**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**Form
      10-Q**




**x**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934****For
                the Quarterly Period Ended September 30, 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 333-131857**




**LIGHTSPACE
      CORPORATION**


(Exact
      name of registrant as specified in its charter)




**Delaware**
            **04-3572975**(State
                or other jurisdiction of incorporation or organization)
            (IRS
                Employer Identification No.)**529
                Main Street, Ste 330, Boston, MA**
            **02129**(Address
                of principal executive offices)
            (Zip
                Code)




Registrant’s
      telephone number, including area code: **(617)
      868-1700**


(Former
      name, former address and former fiscal year, if changed since last report):
      Not
      Applicable




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 o No x




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
            o
            Non-accelerated
                filer
            x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No x




Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date.




**Class**
            
            **Outstanding
                at November 17, 2006**Common
                Stock, par value $0.0001
            
            10,593,111
                shares




















**LIGHTSPACE
      CORPORATION**


**FORM
      10 - Q**


**FOR
      THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006**


**INDEX**






**PAGE****PART
              I - FINANCIAL INFORMATION**Item
              1 - Unaudited Financial StatementsStatements
              of Financial Position as of September 30,
              2006 and December 31, 2005
            3Statements
              of Operations for the Three and Nine Months
              Ended September 30, 2006 and 2005
            4Statement
              of Changes in Stockholders’ Equity (Deficit) for
              the Nine Months Ended September 30, 2006
            5Statements
              of Cash Flows for the Nine Months Ended
              September 30, 2006 and 2005
            6Notes
              to Unaudited Financial Statements
            7Item
              2 - Management's Discussion and Analysis of Financial
              Condition and Results of Operations
            17Item
              3 - Quantitative and Qualitative Disclosures about
              Market Risk
            25Item
              4 - Controls and Procedures
            25**PART
              II - OTHER INFORMATION**Item
              1 - Legal Proceedings
            26Item
              2 - Unregistered Sales of Equity Securities and
              Use of Proceeds
            26Item
              3 - Defaults upon Senior
              Securities
            26Item
              4 - Submission of Matters to a Vote of Security
              Holders
            27Item
              5 - Other Information
            27Item
              6 - Exhibits
            27Signatures
            28









2




**PART
        1. FINANCIAL INFORMATION**


**Item
        1. Unaudited Financial Statements**
  **LIGHTSPACE
          CORPORATION**
 **STATEMENTS
          OF FINANCIAL POSITION**


**September
                  30,** 

                  **2006**
              
              
              **December
                  31,**
                  **2005****ASSETS**Current
                  AssetsCash
                  and cash equivalents
              
              $
              4,768
              
              $
              123,951Accounts
                  receivable
              
              
              51,589
              
              
              35,190Inventory
              
              
              222,384
              
              
              100,807Other
                  current assets
              
              
              270,183
              
              
              113,676Total
                  current assets
              
              
              548,924
              
              
              373,624Property
                  and Equipment - Net
              
              
              52,802
              
              
              39,184Other
                  assets
              
              
              208,625
              
              
              93,072Total
                  Assets
              
              $
              810,351
              
              $
              505,880**LIABILITIES
                  AND STOCKHOLDERS' EQUITY (DEFICIT)**Current
                  LiabilitiesNotes
                  payable
              
              $
              1,604,381
              
              $
              4,639,234Accounts
                  payable
              
              
              891,050
              
              
              658,975Accrued
                  interest
              
              
              47,159
              
              
              538,969Accrued
                  expenses
              
              
              479,831
              
              
              141,574Deferred
                  revenue
              
              
              255,206
              
              
              37,620Total
                  current liabilities
              
              
              3,277,627
              
              
              6,016,372Stockholders'
                  Equity (Deficit)Preferred
                  stock, $0.0001 par value; authorized none and 1,000,000shares
                  at September 30, 2006 and December 31, 2005, respectively;None
                  and 133,732 shares issued and outstanding atSeptember
                  30, 2006 and December 31, 2005, respectively
              
              
              -
              
              
              13Common
                  stock, $0.0001 par value; authorized 30,000,000 shares;5,793,111
                  and 977,182 shares issued and outstandingat
                  September 30, 2006 and December 31, 2005, respectively
              
              
              579
              
              
              98Additional
                  paid-in capital
              
              
              7,195,975
              
              
              2,092,612Retained
                  earning (deficit)
              
              
              (9,663,830
              )
              
              (7,603,215
              )Total
                  stockholders' equity (deficit)
              
              
              (2,467,276
              )
              
              (5,510,492
              )Total
                  Liabilities and Stockholders' Equity (Deficit)
              
              $
              810,351
              
              $
              505,880See
                  notes to unaudited financial
                  statements




3


**LIGHTSPACE
          CORPORATION**
 **STATEMENTS
            OF OPERATIONS**
 **Three
                    Months Ended September 30,**
                
                **Nine
                    Months Ended September 30,****2006**
                
                
                **2005**
                
                
                **2006**
                
                
                **2005**RevenuesProduct
                    sales
                
                $
                191,371
                
                $
                176,459
                
                $
                406,978
                
                $
                946,326Other
                
                
                6,964
                
                
                6,611
                
                
                19,859
                
                
                20,109Total
                    revenues
                
                
                198,335
                
                
                183,070
                
                
                426,837
                
                
                966,435Product
                    Cost
                
                
                228,647
                
                
                126,912
                
                
                578,051
                
                
                742,089Gross
                    Margin
                
                
                (30,312
                )
                
                56,158
                
                
                (151,214
                )
                
                224,346Operating
                    ExpensesResearch
                    and development
                
                
                229,927
                
                
                184,251
                
                
                726,709
                
                
                706,110Selling
                    and marketing
                
                
                250,797
                
                
                135,251
                
                
                742,019
                
                
                461,041General
                    and administrative
                
                
                122,664
                
                
                234,156
                
                
                576,581
                
                
                593,105Total
                    operating expenses
                
                
                603,388
                
                
                553,658
                
                
                2,045,309
                
                
                1,760,256Operating
                    Loss
                
                
                (633,700
                )
                
                (497,500
                )
                
                (2,196,523
                )
                
                (1,535,910
                )Other
                    Income (Expense)Net
                    gain on debt and equity conversion
                
                
                -
                
                
                -
                
                
                402,298
                
                
                -Interest
                    expense - net
                
                
                (40,562
                )
                
                (118,716
                )
                
                (266,390
                )
                
                (430,745
                )Total
                    other income (expense)
                
                
                (40,562
                )
                
                (118,716
                )
                
                135,908
                
                
                (430,745
                )Loss
                    Before Provision For Income Taxes
                
                
                (674,262
                )
                
                (616,216
                )
                
                (2,060,615
                )
                
                (1,966,655
                )Provision
                    For Income Taxes
                
                
                -
                
                
                -
                
                
                -
                
                
                -Net
                    Loss
                
                $
                (674,262
                )
                $
                (616,216
                )
                $
                (2,060,615
                )
                $
                (1,966,655
                )Basic
                    and Diluted Net Loss Per Share
                
                $
                (0.12
                )
                $
                (0.63
                )
                $
                (0.56
                )
                $
                (2.03
                )Weighted
                    Average Common Shares Outstanding
                
                
                5,793,111
                
                
                977,182
                
                
                3,652,698
                
                
                969,182See
                    notes to unaudited financial
                    statements
  4
  **LIGHTSPACE
          CORPORATION**
 **STATEMENT
            OF CHANGES IN STOCKHOLDERS' EQUITY
            (DEFICIT)**
 **January
              1, 2006 to September 30, 2006**
  ****Series
                    A Convertible****
                  **Preferred
                    Stock**
                
                **Common
                    Stock**
                
                **Additional**
                
                **Retained**
                
                **Stockholders'****Shares**
                
                
                
                
                
                **Shares**
                
                
                
                
                **Paid-In**
                
                **Earnings**
                
                **Equity****Issued**
                
                
                **Amount**
                
                
                **Issued**
                
                
                **Amount**
                
                **Capital**
                
                **(Deficit**)
                
                **(Deficit**)Balance,
                    January 1, 2006
                
                
                133,732
                
                $
                13
                
                
                977,182
                
                $
                98
                
                $
                2,092,612
                
                $
                (7,603,215
                )
                $
                (5,510,492
                )Conversion
                    of notes payable
                
                
                
                
                
                
                
                
                1,544,865
                
                
                154
                
                
                2,724,621
                
                
                
                
                
                2,724,775Conversion
                    of senior notes
                
                
                
                
                
                
                
                
                3,110,585
                
                
                311
                
                
                2,488,160
                
                
                
                
                
                2,488,471Conversion
                    of preferred stock
                
                
                (133,732
                )
                
                (13
                )
                
                160,479
                
                
                16
                
                
                85,586
                
                
                
                
                
                85,589Issuance
                    of common warrants
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                264,345
                
                
                
                
                
                264,345Expenses
                    of private placement
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (499,595
                )
                
                
                
                
                (499,595
                )Stock
                    option compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                40,246
                
                
                
                
                
                40,246Net
                    loss for the period
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (2,060,615
                )
                
                (2,060,615
                )Balance
                    September 30, 2006
                
                
                -
                
                $
                -
                
                
                5,793,111
                
                $
                579
                
                $
                7,195,975
                
                $
                (9,663,830
                )
                $
                (2,467,276
                )See
                    notes to unaudited financial
                    statements
  5
  **LIGHTSPACE
          CORPORATION**
 **STATEMENTS
            OF CASH FLOWS**
  **Nine
                    Months Ended September 30,****2006**
                
                **2005**Cash
                    Flows (Uses) from Operating Activities:Net
                    loss
                
                $
                (2,060,615
                )
                $
                (1,966,655
                )Adjustments
                    to reconcile net loss to cash usedin
                    operating activities:Depreciation
                    and amortization
                
                
                25,254
                
                
                21,328Amortization
                    of debt discount and expense
                
                
                19,671
                
                
                143,049Provision
                    for stock option compensation
                
                
                40,246Debt
                    and preferred stock conversion adjustments:Fair
                    value of common stock issued
                
                
                350,018
                
                
                -Fair
                    value of common stock warrants issued
                
                
                264,345
                
                
                -Non-cash
                    gain on debt conversion
                
                
                (890,765
                )
                
                -Other
                    changes in assets and liabilities:Accounts
                    receivable
                
                
                (16,399
                )
                
                12,946Inventory
                
                
                (121,577
                )
                
                176,974Other
                    assets
                
                
                (291,731
                )
                
                (108,739
                )Accounts
                    payable and accrued expenses
                
                
                816,251
                
                
                667,238Deferred
                    revenue
                
                
                217,586
                
                
                (453,069
                )Net
                    cash used in operating activities
                
                
                (1,647,716
                )
                
                (1,506,928
                )Cash
                    Flows (Uses) From Investing Activities:Purchases
                    of property and equipment
                
                
                (38,872
                )
                
                -Net
                    cash used in investing activities
                
                
                (38,872
                )
                
                -Cash
                    Flows (Uses) From Financing Activities:Proceeds
                    from notes payable
                
                
                2,067,000
                
                
                1,664,957Expenses
                    of private placement
                
                
                (499,595
                )
                
                -Net
                    cash provided from financing activities
                
                
                1,567,405
                
                
                1,664,957Net
                    Increase (Decrease) in Cash and Cash Equivalents
                
                
                (119,183
                )
                
                158,029Cash
                    and Cash Equivalents - beginning of period
                
                
                123,951
                
                
                47,546Cash
                    and Cash Equivalents - end of period
                
                $
                4,768
                
                $
                205,575Supplemental
                    Disclosures of Cash Flow InformationInterest
                    paid
                
                $
                88,471
                
                $
                49,601Notes
                    payable and accrued interest converted to common stock
                
                $
                5,839,582
                
                $
                90,000Issuance
                    of stock warrants with financings
                
                $
                125,896
                
                $
                143,049See
                    notes to unaudited financial
                    statements
  6
  **LIGHTSPACE
        CORPORATION**
 **NOTES
        TO****UNAUDITED FINANCIAL
        STATEMENTS**
 **SEPTEMBER
        30, 2006**


**1.
      1. NATURE OF THE BUSINESS AND OPERATIONS**


Lightspace
      Corporation (the “Company”), incorporated in August 2001 as a Delaware
      corporation, provides interactive lighting entertainment products to numerous
      industries including retail stores, family entertainment centers, theme parks,
      fashion shows, nightclubs, special events, stage lighting & sound, health
      clubs and architectural lighting and design.





The
      Company is subject to certain risks common to technology-based companies in
      similar stages of development. Principal risks to the Company include
      uncertainty of growth in market acceptance for the Company’s products;
      dependence on advances in interactive digital environments; history of losses
      since inception; ability to remain competitive in response to new technologies;
      costs to defend, as well as risks of losing, patent and intellectual property
      rights; reliance on limited number of suppliers; reliance on outsourced
      manufacture of the Company’s products for quality control and product
      availability; ability to increase production capacity to meet demand for the
      Company’s products; concentration of the Company’s operations in a limited
      number of facilities; uncertainty of demand for the Company’s products in
      certain markets; ability to manage growth effectively; dependence on key members
      of the Company’s management; limited experience in conducting operations
      internationally; and ability to obtain adequate capital to fund future
      operations.




The
      Company has incurred net operating losses and negative operating cash flows
      since inception. As of September 30, 2006, the Company had an accumulated
      retained earnings deficit of $9,663,830 and an accumulated stockholders’ deficit
      of $2,467,276. The Company has funded its operations through September 30,
      2006
      through the issuance of private placements of common stock and preferred stock,
      borrowings from stockholders and others, and sales of Lightspace products.
      The
      Company’s long-term success is dependent on obtaining sufficient capital to fund
      its operations and development of its products, bringing such products to the
      worldwide market, and obtaining sufficient sales volume to be profitable.








**2.
      BASIS OF PRESENTATION**





The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and the satisfaction of liabilities
      in the ordinary course of business. The Company has incurred net losses from
      operations of $674,262 and $2,060,615 for the three and nine month periods
      ended
      September 30, 2006. Further, the Company has accumulated net losses from
      operations of $9,663,830. These factors, amongst others, indicate that there
      is
      substantial uncertainty that the Company will continue as a going concern.
      The
      financial statements do not include any adjustments related to the recovery
      of
      assets and classification of liabilities that might be necessary should the
      Company be unable to continue as a going concern.




The
      statement of financial position as of September 30, 2006, the statements of
      operations and cash flows for the three and/or nine months ended September
      30,
      2006 and 2005, and the statement of changes in stockholders’ equity (deficit)
      for the nine months ended September 30, 2006 are unaudited. These unaudited
      interim financial statements have been prepared in accordance with accounting
      principles generally accepted in the United States of America and in accordance
      with the instructions for Form 10-Q. Such financial statements do not include
      all of the information and disclosures required for audited financial
      statements. In the opinion of the Company’s management, the unaudited interim
      financial statements have been prepared on the same basis as the Company’s
      audited financial statements and include all adjustments, consisting of normal
      recurring adjustments except as discussed hereafter, necessary for the fair
      presentation of the Company’s financial position, results of its operations,
      cash flows, and stockholders’ equity (deficit) for the periods presented. As
      discussed in Note 10, the nine month period ended September 30, 2006 includes
      a
      net gain of $402,298 related to the securityholder debt and equity conversion
      and exchange. The results of operations for the interim periods are not
      necessarily indicative of the results that can be expected for any other interim
      period or any fiscal year.






7




**LIGHTSPACE
        CORPORATION**
 **NOTES
        TO** **UNAUDITED
        FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2006**


**3.
      RECOGNITION OF SALES**





The
      Company recognizes revenue from the sale of its entertainment systems when
      all
      of the following conditions have been met: (1) evidence exists of an
      arrangement with the customer, typically consisting of a purchase order or
      contract; (2) the Company’s products have been delivered and risk of loss
      has passed to the customer; (3) the Company has completed all of the necessary
      terms of the contract including but not limited to, installation of the product
      and training; (4) the amount of revenue to which the Company is entitled is
      fixed or determinable; and (5) the Company believes it is probable that it
      will be able to collect the amount due from the customer. To the extent that
      one
      or more of these conditions has not been satisfied, the Company defers
      recognition of revenue. Revenue from maintenance contracts is recorded on a
      straight-line basis over the term of the contract. An allowance for
      uncollectible receivables is established by a charge to operations, when in
      the
      opinion of the Company, it is probable that the amount due to the Company will
      not be collected.





**4.
      FILING WITH THE SECURITIES AND EXCHANGE COMMISSION**





The
      Company has filed a Registration Statement on Form S-1, and amendments
      thereto, with the Securities and Exchange Commission to register for sale a
      minimum of 450,000 units, on a best efforts all or none basis, and an
      additional 150,000 units on a best efforts basis, for a maximum of
      600,000 units at a price per unit of $6.40. Each unit consists of:
      (1) eight shares of common stock; (2) eight warrants to purchase a
      total of eight shares of common stock at an exercise price of $1.00 per warrant;
      (3) two warrants to purchase a total of two shares of common stock at an
      exercise price of $1.25 per warrant; and (4) two warrants to purchase a
      total of two shares of common stock at an exercise price of $1.63 per warrant.
      Sale of the minimum or maximum number of units would result in aggregate
      proceeds to the Company of $2,880,000 or $3,840,000, respectively.




The
      Registration Statement was declared effective by the Securities and Exchange
      Commission on October 4, 2006. On November 2, 2006 the Company closed the
      offering period for its securities. The Company sold 600,000 units, the maximum
      allowed, at an offering price of $6.40 per unit, resulting in aggregate proceeds
      to the Company of $3,840,000. After repayment of principal and interest due
      on
      senior notes in the aggregate amount of $1,409,000 and expenses of the offering
      of approximately $496,000, the net proceeds to the Company are approximately
      $1,935,000. In connection with the sale of the units, the Company issued, as
      compensation to the underwriter, a warrant to purchase 102,000 units at an
      exercise price of $7.68 per unit. Each underwriter unit consists of:
      (1) eight shares of common stock; (2) eight warrants to purchase a
      total of eight shares of common stock at an exercise price of $1.00 per warrant;
      (3) two warrants to purchase a total of two shares of common stock at an
      exercise price of $1.25 per warrant; and (4) two warrants to purchase a
      total of two shares of common stock at an exercise price of $1.63 per
      warrant.





The
      sale
      of 600,000 units resulted in the issuance of: (1) 4,800,000 shares of common
      stock; (2) 816,000 warrants to purchase a total of 816,000 shares of common
      stock at an exercise price of $0.96 per warrant (pursuant to the unit warrants
      issued to the underwriter); (3) 5,616,000 warrants to purchase a total of
      5,616,000 shares of common stock at an exercise price of $1.00 per warrant;
      (4)
      1,404,000 warrants to purchase a total of 1,404,000 shares of common stock
      at an
      exercise price of $1.25 per warrant; and (5) 1,404,000 warrants to purchase
      a
      total of 1,404,000 shares of common stock at an exercise price of $1.63 per
      warrant.





Issued
      and
      outstanding shares of the Company’s common stock at November 2, 2006 increased
      to 10,593,111 from 5,793,111 at September 30, 2006. Additionally, issued and
      outstanding common stock warrants at November 2, 2006 were 15,427,789,
      exercisable at prices that range from $0.80 to $7.50. At September 30, 2006,
      the
      Company had issued and outstanding common stock warrants in the aggregate amount
      of 6,187,789, exercisable at prices that range from $0.80 to $7.50.





8




**LIGHTSPACE
        CORPORATION**
 **NOTES
        TO** **UNAUDITED
        FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2006**





**5.
      LOSS PER SHARE**





Basic
      and
      diluted net loss per common share are calculated by dividing the net loss by
      the
      weighted average number of common shares outstanding during the period. Diluted
      net loss per share is the same as basic net loss per share, since the effects
      of
      potentially dilutive securities are excluded from the calculation for all
      periods presented as their inclusion would be anti-dilutive. Dilutive securities
      consist of common stock options, common stock warrants, preferred stock
      warrants, convertible preferred stock and convertible debt.






The
      following potentially dilutive securities were excluded from the calculation
      of
      diluted loss per share because their inclusion would be
      anti-dilutive:




**Three
                  Months Ended September 30,**
              
              **Nine
                  Months Ended September 30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Common
                  stock options
              
              1,794,890
              
              72,080
              
              1,794,890
              
              72,080Common
                  stock warrants
              
              6,187,789
              
              99,938
              
              6,189,789
              
              99,938Preferred
                  stock warrants
              
              -
              
              16,390
              
              -
              
              16,390Convertible
                  preferred stock
              
              -
              
              53,493
              
              -
              
              53,493Convertible
                  debt
              
              -
              
              134,497
              
              -
              
              134,497Total
              
              7,982,679
              
              376,398
              
              7,984,679
              
              376,398








**6.
      STOCK OPTION BASED COMPENSATION**





The
      Company accounted for stock-based compensation arrangements with employees
      and
      directors utilizing the intrinsic-value method for all periods prior to January
      1, 2006. Under this method, stock-based compensation expense is determined
      at
      the measurement date, which is generally the date of grant, as the aggregate
      amount by which the current market value of the equity security exceeds the
      exercise price to be paid. The resulting compensation expense, if any, is
      recognized for financial reporting over the term of vesting or performance.
      Stock-based compensation arrangements with nonemployees or associated with
      borrowing arrangements are accounted for utilizing the fair value method or,
      if
      a more reliable measurement, the value of the services or consideration
      received. Under the fair value method, stock-based compensation expense is
      determined at the measurement date, which again is generally the date of grant,
      as the aggregate amount by which the expected future value of the equity
      security at the date of acquisition exceeds the exercise price to be paid.
      The
      resulting compensation expense, if any, is recognized for financial reporting
      at
      the time the services are rendered and completed. The Company determined the
      fair value of stock-based compensation arrangements for nonemployees and under
      borrowing arrangements utilizing the minimum value method, which excludes as
      a
      computational factor stock volatility.




The
      Company has historically granted stock-based compensation awards to employees
      and directors at an exercise price equal to the current market value of the
      Company’s equity security at the date of grant. Accordingly, no compensation
      expense has been or will be recognized in the financial statements for all
      such
      stock based compensation awards prior to January 1, 2006.




In
      December 2004, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 123(R), Share-Based Payment. This statement
      addresses accounting for stock-based compensation arrangements, including stock
      options and shares issued to employees and directors under various stock-based
      compensation arrangements. This statement requires the Company to use the fair
      value method, rather than the intrinsic-value method, to determine compensation
      expense for all stock-based arrangements for all periods subsequent to December
      31, 2005. Additionally, the Company is no longer permitted to calculate
      stock-based compensation excluding a factor for stock volatility. This statement
      was effective for the Company in 2006 for all prospective stock option and
      share
      grants of stock-based compensation awards and modifications to all prior grants.






9




**LIGHTSPACE
        CORPORATION**
 **NOTES
        TO** **UNAUDITED
        FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2006**




**6.
      STOCK OPTION BASED COMPENSATION (continued)**





The
      following table summarizes the pro forma stock based compen sation
      expense and the related effect on reported results of operations for stock
      option grants to employees and directors for periods prior to January 1, 2006
      that would have been recorded by the Company for the three and nine months
      ended
      September 30, 2006 and 2005 under the provisions of Statement of Financial
      Accounting Standards No. 123(R), Share-Based Payment, if the Company had adopted
      early application thereof.




**Three
                  Months Ended September 30,**
              
              **Nine
                  Months Ended September 30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**Net
                  loss as reported
              
              $
              (674,262
              )
              $
              (616,216
              )
              $
              (2,060,615
              )
              $
              (1,966,655
              )Pro
                  forma stock option compensation
              
              
              (1,881
              )
              
              (6,672
              )
              
              (5,642
              )
              
              (6,672
              )Pro
                  forma net loss
              
              $
              (676,143
              )
              $
              (622,888
              )
              $
              (2,066,257
              )
              $
              (1,973,327
              )Basic
                  and diluted net loss per share:As
                  reported
              
              $
              (0.12
              )
              $
              (0.63
              )
              $
              (0.56
              )
              $
              (2.03
              )Pro
                  forma
              
              $
              (0.12
              )
              $
              (0.64
              )
              $
              (0.57
              )
              $
              (2.04
              )




The
      fair
      value of stock options at the date of grant was determined under the
      Black-Scholes option pricing model. The assumptions utilized for the stock
      options granted prior to January 1, 2006 are as follows: volatility - 59%;
      estimated option exercise period - 2 to 3 years; risk free interest rate -
      3.96%; and expected total forfeitures of 13.2%.




In
      June 2006, the Company’s stockholders and Board of Directors approved
      adoption of the 2006 Stock Incentive Plan (the “2006 Stock Plan”), pursuant to
      which up to 2,118,622 incentive stock options and/or nonqualified stock options
      may be granted to directors, officers, key employees and consultants. In July
      2006, under the 2006 Stock Plan the Company granted to officers and key
      employees 1,736,810 options to purchase 1,736,810 shares of common stock at
      an
      exercise price of $0.80 per option. The options vest ratably over a three year
      period and expire in ten years. Under the provisions of Statement of Financial
      Accounting Standards No. 123(R), Share-Based Payment, the Company determined
      the
      total stock based compensation expense for this option grant was $483,000,
      utilizing the following assumptions: volatility - 57%; estimated option exercise
      period - 2 to 3 years; risk free interest rate - 5.14% to 5.17%; and expected
      total forfeitures related this option grant of 6.9%.




The
      provision for stock based compensation for common stock options granted in
      July
      2006 for the three and nine months ended September 30, 2006 was $40,246. The
      Company did not record a tax benefit related to the provision for stock based
      compensation due to the Company’s net operating loss carryforwards; accordingly,
      the net loss for each period was increased by $40,246 and basic and diluted
      net
      loss per share was increased by $0.01 in each period in the three and nine
      month
      periods ended September 30, 2006.




**7.
      INVENTORY**




At
      December 31, 2005 and September 30, 2006, inventory consisted of raw materials
      of $87,497 and $43,309, and finished products of $13,310 and $179,075,
      respectively.




**8.
      PREFERRED STOCK**




On
      April 27, 2006, the conditions for the closing of the February 9, 2006
      Securityholder Debt and Equity Conversion and Exchange Agreement having been
      met, the 133,732 shares of issued and outstanding Series A convertible preferred
      stock were converted into 160,479 shares of the Company’s common stock. The
      133,732 shares of Series A preferred stock have been retired and the
      authority to issue further classes of preferred stock has been cancelled.







10




**LIGHTSPACE
          CORPORATION**
 **NOTES
          TO** **UNAUDITED
          FINANCIAL STATEMENTS**
 **SEPTEMBER
          30, 2006**






**9.
      COMMON STOCK**




On
      April 18, 2006 the stockholders' of the Company approved resolutions to
      increase the authorized shares of the Company's common stock to 30,000,000,
      and
      to effect a one for 2.5 reverse stock split of the Company's common stock
      effective with the closing of the February 9, 2006 Securityholder Debt and
      Equity Conversion and Exchange Agreement, which occurred on April 27, 2006.
      The accompanying financial statements and notes thereto have been restated
      to
      reflect this one for 2.5 reverse stock split.




The
      Company has authorized 30,000,000 shares of $0.0001 par value of common stock.
      At September 30, 2006 and December 31, 2005, the Company had issued and
      outstanding 5,793,111 and 977,182 shares of common stock, respectively. As
      discussed in Note 4, on November 2, 2006 the Company closed the offering period
      for the sale of its securities. Issued and outstanding shares of the Company’s
      common stock at November 2, 2006 increased to 10,593,111 from 5,793,111 at
      September 30, 2006. Additionally, issued and outstanding common stock warrants
      at November 2, 2006 were 15,427,789, exercisable at prices that range from
      $0.80
      to $7.50. At September 30, 2006, the Company had issued and outstanding common
      stock warrants in the aggregate amount of 6,187,789, exercisable at prices
      that
      range from $0.80 to $7.50.




**10.
      SECURITYHOLDER DEBT AND EQUITY CONVERSION AND EXCHANGE**




On
      February 9, 2006, the Company entered into a Securityholder Debt and Equity
      Conversion and Exchange Agreement (the "Agreement") with holders of
      (1) $1,401,000 in principal amount of convertible notes and $1,538,234 in
      principal amount of demand notes, (2) holders of 133,732 shares of
      Series A preferred stock and (3) existing warrantholders to provide
      for the terms of the debt conversion, preferred conversion and warrant exchange.
      The Agreement was effective upon the receipt by the Company of an aggregate
      investment of at least two million dollars in gross proceeds of senior secured
      notes. Under the terms of the Agreement, (1) the holders of convertible and
      demand notes received 1,544,865 shares of common stock and exchange warrants
      to
      purchase 1,480,849 shares of common stock at exercise prices ranging from $0.80
      to $7.50 per share upon conversion of their notes and any warrants issued in
      conjunction therewith, and the Company’s former CEO received a contingent
      promissory note in the principal amount of $237,381; (2) the holders of
      Series A preferred stock received 160,479 shares of common stock upon
      conversion of their Series A Preferred Stock; and (3) the holders of
      other existing warrants received exchange warrants to purchase 41,063 shares
      of
      common stock at an exercise price of $7.50 per warrant. On April 27, 2006,
      the conditions for the closing of the Securityholder Debt and Equity Conversion
      and Exchange Agreement having been met, the Company effected the conversion
      and
      exchange. As a result of the closing of the Agreement, the Company recorded
      a
      one-time net gain of $402,298. The net gain was comprised of the
      following:




(a)
      To
      effect the conversion of the convertible notes to common stock, the Company
      modified the original conversion ratios, resulting in the issuance of an
      additional 330,536 shares of common stock. Upon conversion, the fair value
      of
      these additional shares, $264,429 (330,536 shares at $0.80 per share), was
      charged to operations as debt conversion expense and as an increase to
      additional paid-in-capital. Under the fair value computation method utilizing
      a
      4.89% risk-free interest rate assumption, 59% volatility factor and an expected
      life of three years, a value of $1,404 was assigned to the 108,534 warrants
      to
      purchase 108,534 shares of common stock at an exercise price of $7.50 per
      warrant issued in connection with this part of the Exchange. The assigned fair
      value of the exchange warrants was accounted for in the same manner as the
      additional shares of common stock issued in the conversion;






11




**LIGHTSPACE
          CORPORATION**
 **NOTES
          TO** **UNAUDITED
          FINANCIAL STATEMENTS**
 **SEPTEMBER
          30, 2006**





**10.
      SECURITYHOLDER DEBT AND EQUITY CONVERSION AND EXCHANGE
      (continued)**





(b)
      To
      effect the conversion of the demand notes, the Company negotiated conversion
      rates of $0.85 to $3.00 with the noteholders, resulting in the issuance of
      868,532 shares of common stock. Upon conversion, the Company recorded a one-time
      gain of $890,765, representing the difference between the principal and accrued
      interest due on the notes, $1,585,591, and the fair value of the shares issued
      to effect the conversion, $694,825 (868,532 shares at $0.80 per share). Under
      the fair value computation method utilizing a 4.89% risk-free interest rate
      assumption, 59% volatility factor and an expected life of three years, a value
      of $137,045 was assigned to the 1,011,063 warrants to purchase 1,011,063 shares
      of common stock at exercise prices that range from $1.00 to $7.50 per warrant
      issued in connection with this part of the conversion. This assigned fair value
      was charged to operations as debt conversion expense and as an increase to
      additional paid-in-capital;




(c) To effect
      the conversion of the Series A Preferred Stock, the Company modified the
      conversion ratio from .4 shares of common stock to 1.2 shares of common stock
      for each share of Series A Convertible Preferred Stock held. This
      modification resulted in the issuance of an additional 106,986 shares of common
      stock. Upon conversion, the fair value of these additional shares, $85,589
      (106,986 shares at $0.80 per share), was charged to operations as conversion
      expense and as an increase to additional paid-in-capital; and




(d)
      In
      connection with the issuance of the $237,381 contingent promissory note to
      the
      former CEO, the Company issued to the former CEO, 361,252 five-year warrants
      to
      purchase 361,252 shares of common stock at an exercise price of $0.80 per
      warrant. The fair value of the warrants at April 27, 2006 was determined to
      be
      $125,896 under the fair value computation method utilizing a 4.89% risk free
      interest rate assumption, 59% volatility factor and an expected life of three
      years. The $125,896 has been classified as deferred financing costs, chargeable
      to operations as additional interest expense over three years, and as an
      increase to additional paid-in-capital.




As
      of
      April 25, 2006, the Company had received an aggregate of $2,400,000 in
      principal amount of senior secured note financing. The Company and the senior
      secured noteholders agreed, effective May 3, 2006, to convert $2,488,471 of
      senior secured note principal and accrued interest, at a conversion price of
      $6.40 per unit, into 388,821 units plus fractional shares and warrants. Each
      unit consists of (1) eight shares of common stock, (2) eight warrants
      to purchase a total of eight shares of common stock at an exercise price of
      $1.00 per warrant; (3) two warrants to purchase a total of two shares of
      common stock at an exercise of $1.25 per warrant: and (4) two warrants to
      purchase a total of two shares of common stock at an exercise price of $1.63
      per
      warrant. The Company issued to the senior secured note holders 3,110,585 shares
      of common stock, 3,110,585 warrants to purchase a total of 3,110,585 shares
      of
      common stock at an exercise price of $1.00 per warrant, 777,646 warrants to
      purchase a total of 777,646 shares of common stock at an exercise price of
      $1.25
      per warrant, and 777,646 warrants to purchase a total of 777,646 shares of
      common stock at an exercise price of $1.63 per warrant.

















12





**LIGHTSPACE
          CORPORATION**
 **NOTES
          TO** **UNAUDITED
          FINANCIAL STATEMENTS**
 **SEPTEMBER
          30, 2006**






**11.
      STOCK INCENTIVE PLANS**





In
      September 2005, the Company’s stockholders and Board of Directors approved the
      2005 Stock Incentive Plan (the “2005 Stock Plan”). The 2005 Plan provides that
      the Board of Directors may grant up to 72,080 incentive stock options and/or
      nonqualified stock options to directors, officers, key employees and to
      consultants. The 2005 Stock Plan provides that the exercise price of each option
      must be at least equal to the fair market value of the common stock at the
      date
      such option is granted. For grants to an individual who ow ns
      more
      than 10% of the outstanding common stock of the Company, the exercise price
      must
      be 110% of fair market value at the time of grant. Options expire in ten years
      or less from the date of grant and vest over a period not to exceed four years.
      At September 30, 2006, the Company has reserved 58,080 shares of common stock
      for issuance under the 2005 Stock Plan. Concurrent with the approval and
      adoption of the 2006 Stock Incentive Plan in June of 2006, no additional options
      will be issued under the 2005 Stock Plan.




In
      June 2006, the Company’s stockholders and Board of Directors approved
      adoption of the 2006 Stock Incentive Plan (the “2006 Stock Plan”), pursuant to
      which up to 2,118,622 incentive stock options and/or nonqualified stock options
      may be granted to directors, officers, key employees and consultants. The 2006
      Stock Plan provides that the exercise price of each option must be at least
      equal to the fair market value of the common stock at the date such option
      is
      granted. For grants to an individual who own more than 10% of the outstanding
      common stock of the Company, the exercise price must be 110% of fair market
      value at the time of grant. Options expire in ten years or less from the date
      of
      grant and vest over a period not to exceed four years. As of September 30,
      2006,
      the Company has reserved 2,118,622 shares of common stock for issuance under
      the
      2006 Stock Plan.




Prior
      to
      the effective date of the Company’s initial public offering, November 2, 2006,
      the Board of Directors determined the fair market value of the common stock
      at
      the date of grant after considering an extensive range of factors. Such factors
      include, among others, the Company’s financial performance to date, the
      Company’s future prospects and opportunities and recent offering prices and
      sales of the Company’s common stock.





In
      September 2005, the Company granted options under the 2005 Stock Plan to
      purchase 72,080 shares of common stock to officers, a director, and key
      employees at an exercise price of $.83 per option, the fair market value of
      the
      Company’s common stock at that date. The options vest at stipulated dates over a
      period not to exceed four years and expire in ten years.





In
      July
      2006, the Company granted options under the 2006 Stock Plan to purchase
      1,736,810 shares of common stock to officers and key employees at an exercise
      price of $.80 per option, the fair market value of the Company’s common stock at
      that date. The options vest at stipulated dates over a period not to exceed
      three years and expire in ten years. Under the provisions of Statement of
      Financial Accounting Standards No. 123(R), Share-Based Payment, the Company
      determined the total stock based compensation expense for this option grant
      was
      $483,000, utilizing the following assumptions: volatility - 57%; estimated
      option exercise period - 2 to 3 years; risk free interest rate - 5.14% to 5.17%;
      and expected total forfeitures related this option grant of 6.9%. At September
      30, 2006, total unrecognized stock based compensation expense related to
      unvested common stock option grants expected to be charged to operations over
      the next two and three quarter years is estimated to be $443,000.











13





**LIGHTSPACE
          CORPORATION**
 **NOTES
          TO** **UNAUDITED
          FINANCIAL STATEMENTS**
 **SEPTEMBER
          30, 2006**




**11.
      STOCK INCENTIVE PLANS (continued)**





Combined
      i nformation
      with respect to stock options issued under the 2005 and 2006 Stock Plans for
      the
      nine month period ended September 30, 2006 is summarized as
      follows:




**September
                  30, 2006****Number
                  of**
                **Shares**
              
              
              **Weighted**
                **Average**
                  **Exercise
                    Price**Options
                  outstanding January 1, 2006
              
              
              72,080
              
              $
              0.83Options
                  granted
              
              
              1,736,810
              
              $
              0.80Options
                  exercised
              
              
              -Options
                  cancelled
              
              
              (14,000
              )
              $
              (0.83
              )Options
                  outstanding September 30, 2006
              
              
              1,794,890
              
              $
              0.80Options
                  exerciseable
              
              
              87,846Weighted
                  average exercise price
              
              $
              0.81Weighted
                  average contractual life (years)
              
              
              9
                  1/2Weighted
                  average fair value of options granted
              
              $
              0.30Options
                  available for grant
              
              
              381,812






**12.
      STOCK WARRANTS**





Issued
      and
      outstanding warrants to purchase Series A convertible preferred stock and common
      stock of the Company are as follows:




**Type
                  of Warrant**
              
              **Date
                  Issued**
              
              **Exercise**Price
              
              **December
                    31,**2005
              
              **September
                    30,**2006
              
              **November
                    2,**2006Series
                  A preferred stock
              
              April
                  10, 2004
              
              $10.25
              
              40,975
              
              -
              
              -Common
                  stock warrant
              
              December
                  1, 2004
              
              $15.00
              
              16,876
              
              -
              
              -Common
                  stock warrant
              
              June
                  8 and 23, 2005
              
              $12.50
              
              42,000
              
              -
              
              -Common
                  stock warrant
              
              July
                  15, 2005
              
              $7.50
              
              23,462
              
              -
              
              -Common
                  stock warrant
              
              September
                  1, 2005
              
              $7.50
              
              17,600
              
              -
              
              -$.80
                  Exchange warrant
              
              April
                  27, 2006
              
              $0.80
              
              -
              
              361,252
              
              361,252$1.00
                  Exchange warrant
              
              April
                  27, 2006
              
              $1.00
              
              -
              
              276,370
              
              276,370$3.00
                  Exchange warrant
              
              April
                  27, 2006
              
              $3.00
              
              -
              
              649,892
              
              649,892$7.50
                  Exchange common warrant
              
              April
                  27, 2006
              
              $7.50
              
              -
              
              234,398
              
              234,398$0.96
                  Unit warrant
              
              November
                  2, 2006
              
              $0.96
              
              -
              
              -
              
              816,000$1.00
                  Unit warrant
              
              May
                  3 and November 2, 2006
              
              $1.00
              
              -
              
              3,110,585
              
              8,726,585$1.25
                  Unit warrant
              
              May
                  3 and November 2, 2006
              
              $1.25
              
              -
              
              777,646
              
              2,181,646$1.63
                  Unit warrant
              
              May
                  3 and November 2, 2006
              
              $1.63
              
              -
              
              777,646
              
              2,181,646Total
                  common stock warrants
              
              
              
              
              
              99,938
              
              6,187,789
              
              15,427,789Total
                  warrants outstanding
              
              
              
              
              
              140,913
              
              6,187,789
              
              15,427,789




On
      April
      27, 2006 in connection with the conversion and exchange under the Securityholder
      Debt and Equity Conversion and Exchange Agreement (see Note 10), the Company
      issued 1,160,660 warrants to purchase a total of 1,160,660 shares of common
      stock at exercise prices ranging from $1.00 to $7.50 per warrant. The warrants
      are exercisable at the option of the holder at any time up until April 30,
      2011,
      at which date the warrants expire. In the event of a stock split of the
      Company’s common stock, the warrants will be adjusted proportionately. The fair
      value of the warrants at April 27, 2006 was determined to be $138,449 under
      the
      fair value computation method utilizing a 4.89% risk free interest rate
      assumption, 59% volatility factor and an expected life of three years. The


14




**LIGHTSPACE
        CORPORATION**
 **NOTES
        TO** **UNAUDITED
        FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2006**




**12.
      STOCK WARRANTS (continued)**





$138,449
      has been charged to operations as debt conversion expense and as an increase
      to
      additional paid-in-capital. Included
      in the 1,160,660 warrants issued in connection with the Securityholder Debt
      and
      Equity Conversion and Exchange Agreement were the 140,913 Series A preferred
      stock warrants and common stock warrants issued and outstanding as of December
      31, 2005. The 140,913 preferred and common stock warrants were exchanged for
      149,597 common stock warrants to purchase 149,597 shares of common stock at
      an
      exercise price of $7.50 per warrant. Additionally, in connection with the
      securityholder debt and equity conversion, $237,381 in principal amount of
      existing notes held by the former CEO were converted into a $237,381 contingent
      promissory note. The Company issued to the former CEO 361,252 warrants to
      purchase a total of 361,252 shares of common stock at an exercise price of
      $0.80
      per warrant. The warrants expire on April 30, 2011, unless the terms for payment
      of the contingent promissory note are not met, in which case the warrants will
      expire on March 31, 2009. The fair value of the warrants at April 27, 2006
      was determined to be $125,896 under the fair value computation method utilizing
      a 4.89% risk free interest rate assumption, 59% volatility factor and an
      expected life of three years. The $125,896 has been classified as deferred
      financing costs, chargeable to operations as additional interest expense over
      three years, and as an increase to additional paid-in-capital. The foregoing
      warrants have been classified permanently within stockholders’ equity, as upon
      exercise, the warrant holder can only receive the specified number of shares
      of
      common stock.





On
      May 3,
      2006, the Company and noteholders holding $2,400,000 in principal amount of
      senior secured notes agreed to convert $2,488,471 of senior secured note
      principal and accrued interest, at a conversion price of $6.40 per unit, into
      388,821 units plus fractional shares and warrants. The units that the Company
      issued to the senior secured note holders are comprised of 3,110,585 shares
      of
      common stock, 3,110,585 warrants to purchase a total of 3,110,585 shares of
      common stock at an exercise price of $1.00 per warrant, 777,646 warrants to
      purchase a total of 777,646 shares of common stock at an exercise price of
      $1.25
      per warrant, and 777,646 warrants to purchase a total of 777,646 shares of
      common stock at an exercise price of $1.63 per warrant. The warrants are
      exercisable at the option of the holder at any time up until April 30, 2011,
      at
      which date the warrants expire. In the event of a stock split of the Company’s
      common stock, the warrants will be adjusted proportionately. No value has been
      assigned to the warrants issued in connection with the conversion. The warrants
      have been classified permanently within stockholders’ equity, as upon exercise,
      the warrant holder can only receive the specified number of shares of common
      stock.





On
      November 2, 2006 the Company closed the offering period for its securities
      (see
      Note 4). The Company sold 600,000 units, the maximum allowed, at an offering
      price of $6.40 per unit, resulting in aggregate proceeds to the Company of
      $3,840,000. The sale of 600,000 units, including warrants issued to the
      underwriter as compensation, resulted in the issuance of: (1) 4,800,000 shares
      of common stock; (2) 816,000 warrants to purchase a total of 816,000 shares
      of
      common stock at an exercise price of $0.96 per warrant (pursuant to the unit
      warrants issued to the underwriter); (3) 5,616,000 warrants to purchase a total
      of 5,616,000 shares of common stock at an exercise price of $1.00 per warrant;
      (4) 1,404,000 warrants to purchase a total of 1,404,000 shares of common stock
      at an exercise price of $1.25 per warrant; and (5) 1,404,000 warrants to
      purchase a total of 1,404,000 shares of common stock at an exercise price of
      $1.63 per warrant. The
      warrants are exercisable at the option of the holder at any time up until April
      30, 2011, at which date the warrants expire. In the event of a stock split
      of
      the Company’s common stock, the warrants will be adjusted proportionately. No
      value has been assigned to the warrants issued in connection with the sale
      of
      units. The warrants have been classified permanently within stockholders’
equity, as upon exercise, the warrant holder can only receive the specified
      number of shares of common stock.





At
      December 31, 2005, September 30, 2006 and November 2, 2006, the weighted average
      exercise price of the common stock warrants outstanding was $10.88, $1.56 and
      $1.30, respectively. At September 30, 2006, the common stock warrants have
      an
      average remaining life of approximately four and one-half years.








15





**LIGHTSPACE
        CORPORATION**
 **NOTES
        TO** **UNAUDITED
        FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2006**





**13.
      INCOME TAXES**





The
      Company has recorded no provisions or benefits for income taxes for any period
      presented due to the net operating losses incurred and the uncertainty as to
      the
      recovery of such net operating losses and other deferred tax assets as a
      reduction of possible future taxable income, if any.





At
      December 31, 2005 and September 30, 2006, the Company had operating loss
      carryforwards of approximately $6,684,000 and $7,357,000, respectively,
      available to offset future taxable income for United States federal and state
      income tax purposes. At September 30, 2006, approximately $6,313,000 of the
      operating loss carryforwards are restricted as to yearly usage, as discussed
      hereafter. The United States federal tax operating loss carryforwards expire
      commencing in 2021 through 2026. The state tax operating loss carryforwards
      expire commencing in 2007 through 2010. Additionally, the Company has research
      and development credit carryforwards of approximately $143,000 and $93,000
      available to be used as a reduction of federal income taxes and state income
      taxes, respectively. The Company has provided a valuation allowance equal to
      the
      full amount of the deferred tax asset related to the operating loss
      carryforwards, tax credits and other items deductible against future taxable
      income, if any, and will continue to fully reserve the deferred tax asset until
      it can be ascertained that all or a portion of the asset will be
      realized.





The
      Company’s ability to use the operating loss carryforwards to offset future
      taxable income is subject to restrictions enacted in the United State Internal
      Revenue Code of 1986. These restrictions severely limit the future use of the
      tax operating loss carryforwards if certain ownership changes described in
      the
      code occur. The common stock ownership changes occurring as a result of the
      securityholder debt and equity conversion on April 27, 2006 and the conversion
      of senior secured notes on May 3, 2006 have resulted in limitations in the
      use
      of the tax operating loss carryforwards. In future years, the restricted tax
      operating loss carryforwards of $6,313,000 can be used only to offset
      approximately $100,000 of taxable income per year, if any. The Company may
      use
      other available tax operating loss carryforwards without limitation. Therefore,
      in future years, the Company may be required to pay income taxes even though
      significant tax operating loss carryforwards exist.




**14.
      SEGMENT INFORMATION**





The
      Company conducts its operations and manages its business in one segment, the
      manufacture of hardware and development of software for interactive lighting
      entertainment. Revenues, denominated in U.S. dollars, by geographical region
      are
      as follows:




**Three
                  Months Ended September 30,**
              
              **Nine
                  Months Ended September 30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**United
                  States
              
              $
              59,812
              
              $
              74,765
              
              $
              288,314
              
              $
              715,127Canada
              
              
              49,100
              
              
              -
              
              
              49,100
              
              
              121,750Europe
              
              
              40,413
              
              
              -
              
              
              40,413
              
              
              -Asia
              
              
              49,010
              
              
              89,177
              
              
              49,010
              
              
              89,177South
                  America
              
              
              -
              
              
              -
              
              
              -
              
              
              21,253Australia
              
              
              -
              
              
              19,128
              
              
              -
              
              
              19,128Total
              
              $
              198,335
              
              $
              183,070
              
              $
              426,837
              
              $
              966,435






16





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





The
      following discussion of the financial condition and results of operations of
      the
      Company should be read in conjunction with the unaudited financial statements
      and the related notes thereto included elsewhere in this Form 10-Q. Except
      for
      the historical information contained herein, the following discussion, as well
      as other information in this report, contains forward-looking statements within
      the meaning of Section 27A of the Securities Act of 1933, as amended, and
      Section 21E of the Securities Exchange Act of 1934, as amended, and is
      subject to the “safe harbor” created by those sections. Some of the
      forward-looking statements can be identified by the use of forward-looking
      terms
      such as “believes,” “expects,” “may,” “will,” “should,” “could,” “seek,”
“intends,” “plans,” “estimates,” “anticipates” or other comparable terms.
      Forward-looking statements involve inherent risks and uncertainties. A number
      of
      important factors could cause actual results to differ materially from those
      in
      the forward-looking statements. Management urges you to consider the risks
      and
      uncertainties described in “Risk Factors” in this report and in the Company’s Registration
      Statement on Form S-1. Management undertakes no obligation to update
      forward-looking statements to reflect events or circumstances after the date
      of
      this report. Management cautions readers not to place undue reliance upon any
      such forward-looking statements, which speak only as of the date
      made.




**Overview**





Lightspace
      provides interactive lighting entertainment products to retail stores, family
      entertainment centers, theme parks, fashion shows, nightclubs, special events,
      stage lighting and sound providers, health clubs and architectural lighting
      and
      design. Our current product lines include: (a) Lightspace Play, an interactive
      36 tile gaming platform for children and adult recreation; (b) Lightspace Dance,
      an interactive floor, generally in sizes of 86 tiles and larger, that displays
      customizable lights and effects; and (c) Lightspace Design, an interactive
      tile
      system that displays customizable lights and video effects that can be mounted
      on any flat surface.





Lightspace
      received the first significant investor equity funding, $1,386,000, in July
      and
      December of 2003 and commenced operations. With this funding, and an additional
      funding of $600,000 through the issuance of convertible notes in April 2004,
      we
      were able to engage contract manufacturers for the initial production run of
      100
      interactive tiles and subsequent production of interactive tiles, hire sales
      and
      marketing staff, introduce the Lightspace products at trade shows, expand the
      research and development department personnel and budget, and lease facilities
      for operations.





From
      December 2003 to June 2004, Lightspace increased employment levels from 5
      employees to 27 employees to pursue sales leads and opportunities, to support
      the installation and maintenance of our products, and to design improvements
      to
      the current product and to develop new product offerings. Lightspace’s initial
      product offering, Lightspace Dance, was complemented with the introduction
      of
      Lightspace Play during this period.





In
      March
      of 2004, we began to experience significant manufacturing problems at the
      contract manufacturer. The manufacturing problems encompassed design errors,
      faulty parts and improper assembly. These problems increased the production
      cost
      and significantly reduced the yield of finished interactive tiles. The reduction
      in available finished product restricted the company from selling products
      to
      customers and pursuing sales leads. These manufacturing problems continued
      until
      product design changes and quality control procedures were fully implemented
      in
      early 2005. The effect of the manufacturing problems and consequent lost sales
      resulted in Lightspace using more cash resources than planned for a longer
      period of time to fund operations and product improvements. Our cash situation
      had become critical, and by September of 2005, employment levels had decreased
      to 11 employees. More significantly, without the required funding, Lightspace
      was unable from March 2005 to September 2005 to engage a contract manufacturer
      for the production of interactive tiles.





In
      September of 2005, we commenced borrowing on a short-term secured basis from
      a
      group of new investors through the issuance of bridge notes. This round of
      funding provided Lightspace with sufficient capital to restart in the fourth
      quarter of 2005 the production of interactive tiles. 480 interactive tiles
      were
      available for sale in the first quarter of 2006. An additional 1,350 interactive
      tiles were manufactured in the second and third quarters of 2006. As of December
      31, 2005, we had issued an aggregate principal amount of $1,700,000 of bridge
      notes.




17




On
      February 9, 2006, Lightspace entered into the Securityholder Debt and Equity
      Conversion and Exchange Agreement (“Agreement”) with holders of (1) $1,401,000
      in principal amount of convertible notes and $1,538,234 in principal amount
      of
      demand notes, (2) holders of 133,732 shares of Series A preferred stock and
      (3)
      existing warrants to provide for the terms of the Debt Conversion, Preferred
      Conversion and Warrant Exchange. Under the terms of the Agreement, (1) the
      holders of convertible and demand notes would receive 1,544,865 shares of common
      stock and exchange warrants to purchase 1,480,849 shares of common stock at
      exercise prices ranging from $0.80 to $7.50 per share upon conversion of their
      notes and any warrants issued in conjunction therewith, and a contingent note
      in
      the principal amount of $237,381; (2) the holders of Series A Preferred Stock
      would receive 160,479 shares of common stock upon conversion of their Series
      A
      Preferred Stock; and (3) the holders of other existing warrants would receive
      exchange warrants to purchase 41,063 shares of common stock at an exercise
      price
      of $7.50 per share. On April 27, 2006, the conditions for the closing of the
      Agreement having been met, the agreement became effective. As a result of the
      closing of the Agreement, we recorded a one-time net gain of
      $402,298.





On
      April
      27, 2006, Lightspace and the holders of the bridge notes agreed to convert
      the
      outstanding principal and accrued interest under the bridge notes, $2,488,471,
      into units at a conversion price of $6.40 per unit. On May 3, 2006, we issued
      388,821 units, and a small number of shares of common stock and unit warrants
      representing fractional units, in exchange for the surrender of all of the
      bridge notes. The
      units
      and fractional units that we issued to the bridge note holders were comprised
      of
      3,110,585 shares of common stock, 3,110,585 warrants to purchase a total of
      3,110,585 shares of common stock at an exercise price of $1.00 per warrant,
      777,646 warrants to purchase a total of 777,646 shares of common stock at an
      exercise price of $1.25 per warrant, and 777,646 warrants to purchase a total
      of
      777,646 shares of common stock at an exercise price of $1.63 per
      warrant.





The
      Security and Exchange Commission declared our registration statement on Form
      S-1
      effective October 4, 2006. On November 2, 2006 Lightspace closed the offering
      period for the sale its securities. We sold 600,000 units, the maximum allowed,
      at an offering price of $6.40 per unit, resulting in aggregate proceeds to
      the
      Company of $3,840,000. After repayment of principal and interest due on senior
      notes in the aggregate amount of $1,409,000 and estimated expenses of the
      offering of $496,000, the net proceeds to Lightspace are estimated to
      approximate $1,935,000. The sale of 600,000 units, including warrants issued
      to
      the underwriter as compensation, resulted in the issuance of: (1) 4,800,000
      shares of common stock; (2) 816,000 warrants to purchase a total of 816,000
      shares of common stock at an exercise price of $0.96 per warrant (pursuant
      to
      the unit warrants issued to the underwriter); (3) 5,616,000 warrants to purchase
      a total of 5,616,000 shares of common stock at an exercise price of $1.00 per
      warrant; (4) 1,404,000 warrants to purchase a total of 1,404,000 shares of
      common stock at an exercise price of $1.25 per warrant; and (5) 1,404,000
      warrants to purchase a total of 1,404,000 shares of common stock at an exercise
      price of $1.63 per warrant. The
      warrants are exercisable at the option of the holder at any time up until April
      30, 2011, at which date the warrants expire.




**Results
      of Operations for the Three and Nine Month Periods Ended September 30, 2006
      and
      200** **5**





**Revenue**




For
      the
      quarter ended September 30, 2006 total revenue was $198,335 as compared to
      $183,070 for the corresponding period in the prior year. The revenue for the
      quarter ended September 30, 2006 was comprised of revenue from the sale of
      products, $191,371, and other revenue of $6,964, as represented by deferred
      maintenance revenue, sales of miscellaneous parts and other services. In the
      quarter ended September 30, 2006, there were four Lightspace Play or Design
      installation sites and two Lightspace Dance installation sites, representing
      287
      interactive tiles. The revenue for the quarter ended September 30, 2005 was
      comprised of revenue from the sales of products, $176,459, and other revenue
      of
      $6,611, comprised principally of deferred maintenance revenue. In the quarter
      ended September 30, 2005, there were three Lightspace Play or Design
      installation sites and one Lightspace Dance installation site, representing
      190
      interactive tiles.






18





For
      the
      nine months ended September 30, 2006 total revenue was $426,837 as compared
      to $966,435 for the corresponding period in the prior year. The revenue for
      the
      nine month period ended September 30, 2006 was comprised of revenue from the
      sale of products, $406,978, and other revenue of $19,859, as represented by
      deferred maintenance revenue, sales of miscellaneous parts and other services.
      In the nine months ended September 30, 2006, there were eleven Lightspace Play
      or Design installation sites and two Lightspace Dance installation sites,
      representing 565 interactive tiles. The revenue for the nine month period ended
      September 30, 2005 was comprised of revenue from the sales of products,
      $946,326, and other revenue of $20,109, comprised principally of rental income
      and deferred maintenance revenue. In the nine months ended September 30, 2005,
      there were seven Lightspace Play or Design installation sites and five
      Lightspace Dance installation sites, representing 1,288 interactive
      tiles.





The
      decline in revenues for the nine month period ended September 2006, $426,837,
      as
      compared to the corresponding nine month period of 2005, $966,435, is due
      principally to the following: (1) the lack of interactive tiles available
      for sale (by the end of October of 2005 we had sold all available inventory
      of
      interactive tiles and did not receive the first production run of 500
      interactive tiles from our contract manufacturer until the first quarter of
      2006); (2) the normal sales process wherein leads are pursued,
      demonstrations made, and terms and dates of installation are agreed upon; and
      (3) product mix (in the 2006 nine month period there were 13 Lightspace
      installations sites as compared to 12 Lightspace installation sites in the
      2005
      period; however, the 2005 nine month period included five Lightspace Dance
      installation sites as compared to two Lightspace Dance installation sites in
      the
      2006 period. Lightspace Dance installations require significantly more
      interactive tiles than Lightspace Play or Design installations).





Our
      product backlog at September 30, 2006 was $281,934, representing 409 interactive
      tiles. We expect that this backlog will be shipped and installed prior to March
      31, 2007. Product backlog at December 31, 2005 was $26,400, representing 36
      interactive tiles. Cancellation of a signed contract or order included in
      product backlog requires the consent of Lightspace.




For
      the
      nine months ended September 30, 2006, sales of our products were made to
      customers in the United States - $288,314, Canada - $49,100, Europe - $40,413,
      and Asia - $49,010. In the nine month period ended September 30, 2006, two
      Lightspace customers comprised more than 10% of revenues. Sales to these two
      customers aggregated $95,313 in the 2006 nine month period. For the nine months
      ended September 30, 2005, sales of our products to customers in the United
      States - $715,127, Canada - $121,750, and internationally - $129,558. In the
      nine month period ended September 30, 2005, due to the large dollar value of
      certain sales and the level of sales volume, we had four customers that each
      comprised more than 10% of revenues. Sales to these four customers aggregated
      $668,782 in the 2005 nine month period.




**Product
      Cost and Gross Margin**





For
      the
      quarters ended September 30, 2006 and 2005, Lightspace recorded gross margins
      of
      a negative $30,312, or a negative 15%, and $56,158, or 31%, respectively. For
      the nine month periods ended September 30, 2006 and 2005, Lightspace recorded
      gross margins of negative $151,214, or negative 35%, and $224,346, or 23%,
      respectively. The nine month period ended September 30, 2006 includes a $57,000
      provision for obsolete inventory component parts resulting from engineering
      design changes to be incorporated into the production of interactive tiles
      in
      the first quarter of 2007. In addition to the provision for obsolescence, the
      other major factor affecting the significant decline in the gross margin for
      the
      nine months ended September 30, 2006 is that the fixed cost of our manufacturing
      and customer service organizations, as discussed hereafter, was spread over
      a
      fewer number of sales of interactive tiles, 565 tiles in 2006 period verses
      1288
      tiles in corresponding period for 2005. Due to the low dollar volume of sales
      in
      each period, these margin rates are not representative of margin rates that
      may
      be achieved if we achieve higher volume levels.




19





Product
      cost includes the direct cost of materials, associated freight charges, and
      the
      allocated per unit cost of the contractor's manufacturing labor, overhead and
      profit associated with products sold. For the most part, these costs are
      variable and increase or decrease with volume. Product cost also includes our
      personnel and related expenses assigned to manufacturing and customer service.
      These latter costs tend to be a fixed cost that decreases on a per unit basis
      as
      volume increases.




While
      not
      apparent due to the low dollar volume of sales in the nine month period ended
      September 30, 2006, we were able to achieve an approximate 17% reduction in
      the
      cost of an interactive tile by changing certain component part suppliers,
      elimination of several component parts, and negotiating a supply contract with
      a
      new contract manufacturer. We expect that with volume increases, we may be
      able
      to achieve further reductions in both the cost of the interactive tiles and
      other system components that will offset the increased cost of plastic used
      in
      our products.




**Operating
      Expenses**




Research
      and development spending was $229,927 for the quarter ended September 30, 2006
      as compared to $184,251 for the quarter ended September 30, 2005. R&D
      expenses were $726,709 for the nine months ended September 30, 2006, as compared
      to $706,110 in the corresponding 2005 period. As previously mentioned, to
      conserve cash subsequent to March 2005, we significantly reduced all
      department spending. 2005 quarterly spending for research and development
      decreased from a high of $268,795 in the quarter ended March 30, 2005 to
      approximately $185,000 for each of the quarters ended September 30 and December
      31, 2005. The increased R&D spending when comparing the quarter ended
      September 30, 2006 to the quarter ended September 30, 2005 of approximately
      $46,000, or 25%, is principally related to the two engineers hired in
      January 2006 and spending for new product development. We intend to hire
      one additional engineer in 2006 to assist in new product development.
      Additionally, we have planned for the fourth quarter of 2006 and fiscal year
      2007 approximately $200,000 in research and development spending, exclusive
      of
      staff salaries, for the design, development and testing of a new generation
      of
      Lightspace products.




Selling
      and marketing expenditures were $250,797 for the quarter ended September 30,
      2006 as compared to $135,251 for the quarter ended September 30, 2005. On a
      year-to-date basis, sales and marketing expenses were $742,019 at September
      30,
      2006, as compared to $461,041 in the corresponding 2005 period. Similar to
      2005
      research and development spending, selling and marketing expenditures were
      significantly reduced after the quarter ended March 31, 2005 to conserve
      cash. The increased sales and marketing spending in both 2006 periods, when
      comparing these periods to 2005, is related to the 2006 hiring of three sales
      personnel, increased spending for trade shows, advertising, print publications,
      and employee travel expenses.




For
      the
      quarter ended September 30, 2006, administrative expenses were $122,664,
      decreasing approximately $111,500 from the $234,156 recorded for the quarter
      ended September 30, 2005. In the quarter ended September 30, 2006, we incurred
      approximately $54,900 in charges related to the fair value of warrants issued
      to
      two officers and a shareholder in connection with either their guarantees of
      Lightspace debts or extensions in the payment terms of notes payable, and
      approximately $64,500 of legal and consultant expenses associated with our
      planned, but subsequently aborted, merger with a public company.





Administrative
      expenses were $576,581 for the nine month period ended September 30, 2006 as
      compared to $593,105 incurred in the corresponding 2005 period. After adjusting
      for the above mentioned 2005 charges for the fair value of warrants issued
      and
      the legal and consultant expenses, administrative expenses increased in the
      nine
      month period ended September 2006 when compared to the corresponding period
      in
      2005. Two of the principal factors contributing to the 2006 increase in our
      administration expenses were: (1) the severance agreement entered into with
      our former CEO, discussed below; and (2) additional internal financial and
      accounting expense incurred in connection with the sale of equity securities
      in
      2006.





On
      April 21, 2006, we entered into a severance agreement with our former Chief
      Executive Officer, pursuant to which he resigned as an officer, director and
      employee of Lightspace effective March 31, 2006. Under the agreement, we
      paid him his accrued wages and vacation pay, reimbursed him for recorded
      expenses incurred on behalf of Lightspace aggregating $47,636, paid him $10,000
      as severance, and paid him $20,000 as a non-refundable advance payment for
      100 hours of consulting work. We also paid $20,000 against an existing
      accounts payable balance to his affiliate, Immersive Productions, and agreed
      to
      use our best efforts to pay the $52,385 balance due to Immersive Productions
      by
      December 31, 2006.






20




**Interest
      Expense**




Interest
      expense for the quarter ended September 30, 2006 was $40,562 as compared to
      $118,716 for the quarter ended September 30, 2005. Interest expense was
      $266,390 for the nine month period ended September 30, 2006 as compared to
      $430,745 in the corresponding 2005 period. The decrease in 2006 interest expense
      for the quarter and on a year-to-date basis is due to the conversion to common
      stock on April 27, 2006 of $2,701,853 in principal amount of convertible and
      demand notes, and the conversion to common stock on May 3, 2006 of $2,400,000
      in
      principal amount of bridge notes, as discussed hereafter.





**Income
      Taxes**





At
      December 31, 2005 and September 30, 2006, Lightspace had operating loss
      carryforwards of approximately $6,684,000 and $7,357,000, respectively,
      available to offset future taxable income for United States federal and state
      income tax purposes. At September 30, 2006, approximately $6,313,000 of the
      operating loss carryforwards are restricted as to yearly usage, as discussed
      hereafter. The United States federal tax operating loss carryforwards expire
      commencing in 2021 through 2026. The state tax operating loss carryforwards
      expire commencing in 2007 through 2010. Additionally, Lightspace has research
      and development credit carryforwards of approximately $143,000 and $93,000
      available to be used as a reduction of federal income taxes and state income
      taxes, respectively. We have provided a valuation allowance equal to the full
      amount of the deferred tax asset related to the operating loss carryforwards,
      tax credits and other items deductible against future taxable income, if any,
      and will continue to fully reserve the deferred tax asset until it can be
      ascertained that all or a portion of the asset will be realized.





Our
      ability to use the operating loss carryforwards to offset future taxable income
      is subject to restrictions enacted in the United State Internal Revenue Code
      of
      1986. These restrictions severely limit the future use of the tax operating
      loss
      carryforwards if certain ownership changes described in the code occur. The
      common stock ownership changes occurring as a result of the securityholder
      debt
      and equity conversion on April 27, 2006 and the conversion of bridge notes
      on
      May 3, 2006 have resulted in limitations in the use of the tax operating loss
      carryforwards. In future years, the restricted tax operating loss carryforwards
      of $6,313,000 can be used only to offset approximately $100,000 of taxable
      income per year, if any. Lightspace may use other available tax operating loss
      carryforwards without limitation. Therefore, in future years, we may be required
      to pay income taxes even though significant tax operating loss carryforwards
      exist.




**Net
      Loss**





The
      net
      loss for the quarter ended September 30, 2006 was $674,262 as compared to a
      net
      loss of $616,216 in the corresponding period of the prior year. Impacting the
      quarter ended September 30, 2006, in addition to the preceding discussion,
      was a
      charge in the amount of 40,246 related to stock option based compensation.
      The
      provisions of Statement of Financial Accounting Standards No. 123(R),
      Share-Based Payment, were first effective for us in the September 2006 quarter,
      and accordingly no prior financials periods were affected by this pronouncement.
      At September 30, 2006, total unrecognized stock based compensation expense
      related to unvested common stock option grants expected to be charged to
      operations over the next two and three quarter years is estimated to be
      $443,000, or approximately $40,000 per quarter.





The
      net
      loss for the nine months ended September 30, 2006 was $2,060,615 as compared
      to
      a net loss of $1,966,655 in the corresponding period of the prior year.
      Impacting the nine months ended September 30, 2006, in addition to the preceding
      discussion, was a one-time gain of $402,298 as a result of the February 9,
      2006
      Securityholder Debt and Equity conversion and Exchange Agreement, which became
      effective on April 27, 2006.




21





**Liquidity,
      Capital Resources and Cash Flow**





Lightspace
      has incurred net operating losses and negative operating cash flows since
      inception. At December 31, 2005 and September 30, 2006, we had an accumulated
      retained deficit of $7,603,215 and $9,663,830 and a stockholders’ deficit of
      $5,510,492 and $2,467,276, respectively. We expect to incur additional losses
      and negative operating cash flows through at least year end 2006. We will
      continue thereafter to incur losses and negative operating cash flows until
      our
      revenue growth reaches that level that is able to support our operating
      expenses.





Lightspace
      has funded its operations through September 30, 2006 through the issuance of
      common stock, Series A Preferred Stock, borrowings from stockholders and others
      pursuant to convertible and demand notes, bridge notes and senior notes, and
      sales of Lightspace products.





On
      April
      18, 2006 our stockholders approved resolutions to increase the authorized shares
      of the Company’s common stock to 30,000,000, and to affect a one for 2.5 reverse
      stock split of the Company’s common stock. The one for 2.5 reverse stock split
      was effective on May 3, 2006. The accompanying financial statements and notes
      thereto, and this management discussion of the results of operations and
      financial position have been restated or modified to reflect this one for 2.5
      reverse stock split.





On
      February 9, 2006, we entered into the Securityholder Debt and Equity
      Conversion and Exchange Agreement (Agreement”) with holders of
      (1) $1,401,000 in principal amount of convertible notes and $1,538,234 in
      principal amount of demand notes, (2) holders of 133,732 shares of
      Series A preferred stock and (3) existing warrantholders to provide
      for the terms of the debt conversion, preferred conversion and warrant exchange.
      On April 27, 2006, the conditions for the closing of the Agreement having
      been met, Lightspace effected the conversion and exchange. Under the terms
      of
      the Agreement, (1) the holders of convertible and demand notes received
      1,544,865 shares of common stock and Exchange Warrants to purchase 1,480,849
      shares of common stock at exercise prices ranging from $0.80 to $7.50 per share
      upon conversion of their Existing Notes and any warrants issued in conjunction
      therewith, and our former CEO received a contingent promissory note in the
      principal amount of $237,381; (2) the holders of Series A preferred
      stock received 160,479 shares of common stock upon conversion of their
      Series A Preferred Stock; and (3) the holders of other Existing
      Warrants received Exchange Warrants to purchase 41,063 shares of common stock
      at
      an exercise price of $7.50 per share. As a result of the closing of the
      Agreement, we recorded a one-time non cash net gain of $402,298.




On
      April
      27, 2006, Lightspace and the holders of the bridge notes agreed to convert
      the
      outstanding principal and accrued interest under the bridge notes, $2,488,471,
      into units at a conversion price of $6.40 per unit. On May 3, 2006, we issued
      388,821 units, and a small number of shares of common stock and unit warrants
      representing fractional units, in exchange for the surrender of all of the
      bridge notes. The
      units
      and fractional units that we issued to the bridgenote holders were comprised
      of
      3,110,585 shares of common stock, 3,110,585 warrants to purchase a total of
      3,110,585 shares of common stock at an exercise price of $1.00 per warrant,
      777,646 warrants to purchase a total of 777,646 shares of common stock at an
      exercise price of $1.25 per warrant, and 777,646 warrants to purchase a total
      of
      777,646 shares of common stock at an exercise price of $1.63 per
      warrant.





After
      giving effect to the one for 2.5 reverse stock split, the Agreement, and the
      bridge notes conversion, at May 3, 2006, we had 5,793,111 shares of issued
      and
      outstanding common stock. Additionally, Lightspace had issued 6,245,869 stock
      options or warrants for the purchase of an equivalent number of shares of common
      stock at exercise prices ranging from $.80 to $7.50. The 133,732 shares of
      Series A Preferred Stock have been retired and the authority to issue further
      classes of preferred stock has been cancelled.





The
      Security and Exchange Commission declared our registration statement on Form
      S-1
      effective October 4, 2006. On November 2, 2006 Lightspace closed the offering
      period for the sale its securities. We sold 600,000 units, the maximum allowed,
      at an offering price of $6.40 per unit, resulting in aggregate proceeds to
      the
      Company of $3,840,000. After repayment of principal and interest due on senior
      notes in the aggregate amount of $1,409,000 and estimated expenses of the
      offering of $496,000, the net proceeds to Lightspace are estimated to
      approximate $1,935,000. The sale of 600,000 units, including warrants issued
      to
      the underwriter as compensation, resulted in the issuance of: (1) 4,800,000
      shares of common stock; (2) 816,000 warrants to purchase a total of 816,000
      shares of common stock at an exercise price of $0.96 per warrant (pursuant
      to
      the unit warrants issued to the underwriter); (3) 5,616,000 warrants to purchase
      a total of 5,616,000 shares of common stock at an exercise price of $1.00 per
      warrant; (4) 1,404,000 warrants to purchase a total of 1,404,000 shares of
      common stock at an exercise price of $1.25 per warrant; and (5) 1,404,000
      warrants to purchase a total of 1,404,000 shares of common stock at an exercise
      price of $1.63 per warrant. The
      warrants are exercisable at the option of the holder at any time up until April
      30, 2011, at which date the warrants expire.




22





Issued
      and
      outstanding shares of the Company’s common stock at November 2, 2006 increased
      to 10,593,111 from 5,793,111 at September 30, 2006. Additionally, issued and
      outstanding common stock warrants at November 2, 2006 were 15,427,789,
      exercisable at prices that range from $0.80 to $7.50. At September 30, 2006,
      the
      Company had issued and outstanding common stock warrants in the aggregate amount
      of 6,187,789, exercisable at prices that range from $0.80 to $7.50.





We
      believe
      that the proceeds from the sale of 600,000 units, together with anticipated
      revenues from sales of our products, will be sufficient to meet our liquidity
      requirements for the next six to 12 months. Our long-term success is dependent
      bringing our products to the worldwide market and obtaining sufficient sales
      volume to be profitable. To achieve these objectives, we may be required to
      raise additional capital through public or private financings or other
      arrangements. It can not be assured that such financings will be available
      on
      terms attractive to us, if at all. Such financings may be dilutive to
      stockholders and may contain restrictive covenants.





**Manufacturing
      Operations**





We
      currently contract for the production and assembly of interactive tiles from
      an
      independent manufacturing company and have had discussions with other contract
      manufacturers as secondary sources for the production and assembly of our
      interactive tiles. The current contract manufacturer is ISO certified and,
      to
      date, we have not experienced either quality or production difficulties. The
      production run is scheduled for a minimum of 200 interactive tiles per week,
      with the ability to increase the weekly production to 400 to 500 interactive
      tiles.





In
      the
      year 2004, in our first attempt to produce interactive tiles in volume
      quantities at a prior contract manufacturer, we experienced significant
      manufacturing problems. These problems encompassed design errors, faulty parts
      and improper assembly. In some months during 2004 we were able to produce only
      10 to 20 interactive tiles. Our engineering and manufacturing staffs spent
      most
      of the 2004 year redesigning certain parts, changing parts suppliers and working
      with our suppliers and contract manufacturer to establish quality control
      procedures, including inspection and interim testing, to facilitate volume
      production of the interactive tiles. These changes were substantially
      implemented at the end of 2004 and fully implemented in early 2005.





The
      volume
      manufacturing difficulties encountered in 2004 became a significant burden
      for
      Lightspace in 2005. In 2004 we were required to spend our resources focusing
      on
      these problems and not on marketing and future product development. The limited
      availability of interactive tiles restricted us from selling products to
      customers and pursuing sale leads. Unable to obtain adequate financing at that
      time, and with the lack of product revenue, the cash situation became critical.
      We were required to terminate staff and significantly reduce all expenditures
      until we obtained financing in September 2005. While we believe that we now
      have
      products that can be manufactured with quality in volume production, there
      can
      be no assurances that we will not again experience manufacturing
      problems.






23





**Deferred
      Revenue and Backlog**





Deferred
      revenue is represented by: (1) advance deposits received from customers for
      the
      future purchase and installation of a Lightspace system and (2) the balance
      of
      deferred maintenance revenue to be recognized as income over the remaining
      term
      of the maintenance contract. Customer deposits are the segment of backlog that,
      in addition to being supported by a signed contract, is also supported by a
      customer advance payment. Our product backlog at September 30, 2006 and December
      31, 2005 was $281,934 (409 interactive tiles) and $26,400 (36 interactive
      tiles), respectively, and was comprised substantially of customer advance
      payments.





**Off-Balance
      Sheet Arrangements**





(1)
      We
      lease certain equipment under non-cancelable leases expiring through May 2007.
      Our prior office lease expired on March 1, 2006. Effective May 1, 2006,
      Lightspace entered into a five-year facilities lease for approximately 16,000
      square feet at a new location to be used for office and manufacturing
      operations. The terms of this new lease provide for average annual base rental
      payments of approximately $293,500 per year, plus an allocated percentage of
      the
      increase in the building operating costs over defined base year operating
      costs.





(2)
      In May
      2005, we entered into a five-year purchase contract with a Chinese parts
      manufacturer under which we have a minimum purchase obligation of $5,000,000.
      The manufacturer has been unable to produce components that meet our
      requirements. In May of 2006, after extensive testing of sample parts, we
      terminated this parts supply contract at no cost to us. Cancellation of this
      contract will not have an affect on the production of interactive tiles as
      adequate supplies of these component parts are currently available from other
      suppliers at competitive prices.





**Recent
      Accounting Pronouncements**





In
      December 2004, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 123(R), Share-Based Payment. This statement
      addresses accounting for stock-based compensation arrangements, including shares
      issued to employees and directors under various stock-based compensation
      arrangements. This statement will require us to use the fair value method,
      rather than the intrinsic-value method, to determine compensation expense for
      all stock-based arrangements. Additionally, Lightspace will no longer be
      permitted to calculate stock-based compensation utilizing the minimum value
      method. This statement was effective for Lightspace in 2006 for all prospective
      grants of stock-based compensation awards and modification of prior stock
      awards. Adoption of this statement will increase compensation costs recognized
      in our statement of operations from historical levels for all prospective awards
      granted and modification of prior stock awards.





**Critical
      Accounting Policies and Estimates**





The
      financial statements of Lightspace are prepared in conformity with accounting
      principles generally accepted in the United States of America. These accounting
      principles require us to make estimates and assumptions that affect the reported
      amounts of assets and liabilities and the disclosure of contingent assets and
      liabilities at the date of the financial statements. Lightspace is also required
      to make certain judgments that affect the reported amounts of revenues and
      expenses during the reporting period. On an on-going basis, we evaluate our
      estimates and the process under which those estimates are formulated. Lightspace
      develops its estimates based upon historical experience as well as assumptions
      that are considered to be reasonable under the circumstances. Actual results
      may
      differ from these estimates.





We
      believe
      that the following critical accounting policies impact the more significant
      judgments and estimates used in the preparation of the financial
      statements:





*Revenue
      Recognition* .
      Lightspace recognizes revenue from the sale of its entertainment systems when
      all of the following conditions have been met: (1) evidence exists of an
      arrangement with the customer, typically consisting of a purchase order or
      contract; (2) our products have been delivered and risk of loss has passed
      to
      the customer; (3) we have completed all of the necessary terms of the contract
      including but not limited to, installation of the product and training; (4)
      the
      amount of revenue to which we are entitled is fixed or determinable; and (5)
      we
      believe it is probable that it will be able to collect the amount due from
      the
      customer. To the extent that one or more of these conditions has not been
      satisfied, Lightspace defers recognition of revenue. Revenue from maintenance
      contracts is recorded on a straight-line basis over the term of the contract.
      An
      allowance for uncollectible receivables is established by a charge to
      operations, when in our opinion it is probable that the amount due to Lightspace
      will not be collected.




24





*Warranty
      Reserve* .
      Our
      products are warranted against defects for twelve months following the sale.
      Reserves for potential warranty claims are provided at the time of revenue
      recognition and are based on several factors including historical claims
      experience, current sales levels and Lightspace’s estimate of repair
      costs.





*Stock-Based
      Compensation* .
      Effective January 1, 2006, we adopted the provisions of Financial
      Accounting Standards No. 123(R), Share-Based Payment. This statement requires
      that the fair value of stock-based awards be measured at the grant date,
      recognized as compensation expense over the defined service period, and be
      adjusted for anticipated forfeitures. We estimate the fair value of each
      stock-based award on the date of grant using a stock option valuation model.
      The
      valuation model incorporates assumptions for stock price volatility, the
      expected exercise period, risk-free interest rate and dividend yield. Some
      of
      these assumptions are subjective and require the exercise of judgment.
      Additionally we must estimate the number of grants that may be forfeited. If
      actual experience differs significantly from our estimates, compensation expense
      that we record in future periods may differ materially from that recorded in
      the
      current period and that amount projected for future periods.





**Item 3.
      Quantitative and Qualitative Disclosures about Market
      Risk**





Market
      risk represents the risk of loss arising from adverse changes in interest
      rates and foreign exchange rates. We do not have any material exposure to
      interest rate risk. All of our products and services are denominated in U.S.
      dollars, as a result of which we are not exposed to foreign currency risk with
      respect to our accounts receivable. All materials and components that we buy
      for
      the manufacturing of our products are also priced in U.S. dollars. We also
      did
      not have any operations outside the United States. Accordingly, we do not have
      any material foreign currency risk at this time.





**Item 4.
      Controls and Procedures**




(a)
      Evaluation of disclosure controls and procedures.




We
      conducted an evaluation, under the supervision and with the participation of
      our
      Chief Executive Officer and Chief Financial Officer, of the effectiveness of
      the
      design and operation of our disclosure controls and procedures (as defined
      in
      Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
      amended (the “Exchange Act”)) as of the end of the period covered by this
      report. Based on this evaluation, our Chief Executive Officer and Chief
      Financial Officer concluded that our disclosure controls and procedures are
      effective, as of the end of the period covered by this report, to ensure that
      information required to be disclosed in our Exchange Act reports is recorded,
      processed, summarized and reported within the time periods specified in the
      Securities and Exchange Commission rules and forms, and that the information
      is
      accumulated and communicated to our management, including our Chief Executive
      Officer and Chief Financial Officer, as appropriate to allow timely decisions
      regarding required disclosure.





(b)
      Changes in internal control over financial reporting





No
      changes
      in our internal control over financial reporting occurred during the quarter
      ended June 30, 2006 that have materially affected, or are reasonably likely
      to
      materially affect, our internal control over financial reporting.








25


**PART
      II - OTHER INFORMATION**


**Item
      1. Legal Proceedings**





None





**Item
      1A. Risk Factors**





There
      are
      no material changes from the risk factors set forth on the Company’s
      registration statement on Form S-1 filed with the Securities and Exchange
      Commission on February 14, 2006, as amended.





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


**Unregistered
      Sales of Equity Securities**





On
      February 9, 2006, Lightspace entered into the Securityholder
      Debt and Equity Conversion and Exchange Agreement (“Agreement”) with holders of
      (1) $1,401,000 in principal amount of convertible notes and $1,538,234 in
      principal amount of demand notes, (2) holders of 133,732 shares of Series A
      preferred stock and (3) existing warrants to provide for the terms of the Debt
      Conversion, Preferred Conversion and Warrant Exchange. Under the terms of the
      Agreement, (1) the holders of convertible and demand notes would receive
      1,544,865 shares of common stock and exchange warrants to purchase 1,480,849
      shares of common stock at exercise prices ranging from $0.80 to $7.50 per share
      upon conversion of their notes and any warrants issued in conjunction therewith,
      and a contingent note in the principal amount of $237,381; (2) the holders
      of
      Series A Preferred Stock would receive 160,479 shares of common stock upon
      conversion of their Series A Preferred Stock; and (3) the holders of other
      existing warrants would receive exchange warrants to purchase 41,063 shares
      of
      common stock at an exercise price of $7.50 per share. On April 27, 2006, the
      conditions for the closing of the Agreement having been met, the agreement
      became effective. As a result of the closing of the Agreement, we recorded
      a
      one-time net gain of $402,298.





On
      April
      27, 2006, Lightspace and the holders of the bridge notes agreed to convert
      the
      outstanding principal and accrued interest under the bridge notes, $2,488,471,
      into units at a conversion price of $6.40 per unit. On May 3, 2006, we issued
      388,821 units, and a small number of shares of common stock and unit warrants
      representing fractional units, in exchange for the surrender of all of the
      bridge notes. The
      units
      and fractional units that we issued to the bridge note holders were comprised
      of
      3,110,585 shares of common stock, 3,110,585 warrants to purchase a total of
      3,110,585 shares of common stock at an exercise price of $1.00 per warrant,
      777,646 warrants to purchase a total of 777,646 shares of common stock at an
      exercise price of $1.25 per warrant, and 777,646 warrants to purchase a total
      of
      777,646 shares of common stock at an exercise price of $1.63 per
      warrant.





In
      June 2006, the our stockholders and Board of Directors approved adoption of
      the 2006 Stock Incentive Plan (the “2006 Stock Plan”), pursuant to which up to
      2,118,622 incentive stock options and/or nonqualified stock options may be
      granted to directors, officers, key employees and consultants. The 2006 Stock
      Plan provides that the exercise price of each option must be at least equal
      to
      the fair market value of the common stock at the date such option is granted.
      For grants to an individual who own more than 10% of our outstanding common
      stock, the exercise price must be 110% of fair market value at the time of
      grant. Options expire in ten years or less from the date of grant and vest
      over
      a period not to exceed four years. In July 2006, we granted options under the
      2006 Stock Plan to purchase 1,736,810 shares of common stock to officers and
      key
      employees at an exercise price of $.80 per option, the fair market value of
      our
      common stock at that date. The options vest at stipulated dates over a period
      not to exceed three years and expire in ten years.





**Use
      of Proceeds from Registered Securities**





The
      Securities and Exchange Commission declared our registration statement on Form
      S-1 effective October 4, 2006. On November 2, 2006 Lightspace closed the
      offering period for the sale its securities. We sold 600,000 units, the maximum
      allowed, at an offering price of $6.40 per unit, resulting in aggregate proceeds
      to us of $3,840,000. Each unit consists of: (1) eight shares of common
      stock; (2) eight warrants to purchase a total of eight shares of common
      stock at an exercise price of $1.00 per warrant; (3) two warrants to
      purchase a total of two shares of common stock at an exercise price of $1.25
      per
      warrant; and (4) two warrants to purchase a total of two shares of common
      stock at an exercise price of $1.63 per warrant. After repayment of principal
      and interest due on senior notes in the aggregate amount of $1,409,000 and
      estimated expenses of the offering of $496,000, the net proceeds to us are
      estimated to approximate $1,935,000. In connection with the sale of our
      securities, we issued, as compensation to the underwriter, a warrant to purchase
      102,000 units at an exercise price of $7.68 per unit. Each underwriter unit
      consists of: (1) eight shares of common stock; (2) eight warrants to
      purchase a total of eight shares of common stock at an exercise price of $1.00
      per warrant; (3) two warrants to purchase a total of two shares of common
      stock at an exercise price of $1.25 per warrant; and (4) two warrants to
      purchase a total of two shares of common stock at an exercise price of $1.63
      per
      warrant.






26





We
      have
      invested the net proceeds of the offering in short-term interest bearing
      securities pending the use thereof to fund our development efforts, sales growth
      and operating losses. None of the offering expenses were incurred or paid,
      directly or indirectly, to our director or officers or their associates or
      to
      persons owning ten percent or more of our common stock or to any affiliates
      of
      ours. The sale of 600,000 units, including warrants issued to the underwriter
      as
      compensation, resulted in the issuance of: (1) 4,800,000 shares of common stock;
      (2) 816,000 warrants to purchase a total of 816,000 shares of common stock
      at an
      exercise price of $0.96 per warrant (pursuant to the unit warrants issued to
      the
      underwriter); (3) 5,616,000 warrants to purchase a total of 5,616,000 shares
      of
      common stock at an exercise price of $1.00 per warrant; (4) 1,404,000 warrants
      to purchase a total of 1,404,000 shares of common stock at an exercise price
      of
      $1.25 per warrant; and (5) 1,404,000 warrants to purchase a total of 1,404,000
      shares of common stock at an exercise price of $1.63 per warrant. The
      warrants are exercisable at the option of the holder at any time up until April
      30, 2011, at which date the warrants expire. The warrants issued to the
      underwriter expire on November 2, 2011.





There
      has
      been no material change in our planned use of the proceeds from the offering
      our
      securities as described in our final prospectus as filed with the Securities
      and
      Exchange Commission pursuant to Rule 424(b).





**Item
      3. Defaults upon Senior Securities**


None





**Item
      4. Submission of Matters to a Vote of Security
      Holders**


None





**Item
      5. Other Information**


None





**Item
      6. Exhibits**


The
      following is a complete list of exhibits filed with the Form 10-Q.




Exhibit
                Nmber
            
            
            Description
                of Exhibit31.1
            *
            
            Certificate
              Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 - Gary
              Florindo31.2
            *
            
            Certificate
              Pursuant to Section 302 of Sarbanes-Oxley Act of 2002 - James C.
              Louney32.1
            *
            
            Certificate
              Pursuant to Section 906 of Sarbanes-Oxley Act of 2002*
              Filed herewith
















27




**SIGNATURES**


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




LIGHTSPACE
              CORPORATIONDate:
              November 17, 2006
            
            By:
            /s/
GARY
              FLORINDOGary
                Florindo
              President,Chief
                Executive Officer andSole
                DirectorDate:
              November 17, 2006
            
            By:
            /s/
              JAMES
              C. LOUNEYJames
              C. Louney
              Chief
                Financial Officerand
                Assistant Secretary






28