UNITED
STATES SECURITIES AND EXCHANGE COMMISSION




Washington,
D.C. 20549





Form
10-Q





(Mark
One)


R
            QUARTERLY
      REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934 For
the quarterly period ended September 30, 2009
 or
 £
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the transition period
from           to





eMAGIN
CORPORATION


(Exact
name of registrant as specified in its charter)





Delaware
            56-1764501(State
      or other jurisdiction of
            (I.R.S.
      Employerincorporation
      or organization)
            Identification
      No.)





3006
Northup Way, Suite 103, Bellevue, Washington 98004


(Address
of principal executive offices)





(425)
284-5200


(Registrant’s
telephone number, including area code)





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





Securities
registered pursuant to Section 12(g) of the Act: Common Stock, $.001 Par Value
Per Share








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.  YesR
     No£





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months
).    Yes  o
    No  o





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





Large
accelerated filer£               Accelerated
filer£             Non-accelerated
filer£         Smaller reporting
companyR





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





The
number of shares of common stock outstanding as of October 31, 2009 was
16,961,902.








eMagin
Corporation


Form
10-Q


For
the Quarter ended September 30, 2009





Table
of Contents


PagePART
      I   FINANCIAL INFORMATIONItem
      1
            Condensed
      Consolidated Financial StatementsCondensed
      Consolidated Balance Sheets as of September 30, 2009 (unaudited) and
      December 31, 2008
            3Condensed
      Consolidated Statements of Operations for the Three and Nine Months ended
      September 30, 2009 and 2008 (unaudited)
            4Condensed
      Consolidated Statements of Changes in Shareholders’ Equity for the Nine
      Months ended September 30, 2009 (unaudited)
            5Condensed
      Consolidated Statements of Cash Flows for the Nine Months ended September
      30, 2009 and 2008 (unaudited)
            6Notes to Condensed Consolidated Financial Statements
      (unaudited)
            7-13Item
      2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            14Item
      3
            Quantitative
      and Qualitative Disclosures About Market Risk
            18Item
      4T
            Controls
      and Procedures
            18PART
      II OTHER INFORMATIONItem
      1
            Legal
      Proceedings
            20Item
      1A
            Risk
      Factors
            20Item
      2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            20Item
      3
            Defaults
      Upon Senior Securities
            20Item
      4
            Submission
      of Matters to a Vote of Security Holders
            20Item
      5
            Other
      Information
            20Item
      6
            Exhibits
            20SIGNATURES
            22CERTIFICATIONS











2











ITEM
1.  Condensed Consolidated Financial Statements








eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
thousands, except share data)





September
      30, 2009
              (unaudited)
            
            
            December
      31, 2008ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            3,709
            
            
            $
            2,404Investments
      – held to maturity
            
            
            97
            
            
            
            97Accounts
      receivable, net
            
            
            4,111
            
            
            
            3,643Inventory
            
            
            2,065
            
            
            
            2,374Prepaid
      expenses and other current assets
            
            
            885
            
            
            
            796Total
      current assets
            
            
            10,867
            
            
            
            9,314Equipment,
      furniture and leasehold improvements, net
            
            
            811
            
            
            
            381Intangible
      assets, net
            
            
            44
            
            
            
            47Other
      assets
            
            
            92
            
            
            
            —Deferred
      financing costs, net
            
            
            —
            
            
            
            362Total
      assets
            
            $
            11,814
            
            
            $
            10,104LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            728
            
            
            $
            1,026Accrued
      compensation
            
            
            807
            
            
            
            837Other
      accrued expenses
            
            
            985
            
            
            
            804Advance
      payments
            
            
            116
            
            
            
            694Deferred
      revenue
            
            
            220
            
            
            
            164Debt
            
            
            —
            
            
            
            1,691Other
      current liabilities
            
            
            715
            
            
            
            798Total
      current liabilities
            
            
            3,571
            
            
            
            6,014Commitments
      and contingenciesRedeemable
      common stock:  522,500 redeemable shares as of December 31,
      2008
            
            
            —
            
            
            
            429Shareholders’
      equity:Preferred
      stock, $.001 par value: authorized 10,000,000 shares:
            
            
            —
            
            
            
            —Series
      B Convertible Preferred stock, (liquidation preference of
      $5,739,000)
              stated
      value $1,000 per share, $.001 par value:  10,000 shares
      designated and 5,739 issued
              and
      outstanding at September 30, 2009 and December 31, 2008.
            
            
            —
            
            
            
            —Common
      stock, $.001 par value: authorized 200,000,000 shares, issued
      andoutstanding,
      16,961,902 shares as of September 30, 2009 and 15,213,959 as
      ofDecember
      31, 2008, net of redeemable common stock
            
            
            17
            
            
            
            15Additional
      paid-in capital
            
            
            206,475
            
            
            
            204,818Accumulated
      deficit
            
            
            (198,249
            )
            
            
            (201,172
            )Total
      shareholders’ equity
            
            
            8,243
            
            
            
            3,661Total
      liabilities and shareholders’ equity
            
            $
            11,814
            
            
            $
            10,104








See notes
to Condensed Consolidated Financial Statements.








3








eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(In
thousands, except share and per share data)


(unaudited)





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Revenue:Product
            
            $
            5,260
            
            
            $
            4,181
            
            
            $
            14,560
            
            
            $
            11,139Contract
            
            
            847
            
            
            
            1,004
            
            
            
            2,543
            
            
            
            2,330Total
      revenue, net
            
            
            6,107
            
            
            
            5,185
            
            
            
            17,103
            
            
            
            13,469Cost
      of goods sold:Product
            
            
            1,996
            
            
            
            2,412
            
            
            
            5,817
            
            
            
            7,030Contract
            
            
            611
            
            
            
            389
            
            
            
            1,528
            
            
            
            1,080Total
      cost of goods sold
            
            
            2,607
            
            
            
            2,801
            
            
            
            7,345
            
            
            
            8,110Gross
      profit
            
            
            3,500
            
            
            
            2,384
            
            
            
            9,758
            
            
            
            5,359Operating
      expenses:Research
      and development
            
            
            463
            
            
            
            306
            
            
            
            1,376
            
            
            
            1,614Selling,
      general and administrative
            
            
            1,772
            
            
            
            1,293
            
            
            
            5,083
            
            
            
            4,797Total
      operating expenses
            
            
            2,235
            
            
            
            1,599
            
            
            
            6,459
            
            
            
            6,411Income
      (loss) from operations
            
            
            1,265
            
            
            
            785
            
            
            
            3,299
            
            
            
            (1,052
            )Other
      income (expense):Interest
      expense
            
            
            (76
            )
            
            
            (508
            )
            
            
            (417
            )
            
            
            (1,677
            )Other
      income, net
            
            
            1
            
            
            
            84
            
            
            
            41
            
            
            
            294Total
      other income (expense)
            
            
            (75
            )
            
            
            (424
            )
            
            
            (376
            )
            
            
            (1,383
            )Net
      income (loss)
            
            $
            1,190
            
            
            $
            361
            
            
            $
            2,923
            
            
            $
            (2,435
            )Income
      (loss) per share, basic
            
            $
            0.07
            
            
            $
            0.02
            
            
            $
            0.18
            
            
            $
            (0.18
            )Income
      (loss) per share, diluted
            
            $
            0.04
            
            
            $
            0.02
            
            
            $
            0.12
            
            
            $
            (0.18
            )Weighted
      average number of shares outstanding:Basic
            
            
            16,513,101
            
            
            
            14,617,235
            
            
            
            16,133,646
            
            
            
            13,854,860Diluted
            
            
            26,592,267
            
            
            
            23,430,416
            
            
            
            24,471,486
            
            
            
            13,854,860











See notes
to Condensed Consolidated Financial Statements.








4








eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY


(In
thousands)








Preferred
      Stock
            
            
            Common
      Stock
            
            
            Additional
              Paid-in
            
            
            Accumulated
            
            
            Total
      Shareholders’Shares
            
            
            Amount
            
            
            Shares
            
            
            Amount
            
            
            Capital
            
            
            Deficit
            
            
            EquityBalance,
      December 31, 2008
            
            
            6
            
            
            $
            —
            
            
            
            15,214
            
            
            $
            15
            
            
            $
            204,818
            
            
            $
            (201,172
            )
            
            $
            3,661Issuance
      of common stock for services
            
            
            —
            
            
            
            —
            
            
            
            499
            
            
            
            —
            
            
            
            304
            
            
            
            —
            
            
            
            304Expiration
      of put options
            
            
            —
            
            
            
            —
            
            
            
            522
            
            
            
            1
            
            
            
            428
            
            
            
            —
            
            
            
            429Exercise
      of common stock warrants
            
            
            —
            
            
            
            —
            
            
            
            727
            
            
            
            1
            
            
            
            (1
            )
            
            
            —
            
            
            
            —Stock-based
      compensation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            926
            
            
            
            —
            
            
            
            926Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,923
            
            
            
            2,923Balance,
      September 30, 2009 (unaudited)
            
            
            6
            
            
            $
            —
            
            
            
            16,962
            
            
            $
            17
            
            
            $
            206,475
            
            
            $
            (198,249
            )
            
            $
            8,243













See notes
to Condensed Consolidated Financial Statements.








5








eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(In
thousands)





Nine
      Months EndedSeptember
      30,2009
            
            
            2008(unaudited)Cash
      flows from operating activities:Net
      income (loss)
            
            $
            2,923
            
            
            $
            (2,435
            )Adjustments
      to reconcile net income (loss) to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
            
            
            65
            
            
            
            183Amortization
      of deferred financing and waiver fees
            
            
            362
            
            
            
            1,152(Reduction
      of) increase in provision for sales returns and doubtful
      accounts
            
            
            (423
            )
            
            
            241Stock-based
      compensation
            
            
            926
            
            
            
            845Amortization
      of common stock issued for services
            
            
            178
            
            
            
            88Amortization
      of discount on notes payable
            
            
            —
            
            
            
            25Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (45
            )
            
            
            (1,860
            )Inventory
            
            
            309
            
            
            
            (163
            )Prepaid
      expenses and other current assets
            
            
            (54
            )
            
            
            254Deferred
      revenue
            
            
            56
            
            
            
            (54
            )Accounts
      payable, accrued compensation, other accrued expenses, and advance
      payments
            
            
            (725
            )
            
            
            94Other
      current liabilities
            
            
            (121
            )
            
            
            (277
            )Net
      cash provided by (used in) operating activities
            
            
            3,451
            
            
            
            (1,908
            )Cash
      flows from investing activities:Purchase
      of equipment
            
            
            (492
            )
            
            
            (236
            )Net
      cash used in investing activities
            
            
            (492
            )
            
            
            (236
            )Cash
      flows from financing activities:Proceeds
      from sale of common stock, net of issuance costs
            
            
            —
            
            
            
            1,580Proceeds
      from debt
            
            
            —
            
            
            
            1,934Payments
      related to deferred financing costs
            
            
            —
            
            
            
            (117
            )Payments
      of debt and capital leases
            
            
            (1,654
            )
            
            
            (694
            )Net
      cash (used in) provided by financing activities
            
            
            (1,654
            )
            
            
            2,703Net
      increase in cash and cash equivalents
            
            
            1,305
            
            
            
            559Cash
      and cash equivalents beginning of period
            
            
            2,404
            
            
            
            713Cash
      and cash equivalents end of period
            
            $
            3,709
            
            
            $
            1,272Cash
      paid for interest
            
            $
            67
            
            
            $
            524Cash
      paid for taxes
            
            $
            46
            
            
            $
            31Common
      stock issued for services charged to prepaid expenses
            
            $
            126
            
            
            $
            202





See notes
to Condensed Consolidated Financial Statements.








6







eMAGIN
CORPORATION


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Note
1:  Description of the Business and Summary of Significant Accounting
Policies





The
Business





eMagin
Corporation (the “Company”) designs, develops, manufactures, and markets OLED
(organic light emitting diode) on silicon microdisplays, virtual imaging
products which utilize OLED microdisplays. The Company’s products are sold
mainly in North America, Asia, and Europe.





Basis
of Presentation





In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements of eMagin Corporation and its subsidiary reflect all
adjustments, including normal recurring accruals, necessary for a fair
presentation.  Certain information and footnote disclosure normally
included in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to instructions, rules and regulations prescribed
by the Securities and Exchange Commission (“SEC”).  The Company
believes that the disclosures provided herein are adequate to make the
information presented not misleading when these unaudited condensed consolidated
financial statements are read in conjunction with the audited consolidated
financial statements contained in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2008.  The results of operations for the
period ended September 30, 2009 are not necessarily indicative of the results to
be expected for the full year.





Reclassifications





Certain
operating expense amounts have been reclassified from Selling, General, and
Administrative to Research and Development in order to conform with prior year’s
presentation.





Use
of Estimates





In
accordance with accounting principles generally accepted in the United States of
America, management utilizes certain estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an on-going basis, management evaluates its estimates and
judgments. Management bases its estimates and judgments on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from those estimates.





Revenue
and Cost Recognition





Revenue is recognized when
persuasive evidence of an arrangement exists, delivery has
occurred, selling price is fixed or determinable and collection is
reasonably assured.  The Company records a reserve for estimated sales
returns, which is reflected as a reduction of revenue at the time of revenue
recognition.  The Company defers revenue recognition on products sold
directly to the consumer with a maximum thirty day right of
return.  Revenue is recognized upon the expiration of the right of
return.





The
Company also earns revenues from certain R&D activities under
both firm fixed-price contracts and cost-type
contracts, including some cost-plus-fee contracts. 
Revenues relating to firm fixed-price contracts are
generally recognized on the percentage-of-completion method
of accounting as costs are incurred (cost-to-cost basis). 
Revenues on cost-plus-fee contracts include costs incurred plus a
portion of estimated fees or profits based on the relationship of costs incurred
to total estimated costs. Contract costs include all direct material and
labor costs and an allocation of allowable indirect costs as
defined by each contract, as periodically adjusted to reflect revised
agreed upon rates. These rates are subject to audit by the other
party.








7




Research
and Development Costs





Research
and development costs are expensed as incurred.





Note
2:  Recently Issued Accounting Pronouncement





In June
2009, the Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“Codification” or “ASC”) became the single source of authoritative
nongovernmental U.S. generally accepted accounting principles (“GAAP”) except
for additional authoritative rules and interpretive releases issued by the SEC.
The Codification did not create any new GAAP standards but incorporated existing
accounting and reporting standards into a new topical structure with a new
referencing system to identify authoritative accounting standards, replacing the
prior references to Statement of Financial Accounting Standards (“SFAS”),
Emerging Issues Task Force (“EITF”), FASB Staff Position (“FSP”),
etc.  Authoritative standards included in the Codification are
designated by their ASC topical reference, and new standards will be designated
as Accounting Standards Updates (“ASU”), with a year and assigned sequence
number.  Beginning with the interim report for this third quarter, the
Company adopted the Codification and it had no effect on its financial position,
results of operations, or cash flows.





Note
3:  Receivables





The
majority of the Company’s commercial accounts receivable are due from Original
Equipment Manufacturers ("OEM’s”). Credit is extended based on evaluation of a
customer’s financial condition and, generally, collateral is not required.
Accounts receivable are payable in U.S. dollars, are due within 30-90 days and
are stated at amounts due from customers, net of an allowance for doubtful
accounts. Any account outstanding longer than the contractual payment terms is
considered past due.





The
Company determines the allowance for doubtful accounts
by considering a number of factors, including the length of time the
trade accounts receivable are past due, historical experience, the
customer's current ability to pay its obligations, and the condition
of the general economy and the industry as a whole.   The Company will
record a specific reserve for individual accounts when the Company becomes aware
of a customer's inability to meet its financial obligations, such as in the case
of bankruptcy filings or deterioration in the customer's operating results or
financial position.  If circumstances related to customers change, the
Company would further adjust estimates of the recoverability of
receivables.





Receivables
consisted of the following (in thousands):





September
      30, 2009
              (unaudited)
            
            
            December
      31, 2008Accounts
      receivable
            
            $
            4,545
            
            
            $
            4,500Less
      allowance for doubtful accounts
            
            
            (434
            )
            
            
            (857
            )Net
      receivables
            
            $
            4,111
            
            
            $
            3,643








8











Note
4:  Net Income (Loss) per Common Share





The net
income (loss) per common share ("basic EPS") is computed by
dividing net income (loss) by the weighted average number of common
shares outstanding and excluding any potential dilution. 
Net income (loss) per common share assuming dilution ("diluted EPS") is computed
by reflecting potential dilution from the exercise of
stock options, warrants, convertible preferred stock and redeemable
stock.





The
following table presents a reconciliation of the numerator and denominator of
the basic and diluted EPS calculations (in thousands, except share and per share
data):








Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Numerator:Net
      income (loss)
            
            $
            1,190
            
            
            $
            361
            
            
            $
            2,923
            
            
            $
            (2,435
            )Adjustment
      for interest expense on convertible notes, net of taxes
            
            
            —
            
            
            
            121
            
            
            
            —
            
            
            
            —$
            1,190
            
            
            $
            482
            
            
            $
            2,923
            
            
            $
            (2,435
            )Denominator:Weighted
      average shares outstanding for basic earnings per share
            
            
            16,513,101
            
            
            
            14,617,235
            
            
            
            16,133,646
            
            
            
            13,854,860Effective
      of dilutive shares:Dilution
      from stock options and warrants
            
            
            2,427,166
            
            
            
            365,216
            
            
            
            685,840
            
            
            
            —Redeemable
      stock
            
            
            —
            
            
            
            117,277
            
            
            
            —
            
            
            
            —Convertible
      notes
            
            
            —
            
            
            
            8,330,688
            
            
            
            —
            
            
            
            —Convertible
      preferred stock
            
            
            7,652,000
            
            
            
            —
            
            
            
            7,652,000
            
            
            
            —Dilutive
      potential common shares
            
            
            10,079,166
            
            
            
            8,813,181
            
            
            
            8,337,840
            
            
            
            —Weighted
      average shares outstanding for diluted earnings per share
            
            
            26,592,267
            
            
            
            23,430,416
            
            
            
            24,471,486
            
            
            
            13,854,860





For the
three and nine months ended September 30, 2009, there were stock options and
warrants outstanding to acquire 3,498,592 and 10,226,638 shares, respectively,
of the Company common stock which were excluded from the calculation of its
diluted earnings per share as their effect would be anti-dilutive.  
The convertible preferred stock is included in the calculation of diluted
earnings per share as all shares are assumed converted.





For the
three and nine months ended September 30, 2008, there were stock options,
warrants and convertible notes outstanding to acquire 10,901,343
and  20,376,584 shares, respectively, of the Company’s common stock
which were excluded from the computation of diluted loss per share because their
effect would be anti-dilutive. For the three and nine months ended September 30,
2008, the Company also excluded 360,000 and 522,500 redeemable shares,
respectively as their effect would be anti-dilutive.  The convertible
notes are included in the calculation of diluted earnings per share as all
shares are assumed converted.





Note
5:  Inventory





Inventory
is stated at the lower of cost or market. Cost is determined using the first-in
first-out method.  The Company reviews the value of its inventory and
reduces the inventory value to its net realizable value based upon current
market prices and contracts for future sales. The components of inventories are
as follows (in thousands):





September
      30,
              2009
              (unaudited)
            
            
            December
      31, 2008Raw
      materials
            
            $
            824
            
            
            $
            1,109Work
      in process
            
            
            324
            
            
            
            280Finished
      goods
            
            
            917
            
            
            
            985Total
      inventory
            
            $
            2,065
            
            
            $
            2,374




9





Note
6:  Prepaid Expenses and Other Current Assets:





Prepaid
expenses and other current assets consist of the following (in
thousands):


September
      30,
              2009
              (unaudited)
            
            
            December
      31, 2008Vendor
      prepayments
            
            $
            418
            
            
            $
            180Other
      prepaid expenses *
            
            
            467
            
            
            
            383Other
      assets
            
            
            —
            
            
            
            233Total
      prepaid expenses and other current assets
            
            $
            885
            
            
            $
            796


*No individual amounts greater
than 5% of current assets.





Note
7:  Debt





Debt, all
of which is current, is as follows (in thousands):


September
      30,2009
              (unaudited)
            
            
            December
      31,
              2008Line
      of credit
            
            $
            —
            
            
            $
            1,631Other
      debt
            
            
            —
            
            
            
            60Total
      debt
            
            $
            —
            
            
            $
            1,691





The
Company’s line of credit with Moriah Capital, L.P. (“Moriah”) matured on August
7, 2009 and the Company repaid a total of approximately $232 thousand in
principal due on the line of credit.  The Company did not renew its
loan agreement with Moriah.





The
Company entered into an agreement effective as of September 1, 2009 (the
“Agreement”), with Access Business Finance, LLC (“Access”) pursuant to which it
may borrow an amount not to exceed $3,000,000.  The Agreement provides
that from time to time the Company may request advances in an amount equal
to the lesser of (i) Borrowing Base less the Availability Reserves and (ii) the
Maximum Amount as defined in the Agreement.  The interest on the line
of credit is equal to the Prime Rate plus 4.00% but may not be less than
7.25%.  The term of the Agreement is for one year and will
automatically renew for successive one year terms unless, at least 60 days’
prior to the end of the current term, the Company gives Access prior
written notice of its intent not to renew or if Access, at least ten
days prior to the end of the current term, gives the Company written notice
of its intent not to renew. The Company’s obligations under the Agreement are
secured by its assets.   As of September 30, 2009, the Company
had not borrowed on its line of credit.  The Company paid $25,000 in
annual loan fees to Access which were charged to prepaid expense and will be
amortized over the life of the Agreement.  As of September 30, 2009,
$2,000 had been amortized to interest expense.





In the
three and nine months ended September 30, 2009, approximately $61 thousand and
$362 thousand, respectively, of deferred debt issuance costs were amortized to
interest expense.  For the three and nine months ended September 30,
2009, interest expense includes interest paid or accrued of approximately $15
thousand and $55 thousand, respectively, on outstanding debt.





Note
8:  Stock-based Compensation





The
Company uses the fair value method of accounting for share-based compensation
arrangements. The fair value of stock options is estimated at the date of grant
using the Black-Scholes option valuation model.   Stock-based
compensation expense is reduced for estimated forfeitures and is amortized over
the vesting period using the straight-line method.





The
following table summarizes the allocation of non-cash stock-based compensation
to the expense categories for the three and nine month periods ended September
30, 2009 and 2008 (in thousands):





Three
      Months Ended September 30,
              
              
              Nine
      Months Ended September 30,2009
              
              
              2008
              
              
              2009
              
              
              2008Cost
      of revenue
              
              $
              25
              
              
              $
              31
              
              
              $
              111
              
              
              $
              106Research
      and development
              
              
              39
              
              
              
              58
              
              
              
              165
              
              
              
              192Selling,
      general and administrative
              
              
              317
              
              
              
              149
              
              
              
              650
              
              
              
              547Total
      stock compensation expense
              
              $
              381
              
              
              $
              238
              
              
              $
              926
              
              
              $
              845




10




At
September 30, 2009, total unrecognized non-cash compensation cost related to
stock options was approximately $415 thousand, net of
forfeitures.  Total unrecognized compensation cost will be adjusted
for future changes in estimated forfeitures and is expected to be recognized
over a weighted average period of approximately 1.2 years.





Options
granted to non-employees are measured at the grant date using a fair value
options pricing model and remeasured to the current fair market value at each
reporting period as the underlying options vest and services are
rendered.  For the nine months ended September 30, 2009, there were
60,000 options granted to consultants.  The following assumptions were
used in the Black-Scholes option pricing model to determine the fair value of
stock options granted:  dividend yield – 0%; risk free interest rates
– 1.44% to 1.64%; expected volatility – 71.4% to 84.1%; and expected term – 3
years.





There
were 411,600 and 1,278,841 options granted to employees and directors during the
three and nine months ended September 30, 2009 and 171,000 and 919,253 options
granted to employees and directors during the three and nine months ended
September 30, 2008. The following key assumptions were used in the Black-Scholes
option pricing model to determine the fair value of stock options
granted:





For
      the Nine Months Ended September 30,2009
            
            
            2008Dividend
      yield
            
            
            0
            %
            
            
            0
            %Risk
      free interest rates
            
            2.02
      to 2.51
            %
            
            2.46
      to 3.37
            %Expected  volatility
            
            80.3
      to 86.4
            %
            
            88.4
      to 92.3
            %Expected
      term (in years)
            
            4.0
      to 5.5
            
            
            
            5





The
Company has not declared or paid any dividends and do not currently expect to do
so in the near future.  The risk-free interest rate used in the
Black-Scholes option pricing model is based on the implied yield currently
available on U.S. Treasury securities with an equivalent
term.   Expected volatility is based on the weighted average
historical volatility of the Company’s common stock for the most recent five
year period.  The expected term of options represents the period that
the Company’s stock-based awards are expected to be outstanding and was
determined based on historical experience and vesting schedules of similar
awards.





The 2008
Incentive Stock Plan (“the 2008 Plan”) adopted and approved by the Board of
Directors on November 5, 2008 provides for  shares of common stock and
options to purchase shares of common stock to employees, officers, directors and
consultants.  The 2008 Plan has an aggregate of 2,000,000
shares. As of September 30, 2009, 1,278,841 options were granted from this
plan with a fair value of approximately $814 thousand and 498,533 shares
were issued with a fair value of approximately $304 thousand. At September
30, 2009, there were 222,626 shares available for grant.





A summary
of the Company’s stock option activity for the nine months ended September 30,
2009 is presented in the following tables:


Number
      of Shares
            
            
            Weighted
      Average Exercise Price
            
            
            Weighted
      Average Remaining Contractual Life (In Years)
            
            
            Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2009
            
            
            1,615,673
            
            
            $
            1.63Options
      granted
            
            
            1,278,841
            
            
            
            1.03Options
      exercised
            
            
            —Options
      forfeited
            
            
            (71,598
            )
            
            
            2.60Options
      cancelled
            
            
            —Outstanding
      at September 30, 2009
            
            
            2,822,916
            
            
            $
            1.33
            
            
            
            6.37
            
            
            $
            1,549,944Vested
      or expected to vest at September 30, 2009 (1)
            
            
            2,740,781
            
            
            $
            1.29
            
            
            
            6.37
            
            
            $
            1,068,090Exercisable
      at September 30, 2009
            
            
            2,001,564
            
            
            $
            1.39
            
            
            
            6.71
            
            
            $
            1,068,090








11











The
Company’s stock option activity for the nine months ended September 30, 2009
(continued):





Options
      Outstanding
            
            
            Options
      ExercisableNumber
      Outstanding
            
            
            Weighted
      Average Remaining Contractual Life (In Years)
            
            
            Weighted
      Average Exercise Price
            
            
            Number
      Exercisable
            
            
            Weighted
      Average Exercisable Price$
            0.34
      - $0.98
            
            
            
            1,226,793
            
            
            
            6.56
            
            
            $
            0.83
            
            
            
            895,127
            
            
            $
            0.81$
            1.00
      - $1.44
            
            
            
            1,200,177
            
            
            
            7.40
            
            
            
            1.20
            
            
            
            773,390
            
            
            
            1.24$
            2.60
      - $2.70
            
            
            
            358,746
            
            
            
            2.75
            
            
            
            2.62
            
            
            
            298,847
            
            
            
            2.61$
            3.50
      - $22.50
            
            
            
            37,200
            
            
            
            2.03
            
            
            
            9.75
            
            
            
            34,200
            
            
            
            9.542,822,916
            
            
            
            6.37
            
            
            $
            1.33
            
            
            
            2,001,564
            
            
            $
            1.39





(1)  The
expected to vest options are the result of applying the pre-vesting forfeiture
rate assumptions to total unvested options.





The
aggregate intrinsic value in the table above represents the difference between
the exercise price of the underlying options and the quoted price of the
Company’s common stock.  There were 2,417,970 options in-the-money at
September 30, 2009.   The Company’s closing stock price was $1.65
as of September 30, 2009. The Company issues new shares of common stock upon
exercise of stock options.





Note
9:  Shareholders’ Equity





Preferred
Stock





The
Company has designated 10,000 shares of the Company’s preferred stock as
Preferred Stock – Series B at a stated value of $1,000 per share.  The
Preferred Stock – Series B is convertible into common stock at a conversion
price of $0.75 per share.  The Preferred Stock – Series B does not pay
interest.  The holders of the Preferred Stock – Series B are not
entitled to receive dividends unless the Company’s Board of Directors declare a
dividend for holders of the Company’s common stock and then the dividend shall
be equal to the amount that such holder would have been entitled to receive if
the holder converted its Preferred Stock – Series B into shares of the Company’s
common stock. Each share of Preferred Stock – Series B has voting rights
equal to (i) the number of shares of Common Stock issuable upon conversion of
such shares of Preferred Stock – Series B at such time (determined without
regard to the shares of Common Stock so issuable upon such conversion in respect
of accrued and unpaid dividends on such share of Preferred Stock) when the
Preferred Stock – Series B votes together with the Company’s Common Stock or any
other class or series of stock of the Company and (ii) one vote per share of
Preferred Stock when such vote is not covered by the immediately preceding
clause.  In the event of a liquidation, dissolution, or winding up of the
Company, the Preferred Stock – Series B is entitled to receive liquidation
preference before the Common Stock.  The Company may at its option
redeem the Preferred Stock – Series B by providing the required notice to the
holders of the Preferred Stock – Series B and paying an amount equal to $1,000
multiplied by the number of shares for all of such holder’s shares of
outstanding Preferred Stock – Series B to be redeemed.  As of
September 30, 2009, there were 5,739 shares of Preferred Stock – Series B issued
and outstanding.





Common
Stock





For the
three and nine months ended September 30, 2009 and 2008, there were no stock
options exercised.  For the three and nine months ended September 30,
2009, there were 2.9 million warrants exercised on a cashless basis resulting in
727 thousand shares of common stock issued. No warrants were exercised for the
three and nine months ended September 30, 2008.





For the
three and nine months ended September 30, 2009, the Company issued 42,857 and
498,533 shares of common stock, respectively, for payment of approximately $45
thousand and $304 thousand, respectively, for services rendered and to be
rendered in the future.  For the three and nine months ended September
30, 2008, the Company issued 629,400 and 811,400 shares of common stock,
respectively, for payment of approximately $441 thousand and $643 thousand,
respectively, for services rendered and to be rendered in the
future.  The Company recorded the fair value of the services rendered
and to be rendered in the future in prepaid expenses and selling, general and
administrative expenses in the accompanying unaudited condensed consolidated
financial statements for the three and nine months ended September 30, 2009 and
2008.





At
December 31, 2008, the 522,500 shares underlying the 2007 and 2008 put options
(“put options”) granted to Moriah were presented on the balance sheet as
redeemable common stock in the amount of $429,000 which represented the amount
for which the shares may be redeemed at the option of
Moriah.   On August 7, 2009, the put options expired when Moriah
elected not to exercise its put options.  At September 30, 2009, the
522,500 shares were classified as permanent equity on the balance
sheet.





12





Note
10:  Income Taxes





The
Company accounts for income taxes under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the Company’s
financial statements or tax returns.  The effect on deferred tax
assets and liabilities of changes in tax rates will be recognized as income or
expense in the period that the change occurs.  A valuation allowance
for deferred tax assets is recorded when it is more likely than not that some or
all of the benefit from the deferred tax asset will not be
realized.  Changes in circumstances, assumptions and clarification of
uncertain tax regimes may require changes to any valuation allowances associated
with the Company’s deferred tax assets.





The tax
years 2005-2008 remain open to examination by the major taxing jurisdictions to
which the Company is subject. In the event that the Company is assessed interest
or penalties at some point in the future, it will be classified in the financial
statements as general and administrative expense.





Note
11:  Commitments and Contingencies





Royalty
Payments





The Company, in accordance with
a royalty agreement with Eastman Kodak, must pay to Eastman Kodak a
certain percentage of net sales with respect to certain
products, which percentages are defined in the agreement. The percentages
are on a sliding scale depending on the amount of sales generated. Any
minimum royalties paid will be credited against the amounts due based on
the percentage of sales. The royalty agreement terminates upon the
expiration of the issued patent which is the last to expire.





Effective
May 30, 2007, Kodak and eMagin entered into an intellectual property agreement
where eMagin has assigned Kodak the rights, title, and interest to a Company
owned patent currently not being used by the Company and in consideration, Kodak
waived the royalties due under the existing licensing agreements for the first
six months of 2007, and reduced the royalty payments by 50% for the second half
of 2007 and for the entire calendar year of 2008. In addition, the minimum
royalty payment was delayed until December 1st for the years 2007 and
2008.  The Company recorded approximately $142 thousand and $396
thousand for the three and nine months ended September 30, 2008, respectively,
as income from the license of intangible assets and included this amount as
other income in the condensed consolidated statements of operations. Royalty
expense (including amounts imputed – see above) was approximately $284 thousand
and $792 thousand, respectively, for the three and nine months ended September
30, 2008.





Effective
January 1, 2009, the royalty payments are to be calculated at
100%.  The minimum annual royalty payment of $125 thousand was
paid in January 2009.





In late
2008, the Company began evaluating the status of its manufacturing process and
the use of the IP associated with its license agreement.  After this
analysis and after making a few changes to its manufacturing process, the
Company determined it was no longer using the IP covered under the license
agreement.  As such, future royalty payments will be limited to the
minimum royalty payment amount of $125,000 plus any residual royalties on sales
of product produced prior to the manufacturing process change if such amount
exceeds the minimum royalty payment. The associated royalty liability has been
reduced to royalties on inventory produced prior to the manufacturing process
changes.  The Company is in discussions with the licensor regarding
its position on the license agreement and the final outcome of these discussions
is yet to be determined. As of September 30, 2009, the Company’s believes that
the total royalty owed is $250 thousand which is based on applying the royalty
formula to only the sold displays produced prior to the manufacturing process
changes.  Until a final outcome is reached, the Company will continue
to recognize the reduced royalty liability as stated above.  For the
nine months ended September 30, 2009, the Company estimated that the royalty
would be approximately $1.0 million if the Company applied the royalty formula
to all sold displays produced without consideration of the change in the
manufacturing process.   For the nine months ended September 30,
2009, the Company recorded $250 thousand as royalty expense in its consolidated
statements of operations and the associated liability on its consolidated
balance sheet as the Company believes that is the amount due under the
agreement.





Contractual
Obligations





The Company leases
office facilities and office, lab and factory equipment under operating
leases.  Certain leases provide for payments of monthly operating expenses.
The Company currently has lease commitments for space in Hopewell Junction, New
York and Bellevue, Washington.  In May 2009, the Company renewed its
lease with IBM until May 31, 2014 with the option of extending the lease for
five years.  The Company’s prior lease in Bellevue, Washington expired
August 31, 2009.  The Company signed a lease agreement for 5,100
square feet of office space effective September 1, 2009 through August 31, 2014
which will reduce the Company’s monthly rent by approximately $26 thousand. Rent
expense was approximately $336 thousand and $1.1 million, respectively, for the
three and nine months ended September 30, 2009 and $332 thousand and $996
thousand, respectively, for the three and nine months ended September 30,
2008.





Note
12:  Subsequent Events





In
preparing the Company’s financial statements, the Company evaluated events and
transactions for potential recognition or disclosure through November 12, 2009,
the date on which this Quarterly Report on Form 10-Q was filed with the
SEC.





13





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





Statement
of Forward-Looking Information





In this
quarterly report, references to "eMagin Corporation," "eMagin," "Virtual
Vision," "the Company," "we," "us," and "our" refer to eMagin Corporation and
its wholly owned subsidiary, Virtual Vision, Inc.





Except
for the historical information contained herein, some of the statements in this
Report contain forward-looking statements that involve risks and uncertainties.
These statements are found in the sections entitled "Business," "Management's
Discussion and Analysis of Financial Condition and Results of Operation,"
and "Risk Factors." They include statements concerning: our business strategy;
expectations of market and customer response; liquidity and capital
expenditures; future sources of revenues; expansion of our proposed product
line; and trends in industry activity generally. In some cases, you can identify
forward-looking statements by words such as "may," "will," "should," "expect,"
"plan," "could," "anticipate," "intend," "believe," "estimate," "predict,"
"potential," "goal," or "continue" or similar terminology. These statements are
only predictions and involve known and unknown risks, uncertainties and other
factors, including, but not limited to, the risks outlined under "Risk Factors,"
that may cause our actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by such
forward-looking statements. For example, assumptions that could cause actual
results to vary materially from future results include, but are not limited to:
our ability to successfully develop and market our products to customers; our
ability to generate customer demand for our products in our target markets; the
development of our target markets and market opportunities; our ability to
manufacture suitable products at competitive cost; market pricing for our
products and for competing products; the extent of increasing competition;
technological developments in our target markets and the development of
alternate, competing technologies in them; and sales of shares by existing
shareholders. Although we believe that the expectations reflected in the forward
looking statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Unless we are required to do so under
federal securities laws or other applicable laws, we do not intend to update or
revise any forward-looking statements.





Overview





We design
and manufacture miniature displays, which we refer to as
OLED-on-silicon-microdisplays, and microdisplay modules for virtual imaging,
primarily for incorporation into the products of other manufacturers.
Microdisplays are typically smaller than many postage stamps, but when viewed
through a magnifier they can contain all of the information appearing on a
high-resolution personal computer screen. Our microdisplays use organic light
emitting diodes, or OLEDs, which emit light themselves when a current is passed
through the device. Our technology permits OLEDs to be coated onto silicon chips
to produce high resolution OLED-on-silicon microdisplays.





We
believe that our OLED-on-silicon microdisplays offer a number of advantages in
near to the eye applications over other current microdisplay technologies,
including lower power requirements, less weight, fast video speed without
flicker, and wider viewing angles. In addition, many computer and video
electronic system functions can be built directly into the OLED-on-silicon
microdisplay, resulting in compact systems with lower expected overall system
costs relative to alternate microdisplay technologies.





We hold a
license from Eastman Kodak for use of their OLED related technology and we have
developed a strong portfolio of our own patents, manufacturing know-how and
technology to create high performance OLED-on-silicon microdisplays and related
optical systems. We believe our technology and intellectual property portfolio
gives us a leadership position in OLED and OLED-on-silicon microdisplay
technology. We believe that we are the only company to demonstrate publicly and
market full-color small molecule OLED-on-silicon microdisplays.





Company
History





As of
January 1, 2003, we were no longer classified as a development stage company. We
transitioned to manufacturing our product and have significantly increased our
marketing, sales, and research and development efforts, and expanded our
operating infrastructure. Currently, most of our operating expenses are labor
related and semi-fixed. If we are unable to generate significant revenues, our
net losses in any given period could be greater than expected.





14





CRITICAL
ACCOUNTING POLICIES





The
Securities and
Exchange Commission ("SEC") defines "critical accounting
policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that
are inherently uncertain and may change in subsequent periods.
Not all of the accounting policies require
management to make difficult, subjective or complex judgments or
estimates.  However, the following policies could be deemed to be
critical within the SEC definition.





Revenue
and Cost Recognition





Revenue
on product sales is recognized when persuasive evidence of an arrangement
exists, such as when a purchase order or contract is received from the customer,
the price is fixed, title and risk of loss to the goods has changed and there is
a reasonable assurance of collection of the sales proceeds. We obtain written
purchase authorizations from our customers for a specified amount of product at
a specified price and consider delivery to have occurred at the time of
shipment. We record a reserve for estimated sales returns, which is reflected as
a reduction of revenue at the time of revenue
recognition.   Products sold directly to consumers have a thirty
day right of return.  Revenue on consumer products is deferred until
the right of return has expired.





Revenues
from research and development activities relating to firm fixed-price contracts
are generally recognized on the percentage-of-completion method of accounting as
costs are incurred (cost-to-cost basis). Revenues from research and development
activities relating to cost-plus-fee contracts include costs incurred plus a
portion of estimated fees or profits based on the relationship of costs incurred
to total estimated costs. Contract costs include all direct material and labor
costs and an allocation of allowable indirect costs as defined by each contract,
as periodically adjusted to reflect revised agreed upon rates. These rates are
subject to audit by the other party.





Use
of Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management 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 as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. These estimates and assumptions relate to recording net revenue,
collectibility of accounts receivable, useful lives and impairment of tangible
and intangible assets, accruals, income taxes, inventory realization and other
factors. Management has exercised reasonable judgment in deriving these
estimates. Consequently, a change in conditions could affect these
estimates.





Fair
Value of Financial Instruments





eMagin’s
cash, cash equivalents, accounts receivable, short-term investments, accounts
payable and debt are stated at cost which approximates fair value due to the
short-term nature of these instruments.





Stock-based
Compensation





eMagin
maintains several stock equity incentive plans.  The 2005 Employee
Stock Purchase Plan (the “ESPP”) provides our employees with the opportunity to
purchase common stock through payroll deductions.  Employees purchase
stock semi-annually at a price that is 85% of the fair market value at certain
plan-defined dates.  As of September 30, 2009, the number of shares of
common stock available for issuance was 300,000. As of September 30,
2009, no shares have been issued from this plan.





The 2003
Stock Option Plan (the”2003 Plan”) provides for grants of shares of common stock
and options to purchase shares of common stock to employees, officers, directors
and consultants.   Under the 2003 plan, an ISO grant is granted
at the market value of our common stock at the date of the grant and a non-ISO
is granted at a price not to be less than 85% of the market value of the common
stock.  These options have a term of up to 10 years and vest over a
schedule determined by the Board of Directors, generally over a five year
period.  The amended 2003 Plan provides for an annual increase in
common stock available for issuance by 3% of the diluted shares outstanding on
January 1 of each year for a period of 9 years which commenced January 1,
2005.





The 2008
Incentive Stock Plan (“the 2008 Plan”) adopted and approved by the Board of
Directors on November 5, 2008 provides for the issuance of shares of common
stock and options to purchase shares of common stock to employees, officers,
directors and consultants.  The 2008 Plan has an aggregate of
2,000,000 shares.  For the three and nine months ended September 30, 2009,
there were 42,857 and 498,533 shares of common stock, respectively, issued to
consultants. In addition, there were 411,600 and 1,278,841 options granted from
the plan for the three and nine months ended September 30, 2009.





15





We
account for the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors by estimating the
fair value of stock awards at the date of grant using the Black-Scholes option
valuation model.  Stock-based compensation expense is reduced for
estimated forfeitures and is amortized over the vesting period using the
straight-line method. See Note 8 of the Condensed Consolidated Financial
Statements – Stock Compensation for a further discussion on stock-based
compensation.





NEW
ACCOUNTING PRONOUNCEMENTS





See Note
2 of the Condensed Consolidated Financial Statements in Item 1 for a description
of recent accounting pronouncements.





RESULTS
OF OPERATIONS





THREE
MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE MONTHS AND
NINE MONTHS ENDED SEPTEMBER 30, 2008





Revenues





Revenues
for the three and nine months ended September 30, 2009 were approximately
$6.1 million and $17.1 million, respectively, as compared to approximately $5.2
million and $13.5 million for the three and nine months ended September 30,
2008, respectively, an increase of approximately 18% and 27%,
respectively.  Higher revenue for the three and nine month periods was
due to increased customer demand and product availability.








For the
three and nine months ended September 30, 2009, product revenue increased
approximately $1.1 million and $3.4 million, respectively, as compared to the
three and nine months ended September 30, 2008.  The increase was due
to higher customer demand and increased product availability for our OLED
displays in the first nine months of 2009 as compared to the first nine months
of 2008. For the three months ended September 30, 2009, contract revenue
decreased approximately $0.2 million as compared to the three months ended
September 30, 2008 and for the nine months ended September 30, 2009 increased
approximately $0.2 million as compared to the nine months ended September 30,
2008.  The change in revenue is a result of fluctuations in contract
activity.





Cost
of Goods Sold





Cost of
goods sold includes direct and indirect costs associated with
production.  Cost of goods sold for the three and nine months ended
September 30, 2009 were approximately $2.6 million and $7.3 million as compared
to approximately $2.8 million and $8.1 million for the three and nine months
ended September 30, 2008, a decrease of approximately $0.2 million and $0.8
million, respectively.  Cost of goods sold as a percentage of revenues
improved from 54% for the three months ended September 30, 2008 to 43% for the
three months ended September 30, 2009. Cost of goods sold as a percentage of
revenues improved from 60% for the nine months ended September 30, 2008 to 43%
for the nine months ended September 30, 2009. Cost of goods is comprised
primarily of material and labor cost. The labor portion of cost of goods is
mostly fixed. Improved manufacturing yield, lower royalty expense and lower
warranty expense resulted in a lower cost of goods sold percentage.





The
following table outlines product, contract and total gross profit and related
gross margins for the three and nine months ended September 30, 2009 and
2008 (dollars in thousands):





Three months ended
              September 30,
            
            
            Nine months ended
              September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008(unaudited)
            
            
            (unaudited)Product
      revenue gross profit
            
            $
            3,264
            
            
            $
            1,769
            
            
            $
            8,743
            
            
            $
            4,109Product
      revenue gross margin
            
            
            62
            %
            
            
            42
            %
            
            
            60
            %
            
            
            37
            %Contract
      revenue gross profit
            
            $
            236
            
            
            $
            615
            
            
            $
            1,015
            
            
            $
            1,250Contract
      revenue gross margin
            
            
            28
            %
            
            
            61
            %
            
            
            40
            %
            
            
            54
            %Total
      gross profit
            
            $
            3,500
            
            
            $
            2,384
            
            
            $
            9,758
            
            
            $
            5,359Total
      gross margin
            
            
            57
            %
            
            
            46
            %
            
            
            57
            %
            
            
            40
            %





The
gross profit for the three and nine months ended September 30, 2009 was
approximately $3.5 million and $9.8 million as compared to approximately $2.4
million and $5.4 million for the three and nine months ended September 30, 2008,
an increase of $1.1 million and $4.4 million, respectively.  Gross
margin was 57% for the three months ended September 30, 2009 up from 46% for the
three months ended September 30, 2008.  Gross margin was 57% for the
nine months ended September 30, 2009 up from 40% for the nine months ended
September 30, 2008.  The increase was mainly attributed to the fuller
utilization of our fixed production overhead due to improved yields and a
reduction in royalty and warranty expenses.  See Note 11 of the
Condensed Consolidated Financial Statements - Commitments and Contingencies for
further discussion on the royalty payments.




16


The
product gross profit for the three and nine months ended September 30, 2009
was approximately $3.3 million and $8.7 million as compared to approximately
$1.8 million and $4.1 million for the three and nine months ended September 30,
2008, an increase of $1.5 million and $4.6 million,
respectively.  Product gross margin was 62% for the three months ended
September 30, 2009 up from 42% for the three months ended September 30,
2008.  Product gross margin was 60% for the nine months ended
September 30, 2009 up from 37% for the nine months ended September 30,
2008.  The increase was attributed to the fuller utilization of our
fixed production overhead due to improved yields and a reduction in royalty and
warranty expenses. See Note 11 of the Condensed Consolidated Financial
Statements - Commitments and Contingencies for further discussion on the royalty
payments.





The
contract gross profit for the three and nine months ended September 30,
2009 was approximately $0.2 million and $1.0 million as compared to
approximately $0.6 million and $1.3 million for the three and nine months ended
September 30, 2008, a decrease of $0.4 million and $0.3 million,
respectively.  Contract gross margin was 28% for the three months
ended September 30, 2009 down from 61% for the three months ended September 30,
2008.  Contract gross margin was 40% for the nine months ended
September 30, 2009 down from 54% for the nine months ended September 30,
2008.  The contract gross margin is dependent upon the mix of costs,
internal versus external third party costs, with the external third party costs
causing a lower gross margin and reducing the contract gross
profit.





Operating
Expenses





Research and
Development.  Research and development expenses include salaries,
development materials and other costs specifically allocated to the development
of new microdisplay products, OLED materials and subsystems.  Research
and development expenses for the three and nine months ended September
30, 2009 were approximately $0.5 million and $1.4 million, respectively, as
compared to $0.3 million and $1.6 million for the three and nine months ended
September 30, 2008, an increase of approximately $0.2 million and a decrease of
approximately $0.2 million, respectively.  The increase of $0.2 million was
primarily due to the lower allocation of research and development resources and
expenses related to contracts to cost of goods sold offset by the reduction in
expense due to the streamlining of the research and development effort in the
subsystems area.  The decrease of $0.2 million was primarily related
to the reduction in expense due to the streamlining of the research and
development effort in the subsystems area.





Selling, General and
Administrative.  Selling, general and administrative
expenses consist principally of salaries, fees for professional services
including legal fees, as well as other marketing and administrative
expenses.  Selling, general and administrative expenses for the three
and nine months ended September 30, 2009 were approximately $1.8 million and
$5.1 million, respectively, as compared to approximately $1.3 million and
$4.8 million for the three and nine months ended September 30, 2008, an increase
of approximately $0.5 million and $0.3 million, respectively.  The
increase of $0.5 million for the three months is primarily related to an
increase of personnel costs, non-cash compensation, and professional
services.  The increase of $0.3 million for the nine months is
primarily related to an increase in personnel costs, non-cash compensation, and
tradeshow costs, offset by a decrease in reserve for allowance for bad
debts.





Other Income (Expense), net.
Other income (expense), net consists primarily of interest income earned on
investments, interest expense related to the secured debt, and income from the
licensing of intangible assets.





For the
three and nine months ended September 30, 2009, interest expense was
approximately $76 thousand and $417 thousand, respectively, as compared to
$508 thousand and $1.7 million, respectively, for the three and nine months
ended September 30, 2008.   For the three and nine months ended
September 30, 2009, the interest expense associated with debt was $7 thousand
and $48, respectively, loan fees associated with the new line of credit was $7
thousand, and the amortization of the deferred costs associated with the debt
was $62 thousand and $362 thousand, respectively.  The breakdown of
the interest expense for the three and nine month period in 2008 was as
follows:  interest expense associated with debt of approximately $177
thousand and $501 thousand, respectively; the amortization of the deferred costs
and waiver fees associated with the debt of approximately $331 thousand and $1.2
million, respectively; and the amortization of the debt discount associated with
the debt of approximately $0 and $25 thousand, respectively.   The
decrease in interest expense for the three and nine months ended September 30,
2009 as compared to the three and nine months ended September 30, 2008 was
primarily a result of carrying a lower balance on our line of credit, the
repayment and conversion of the 8% Senior Secured Convertible Notes in December
2008, and lower deferred debt issuance costs.





Other
income for the three and nine months ended September 30, 2009 was approximately
$1 thousand and $41 thousand, respectively, as compared to $84 thousand and $294
thousand, respectively, for the three and nine months ended September 30,
2008.  The other income for the three and nine months ended September 30,
2009 was interest income of approximately $1 thousand and $3 thousand,
respectively, and for a settlement of a liability, $0 and $38 thousand,
respectively. Other income for the three and nine months ended September 30,
2008 was interest income of approximately $2 thousand and $6 thousand,
respectively; $142 thousand and $396 thousand, respectively, was income from a
gain on the license of intangible assets; $0 and $18 thousand, respectively, of
income from equipment salvage; and is offset by approximately $60 thousand and
$126 thousand, respectively, of expense from registration payment
arrangements.    See Note 11:  Commitments and
Contingencies – Royalty Payments for additional information.




17




Liquidity
and Capital Resources





As of
September 30, 2009, we had approximately $3.7 million of cash and cash
equivalents as compared to $2.4 million as of December 31, 2008.  The
change in cash and investments was primarily due to cash provided by operations
of approximately $3.5 million offset by cash used for financing and investing
activities of approximately $2.2 million.





Cash flow
provided by operating activities during the nine months ended September 30, 2009
was approximately $3.5 million, attributable to our net income of approximately
$2.9 million, non-cash expenses of $1.1 million offset by approximately $0.6
million from the change in operating assets and liabilities. Cash flow used
in operating activities during the nine months ended September 30, 2008 was
approximately $1.9 million primarily attributable to our net loss of $2.4
million and an increase in accounts receivable of $1.9 million offset by
non-cash expenses of $2.5 million.





Cash used
in investing activities during the nine months ended September 30, 2009 and 2008
was approximately $492 thousand and $236 thousand, respectively, used for
equipment purchases.





Cash used
in financing activities during the nine months ended September 30, 2009 was
approximately $1.7 million to pay down the line of credit.  Cash
provided by financing activities during the nine months ended September 30, 2008
was approximately $2.7 million and was comprised of approximately $1.6 million
from the sale of common stock, $1.8 million from the line of credit, and offset
by payments on debt of $0.7 million.





As we
have reported, our business continues to experience revenue growth. This trend,
if it continues, may result in higher accounts receivable levels and may require
increased production and/or higher inventory levels.  We anticipate that
our cash needs to fund these requirements as well as other operating or
investing cash requirements over the next twelve months will be less than our
current cash on hand and the cash we anticipate generating from
operations.  We anticipate that we will not require additional funds
over the next twelve months other than perhaps for discretionary capital
spending.  If unanticipated events arise during the next twelve months, we
believe we can raise sufficient funds. However, if we are unable to obtain
sufficient funds, we may further reduce the size of our organization and/or be
forced to reduce and/or curtail our production and operations, all of which
could have a material adverse impact on our business prospects.





Off-Balance Sheet
Arrangements





We do not
have any off balance sheet arrangements that are reasonably likely to have a
current or future effect on our financial condition, revenues, results of
operations, liquidity or capital expenditures.





ITEM
3.  Quantitative and Qualitative Disclosures About Market
Risk





Not
applicable.





ITEM
4T.  Controls and Procedures





(a)  Evaluation of Disclosure Controls
and Procedures. Based on an evaluation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended) required by paragraph (b) of
Rule 13a-15 or Rule 15d-15, as of the end of the period covered by
this Report, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were not effective in
ensuring that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Commission’s rules and
forms. Our Chief Executive Officer and Chief Financial Officer also concluded
that, as of the end of the period covered by this Report, there were material
weaknesses in both the design and effectiveness of our internal control over
financial reporting.  Management has assessed these deficiencies and
has determined that there were two general categories of material weaknesses
(described below) in eMagin’s internal control over financial
reporting.  As a result of our assessment that material weaknesses in
our internal control over financial reporting existed as of September 30, 2009,
management has concluded that our internal control over financial reporting was
not effective as of September 30, 2009.  A material weakness is a
deficiency, or a combination of deficiencies, in internal control over financial
reporting such that there is a reasonable possibility that a material
misstatement of our annual or interim financial statements will not be prevented
or detected on a timely basis.





The
material weaknesses we have identified in our Form 10-K for the year ended
December 31, 2008 include:





Deficiencies
pertaining to the lack of controls or ineffectively designed
controls.
Our control design analysis and process walk-throughs disclosed a number of
instances where review approvals were undocumented, where established policies
and procedures were not defined, and controls were not in place.




18




Deficiencies
related to information technology control design and operating effectiveness
weaknesses.This material weakness
resulted from the absence of key formalized information technology policies and
procedures and could result in (1) unauthorized system access, (2) application
changes being implemented without adequate reliability testing, (3) inconsistent
investigation of system errors and the absence of timely or properly considered
remedial actions, and (4) over reliance on spreadsheet applications without
quality control assurances.  These factors could lead to material
errors and misstatements to financial statements occurring without timely
detection.





There has
been an ongoing focus on the remediation activities to address the material
weakness in disclosure and financial reporting controls.  We have
formalized and documented our review process, have better defined policies and
procedures, and established additional controls where
necessary.   During our third quarter, we tested our controls
that were in place through June 30, 2009 and we had made significant improvement
with fewer deficiencies. As part of the assessment, we are and will continue to
conduct testing and evaluation of the controls implemented as part of the
remediation plan to ascertain that they operate effectively.  We
anticipate that these remediation actions and resulting improvement in controls
will generally strengthen our disclosure controls and procedures and represent
ongoing improvement measures. While we have taken steps to remediate the
material weaknesses, these steps may not be adequate to fully do so, and
additional measures may be required.





(b)  Changes in Internal
Controls.  During the quarter ended September 30, 2009, other
than the remediation activities noted above, there were no changes in our
internal control over financial reporting identified in connection with the
evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.











19














PART
II - OTHER INFORMATION





ITEM
1.  Legal Proceedings





None.





ITEM
1A.  Risk Factors





In
addition to other information set forth in this Report, you should carefully
consider the risk factors previously disclosed in “Item 1A to Part 1” of our
Annual Report on Form 10-K for the year ended December 31,
2008.  There were no material changes from the risk factors during the
three and nine months ended September 30, 2009.





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





None.





ITEM
3.  Defaults Upon Senior Securities





None.





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





None.





ITEM
5.  Other Information





None.





ITEM
6.  Exhibits





20











EXHIBITNUMBER
            
            DESCRIPTION31.1
            
            Certification
      by Principal Executive Officer pursuant to Sarbanes Oxley Section 302
      (1)31.2
            
            Certification
      by Principal Financial Officer pursuant to Sarbanes Oxley Section 302
      (1)32.1
            
            Certification
      by Chief Executive Officer pursuant to 18 U.S.C. Section 1350
      (1)32.2
            
            Certification
      by Chief Financial Officer pursuant to 18 U.S.C. Section 1350
      (1)





(1)           Filed
herewith.








21











SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized on this 12th day of November 2009.





eMAGIN
      CORPORATIONBy:
            /s/ Andrew
      G. SculleyAndrew
      G. SculleyChief
      Executive OfficerPrincipal
      Executive Officer





By:
            /s/ Paul
      CampbellPaul
      CampbellChief
      Financial OfficerPrincipal
      Accounting and Financial Officer














22