.**  **Quarterly
          Results (Unaudited)**
 
 Summarized
                      unaudited results of operations for each quarter of the years
                      ended
                      December 31, 2006 and
                      December 31, 2005 are as follows:Year
                      Ended
                  
                  First
                      Quarter
                  
                  Second
                      Quarter
                  
                  Third
                      Quarter
                  
                  Fourth
                      QuarterDecember
                      31, 2006Revenue
                  
                  $
                  85,694
                  
                  $
                  59,148
                  
                  $
                  298,046
                  
                  $
                  31,116Gross
                      margin
                  
                  $
                  (1,462,636
                  )
                  $
                  (1,542,866
                  )
                  $
                  (1,367,278
                  )
                  $
                  (1,014,860
                  )Loss
                      before cumulativeeffect
                      of change inaccounting
                      principle
                  
                  $
                  5,632,669
                  
                  $
                  5,304,581
                  
                  $
                  4,173,985
                  
                  $
                  3,631,834Cumulative
                      effect of changein
                      accounting principle
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  (223,993
                  )Net
                      loss
                  
                  $
                  5,632,669
                  
                  $
                  5,304,581
                  
                  $
                  4,173,985
                  
                  $
                  3,855,827Net
                      loss per share - basic and
                    diluted:Loss
                      per share beforecumulative
                      effect of changein
                      accounting principle
                  
                  $
                  (0.15
                  )
                  $
                  (0.13
                  )
                  $
                  (0.10
                  )
                  $
                  (0.08
                  )Cumulative
                      effect of changein
                      accounting principle
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  -
                  
                  $
                  (0.01
                  )Net
                      loss per share
                  
                  $
                  (0.15
                  )
                  $
                  (0.13
                  )
                  $
                  (0.10
                  )
                  $
                  (0.09
                  )Year
                      Ended
                  
                  
                  First
                      Quarter
                  
                  
                  Second
                      Quarter
                  
                  
                  Third
                      Quarter
                  
                  
                  Fourth
                      QuarterDecember
                      31, 2005Revenue
                  
                  $
                  97,759
                  
                  $
                  41,149
                  
                  $
                  58,457
                  
                  $
                  40,359Gross
                      margin
                  
                  $
                  27,915
                  
                  $
                  (47,895
                  )
                  $
                  965
                  
                  $
                  (1,500,350
                  )Net
                      loss
                  
                  $
                  2,148,535
                  
                  $
                  3,524,447
                  
                  $
                  3,620,751
                  
                  $
                  4,730,906Basic
                      and diluted loss per share$
                  (0.06
                  )
                  $
                  (0.10
                  )
                  $
                  (0.10
                  )
                  $
                  (0.13
                  )
 
 **8.**  **Inventory
          Reserves**
 
 Balance
                      at Beginning of Period
                  
                  Additions
                      - Charged to Expense
                  
                  Deductions
                      - and Writeoffs Charged to Reserves
                  
                  Balance
                      at End of PeriodYear
                      ended December 31, 2006Inventory
                      allowance
                  
                  $
                  351,377
                  
                  $
                  444,364
                  
                  $
                  (500,329
                  )
                  $
                  295,412Year
                      ended December 31, 2005Inventory
                      allowance
                  
                  $
                  -
                  
                  $
                  351,377
                  
                  $
                  -
                  
                  $
                  351,377Year
                      ended December 31, 2004Inventory
                      allowance
                  
                  $
                  210,000
                  
                  $
                  -
                  
                  $
                  (210,000
                  )
                  $
                  -
 
 **9.**  **Management
          Changes**
 
 On
          June
          13, 2006, Theodore H. Banzhaf resigned as our Executive Vice President of
          Strategic Planning and as President and Chief Executive Officer of SpatiaLight
          Technologies, Inc., a non-active wholly owned subsidiary, effective immediately.
          Mr. Banzhaf’s vested options to purchase 265,000 common shares of the Company
          awarded pursuant to his Time Accelerated Restricted Stock Award Plan expired
          on
          September 13, 2006. Pursuant to a General Release contract between Mr.
          Banzhaf
          and us, Mr. Banzhaf received his current salary through September 9, 2006.
 
 JeWon
          Yeun resigned as our President of SpatiaLight Korea, effective May 31,
          2006.
  72
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 On
          November 3, 2006, Robert A. Olins resigned as our Chief Executive Officer,
          Secretary, Treasurer and a Director, effective immediately. In accordance
          with a
          severance agreement dated December 12, 2006, Mr. Olins will continue to
          work
          with us on a consultant basis, for $1,500 per week for a period of 13 months.
          We
          may also, upon approval of the stockholders at our 2007 Annual Meeting,
          exchange
          all outstanding stock options granted to Mr. Olins for a number of shares
          of our
          common stock that is equal to the value of the outstanding options as of
          the
          date of stockholder approval of the option exchange. The value of the options
          will be determined in accordance with the Black-Scholes valuation method,
          based
          on the assumptions used in valuing our stock options under SFAS
          123R.
 
 On
          November 3, 2006, the Company’s Board of Directors elected Don S. Suh, 49, as
          the Company’s Chief Executive Officer, replacing Robert A. Olins. On December
          12, 2006, Mr. Suh’s employment was terminated and his non-vested options were
          cancelled as of that date.
 
 On
          November 3, 2006, the Company’s Board of Directors appointed David F. Hakala, 54
          to be the Chairman of the Board of Directors, replacing Lawrence Matteson
          who
          remained on the Board through December 31, 2006. Dr. Hakala was also appointed
          as the Principal Accounting Officer. Dr. Hakala continues in the capacity
          as
          Chief Operating Officer. On December 12, 2006 Dr. Hakala was appointed
          our Chief
          Executive Officer in addition to his other responsibilities.
 
 On
          December 31, 2006, Lawrence Matteson resigned from the Board of
          Directors.
 
 **10.**  **Commitments
          and Contingencies**
 
 *Lease
          Commitments*
 
 Our
          lease
          commitments are described in Note 4. As
          discussed in Note 4, in September 2004, we entered into a fifty year term
          lease
          with the Gyeongnam provincial government for 8.3 acres of undeveloped land
          in
          Jinsa, Gyeongnam province in South Korea. We have received a 100% land
          lease
          payment exemption because the land has been designated a “free economic zone” by
          the South Korean national government and the South Korean government also
          certified us as a “high technology” company. Under our agreement with the
          Gyeongnam provincial government we could lose our land lease payment exemption
          in the event that we lose our “high technology” certification, which could
          increase the costs of operating the facility and negatively impact our
          business.
          Additionally, if we were to lose, we might be required to donate the building
          to
          the South Korean government.
 
 *Alleged
          Events of Default on Senior Secured Convertible Notes*
 
 Certain
          allegations of events of default related to the November 30, 2004 Financing
          have
          been communicated to us as more fully described in Note 3.
  *Guarantees
          and Indemnifications*
  As
          permitted under New York law and in accordance with our Bylaws, we indemnify
          our
          officers and directors for certain events or occurrences while the officer
          or
          director is or was serving at the Company’s request in such capacity. The term
          of the indemnification period is for the officer’s or director’s lifetime. The
          maximum amount of potential future indemnification is unlimited. We are
          unable
          to estimate the fair value of these indemnification agreements and accordingly,
          we have not recorded any liabilities for these agreements as of
          December 31, 2006.
 
 *Other*
 
 In
          connection with his departure, Don Suh, our former Chief Executive Officer,
          has
          filed a claim against the Company alleging the Company violated the
          Sarbanes-Oxley Whistleblower laws and is asking for severance of $250,000
          plus a
          year’s worth of benefits. We do not believe that his assertions have merit but
          cannot predict the ultimate outcome of any potential litigation.
 
 We
          are
          not currently involved in any other material legal proceedings. We are
          a party
          to routine claims and lawsuits from time to time in the ordinary course
          of
          business. While the outcome of such ordinary course proceedings cannot
          be
          predicted with certainty, we believe that the resolution of any future
          ordinary
          course matters individually or in the aggregate will not have a material
          adverse
          effect on our business, financial condition or results of operations.
 
 *U.S.
          Securities and Exchange Commission Investigations*
 
 As
          previously reported in our post-effective amendments to the Form S-3
          Registration Statement registering the common shares underlying the Senior
          Secured Convertible Notes (the “Financing Registration Statement”) (File No.
          333-122391) and the Form S-3 Registration Statement registering common
          shares on
          a “shelf” (the “Shelf Registration Statement”) (File No. 333-122392), we filed
          an unauthorized consent of BDO Siedman LLP to Amendment Nos. 5 and 6 to
          the
          Financing Registration Statement and to Amendment Nos. 3 and 4 to the Shelf
          Registration Statement in order to incorporate by reference their report
          on our
          consolidated financial statements for the fiscal years ended December 31,
          2002
          and 2003, respectively. Although we received the requisite authorized consents
          from BDO Seidman LLP to incorporate by reference their report on the
          consolidated financing statements into the Financing Registration Statement
          and
          the Shelf Registration Statement when initially filed and in subsequent
          amendments thereto (and BDO Seidman LLP has not withdrawn these subsequent
          consents), we did not receive the requisite authorization from BDO Seidman
          LLP
          to file its consent as an exhibit to the penultimate and final pre-effective
          amendments to either the Financing Registration Statement or the Shelf
          Registration Statement (i.e. Amendment Nos. 5 and 6 and Amendment Nos.
          3 and 4
          to the respective registration statements). The penultimate and final
          pre-effective amendments to both the Financing Registration Statement and
          the
          Shelf Registration Statement were filed with the SEC on July 27, 2005.
  73
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 The
          Audit
          Committee of our Board of Directors conducted an investigation and review
          of the
          developments pertaining to the BDO Seidman LLP consent issue with the assistance
          of independent counsel.
 
 The
          Audit
          Committee delivered its draft report, dated October 31, 2005, to our then-Chief
          Executive Officer, Robert A. Olins. The Report concluded that the evidence
          does
          not support a finding that any of our employees included the unauthorized
          BDO
          Seidman LLPconsents in the amendments to the Registration Statements referred
          to
          above with fraudulent intent or with specific knowledge that BDO Seidman
          LLP had
          not authorized the filing of these consents. It concluded that the evidence
          was
          consistent with our inclusion of the consents due to lack of communication,
          a
          series of misunderstandings and/or a failure of inquiry. As to Mr. Olins,
          the
          Report concluded that the Audit Committee found no evidence that Mr. Olins
          was
          informed that BDO Seidman LLP had not authorized the filing of these consents.
          However, it also found no evidence that Mr. Olins inquired or determined
          whether
          BDO Seidman LLP had in fact authorized inclusion of the consents in these
          filings. The Audit Committee Report determined that Mr. Olins, as our Chief
          Executive Officer, did not exercise sufficient diligence in supervising
          the
          filing of the amendments to the Registration Statements, that this was
          a
          particularly serious failing in light of the SEC having highlighted the
          need for
          consents from BDO Seidman LLP, and that as CEO he bears responsibility
          for the
          filings. The Audit Committee also stated its belief that, throughout the
          process
          of preparing and filing the amendments to the Registration Statements,
          Mr. Olins
          acted with our best interests and the best interests of our stockholders
          in
          mind, and that his lack of diligence was not motivated by self-interest
          and that
          nothing related to this incident personally benefited him financially.
 
 The
          Audit
          Committee recommended three remedial actions. It concluded that the membership
          of the Board of Directors should be supplemented with a financial expert
          within
          the meaning of SEC rules. It also concluded that we must improve our corporate
          governance and disclosure controls, including hiring a full-time Chief
          Financial
          Officer and a Controller (who can be the same person). It further concluded
          that
          by reason of Mr. Olins' responsibility as CEO for supervision of corporate
          filings, he should reimburse us for the sum of $50,000, a portion of the
          costs
          incurred by us by reason of the unauthorized BDO Seidman LLP consents and
          the
          resulting inquiries. In compliance with the Audit Committee Report, in
          December
          2005, Mr. Olins made the $50,000 payment to reimburse the Company. To date,
          our
          Board of Directors has not been supplemented with a financial expert and
          although we have not hired a fulltime CFO or Controller, we have hired
          a
          Director of Accounting and Finance.
 
 We
          have
          been advised by the Staff of the SEC that the Staff is conducting an
          investigation into matters and events pertaining to the filing of the
          unauthorized BDO consents. We have been cooperating fully with the Staff
          with
          respect to this matter.
  As
          discussed in Note 2 - Short Swing Profits and SEC
          Investigation, the Staff of the SEC is conducting an investigation into
          transactions in our securities by Mr. Olins and an entity he controls.
          We have
          been cooperating fully with the Staff with respect to this matter.
  *Other
          matters*
 
 Following
          the filing in July 2005 of amendment number 6 to the Financing Registration
          Statement and amendment number 4 to the “shelf” registration statement, which
          contained the unauthorized consents referred to above, the Staff of the
          SEC
          declared both of the registration statements effective. In August 2005,
          we filed
          post-effective amendments number 1 to both of these registration statements
          (those post-effective amendments were subsequently withdrawn and replaced
          by
          additional post-effective amendments), which disclosed the filing of the
          unauthorized consents.
 
 Because
          both registration statements were used to sell common shares after the
          Staff of
          the SEC declared the registration statements effective, it is conceivable
          that
          there may be litigation against us or our officers or directors under Section
          11
          of the Securities Act. Although we do not believe that the filing of an
          invalid
          consent constitutes a materially misleading statement or an omission to
          disclose
          a material fact within the meaning of Section 11 of the Securities Act,
          a
          contrary determination could result in a liability for us.
 
 At
          present, we are unable to ascertain the exact amount of damages, if any,
          to
          which we could potentially be subject under a Section 11 claim instituted
          by any
          persons who directly purchased shares pursuant to those registration statements.
          Furthermore, at this date, we cannot ascertain the amount of damages, if
          any,
          for which we could be liable for claims instituted by any subsequent purchasers
          who could trace the shares purchased by them to those registration statements.
          In August 2005, we sold 500,000 common shares to three institutional purchasers
          for $5.40 per share pursuant to the “shelf” registration statement referenced
          herein. Each of those investors has since represented to us in writing,
          in
          connection with a separate transaction, that they have disposed of all
          of those
          shares. One of those institutional investors has represented to us that
          it sold
          those shares at a sale price at or higher than its purchase price from
          us. We
          believe, based upon discussions with the other two investors, that they
          sold
          their shares at a sale price of not lower than $4.25 per share. Therefore,
          we
          believe that our maximum damages pursuant to Section 11 claims from direct
          purchasers, which we would fully contest, would be $391,000, or the difference
          between the two investor’s purchase price and lowest believed resale price,
          multiplied by the 340,000 shares that they purchased and then
          resold.
 
 In
          addition to any damage claims, which may be material to our financial condition,
          any lawsuit alleging securities law violations could require us to expend
          significant financial and managerial resources.
   74
 SPATIALIGHT,
            INC.
 NOTES
            TO
            CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
            31, 2006, 2005 AND 2004
 **11.**  **Subsequent
          Events after December 31, 2006**
 
 On
          February 14, 2007, our $75,000,000 Shelf registration statement (333-137100)
          was
          declared effective.
 
 On
          February 23, 2007, when the price of our common stock was $1.31, we sold
          to five
          institutional buyers that participated in the November 2006 Financing,
          an
          aggregate of 2,190,477 of our common shares at a purchase price of $1.05
          per
          share. In addition, we issued 600,000 shares of our common stock, valued
          at
          $786,000, as a fee to obtain a one-time waiver of contractual prohibitions
          under
          the November 2006 Financing against offering shares of our common stock
          for less
          than $1.30 per share. We received aggregate proceeds of $2.3 million, before
          issuance costs, from the sale of these shares, which will be used for working
          capital and other corporate purposes. We made the sale pursuant to our
“shelf”
registration statement on Form S-3 (File No. 333-137100), which was declared
          effective by the SEC on February 14, 2007.
 
 On
          March
          6, 2007, we entered into First Amendments to Registration Rights Agreement
          amending the Registration Rights Agreements dated September 26, 2006 between
          the
          Company and each of Bluegrass Growth Fund, L.P. and Bluegrass Growth Fund,
          LTD.
          In exchange for the forgiveness of accrued liquidated damages under the
          Registration Rights Agreement in the amount of $30,806 and the rescission
          of an
          obligation to issue 250,000 warrants to purchase Common Shares, the Company
          issued to Bluegrass Growth Fund, L.P. and Bluegrass Growth Fund, LTD. an
          aggregate of 500,000 Common Shares. The Common Shares, valued at $545,000
          were
          issued on March 6, 2007, when the price of our common stock was $1.09,
          were
          issued pursuant to the Company’s Registration Statement on Form S-3 (File No.
          333-137100), which was declared effective by the U.S. Securities and Exchange
          Commission on February 14, 2007.
 
 On
          March
          9, 2007, we were orally informed by LGE of their intent to discontinue
          production of RPTVs (both LCoS and DLP). As a result, we do not expect
          significant further sales to LGE, are currently in negotiations with LGE
          related
          to an appropriate exit strategy, and are currently assessing the impact
          of this
          communication on our business. This may result in an impairment charge
          to our
          long lived assets at our manufacturing plant in South Korea in the first
          quarter
          of fiscal year 2007.
 
  75
  **Item
          9.**  **Changes
          in and Disagreements with Accountant on Accounting and Financial
          Disclosure.**
 
 None.
 
 **Item
          9A. Controls and Procedures.**
 
 *Disclosure
          Controls and Internal Controls.* **** As
          of
          December 31, 2006, under the supervision of our principal executive and
          financial officer (CEO), we evaluated the effectiveness of the design and
          operation of our "disclosure controls and procedures", as such term is
          defined
          under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934,
          as
          amended (Disclosure Controls), and our "internal controls and procedures
          for
          financial reporting" (Internal Controls).
  *Limitations
          on the Effectiveness of Controls.* Our CEO
          does not expect that our Disclosure Controls or our internal control over
          financial reporting will prevent all error and all fraud. A control system,
          no
          matter how well conceived and operated, can provide only reasonable, not
          absolute, assurance that the control system’s objectives will be met. Further,
          the design of a control system must reflect the fact that there are resource
          constraints, and the benefits of controls must be considered relative to
          their
          costs. We have only had limited revenue derived from the sale of our
          microdisplay products in the current reporting period and since we commenced
          operations. While the evaluation of our Disclosure Controls and Procedures
          and
          Internal Controls has accounted for such limited sales and revenue, new
          or
          additional controls may or may not be required once we begin selling our
          microdisplay products in increased volume in the ordinary course of business.
          Because of the inherent limitations in all control systems, no evaluation
          of
          controls can provide absolute assurance that all control issues and instances
          of
          fraud, if any, within the Company have been detected. These inherent limitations
          include the realities that judgments in decision-making can be faulty,
          and that
          breakdowns can occur because of simple error or honest mistake. Additionally,
          controls can be circumvented by the individual acts of some persons, by
          collusion of two or more persons, or by management override of the controls.
          The
          design of any system of controls also is based in part upon certain assumptions
          about the likelihood of future events, and there can be no assurance that
          any
          design will succeed in achieving its stated goals under all potential future
          conditions. Over time, specific controls may or may not become inadequate
          (e.g.,
          when we commence to sell our products in increased volume in the ordinary
          course
          of business) because of changes in conditions or deterioration in the degree
          of
          compliance with policies or procedures. Because of the inherent limitations
          in a
          cost-effective control system, misstatements due to error or fraud may
          occur and
          not be detected.
  **Conclusion
          regarding the Effectiveness of Disclosure Controls and
          Procedures**
  As
          of
          December 31, 2006, the end of the period covered by this Annual Report,
          our
          Chief Executive and Financial Officer (the “Certifying Officer”) conducted
          evaluations of our Disclosure Controls and Procedures. As defined under
          Sections
          13a-15(e) and 15d-15(e) of the Exchange Act, the term “Disclosure Controls and
          Procedures” means controls and other procedures of an issuer that are designed
          to ensure that information required to be disclosed by the issuer in the
          reports
          that it files or submits under the Exchange Act is recorded, processed,
          summarized and reported, within the time periods specified in the SEC’s rules
          and forms. Disclosure Controls and Procedures include, without limitation,
          controls and procedures designed to ensure that information required to
          be
          disclosed by an issuer in the reports that it files or submits under the
          Exchange Act is accumulated and communicated to our management, including
          our
          chief executive and financial officer, to allow timely decisions regarding
          required disclosure. Based on his evaluation, for the reasons set forth
          below,
          the Certifying Officer has concluded that our Disclosure Controls and Procedures
          were not effective to ensure that material information is recorded, processed,
          summarized and reported by management on a timely basis in order to comply
          with
          our disclosure obligations under the Exchange Act, and the rules and regulations
          promulgated thereunder.
  **Management’s
          Report on Internal Control Over Financial Reporting**
  Our
          management, under the supervision of the Certifying Officer, is responsible
          for
          establishing and maintaining adequate internal control over financial reporting
          as defined in Rule 13a-15(f) under the Exchange Act. An internal control
          system
          is designed to provide reasonable assurance regarding the preparation and
          fair
          presentation of published financial statements. Management has assessed
          the
          effectiveness of our internal control over financial reporting as of December
          31, 2006. In making its assessment of internal control over financial reporting,
          management used the criteria set forth by the Committee of Sponsoring
          Organizations (“COSO”) of the Treadway Commission in its report entitled
“Internal Control—Integrated Framework.”
 
 Internal
          control over financial reporting is a process designed to provide reasonable
          assurance regarding the reliability of financial reporting and the preparation
          of financial statements for external purposes in accordance with GAAP.
          Internal
          control over financial reporting includes those policies and procedures
          that:
 
 ·
              pertain
                  to the maintenance of records that, in reasonable detail, accurately
                  and
                  fairly reflect our transactions and dispositions of the
                  assets; ·
              provide
                  reasonable assurance that transactions are recorded as necessary
                  to permit
                  preparation of financial statements in accordance with GAAP, and
                  that our
                  receipts and expenditures are being made only in accordance with
                  authorizations of our management and Board of Directors;
                  and ·
              provide
                  reasonable assurance regarding prevention or timely detection of
                  unauthorized acquisition, use, or disposition of our assets that
                  could
                  have a material effect on the financial
                  statements.  76
 
 A
          material weakness in internal control over financial reporting is a control
          deficiency (within the meaning of the Public Company Accounting Oversight
          Board
          Auditing Standard No. 2), or combination of control deficiencies, that
          results
          in there being more than a remote likelihood that a material misstatement
          of the
          annual or interim financial statements will not be prevented or
          detected.
 
 Because
          of its inherent limitations, internal control over financial reporting
          may not
          prevent or detect misstatements. It is also a process that involves human
          diligence and compliance and may be subject to lapses in judgment and breakdowns
          resulting from human judgments. Internal control over financial reporting
          can
          also be circumvented by collusion or improper management override. Furthermore,
          projections of any evaluation of effectiveness to future periods are subject
          to
          the risks that controls may become inadequate because of changes in condition,
          or that the degree of compliance with the policies or procedures may
          deteriorate.
 
 As
          a
          result of our assessment, performed on the basis of the COSO criteria,
          management has identified the material weaknesses in annual financial reporting
          set forth below, and has concluded that, based on the specified criteria,
          we did
          not maintain effective internal control
          over financial reporting as of December 31, 2006.
 
 The
          material weaknesses identified were:
  ·
                Our
                      Audit Committee does not have a financial expert (as defined
                      by SEC
                      rules).
 ·
                We
                      lack a qualified financial executive to perform independent secondary
                      reviews over complex and non-routine accounting matters to
                      ensure they are
                      reported in accordance with
                      GAAP.
 ·
              We
                  lack information technology controls and procedures that would
                  likely
                  prevent unauthorized access to the accounting and financial systems,
                  and
                  ensure that the accounting and financial records are recoverable
in
                  the event of a disaster. ·
              We
                  do not maintain formal accounting policies and procedures related
                  to the
                  updating of standard costs and review of variances with actual costs
                  to ensure the accuracy and appropriateness of the valuation of
                  inventory. 
 **Remediation
          Plans**
 
 Management
          has reported to the Audit Committee the identification of the material
          weaknesses identified in its assessment. We intend to pursue the following
          corrective actions during fiscal year 2007 to address the material weaknesses
          we
          have identified. Our remediation plans include:
 
 Corporate
          governance - We have not taken any steps, as of the date of this filing,
          to
          address the material weaknesses relating to the facts that the audit committee
          does not have a financial expert, as defined by SEC rules. We do not presently
          have specific plans with respect to adding a director who would constitute
          a
          financial expert, nor for the addition of financial executive management
          to
          perform independent secondary reviews over complex and non-routine accounting
          matters, though we may engage a third party provider to provide such a
          service
          on a consultant basis.
 
 We
          will
          institute formal accounting policies and procedures relating to information
          technology and to the updating of standard costs and reviewing of variances
          with
          actual costs during 2007.
 
 SpatiaLight,
          Inc.'s independent auditors have issued an attestation report on management's
          assessment of the company's internal control over financial reporting.
          Such
          report immediately follows this report.
 77
  **REPORT
          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING**
 **FIRM
          ON INTERNAL CONTROL OVER FINANCIAL REPORTING**
 
 To
          the
          Board of Directors and Stockholders of
 SpatiaLight,
          Inc.
 
 We
          have
          audited management's assessment, included in the accompanying Management's
          Report on Internal Control Over Financial Reporting, that SpatiaLight,
          Inc.
          (“Company”) did not maintain effective internal control over financial reporting
          as of December 31, 2006, because of the effect of material weaknesses identified
          in management's assessment, based on criteria established in Internal Control
          -
          Integrated Framework issued by the Committee of Sponsoring Organizations
          of the
          Treadway Commission (the COSO criteria). SpatiaLight, Inc.'s management
          is
          responsible for maintaining effective internal control over financial reporting
          and for its assessment of the effectiveness of internal control over financial
          reporting. Our responsibility is to express an opinion on management's
          assessment and an opinion on the effectiveness of the Company's internal
          control
          over financial reporting based on our audit.
 
 We
          conducted our audit in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether effective
          internal control over financial reporting was maintained in all material
          respects. Our audit included obtaining an understanding of internal control
          over
          financial reporting, evaluating management's assessment, testing and evaluating
          the design and operating effectiveness of internal control, and performing
          such
          other procedures as we considered necessary in the circumstances. We believe
          that our audit provides a reasonable basis for our opinion.
 
 A
          company's internal control over financial reporting is a process designed
          to
          provide reasonable assurance regarding the reliability of financial reporting
          and the preparation of financial statements for external purposes in accordance
          with generally accepted accounting principles. A company's internal control
          over
          financial reporting includes those policies and procedures that (1) pertain
          to
          the maintenance of records that, in reasonable detail, accurately and fairly
          reflect the transactions and dispositions of the assets of the company;
          (2)
          provide reasonable assurance that transactions are recorded as necessary
          to
          permit preparation of financial statements in accordance with generally
          accepted
          accounting principles, and that receipts and expenditures of the company
          are
          being made only in accordance with authorizations of management and directors
          of
          the company; and (3) provide reasonable assurance regarding prevention
          or timely
          detection of unauthorized acquisition, use, or disposition of the company's
          assets that could have a material effect on the financial
          statements.
 
 Because
          of its inherent limitations, internal control over financial reporting
          may not
          prevent or detect misstatements. Also, projections of any evaluation of
          effectiveness to future periods are subject to the risk that controls may
          become
          inadequate because of changes in conditions, or that the degree of compliance
          with the policies or procedures may deteriorate.
 
 A
          material weakness is a control deficiency, or combination of control
          deficiencies, that results in more than a remote likelihood that a material
          misstatement of the annual or interim financial statements will not be
          prevented
          or detected. The following material weaknesses have been identified and
          included
          in management's assessment:
  ·
              The
                  Audit Committee does not have a financial expert (as defined by
                  SEC
      rules).  ·
              The
                  Company does not currently have a qualified financial executive to
                  perform independent secondary reviews over complex and non-routine
                  accounting matters to ensure they are reported in accordance with
                  GAAP.  ·
              The
                  Company lacks information technology controls and procedures that
                  would
                  likely prevent unauthorized access to the accounting and financial
                  systems, and ensure that the accounting and financial records are
                  recoverable in the event of a disaster.  ·
              The
                  Company does not maintain formal accounting policies and procedures
                  related to the updating of standard costs and review of variances
                  with actual costs to ensure the accuracy and appropriateness of
                  the
                  valuation of inventory.  78
 
 These
          material weaknesses were considered in determining the nature, timing,
          and
          extent of audit tests applied in our audit of the 2006 consolidated financial
          statements, and this report does not affect our report dated March 15,
          2007 on
          those consolidated financial statements.
 
 In
          our
          opinion, management's assessment that SpatiaLight, Inc. did not maintain
          effective internal control over financial reporting as of December 31,
          2006 is
          fairly stated, in all material respects, based on the COSO criteria. Also,
          in
          our opinion, because of the effect of the material weaknesses described
          above on
          the achievement of the objectives of the control criteria, SpatiaLight,
          Inc. has
          not maintained effective internal controls over financial reporting as
          of
          December 31, 2006 based on the COSO criteria.
 
 We
          have
          also audited, in accordance with the standards of the Public Company Accounting
          Oversight Board (United States), the consolidated balance sheets of SpatiaLight,
          Inc. and its subsidiaries as of December 31, 2006 and 2005, and the related
          consolidated statements of operations, stockholders’ equity (deficit) and cash
          flows for each of the three years in the period ended December 31, 2006
          and our
          report dated March 15, 2007 (which includes a matter of emphasis paragraph
          relating to SpatiaLight, Inc.’s ability to continue as a going concern),
          expressed an unqualified opinion thereon.
 
 
 
 /s/
          ODENBERG, ULLAKKO, MURANISHI & CO. LLP
 
 San
          Francisco, California
 March
          15,
          2007
 
 
  **Item
          9B.**  **Other
          Information.**
   None
  79
  **PART
          III**
 
 **Item
          10.**  **Directors,
          Executive Officers and Corporate Governance.**
 
 **DIRECTORS
          AND EXECUTIVE OFFICERS OF THE COMPANY**
 
 **Name**
                **Age**
                
                **Position(s)**David
                    F. Hakala
                54
                
                Chief
                    Executive Officer, Chief Operating Officer, Principle Financial
                    and
                    Accounting Officer, Chairman of Board of DirectorsMichael
                    S. Jin
                43
                
                Chief
                    Technology OfficerClaude
                    Piaget
                65
                
                DirectorJerilyn
                    Kessel
                47
                
                DirectorHerbert
                    Ehrenthal
                69
                
                DirectorRobert
                    C. Munro
                79
                
                Director
 
 All
          Directors serve for terms of one year and until their successors are duly
          elected. All officers serve at the pleasure of the Board of Directors.
          There are
          no family relationships between any of our directors and officers.
 
 **David
          F. Hakala** ,
          Chief
          Operating Officer since September 2002. Dr. Hakala was elected to the Board
          of
          Directors in June 2006. On November 3, 2006, Dr. Hakala became our Principal
          Financial and Accounting Officer as well as the Chairman of our Board of
          Directors in addition to his former duties. On December 12, 2006, Dr. Hakala
          became our Chief Executive Officer, in addition to his former duties. During
          the
          course of his career, Dr. Hakala has been directly responsible for the
          manufacturing startup and ramp-up of numerous products, and their associated
          manufacturing facilities, including several models of HDTV and of HDTV-ready
          televisions, the DTC-100 HD TV/DBS decoder box, the decoder box for the
          DirecTV
          DBS satellite system as well as 31” and 35” Very Large Screen (VLS) direct view
          CRTs. Prior to joining SpatiaLight, from 1994 to 2001, Dr. Hakala served
          in
          various senior management positions with Thomson Multimedia, including
          Vice
          President of Manufacturing Operations, and most recently as Vice President,
          Product Development, Americas, in which he was responsible for the design
          and
          development of television and video systems, including digital television
          with
          integrated HDTV decoders, projection systems and other advanced display
          systems,
          including the Thomson RCA L50000 LCoS project.
 
 **Michael
          S. Jin** ,
          Chief
          Technology Officer since July 7, 2004, joined SpatiaLight in April 2000,
          and has
          directed SpatiaLight’s efforts to develop and enhance LCoS cell structure,
          processing technologies and overall product performance. Dr. Jin has also
          served
          as a leader on the technical front in growing our relationships with television
          OEMs throughout Asia. Prior to joining SpatiaLight, Dr. Jin served as a
          Vice
          President and the Principal Investigator for New Interconnect and Packaging
          Technology, Inc., based in San Diego, CA, working on numerous DARPA, STTR
          and
          SBIR programs in the areas of Optoelectronic Interconnects, Volumetric
          3-D
          Displays Based on 2-Photon Transition Materials, MEMS Laser Beam Steering
          Devices, 3-D Optoelectronic and IC Packaging Technologies and Phase-Shift
          Masks
          for High-Resolution Lithography. Previously, Dr. Jin was engaged in developing
          thin film devices for laser fusion research at the University of Rochester
          Laboratory for Laser Energetics. Dr. Jin received his Bachelor’s and Master’s
          degrees in Optics from the University of Rochester and his Ph.D. in Applied
          Physics from the University of California at San Diego.
 
 **Claude
          Piaget** ,
          director since June 2001, served as Chief Executive Officer and Senior
          Vice
          President, International Relations of Digital Video Broadcasting, a global
          consortium involved in the promotion of unified worldwide standards for
          digital
          television. Dr. Piaget’s broad industry experience includes several executive
          positions with Philips Electronics, including market development manager
          from
          1995 to 1997, company strategy expert from 1994 to 1995 and development
          manager
          from 1986 to 1994. Previously, he was involved in researching semiconductor
          physics, components, devices and systems. He has participated in the development
          of information and communication technologies and consortiums in Europe,
          Asia
          and Latin America. He holds a Masters degree in Physics Engineering and
          a Ph.D.
          in Physics from the University of Paris.
 
 **Jerilyn
          Kessel** ,
          elected
          to the Board of Directors in June 2006 is a Strategic Marketing and Consumer
          Research and Business Development Consultant with an expansive list of
          A-list
          clients in the Media, Filmed Entertainment and Telecommunication Industries
          including leading television networks, film studios, internet companies
          and
          telecom businesses.  Ms.  Kessel is best known for her analytic
          insights into consumers’ adoption of new technology formats and audiences’
changing viewing habits across expanding media options.  Ms. Kessel teamed
          with ICR Survey Research in 1997 to create CENTRIS sm ,
          a
          leading media research service.  In October 2005, Ms. Kessel left CENTRIS
          to return to her consulting practice full time.  In March 2003, Ms. Kessel
          became a principle in Brand Advisors, LLC (a subsidiary of The Salter Group,
          a
          company that provides financial forecasts and valuations for television
          and
          film).   From September 1999 through February 2002, she was a Founding
          Partner in Global Media Ventures, LLC.  Beginning in 1996, Ms. Kessel was a
          founding partner of WebFeat, Inc., which was then acquired by American
          Interactive Media, Inc. in 1997.  In 1993, Ms. Kessel joined Entertainment
          Made Convenient (Emc 3 )
          as part
          of its founding management team, serving as Senior Vice President Program
          Planning & Marketing.   Ms. Kessel served as Managing Director of
          Video Flash, which she co-founded, from 1987 through 1990 and a Senior
          Consultant at the New York based management consulting firm of Alexander
          and
          Associates.  Ms. Kessel is a graduate of The Wharton School at the
          University of Pennsylvania where she majored in Finance and Entrepreneurial
          Management.
  80
  **Herbert
          Ehrenthal** ,
          elected
          to the Board of Directors in June 2006, is currently Vice President Global
          Advertising and Marketing at Schering-Plough Corporation, the global
          research-based pharmaceutical company, where he has been since 2003. Mr.
          Ehrenthal is responsible for directing the creation of all consumer
          communication programs and initiatives on a worldwide basis across all
          Schering-Plough pharmaceutical brands. Prior to joining Shering-Plough,
          Mr.
          Ehrenthal was an Executive Director at Pharmacia Corporation (now Pfizer),
          responsible for all overseas consumer activities. In 1987, Mr. Ehrenthal
          founded
          Rubin Ehrenthal and Associates. He pioneered one of the first successful
          Direct
          to Consumer marketing programs in the United States. That agency merged
          in 1991
          and was renamed Healthworld. Mr. Ehrenthal became President and COO when
          Healthworld went public in November 1997, where he continued his career
          at the
          agency through 2001 when it was purchased by a conglomerate, at which time
          he
          retired from his positions as President and COO and a member of the Board.
          Mr.
          Ehrenthal is a graduate of City College in New York where he majored in
          History.
 
 **Robert
          C. Munro** ,
          director since February 2004, has served as a private business consultant
          in the
          finance, banking and retail industries in the United States, the United
          Kingdom
          and throughout Europe since 1985. He currently sits on the board of directors
          of
          UNET 2 Corporation, a privately held electronic publishing company based
          in New
          York. Mr. Munro is a Fellow of the Institute of Directors in the United
          Kingdom.
          He has extensive global business experience in the banking, real estate
          and
          shipping industries. Mr. Munro received a Master’s degree from Edinburgh
          University in Scotland.
 
 **Section
          16(a) Beneficial Ownership Reporting Compliance**
  Section
          16(a) of the Securities Exchange Act of 1934, as amended, requires directors,
          executive officers and persons who beneficially own more than 10% of our
          common
          shares to file with the SEC initial reports of ownership and reports of
          changes
          in ownership of common shares and other equity securities. Executive officers,
          directors and greater than 10% shareholders are required by SEC regulations
          to
          furnish us with copies of all Section 16(a) reports they file. Except as
          set
          forth below, to our knowledge, based solely on a review of the copies of
          such
          reports furnished to the Corporation for fiscal 2005, executive officers,
          directors and greater than 10% shareholders filed the required Section
          16(a)
          reports of material transactions in a timely manner in 2006.
 
 Robert
          A.
          Olins, our former Chief Executive Officer, Secretary, Treasurer and a Director
          failed to report the sale of an aggregate of 70,556 of our common shares
          in
          August 2005 and February 2006 at sales prices ranging from $5.30 to $3.00.
          Pursuant to Section 16 of the Exchange Act, in July 2006, Mr. Olins has
          filed
          the delinquent reports and disgorged $22,273 in “short swing profits” that he
          realized from the sales. These funds are recorded as an increase in additional
          paid in capital during the third quarter 2006.
 
 **Code
          of Ethics**
 
 We
          have a
          Code of Business Conduct and Ethics which is applicable to all of our employees
          including the principal executive officer, the principal financial officer
          and
          the principal accounting officer or Controller. The Code of Business Conduct
          and
          Ethics and any amendments or waivers are available on our website
          www.spatialight.com under Corporate Governance.
 
 **Audit
          Committee**
 
 The
          Audit
          Committee of the Board of Directors (which is formed in compliance with
          section
          3(a)(58)(A) of the Securities and Exchange Act of 1934) bears primary
          responsibility for our financial statements and for our reporting process,
          including our system of internal controls. The primary purpose of our Audit
          Committee is to monitor: (1) the integrity of our financial statements;
          (2) our
          compliance with legal and regulatory requirements; (3) the independence
          and
          performance of our external auditors; and (4) the adequacy of our internal
          controls. The Audit Committee consists of three directors that meet the
          independence standards of the SEC and NASD and met 13 times during last
          fiscal
          year. From January 1, 2006 through June 30, 2006, the members of the Audit
          Committee were Messrs. Matteson, Munro (Chair), and Piaget. From July 1,
          2006
          through December 31, 2006, the members of the Audit Committee were Messrs.
          Matteson and Piaget and Ms. Kessel (Chair). After December 31, 2006, the
          members
          of the Audit Committee were Dr. Piaget and Ms. Kessel. Mr. Munro was elected
          to
          the Audit Committee on February 2, 2007. The Audit Committee is responsible
          for
          the appointment, retention and termination of a firm of independent registered
          public accountants and monitoring the effectiveness of the audit effort,
          our
          financial and accounting organization and our system of internal accounting
          and
          disclosure controls. However, none of the members of the Audit Committee
          qualify
          as an Audit Committee Financial Expert, as defined by SEC rules. The Audit
          Committee has reviewed and discussed the audited financial statements with
          management and has discussed with Odenberg, Ullakko, Muranishi & Co., LLP
          their independence and the matters required under Auditing Standard No.
          61. The
          Audit Committee has recommended to the Board of Directors that the audited
          financial statements be included in our annual report on From 10-K for
          2006. Our
          limited resources have made it difficult to recruit an individual with
          the
          necessary qualifications to serve as a financial expert. The Audit Committee
          Charter is available on our website.
  81
 
 **Item
          11.**  **Executive
          Compensation.**
 
 The
          following Compensation Discussion and Analysis describes the material elements
          of compensation for the executive officers identified in the Summary
          Compensation Table (“Named Executive Officers”). As more fully described below,
          the Compensation Committee of the Board of Directors (the “Committee”) makes all
          decisions for the total direct compensation, including the amount of base
          salaries and bonuses, and timing and terms of equity based compensation
          award
          for the Executive Officers of the Company. The Committee’s recommendations for
          the total direct compensation of the Company’s Chief Executive Officer are
          subject to approval of the Board of Directors.
 
 **Compensation
          Program Discussion and Analysis**
 
 Our
          compensation and benefits programs are intended to attract, retain and
          motivate
          individuals with the necessary scientific, engineering and business knowledge
          and experience to accomplish our overall business objectives and to motivate
          these individuals to devote their time and energy for the benefit of our
          stockholders. Consequently, the guiding principles of our compensation
          programs
          are:
 
 ·
              simplicity,
                  clarity, and fairness to both the employee and the
                  Company; ·
              preservation
                  of Company resources; ·
              delivery
                  of sufficient current cash compensation to attract and retain accomplished
                  individuals in a highly competitive market;
                  and ·
              opportunity
                  to receive significant compensation if the Company is
                  successful. 
 Each
          element of our compensation program contributes to these overall goals
          in a
          different way.
 
 ·
              Base
                  Salary and Benefits are designed to provide a minimum threshold
                  to attract
                  and retain employees identified as necessary for our
                  success. ·
              Cash
                  Bonuses are designed to reward employees for accomplishment of
                  annual
                  goals or performance criteria that have been determined by the
                  Board of
                  Directors to support our long-term operational
                  goals. ·
              Stock
                  and option awards and individual incentive arrangements are designed
                  to
                  provide a long-term incentive to individuals that are critical
                  to our
                  success as reflected in the market price of our common
                  stock. 
 *Base
          Salaries*
 
 Executive
          officer base salaries are based on job responsibilities and individual
          contribution, with reference to base salary levels of executives at peer
          developmental electronic components companies. The goal of the Committee
          is to
          maintain base salaries at sufficient levels to prevent the loss of key
          executives without providing an industry-leading salary structure. The
          Committee
          proposes base salaries for the executive officers listed in “Summary of
          Compensation” (the “Named Executive Officers”) for approval by the Board of
          Directors every year based on information provided by the Company’s Chief
          Executive Officer. Mr. Olins was not paid a base salary during 2005 and
          the
          Compensation Committee did not authorize a salary for Mr. Olins during
          2006
          because it was believed that Mr. Olins’ long-term incentives were sufficient to
          reward him for his services to the Company. The Compensation Committee
          recommended and the Board of Directors approved the payment of a housing
          and
          automobile allowance of $100,372 during 2006. Mr. Olins, our former Chief
          Executive Officer, proposed, the Committee recommended, and the Board of
          Directors approved, a 10% increase in the base salary of Mr. Hakala on
          the basis
          of the increased responsibility assigned to the Chief Operating Officer
          and the
          compensation paid to other executives in similar positions. There were
          no
          changes to the salaries paid to the other Named Executive Officers during
          2006.
  *Cash
          Bonuses*
 
 Cash
          bonuses are awarded on the proposal of the Chief Executive Officer, the
          recommendation of the Compensation Committee and the approval of the Board
          of
          Directors when it is determined that an individual has accomplished a
          significant short-term goal identified as supporting the long-term performance
          or profitability of the Company, or when necessary to correct inconsistencies
          between the salary paid to a Named Executive Officer and other executives
          of the
          Company or of other companies that are similarly situated. No cash bonuses
          were
          awarded during 2006.
  82
  *Stock
          and Option Awards*
 
 Awards
          under the Company’s 2006 Incentive Plan, the 1999 Stock Option Plan (the
“Plans”) or under individual incentive agreements are used to encourage Named
          Executive Officers to have a strategic outlook and to conform their economic
          incentives with the interests of our stockholders. The type and amount
          of award
          is based upon job responsibilities, potential for individual contribution
          to
          Company performance, total cash compensation in the form of base salary
          and
          bonuses, and the number of previous awards then outstanding or exercisable.
          The
          Compensation Committee is authorized to grant Awards under the Company’s Plans
          on its own without proposal from the Chief Executive Officer or the approval
          of
          the Board of Directors. However, in most cases, the awards are initiated
          by the
          Chief Executive Officer. The Compensation Committee does not have a regular
          schedule for awarding equity-based compensation and the timing of such
          awards is
          subject to the discretion of the Compensation Committee. On February 2,
          2006, as
          part of the general review of competitive salary structures within the
          Company,
          the Compensation Committee awarded options to purchase 500,000 shares of
          common
          stock at $2.60 per share to Mr. Olins and options to purchase 150,000 shares
          of
          common stock at $2.60 per share to Mr. Suh. The difference between the
          number of
          options awarded reflects the different responsibilities of the individuals
          and
          that no base salary is paid to Mr. Olins. The Compensation Committee believes
          that the level of awards made to the Named Executive Officers in 2006 is
          consistent with the level of responsibility, other compensation paid, and
          company performance that is within such individual's control.
 
 Stock
          options provide for financial gain derived from the potential appreciation
          in
          stock price from the date that the option is granted until the date that
          the
          option is exercised. The exercise price of stock option grants is set at
          fair
          market value on grant date. Under the Plans, the Compensation Committee
          may not
          grant stock options at a discount to fair market value or reduce the exercise
          price of outstanding stock options except in the case of a stock split
          or other
          similar event. The Company’s long-term performance ultimately determines the
          value of stock options, because gains from stock option exercises are entirely
          dependent on the long-term appreciation of the Company’s stock price. Because a
          financial gain from stock options is only possible after the price of our
          common
          stock has increased, we believe grants encourage executives and other employees
          to focus on behaviors and initiatives that should lead to an increase in
          the
          price of our common stock, which benefits all our stockholders.
 
 We
          do not
          backdate options or grant options retroactively or stock options with a
          so-called “reload” feature. In addition, we do not plan to coordinate grants of
          options so that they are made before announcement of favorable information,
          or
          after announcement of unfavorable information.
 
 *Impact
          of Section 162(m) of the Code*
 
 The
          Compensation Committee has considered the potential impact of Section 162(m)
          of
          the Code, adopted under the Revenue Reconciliation Act of 1993. This section
          disallows a tax deduction for any publicly held corporation, for individual
          compensation exceeding $1,000,000 in any taxable year paid the Named Executive
          Officers unless (1) the compensation is payable solely on account of the
          attainment of performance goals, (ii) the performance goals are determined
          by a
          committee of two or more outside directors, (iii) the material terms under
          which
          compensation is to be paid are disclosed to and approved by shareholders
          and
          (iv) the committee certifies that the performance goals were met. Our 1999
          Stock
          Option Plan and 2006 Incentive Plan were approved by our Shareholders so
          that
          compensation attributable to stock options and certain other awards granted
          under such plans may be excluded from the $1,000,000 threshold.
 
 The
          Compensation Committee continues to consider other steps which might be
          in the
          Company’s best interest to comply with Section 162(m), while reserving the right
          to award future compensation which would not comply with the Section 162(m)
          requirements for non-deductibility if the Compensation Committee concluded
          that
          this was in the Company’s best interests.
  83
 
 The
          following table sets forth the compensation paid by us for the fiscal year
          ended
          December 31, 2006, to our Chief Executive Officer and all of the other
          executive
          officers as of December 31, 2006.
 
 **SUMMARY
                      COMPENSATION TABLE - 2006**Name
                      and Principal Position
                  
                  Year
                  
                  Salary
                      ($)
                  
                  Stock
                      Awards ($)
                  
                  
                  
                  All
                      Other Compensation
                  
                  
                  
                  Total
                      ($)(a)
                  
                  (b)
                  
                  (c
                      )
                  
                  (e)
                  
                  (f)
                  
                  (i)
                  
                  
                  
                  (j)Robert
                      A. Olins, former Chief Executive Officer, Treasurer,
                    Secretary
                      and Principal Financial and Accounting Officer
                  
                  
                  2006
                  
                  $
                  -
                  
                  $
                  966,500
                  
                  
                  (2
                  )
                  $
                  100,372
                  
                  
                  (1
                  )
                  $
                  1,066,872David
                      F. Hakala, Chief Executive Officer effective
                    December
                      12, 2006, Chief Operating Officer and Principal Financial and
                      Accounting
                      Officer
                  
                  
                  2006
                  
                  $
                  256,154
                  
                  $
                  -
                  
                  
                  
                  
                  $
                  -
                  
                  
                  
                  
                  $
                  256,154Michael
                      S. Jin, Chief Technology Officer
                  
                  
                  2006
                  
                  $
                  200,000
                  
                  $
                  -
                  
                  
                  
                  
                  $
                  -
                  
                  
                  
                  
                  $
                  200,000Don
                      S. Suh, Chief Executive Officer from November 3,
                    2006
                      to December 12, 2006, former Senior Vice President, Marketing
&
                      Sales
                  
                  
                  2006
                  
                  $
                  200,250
                  
                  $
                  152,250
                  
                  
                  (2
                  )
                  $
                  -
                  
                  
                  
                  
                  $
                  352,500
 
 (1)
              Represents
                  (a) $75,179 paid by the Company for housing for Robert Olins and
                  (b)
                  $25,193 paid by the Company for a car for Mr.
                  Olins. (2)
              The
                  assumptions used to derive the fair value of the stock option awards
                  noted
                  above are discussed in Footnote 1 to the Consolidated Financial
                  Statements. 
 **Grants
          of Plan Based Awards**
 
 The
          following table sets forth certain information for the year ended December
          31,
          2006, with respect to plan based awards granted to the individuals named
          in the
          Summary Compensation Table.
 **GRANTS
                      OF PLAN-BASED AWARDS - 2006**Name
                  
                  Grant
                      Date
                  
                  All
                      Other Option Awards: Number of Securities Underlying
                      Options
                  
                  Exercise
                      of Base Price of Option Awards ($/Sh)
                  
                  Grant
                      Date Fair Value of Stock and Option Awards(a)
                  
                  (b)
                  
                  (j)
                  
                  (k)
                  
                  (l)Robert
                      A. Olins
                  
                  
                  2/6/2006
                  
                  
                  500,000
                  
                  $
                  2.60
                  
                  $
                  966,500Don
                      S. Suh
                  
                  
                  2/6/2006
                  
                  
                  150,000
                  
                  $
                  2.60
                  
                  $
                  297,936
  84
  The
          following table sets forth total outstanding equity awards at year-end
          for the
          individuals names in the Summary Compensation Table.
 **OUTSTANDING
                      EQUITY AWARDS AT FISCAL YEAR END - 2006**Name
                  
                  Number
                      of Securities Underlying Unexercised Options (#)
                      Exercisable
                  
                  Option
                      Exercise Price ($)
                  
                  Option
                      Expiration Date(a)
                  
                  (b)
                  
                  (e)
                  
                  (f)Robert
                      A. Olins
                  
                  
                  750,000
                  
                  $
                  1.50
                  
                  
                  6/5/2011Robert
                      A. Olins
                  
                  
                  500,000
                  
                  $
                  2.15
                  
                  
                  8/22/2011Robert
                      A. Olins
                  
                  
                  489,444
                  
                  $
                  3.60
                  
                  
                  1/27/2012Robert
                      A. Olins
                  
                  
                  300,000
                  
                  $
                  2.49
                  
                  
                  12/30/2012Robert
                      A. Olins
                  
                  
                  200,000
                  
                  $
                  2.10
                  
                  
                  5/21/2013Robert
                      A. Olins
                  
                  
                  285,417
                  
                  $
                  5.21
                  
                  
                  1/4/2014Robert
                      A. Olins
                  
                  
                  179,583
                  
                  $
                  5.60
                  
                  
                  7/6/2014Robert
                      A. Olins
                  
                  
                  500,000
                  
                  $
                  4.97
                  
                  
                  1/17/2015Robert
                      A. Olins
                  
                  
                  500,000
                  
                  $
                  2.60
                  
                  
                  2/5/2016Total
                      Mr. Olins
                  
                  
                  3,704,444David
                      F. Hakala
                  
                  
                  335,000
                  
                  $
                  2.66
                  
                  
                  9/3/2012Michael
                      S. Jin
                  
                  
                  20,000
                  
                  $
                  4.94
                  
                  
                  4/23/2010Michael
                      S. Jin
                  
                  
                  5,000
                  
                  $
                  1.25
                  
                  
                  12/28/2010Michael
                      S. Jin
                  
                  
                  15,000
                  
                  $
                  1.93
                  
                  
                  4/22/2011Michael
                      S. Jin
                  
                  
                  35,000
                  
                  $
                  5.10
                  
                  
                  4/22/2012Michael
                      S. Jin
                  
                  
                  125,000
                  
                  $
                  5.60
                  
                  
                  7/6/2014Michael
                      S. Jin
                  
                  
                  100,000
                  
                  $
                  4.97
                  
                  
                  1/17/2015Total
                      Mr. Jin
                  
                  
                  300,000Don
                      S. Suh
                  
                  
                  150,000
                  
                  $
                  5.55
                  
                  
                  3/12/2007Don
                      S. Suh
                  
                  
                  75,000
                  
                  $
                  2.60
                  
                  
                  3/12/2007Total
                      Mr. Suh
                  
                  
                  225,000
  The
          following table sets forth total options exercised and stock vested during
          2006
          for the individuals names in the Summary Compensation Table.
 **OPTIONS
                      EXERCISES AND STOCK VESTED - 2006**Option
                      AwardsName
                  
                  Number
                      of Shares Acquired on Exercise (#)
                  
                  Value
                      Realized on Exercise ($)(a)
                  
                  (b)
                  
                  (c
                      )Robert
                      A. Olins
                  
                  
                  25,000
                  
                  $
                  69,500
   85
  The
          following table sets forth Director compensation for 2006.
 **DIRECTOR
                      COMPENSATION - 2006**Name
                  
                  Option
                      Awards ($)
                  
                  Total
                      ($)(a)
                  
                  (d)
                  
                  (h)Lawrence
                      J. Matteson
                  
                  $
                  85,112
                  
                  $
                  85,112Claude
                      Piaget
                  
                  $
                  85,112
                  
                  $
                  85,112Robert
                      C. Munro
                  
                  $
                  85,112
                  
                  $
                  85,112Herbert
                      Ehrenthal
                  
                  $
                  9,599
                  
                  $
                  9,599Jerilyn
                      Kessel
                  
                  $
                  9,599
                  
                  $
                  9,599
  The
          assumptions used to derive the fair value of the stock option awards noted
          above
          are discussed in Footnote 1 to the Consolidated Financial Statements. As
          of
          December 31, 2006 Mr. Matteson, who resigned from the Board of Directors
          as of
          December 31, 2006, had an aggregate of 279,500 options outstanding, Dr.
          Piaget
          had an aggregate of 175,000 options outstanding, Mr. Munro had an aggregate
          of
          75,000 options outstanding, and Mr. Ehrenthal and Ms. Kessel each had 25,000
          options outstanding.
  **Employment
          Arrangements and Agreements**
  Robert
          A.
          Olins served as one of our directors from 1998 to November 2006 and has
          also
          served as our Chief Executive Officer, Secretary and Treasurer of the
          Corporation from July 2000 to November 2006. Mr. Olins did not have an
          employment agreement. In accordance with a severance agreement dated December
          12, 2006, Mr. Olins will continue to work with us on a consultant basis,
          for
          $1,500 per week for a period of 13 months. In addition, subject to the
          approval
          by our shareholders, the severance agreement provides for the exchange
          of all
          outstanding options under Plans for Common Shares having a value on date
          of
          exchange equal to the fair market value of the options. The exchange will
          require approval by our shareholders at the next annual meeting. The value
          of
          the options will be determined in accordance with the Black-Scholes valuation
          method, based on the assumptions used in valuing our stock options under
          SFAS
          123R.
  Don
          S.
          Suh served as our Senior Vice President - Marketing and Sales from July
          19, 2004
          and as our Chief Executive Officer from November 3, 2006 to December 12,
          2006.
          We do not have an employment or separation agreement with Mr. Suh.
  David
          F.
          Hakala has served as our Chief Operating Officer since September 3, 2002.
          On
          November 3, 2006, Dr. Hakala became our Principal Financial and Accounting
          Officer as well as the Chairman of our Board of Directors. On December
          12, 2006,
          Dr. Hakala became our Chief Executive Officer. We do not have an employment
          agreement with Dr. Hakala. We have extended Dr. Hakala’s employment by one-year
          extensions on the anniversary of his employment.
  Michael
          S. Jin was promoted to Chief Technology Officer on July 7, 2004. We do
          not have
          an employment agreement with Dr. Jin.
  **Compensation
          Committee Interlocks and Insider Participation**
  No
          member
          of the Compensation Committee was an officer or former officer of the Company
          or
          had any material relationship or transactions with the Company and no officer
          of
          the Company sits on the compensation committee or other body that has the
          power
          to establish the compensation of any member of the Compensation
          Committee.
  86
 
 **Compensation
          Committee Report**
 
 The
          Compensation Committee reviewed and discussed with the Company’s management the
          Compensation Discussion and Analysis for the year ended December 31, 2006.
          Based
          upon such review and Discussion, the members of the Compensation Committee
          recommended to the Board of Directors that the Compensation Discussion
          and
          Analysis for the year ended December 31, 2006 be included in the Company’s
          Annual Report on Form 10-K filed with the SEC.
 
 Herbert
          Ehrenthal
 Claude
          Piaget
  87
  **Item
          12.**  **Security
          Ownership of Certain Beneficial Owners and Management and Related Shareholder
          Matters.**
 
 The
          following table sets forth information regarding beneficial ownership of
          common
          shares as of March 14, 2007, by each person known by us to own beneficially
          more
          than five percent of our outstanding common shares, by each of our directors,
          and by each of our executive officers named in the Summary Compensation
          Table
          contained in “Executive Compensation,” and by all of our directors and executive
          officers as a group. Except as otherwise noted, each person named in the
          table
          has sole voting and investment power with respect to all common shares
          shown as
          beneficially owned by him, her or it.
 
 **Name
                      and Address**
                    **Beneficial
                      Owner**
                  
                  **Amount
                      and Nature of Beneficial Ownership**
                  
                  
                  
                  **Percent
                      of Class**Robert
                      A. Olins
                    Argyle
                      Capital Management Corp.
                    27
                      De Silva Island, Mill Valley, CA 94941
                  
                  
                  9,410,066
                  
                  
                  (1
                  )
                  
                  18.3
                  %Wellington
                      Management Company, LLP
                    75
                      State Street
                    Boston,
                      Massachusetts 02109
                  
                  
                  3,185,914
                  
                  
                  (2
                  )
                  
                  6.7
                  %Adele
                      Becker
                    215
                      E 68th Street
                    New
                      York, NY 10021
                  
                  
                  2,779,333
                  
                  
                  (3
                  )
                  
                  5.8
                  %Herbert
                      Ehrenthal
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  531,275
                  
                  
                  (4
                  )
                  
                  *Lawrence
                      J. Matteson
                    5
                      Hogan Ct.
                    Pittsford,
                      NY 14534
                  
                  
                  274,000
                  
                  
                  (5
                  )
                  
                  *Claude
                      Piaget
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  162,500
                  
                  
                  (6
                  )
                  
                  *Robert
                      C. Munro
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  62,500
                  
                  
                  (7
                  )
                  
                  *Jerilyn
                      Kessel
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  12,500
                  
                  
                  (8
                  )
                  
                  *David
                      F. Hakala
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  336,000
                  
                  
                  (9
                  )
                  
                  *Michael
                      S. Jin
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  315,255
                  
                  
                  (10
                  )
                  
                  *Don
                      S. Suh
                    Five
                      Hamilton Landing, Suite 100
                    Novato,
                      CA 94949
                  
                  
                  230,000
                  
                  
                  (11
                  )
                  
                  *All
                      directors and officers as a group (7 persons)
                  
                  
                  1,694,030
                  
                  
                  
                  
                  
                  3.5
                  %
   (1)
              Based
                  solely upon information contained in Section 16 filings made by
                  named
                  shareholder, includes 2,376,000 Shares beneficially owned subject
                  to
                  conversion of principal of convertible notes held by Argyle Capital
                  Management Corporation (Argyle), of which Mr. Olins is President
                  and over
                  which Mr. Olins exercise voting control, and 1,678,597 Shares owned
                  by
                  Argyle. Also includes 1,411,870 common shares and Warrants to purchase
                  239,360 common shares held by Mr. Olins and 3,704,444 Shares subject
                  to
                  outstanding stock options held by Mr. Olins that are exercisable
                  on or
                  before May 13, 2007. (2)
              Based
                  solely upon information filed in a Schedule 13G by named
                  stockholder. (3)
              Based
                  solely upon information provided by named
                  stockholder. (4)
              Includes
                  518,775 Shares based on information filed in a Form 3 by named
                  stockholder, 12,500 Shares subject to options exercisable on or
                  before May
                  13, 2007. (5)
              Includes
                  7,000 Shares based on information filed in a Form 3 by named stockholder,
                  254,200 Shares subject to options exercisable on or before May
                  13,
                  2007. (6)
              Includes
                  162,500 Shares subject to options exercisable on or before May
                  13,
                  2007. (7)
              Includes
                  62,500 Shares subject to options exercisable on or before May 13,
                  2007. (8)
              12,500
                  Shares subject to options exercisable on or before May 13,
                  2007. (9)
              Includes
                  335,000 Shares subject to options exercisable on or before May
                  13,
                  2007. (10)
              Includes
                  300,000 Shares subject to options exercisable on or before May
                  13,
                  2007. (11)
              Includes
                  225,000 Shares subject to options exercisable on or before May
                  13,
                  2007.  88
 
 We
          pledged substantially all of our assets to the purchasers of our Senior
          Secured
          Convertible Notes in November 2004.  This pledge of assets could result in
          a change of control of our Company in the future.  Two holders of our
          Senior Secured Convertible Notes have alleged certain events of default
          under
          their Notes.  Although we believe that these allegations are not correct
          and are without foundation, this matter could potentially result in a change
          of
          control of the Company in the future.
 
 Argyle
          Capital Management Corporation, a company owned and controlled by Robert
          A.
          Olins, our former Chief Executive Officer, Secretary, Treasurer and a former
          director, has a subordinated security interest in all assets, which could
          result
          in a change of control of the Company in the future.
 
 **Item
          13.**  **Certain
          Relationships and Related Transactions, and Director
          Independence.**
 
 The
          Company’s Code of Business Conduct and Ethics (the “Code”), which is available
          on the Company’s website (www.spatialight.com), prohibits all conflicts of
          interest. Under the Code, conflicts of interest occur when private or family
          interests interfere in any way, or even appear to interfere, with the interests
          of the Company. The Company’s prohibition on conflicts of interest under the
          Code includes any related person transaction. Any employee with knowledge
          of a
          conflict of interest, including a related party transaction, must notify
          the
          Chairman of our Audit Committee, who will undertake such review of the
          transaction as is appropriate. Any transaction between the Company and
          an
          officer or director of the Company must be approved by the Audit Committee
          or
          the Board of Directors. During the year ended December 31, 2006, the following
          related party transactions occurred with the approval of the Board of Directors.
 
 *Argyle
          Notes:*
 
 During
          the year ended December 31, 2006, the Company was indebted to Argyle Capital
          Management Corporation (Argyle), a company owned and controlled by Robert
          A.
          Olins, our former Chief Executive Officer, Secretary, Treasurer, and Director,
          in the amount of $1,188,000 pursuant to a series of promissory notes bearing
          interest at 6%, due December 31, 2008. Both principal and interest are
          convertible into our Common Shares at $0.50 per share and are secured by
          substantially all of our assets. Interest on these notes has been prepaid
          through December 31, 2008. At December 31, 2006, the carrying value of
          the
          Argyle notes was $1,188,000.
 
 *Additional
          Financing Commitment*
 
 In
          November 2004, Robert A. Olins, the Chief Executive Officer and a director
          of
          SpatiaLight, and Greenpark Limited, an unaffiliated shareholder of SpatiaLight,
          jointly and severally committed, in the event that the Board determines
          that
          such financing is necessary, to provide us with up to $6,000,000 in future
          financing on terms and conditions to be determined at the time of any such
          transaction. That financing commitment shall be reduced by any funds that
          SpatiaLight receives from future sales or exercises of its equity, debt
          or
          derivative securities, including the sale of our common shares under the
          Prospectus that we filed with the SEC on January 31, 2005, as part of a
“shelf”
registration process. As of the date of this filing we have received an
          aggregate total of greater than $6 million and Mr. Olins and Greenpark
          Ltd. have
          no obligation under this commitment.
  *Short-term
          Financing*
  On
          December 16, 2005, we borrowed $224,384 from Robert A. Olins, our Chief
          Executive Officer and a director. Mr. Olins obtained these funds by drawing
          down
          on a personal line of credit from a bank, which is the same bank that we
          utilize
          for our domestic commercial banking requirements. Based upon discussions
          among
          Mr. Olins and other members of our Board of Directors, we have agreed to
          repay
          the borrowed funds to Mr. Olins on the same terms that he agreed to with
          the
          bank. Therefore, we were required to repay the full principal amount of
          the loan
          plus interest at a rate of 8.25% per annum on February 16, 2006, the maturity
          date. We have also agreed to reimburse Mr. Olins for a $30,000 fee that
          he was
          required to pay to the bank. We repaid the loan in and the fee was reimbursed
          to
          Mr. Olins in January 2006. Between September and November 2006, we borrowed
          an
          aggregate of $252,199 from Mr. Olins. These short-term loans were non-interest
          bearing, with a term of three months or less, and were completely paid
          off by
          the end of November 2006.
  89
 
 Between
          September and November 2006, we borrowed an aggregate of $355,000 from
          Mr.
          Herbert Ehrenthal, a director of our company. These notes bore interest
          at 8%,
          with a term of three months or less, and were completely paid off by December
          1,
          2006.
 
 **Item
          14.**  **Principal
          Accountant Fees and Services.**
 
 The
          following table contains the fees billed to us for the last two fiscal
          years by
          Odenberg, Ullakko, Muranishi & Co., LLP, our current independent registered
          public accountants for the two years ended December 31, 2006.
 
 2006
                  
                  
                  2005Audit
                      Fees
                  
                  $
                  435,937
                  
                  (1
                  )
                  $
                  350,467
                  
                  (1
                  )Audit-Related
                      Fees
                  
                  
                  2,250
                  
                  (2
                  )
                  
                  -Tax
                      Fees
                  
                  
                  11,860
                  
                  (3
                  )
                  
                  -All
                      Other Fees
                  
                  
                  9,128
 
 (1)
              Includes
                  fees associated with the annual audit of consolidated financial
                  statements
                  and internal control over financial reporting in compliance with
                  regulatory requirements under Sarbanes-Oxley Act of 2002, review
                  of our
                  quarterly reports on Form 10-Q, annual report on Form 10-K, and
                  consents
                  issued in connection with our Form S-3 filings, assistance and
                  review of
                  other documents with the SEC. (2)
              Includes
                  accounting consultations (3)
              Includes
                  fees for tax compliance (tax return preparation assistance) and
                  general
                  tax planning.  Our
          Audit
          Committee adopted a policy for engaging our independent registered public
          accountants, for audit and non-audit services that includes requirements
          for the
          Audit Committee to pre-approve audit and non-audit services provided by
          the
          independent auditor. All of the audit and audit related fees provided by
          Odenberg, Ullakko, Muranishi & Co., LLP (described in the footnotes to the
          table above) and related fees were approved in advance by our Audit
          Committee.
 
 **PART
          IV**
 
 **Item
          15.**  **Exhibits
          and Financial Statement Schedules.**
 
 (a).  The
          following documents are filed as part of this Report under Item 8
          herein:
  1.
              Consolidated
                  Financial Statements  PageReport
                      of Independent Registered Public Accounting Firm
                  38Consolidated
                      Balance Sheets at December 31, 2006 and 2005
                  39Consolidated
                      Statements of Operations for years ended December 31, 2006,
                      2005 and
                      2004
                  40Consolidated
                        Statements of Stockholders’ Equity (Deficit) for years ended 
                        December 31, 2006, 2005 and 2004
                  41Statements
                      of Cash Flows for years ended December 31, 2006, 2005 and
                      2004
                  44Notes
                      To Consolidated Financial Statements
                  46
 2.
              Consolidated
                  Financial Statement Schedules 
 All
          schedules are omitted because the required information is inapplicable
          or the
          information is presented in the Consolidated Financial Statements and/or
          the
          Notes thereto in Item 8 herein.
 90
 (b).  Exhibits
 
 **Exhibit
                    #**
                
                **Description**3.1
                
                Certificate
                    of Incorporation, as amended (Amendments to document filed as
                    Exhibit 3.1
                    to the Company’s Amendment No. 1 to Form S-3 Registration Statement filed
                    November 18, 1999).3.2
                
                Bylaws
                    (incorporated by reference to Exhibit B to the Company’s Form 8-K filed
                    February 7, 1995).10.1
                
                1999
                    Stock Option Plan (incorporated by reference to Exhibit 10.4
                    to the
                    Company’s Amendment No. 1 to Form S-3 Registration Statement filed on
                    November 18, 1999).10.2
                
                Employment
                    Amendment No. 1 between the Company and Theodore H. Banzhaf date
                    July 6,
                    2005 (the original Employment Agreement was filed as Exhibit
                    10.1 to the
                    Company’s quarterly report on Form 10-Q filed with the SEC on August
                    14.
                    2003).10.3
                
                Amendment
                    No. 2 to Time Accelerated Restricted Stock Award Plan (TARSAP)
                    between
                    SpatiaLight, Inc. and Theodore Banzhaf, dated as of July 6, 2005
                    (the
                    Amended and Restated TARSAP Agreement was filed as Exhibit 10.1
                    to the
                    Company’s quarterly report on Form 10-Q filed with the SEC on May 13,
                    2004).10.4
                
                Amendment
                    to Lease Agreement between the Company and Hamilton Marin, LLC,
                    dated May
                    17, 2002 (Lease Agreement filed as exhibit 10.18 in Form 10-QSB
                    filed on
                    August 14, 2002).10.5
                
                LCoS
                    Supply Agreement dated as of July 1, 2004, between SpatiaLight,
                    Inc. and
                    LG Electronics Inc.* (filed as Exhibit 10.5 to the Company’s Annual Report
                    on Form 10-K/A filed with SEC on December 29, 2005).10.6
                
                Securities
                    Purchase Agreement-Private Placement on January 13, 2006 (the
                    original
                    Securities Purchase Agreement was filed as Exhibit 10.1 to the
                    Company’s
                    current report on Form 8-K filed with SEC on January 19,
                    2006).10.7
                
                Registration
                    Rights Agreement-Private Placement on January 13, 2006 (the original
                    Registration Rights Agreement was filed as Exhibit 10.2 to the
                    Company’s
                    current report on Form 8-K filed with SEC on January 19,
                    2006).10.8
                
                Securities
                    Purchase Agreement-Private Placement on October 12, 2005 (the
                    original
                    Securities Purchase Agreement was filed as Exhibit 10.1 to the
                    Company’s
                    current report on Form 8-K filed with SEC on October 13,
                    2005).10.9
                
                Registration
                    Rights Agreement-Private Placement on October 12, 2005 (the original
                    Registration Rights Agreement was filed as Exhibit 10.2 to the
                    Company’s
                    current report on Form 8-K filed with SEC on October 13,
                    2005).10.10
                
                Warrant
                    issued to Portside Growth and Opportunity Fund in connection
                    with the
                    Private Placement-October 12, 2005 (the original Warrant was
                    filed as
                    Exhibit 10.4 to the Company’s current report on Form 8-K filed with SEC on
                    October 13, 2005).10.11
                
                Warrant
                    issued to Smithfield Fiduciary LLC in connection with the Private
                    Placement-October 12, 2005 (the original Warrant was filed as
                    Exhibit 10.5
                    to the Company’s current report on Form 8-K filed with SEC on October 13,
                    2005).10.12
                
                Warrant
                    issued to Bluegrass Growth Fund LP in connection with the Private
                    Placement-October 12, 2005 (the original Warrant was filed as
                    Exhibit 10.6
                    to the Company’s current report on Form 8-K filed with SEC on October 13,
                    2005).10.13
                
                Warrant
                    issued to Greenpark Limited in connection with the Private
                    Placement-October 12, 2005 (the original Warrant was filed as
                    Exhibit 10.7
                    to the Company’s current report on Form 8-K filed with SEC on October 13,
                    2005).10.14
                
                Warrant
                    issued to Steven F. Tripp in connection with the Private Placement-October
                    12, 2005 (the original Warrant was filed as Exhibit 10.8 to the
                    Company’s
                    current report on Form 8-K filed with SEC on October 13,
                    2005).10.15
                
                Warrant
                    issued to Robert Woods in connection with the Private Placement-October
                    12, 2005 (the original Warrant was filed as Exhibit 10.9 to the
                    Company’s
                    current report on Form 8-K filed with SEC on October 13,
                    2005).10.16
                
                Form
                    of Replacement Note - November 2004 Financing (original filed
                    as Exhibit
                    10.1 to the Company’s current report on Form 8-K filed with the SEC on
                    December 22, 2004).10.17
                
                Form
                    of Replacement and Exchange Agreement - November 2004 Financing
                    (original
                       filed as Exhibit 10.3 to the Company’s current report on Form 8-K filed
                    with the SEC on December 22, 2004).10.18
                
                Securities
                    Purchase Agreement-November 2004 Financing (the original Securities
                    Purchase Agreement was filed as Exhibit 10.1 to the Company’s current
                    report on Form 8-K filed with SEC on December 6,
                    2004).
  91
  10.19
                
                Registration
                    Rights Agreement-November 2004 Financing (the original Registration
                    Rights
                    Agreement was filed as Exhibit 10.10 to the Company’s current report on
                    Form 8-K filed with SEC on December 6, 2004).10.20
                
                Intercreditor
                    and Subordination Agreement-November 2004 Financing (the original
                    Intercreditor and Subordination Agreement was filed as Exhibit
                    10.11 to
                    the Company’s current report on Form 8-K filed with SEC on December 6,
                    2004).10.21
                
                Korean
                    Pledge Agreement-November 2004 Financing (the original Korean
                    Pledge
                    Agreement was filed as Exhibit 10.13 to the Company’s current report on
                    Form 8-K filed with SEC on December 6, 2004).10.22
                
                Pledge
                    and Security Agreement-November 2004 Financing (the original
                    Pledge and
                    Security Agreement was filed as Exhibit 10.14 to the Company’s current
                    report on Form 8-K filed with SEC on December 6, 2004).10.23
                
                Negative
                    Pledge Agreement-November 2004 Financing (the original Negative
                    Pledge
                    Agreement was filed as Exhibit 10.15 to the Company’s current report on
                    Form 8-K filed with SEC on December 6, 2004).10.24
                
                Extension
                    and Modification Agreement-November 2004 Financing (the original
                    Extension
                    and Modification Agreement was filed as Exhibit 10.16 to the
                    Company’s
                    current report on Form 8-K filed with SEC on December 6,
                    2004).10.25
                
                Resident
                    Agreement (Lease) between SpatiaLight, Inc. and Korea Industrial
                    Complex
                    Corporation (original Resident Agreement (Lease) was filed as
                    Exhibit 10.1
                    to the Company’s current report on Form 8-K filed with SEC on November 15,
                    2004).14.1
                
                Code
                    of Business Conduct and Ethics†16.1
                
                Letter
                    from BDO Seidman LLP dated December 6, 2004 (original letter
                    filed as
                    Exhibit 16.1 to the Company’s current report on Form 8-K filed with the
                    SEC on December 10, 2004).21.1
                
                Principal
                    subsidiaries of the Company.23.1
                
                Consent
                    of Odenberg, Ullakko, Muranishi & Co. LLP24.1
                
                Power
                    of Attorney.31.1
                
                Certification
                    of Chief Executive Officer and Principal Financial and Accounting
                    Officer
                    Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange
                    Act of
                    1934, as amended.32.1
                
                Certification
                    of Chief Executive Officer and Principal Financial and Accounting
                    Officer
                    Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                    906 of
                    the Sarbanes-Oxley Act of 2002.
 *Confidential
          Treatment has been requested with respect to certain portions of this exhibit.
          Omitted portions have been filed separately with the Securities and Exchange
          Commission.
 † Previously filed.
 92
 **SIGNATURES**
 
 Pursuant
          to the requirements of Section 13 or 15(d) of the Securities Exchange Act
          of
          1934, the Registrant has duly caused this report to be signed on its behalf
          by
          the undersigned, thereunto duly authorized, on the 15th day of March 2007.
 
 .
 SPATIALIGHT,
                  INCBy:
                /s/ David
                  F.
                  HakalaDavid
                    F. Hakala
                  Chief
                    Executive Officer, Chief Operating
                  Officer,
                    Principal Financial and Accounting
                  Officer
 Pursuant
          to the requirements of the Securities Exchange Act of 1934, this report
          has been
          signed below by the following persons on behalf of the Registrant and in
          the
          capacities and on the dates indicated.
 
 
  
 Signature
                  Title
                  Date/s/ DAVID
                    F.
                    HAKALA
                  Chief
                    Executive Officer, Chief Operating Officer
                  March
                      15,
                      2007David
                    F. Hakala*/s/ CLAUDE PIAGET
                    Claude
                    Piaget
                  Director
                  March
                      15, 2007*/s/ ROBERT C. MUNRO
                    Robert
                    C. Munro
                  Director
                  March
                      15, 2007*/s/ JERILYN KESSEL
                    Jerilyn
                    Kessel
                  Director
                  March
                      15, 2007*/s/ HERBERT EHRENTHAL
                    Herbert
                    Ehrenthal
                  Director
                  March
                      15, 2007Pursuant to Power of Attorney
                    filed as
                    Exhibit 24.1/s/ DAVID F. HAKALA
                    David
                    F. Hakala
                  Director
                  March
                      15, 2007(Attorney-in-fact)
   93