**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 June 30, 2006****or**£
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934****For the transition period
                from               
                to**





**Commission
      file number 001-15751**





**eMAGIN
      CORPORATION**


*(Exact
      name of registrant as specified in its charter* *)*





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





**10500
      NE 8** **th** **Street, Suite 1400, Bellevue, Washington 98004**


*(Address
      of principal executive offices)*





**(425)
      749-3600**


*(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. Yes R No £





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 R




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





The
      number of shares of common stock outstanding as of July 31, 2006 was
      100,522,492.


















**eMagin
      Corporation**


**Form
      10-Q**


**For
      the Quarter ended June 30, 2006**





**Table
      of Contents**


**Page****PART
                I   FINANCIAL INFORMATION**Item
                1
            Condensed
                Consolidated Financial StatementsCondensed
                Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December
                31, 2005
            3Condensed
                Consolidated Statements of Operations for the Three and Six Months
                ended
                June 30, 2006 and 2005 (unaudited)
            4Condensed
                Consolidated Statements of Changes in Shareholders’ Equity for the Three
                and Six Months ended June 30, 2006 (unaudited)
            5Condensed
                Consolidated Statements of Cashflows for the Six Months ended June
                30,
                2006 and 2005 (unaudited)
            6Notes
                to Condensed Consolidated Financial Statements (unaudited)
            7Item
                2
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            14Item
                3
            Quantitative
                and Qualitative Disclosures About Market Risk
            18Item
                4
            Controls
                and Procedures
            18**PART
                II   OTHER INFORMATION**Item
                1
            Legal
                Proceedings
            19Item
                1A
            Risk
                Factors
            19Item
                2
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            24Item
                3
            Defaults
                Upon Senior Securities
            24Item
                4
            Submission
                of Matters to a Vote of Security Holders
            24Item
                5
            Other
                Information
            24Item
                6
            Exhibits
            24**SIGNATURES****CERTIFICATIONS**


2


**ITEM
      1.   Condensed Consolidated Financial
      Statements**








**eMAGIN
      CORPORATION**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**(In
      thousands, except share data)**





**June
                  30,2006**
              **(unaudited)**
            
            **December
                  31,2005****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            255
            
            $
            6,727Investments
                - held to maturity
            
            
            124
            
            
            120Accounts
                receivable, net
            
            
            954
            
            
            762Inventory
            
            
            3,614
            
            
            3,839Prepaid
                expenses and other current assets
            
            
            832
            
            
            1,045Total
                current assets
            
            
            5,779
            
            
            12,493Equipment,
                furniture and leasehold improvements, net
            
            
            983
            
            
            1,299Intangible
                assets, net
            
            
            56
            
            
            57Other
                assets
            
            
            233
            
            
            233Total
                assets
            
            $
            7,051
            
            $
            14,082**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            2,686
            
            $
            562Accrued
                compensation
            
            
            1,018
            
            
            1,010Other
                accrued expenses
            
            
            875
            
            
            1,894Deferred
                revenue
            
            
            98
            
            
            96Current
                portion of capitalized lease obligations
            
            
            9
            
            
            16Other
                current liabilities
            
            
            148
            
            
            47Total
                current liabilities
            
            
            4,834
            
            
            3,625Capitalized
                lease obligations
            
            
            4
            
            
            6Long-term
                debt
            
            
            37
            
            
            50Total
                liabilities
            
            
            4,875
            
            
            3,681Commitments
                and contingenciesShareholders’
                equity:Preferred
                stock, $.001 par value: authorized 10,000,000 shares; no shares issued
                and
                outstanding
            
            
            —
            
            
            —Common
                stock, $.001 par value: authorized 200,000,000 shares, issued and
                outstanding, 100,422,492 shares as of June 30, 2006 and 99,972,458
                shares
                as of December 31, 2005
            
            
            100
            
            
            100Additional
                paid-in capital
            
            
            177,633
            
            
            175,860Accumulated
                deficit
            
            
            (175,557
            )
            
            (165,559
            )Total
                shareholders’ equity
            
            
            2,176
            
            
            10,401Total
                liabilities and shareholders’ equity
            
            $
            7,051
            
            $
            14,082








See
      notes
      to Condensed Consolidated Financial Statements .


3


**eMAGIN
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**(In
      thousands, except share data)**


**(unaudited)**





**Three
                Months Ended June 30,**
            
            **Six
                Months Ended****June
                30,****2006**
            
            **2005**
            
            **2006**
            
            **2005**Revenue:Product
                revenue
            
            $
            1,674
            
            $
            616
            
            $
            3,245
            
            $
            1,307Contract
                revenue
            
            
            ---
            
            
            36
            
            
            70
            
            
            36Total
                revenue, net
            
            
            1,674
            
            
            652
            
            
            3,315
            
            
            1,343Cost
                of goods sold
            
            
            2,965
            
            
            2,389
            
            
            5,994
            
            
            4,346Gross
                loss
            
            
            (1,291
            )
            
            (1,737
            )
            
            (2,679
            )
            
            (3,003
            )Operating
                expenses:Research
                and development
            
            
            1,304
            
            
            1,130
            
            
            2,542
            
            
            2,016Selling,
                general and administrative
            
            
            2,248
            
            
            1,760
            
            
            4,836
            
            
            3,095Total
                operating expenses
            
            
            3,552
            
            
            2890
            
            
            7,378
            
            
            5,111Loss
                from operations
            
            
            (4,843
            )
            
            (4,627
            )
            
            (10,057
            )
            
            (8,114
            )Other
                income (expense):Interest
                expense
            
            
            ---
            
            
            (1
            )
            
            ---
            
            
            (2
            )Other
              income, net
            
            
            5
            
            
            130
            
            
            59
            
            
            149Total
                other income, net
            
            
            5
            
            
            129
            
            
            59
            
            
            147Net
                loss
            
            $
            (4,838
            )
            $
            (4,498
            )
            $
            (9,998
            )
            $
            (7,967
            )Loss
                per share, basic and diluted
            
            $
            (0.05
            )
            $
            (0.05
            )
            $
            (0.10
            )
            $
            (0.10
            )Weighted
                average number of shares outstanding:Basic
                and diluted
            
            
            100,114,000
            
            
            82,445,000
            
            
            100,076,000
            
            
            81,955,000








See
      notes
      to Condensed Consolidated Financial Statements .





4


**eMAGIN
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**


**(In
      thousands)**








**Additional**
            
            
            
            **Total****Common
                Stock**
            
            **Paid-In**
            
            **Accumulated**
            
            **Shareholders’****Shares**
            
            **Amount**
            
            **Capital**
            
            **Deficit**
            
            **Equity**Balance,
                December 31, 2005
            
            
            99,972
            
            $
            100
            
            $
            175,860
            
            $
            (165,559
            )
            $
            10,401Stock-based
                compensation
            
            
            -----
            
            
            -----
            
            
            1,581
            
            
            -----
            
            
            1,581Issuance
                of common stock for services
            
            
            450
            
            
            -----
            
            
            192
            
            
            -----
            
            
            192Net
                loss
            
            
            -----
            
            
            -----
            
            
            -----
            
            
            (9,998
            )
            
            (9,998
            )Balance,
                June 30, 2006, (unaudited)
            
            
            100,422
            
            $
            100
            
            $
            177,633
            
            $
            (175,557
            )
            $
            2,176










See
      notes
      to Condensed Consolidated Financial Statements .


5





**eMAGIN
      CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(In
      thousands)**







**Six
                  months ended June 30,****2006**
            
            **2005****(unaudited)**Cash
                flows from operating activities:Net
                loss
            
            $
            (9,998
            )
            $
            (7,967
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            513
            
            
            378Reduction
                in provision for sales returns and doubtful accounts
            
            
            (13
            )
            
            (101
            )Stock-based
                compensation
            
            
            1,581
            
            
            ---Issuance
                of common stock for services
            
            
            192
            
            
            240Changes
                in operating assets and liabilities:Accounts
                receivable
            
            
            (180
            )
            
            150Inventory
            
            
            226
            
            
            (1,489
            )Prepaid
                expenses and other current assets
            
            
            213
            
            
            (389
            )Deferred
                revenue
            
            
            2
            
            
            ---Accounts
                payable, accrued compensation, and other accrued expenses
            
            
            1,106
            
            
            540Other
                current liabilities
            
            
            101
            
            
            10Net
                cash used in operating activities
            
            
            (6,257
            )
            
            (8,628
            )Cash
                flows from investing activities:Purchase
                of equipment
            
            
            (194
            )
            
            (494
            )Purchase
                of investments - held to maturity
            
            
            (4
            )
            
            ---Purchase
                of intangibles and other assets
            
            
            (2
            )
            
            35Net
                cash used by investing activities
            
            
            (200
            )
            
            (459
            )Cash
                flows from financing activities:Proceeds
                from exercise of stock options and warrants
            
            
            ---
            
            
            1,564Payments
                of long-term debt and capital leases
            
            
            (15
            )
            
            (7
            )Net
                cash (used) provided by financing activities
            
            
            (15
            )
            
            1,557Net
                (decrease) in cash and cash equivalents
            
            
            (6,472
            )
            
            (7,530
            )Cash
                and cash equivalents beginning of period
            
            
            6,727
            
            
            13,457Cash
                and cash equivalents end of period
            
            $
            255
            
            $
            5,927Cash
                paid for interest
            
            $
            ---
            
            $
            8Cash
                paid for taxes
            
            $
            35
            
            $
            ---







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 Account Policies**





***The
      Business***





eMagin
      Corporation is a developer and manufacturer of optical systems and microdisplays
      for use in the electronics industry. eMagin also develops and markets
      microdisplay systems and optics technology for commercial, industrial and
      military applications.





***Basis
      of Presentation***





In
      the
      opinion of management, the accompanying unaudited condensed consolidated
      financial statements of eMagin Corporation and its subsidiary reflects 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 have been condensed or omitted pursuant
      to instruction, rules and regulations prescribed by the Securities and Exchange
      Commission. 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, 2005.





Certain
      prior-period balances have been reclassified to conform to the current period
      presentation. These reclassifications had no impact on revenue, net loss, assets
      or liabilities in either period presented. The results of operations for the
      period ended June 30, 2006 are not necessarily indicative of the results to
      be
      expected for the full year.





The
      condensed consolidated financial statements have been prepared assuming that
      the
      Company will continue as a going concern. The Company has had recurring losses
      from operations which it believes will continue through 2006. These factors
      raise substantial doubt regarding the Company’s ability to continue as a going
      concern without continuing to obtain additional funding. If management is
      unsuccessful in its efforts to obtain additional funding, the Company will
      reduce its operating plan which will have an impact on its ability to achieve
      profitability. The condensed consolidated financial statements do not include
      any adjustments that might result from the outcome of this
      uncertainty.





***Use
      of Estimates***





In
      accordance with accounting principles generally accepted in the United States,
      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
      Recognition***





Revenue
      is recognized when products are shipped to customers, net of allowances for
      anticipated returns. The Company’s revenue-earning activities generally involve
      delivering products and revenues are considered to be earned when the Company
      has completed the process by which it is entitled to such revenues. Revenue
      is
      recognized when persuasive evidence of an arrangement exists, delivery has
      occurred, the selling price is fixed or determinable and collection is
      reasonably assured. The Company defers revenue recognition on products sold
      directly to the consumer with a fifteen day right of return. Revenue is
      recognized upon the expiration of the right of return.




7




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.





***Stock-based
      Compensation***





The
      Company maintains several stock equity incentive plans. The 2005 Employee Stock
      Purchase Plan (the “ESPP”) provides the Company’s 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 June 30, 2006, the number of shares of common stock
      available for issuance was 1,500,000. As of June 30, 2006, the plan had not
      been
      implemented.





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 the Company’s 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 at the date of grant. These options have a term of up to 10 years and
      vest
      over a schedule determined by the Board of Directors, generally five years.
      The
      amended 2003 Plan provides for an annual increase of 3% of the diluted shares
      outstanding on January 1 of each year for a period of nine (9) years which
      commenced January 1, 2005.





On
      January 1, 2006, the Company adopted the provisions of Financial Accounting
      Standards Board (“FASB”) Statement No. 123(R), “ *Share-Based
      Payment”* ,
      (“SFAS
      No. 123R”), which requires the Company to recognize expense related to the fair
      value of the Company’s share-based compensation. Prior to January 1, 2006, the
      Company accounted for share-based compensation under the recognition and
      measurement provisions of Accounting Principles Board Opinion No. 25
      ("APB No. 25"), “ *Accounting for Stock Issued
      to Employees”,* and
      related interpretations, as permitted by FASB Statement No. 123, "Accounting
      for
      Stock-Based Compensation" (“SFAS No. 123”). In accordance with APB No. 25, no
      compensation cost was required to be recognized for options granted that had
      an
      exercise price equal to the market value of the underlying common stock on
      the
      date of grant.





The
      Company adopted SFAS No. 123R using the modified prospective transition method
      and consequently has not retroactively adjusted results for prior periods.
      Under
      this transition method, compensation cost associated with stock options
      includes: a) compensation cost for all share-based compensation granted prior
      to, but not vested as of January 1, 2006, based on the grant-date fair value
      estimated in accordance with the original provisions of SFAS No.123 and b)
      compensation cost for all share-based compensation granted beginning January
      1,
      2006, based on the grant-date fair value estimated in accordance with the
      provisions of SFAS No.123R. The Company uses the straight-line method for
      recognizing compensation expense. Compensation expense for awards under SFAS
      123R includes an estimate for forfeitures.





See
      Note
      7 for further information regarding the Company’s stock-based compensation
      assumptions and expenses, including the impact of adoption on the Company’s
      condensed Consolidated Financial Statements and pro forma disclosures for prior
      periods as if we had recorded stock-based compensation expense.





**Note
      2: Receivables**





The
      majority of the Company’s commercial accounts receivable is 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, eMagin's previous loss history, the
      customer's current ability to pay its obligation, 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.





8


Receivables
      consisted of the following (in thousands):





**June
                30,****2006**
              **(unaudited)**
            
            **December
                31,  2005**Accounts
                receivable
            
            $
            1,429
            
            $
            1,249Less
                allowance for doubtful accounts
            
            
            (475
            )
            
            (487
            )Net
                receivables
            
            $
            954
            
            $
            762





**Note
      3: Research and Development Costs**





Research
      and development costs are expensed as incurred.





**Note
      4: Net Loss per Common Share**





In
      accordance with SFAS No. 128, net loss per common share amounts ("basic EPS")
      was computed by dividing net loss by the weighted average number
      of common shares outstanding and excluding any
      potential dilution.  Net loss per common share assuming dilution
      ("diluted EPS") was computed by reflecting potential dilution from the
      exercise of stock options and warrants.  Common stock equivalent
      shares are excluded from the computation if their effect is antidilutive. As
      of
      June 30, 2006 and 2005, there were stock options and warrants outstanding to
      acquire 36,081,749 and 34,132,127 shares of our common stock, respectively.
      These shares were excluded from the computation of diluted loss per share
      because their effect would be antidilutive.





**Note
      5: Inventories**





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):





**June
                30, 2006**
              **(unaudited)**
            
            **December
                31, 2005**Raw
                materials
            
            $
            2,066
            
            $
            2,353Work
                in process
            
            
            250
            
            
            107Finished
                goods
            
            
            1,298
            
            
            1,379Total
                Inventory
            
            $
            3,614
            
            $
            3,839





**Note
      6: Debt**





Debt
      is
      as follows (in thousands):





**June
                30, 2006**
              **(unaudited)**
            
            **December
                31, 2005**Current
                portion of capitalized lease obligations
            
            $
            9
            
            $
            16Long-term
                capitalized lease obligations
            
            
            4
            
            
            6Long-term
                debt
            
            
            37
            
            
            50Total
                debt
            
            $
            50
            
            $
            72





9




**Note
      7: Stock-based Compensation**





On
      January 1, 2006, the Company adopted the provisions of SFAS No. 123R, which
      requires the Company to recognize expense related to the fair value of the
      Company’s share-based compensation issued to employees and directors. Prior to
      January 1, 2006, the Company accounted for share-based compensation under the
      recognition and measurement provisions of APB No. 25 and related
      interpretations, as permitted by SFAS No. 123. We adopted SFAS No. 123R using
      the modified prospective transition method. Accordingly, periods prior to
      adoption have not been restated. Compensation cost recognized for the three
      and
      six months ended June 30, 2006 includes a) compensation cost for all share-based
      compensation granted prior to, but not vested as of January 1, 2006, based
      on
      the grant-date fair value estimated in accordance with the original provisions
      of SFAS No.123 and b) compensation cost for all share-based compensation granted
      beginning January 1, 2006, based on the grant-date fair value estimated in
      accordance with the provisions of SFAS No.123R. The compensation cost was
      recognized using the straight-line attribution method.





The
      following table summarizes the allocation of non-cash stock-based compensation
      to our expense categories for the three and six month periods ended June 30,
      2006 (in thousands):





Three
                Months Ended
              June
                30, 2006
            
            Six
                Months Ended
              June
                30, 2006Cost
                of revenue
            
            $
            123
            
            $
            258Research
                and development
            
            
            131
            
            
            259Selling,
                general and administrative
            
            
            536
            
            
            1,064Total
                stock compensation expense
            
            $
            790
            
            $
            1,581





For
      the
      three and six months ended June 30, 2006, stock compensation was approximately
      $0.8 million and $1.6 million, respectively. At June 30, 2006, total
      unrecognized non-cash compensation costs related to stock options was
      approximately $6.1 million, net of estimated 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
      5.2 years.





The
      Company recognizes compensation expense for options granted to non-employees
      in
      accordance with the provision of Emerging Issues Task Force (“EITF”) consensus
      Issue 96-18, “ *Accounting
      for Equity Instruments that are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling Goods or Services,”* which
      requires using a fair value options pricing model and re-measuring such stock
      options to the current fair market value at each reporting period as the
      underlying options vest.





In
      determining the fair value of stock options granted during the six month periods
      ended June 30, 2006 and 2005, the following key assumptions were used in the
      Black-Scholes option pricing model:








**For
                the Six Months Ended June 30,****2006**
            
            **2005**Dividend
                yield
            
            0%
            
            0%Risk
                free interest rates
            
            5.10%
            
            3.98%Expected
                volatility
            
            123%
            
            69%Expected
                term (in years)
            
            5
                years
            
            7
                years





We
      have
      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 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 our stock-based awards
      are expected to be outstanding and was determined based on historical experience
      and vesting schedules of similar awards.




10





The
      following table shows the proforma effect on our net loss and net loss per
      share
      had compensation expense been determined based on the fair value at the award
      grant date in accordance with SFAS No. 123 for the three and six months ended
      June 30, 2005 (in thousands, except per share data):





**Three
                Months Ended**
              **June
                30, 2005**
            
            **Six
                Months Ended**
              **June
                30, 2005**Net
                loss, as reported
            
            $
            (4,498
            )
            $
            (7,967
            )Deduct: 
                Stock-based employee compensation expense determined under fair value
                method
            
            
            (527
            )
            
            (2,055
            )Pro
                forma net loss
            
            $
            (5,025
            )
            $
            (10,022
            )Net
                loss per share:Basic
                and diluted, as reported
            
            $
            (
                0.05
            )
            $
            (0.10
            )Basic
                and diluted, pro forma
            
            $
            (0.06
            )
            $
            (0.12
            )








A
      summary
      of the Company’s stock option activity for the six months ended June 30, 2006 is
      presented in the following tables:




**Number
                of Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Average Remaining Contractual Life (In Years)**
            
            **Aggregate
                Intrinsic Value**Outstanding
                at January 1, 2006
            
            18,052,636
            
            $
                1.09Options
                granted
            
            1,080,000
            
            0.55Options
                exercised
            
            ----
            
            ----Options
                cancelled
            
            (2,405,358)
            
            1.07Outstanding
                at June 30, 2006
            
            16,727,278
            
            $
                1.04
            
            4.26
            
            $
                95,000Vested
                or expected to vest at June 30, 2006 (1)
            
            16,058,187
            
            $
                1.02
            
            3.71
            
            $
                95,000Exercisable
                at June 30, 2006
            
            9,392,781
            
            $
                1.04
            
            3.31
            
            $
                95,000








**Options
                Outstanding**
            
            **Options
                Exercisable****Number
                Outstanding**
            
            **Weighted
                Average Remaining Contractual Life (In Years)**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                Exercisable**
            
            **Weighted
                Average Exercisable Price**$0.21
                - $0.85
            
            7,492,258
            
            4.05
            
            $0.50
            
            4,516,036
            
            $0.45$1.00
                - $1.50
            
            4,395,914
            
            5.38
            
            1.14
            
            1,505,021
            
            1.13$1.52
                - $6.30
            
            4,839,106
            
            3.57
            
            1.80
            
            3,371,724
            
            1.8016,727,278
            
            4.26
            
            $1.04
            
            9,392,781
            
            $1.04








(1)
      The
      expected to vest options are the result of applying the pre-vesting forfeiture
      rate assumptions to total outstanding 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 for the 1,192,015 options that were in-the-money at June
      30,
      2006. The Company’s closing stock price was $0.29 as of June 30, 2006. The
      Company issues new shares of common stock upon exercise of stock
      options.





11




**Note
      8: Shareholders’ Equity**





For
      the
      three and six months ended June 30, 2006, there were no warrants and stock
      options exercised as compared to the three and six months ended June 30, 2005
      where the Company received approximately $318,000 and $1.6 million,
      respectively, in proceeds from the exercise of approximately 600,000 and 3.0
      million warrants and options, respectively. For the three and six months ended
      June 30, 2006, the Company also issued approximately 373,000 and 450,000 shares
      of common stock, respectively, in lieu of payment of approximately $142,000
      and
      $192,000, respectively, for services rendered and to be rendered in the
      future.  For the three and six months ended June 30, 2005, the Company also
      issued approximately 284,000 and 296,000 shares of common stock, respectively,
      in lieu of payment of approximately $244,000 and $257,000, respectively, for
      services rendered and to be rendered in the future.





**Note
      9: Commitments and Contingencies**





***Royalty
      Payments***





The Company, in accordance with
      a royalty agreement, with Eastman Kodak is obligated to make
      minimum annual royalty payments of $125,000 which commenced on January 1,
      2001. Under this agreement, the Company must pay to Eastman Kodak a certain
      percentage of net sales of 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 last-to-expire
      issued patent.





The
      Company paid $125,000 for the minimum amount due for 2006 and 2005. The amount
      was recorded in prepaid expenses and will be amortized as the
      Company records the royalty expense as defined in the agreement. Royalty
      expense was approximately $106,000 and $191,000, respectively, for the three
      and
      six months ended June 30, 2006 and approximately $42,000 and $65,000,
      respectively, for the three and six months ended June 30, 2005.





***Contractual
      Obligations***





The Company leases
      office facilities and office, lab and factory equipment under operating leases
      expiring through 2009.  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. Rent expense was
      approximately $332,000 and $679,000 for the three and six months ended June
      30,
      2006, respectively, and approximately $241,000 and $475,000 for the three and
      six months ended June 30, 2005, respectively.





**Note
      10: Legal Proceedings** ******





On
      December 6, 2005, New York State Urban Development Corporation commenced action
      in the Supreme Court of the State of New York, County of New York against the
      Company, asserting breach of contract and seeking to recover a $150,000 grant
      which was made to the Company based on goals set forth in the agreement for
      recruitment of employees.  The Company has received an extension of time to
      answer the Complaint and is in on-going negotiations with New York State Urban
      Development Corporation in order to resolve this matter. See Note 11 for further
      information.


******


**Note
      11:** **Subsequent
      Events**





On
      July
      13, 2006, the Company agreed to a settlement with the New York State Urban
      Development Corporation to repay $112,200 of a $150,000 grant made to the
      Company based on goals set forth in an agreement for recruitment of employees.
      The repayment will be made through monthly payments of $3,117 per month
      commencing August 1, 2006 and ending on July 1, 2009.





12




On
      July
      21, 2006, the Company entered into several Note Purchase Agreements for the
      sale
      of approximately $6.5 million of senior secured debentures and warrants. The
      investors purchased $5.97 million principal amount of notes with conversion
      prices of $0.26 per share that may convert into approximately 23.0 million
      shares of common stock and 5 year warrants exercisable at $0.36 per share for
      approximately 16.1 million shares of common stock. An additional $0.5 million
      will be invested through the exercise of a warrant to purchase approximately
      1.92 million shares of common stock at $0.26 per share prior to December 14,
      2006, or at the request of the Company, by the purchase of additional notes
      and
      warrants. If the notes are not converted, 50% of the principal amount will
      be
      due July 21, 2007 and the remaining 50% due January 21, 2008. Commencing
      September 1, 2006, 6% interest is payable in quarterly installments on
      outstanding notes.





On
        July
        21, 2006, certain employees and Directors of the Company agreed to forfeit
        approximately 4.7 million shares of existing stock options in return for
        re-pricing 8.7 million existing options at $0.26 per share. Option grants
        that
        have not been re-priced will remain unchanged. The Company offered the
        re-pricing to employees and Directors in lieu of making j new grants. The
        unvested options which were re-priced will continue to vest on original vesting
        schedules, but in no event prior to January 19, 2007. Previously vested options
        which were re-priced will now vest on January 19, 2007. Re-priced grants
        will be
        forfeited if the individual leaves voluntarily. The Company is currently
        evaluating the impact. of this re-pricing on its result of operations. Any
        additional compensation charges will be recognized over the shorter of the
        six
        months ended January 19, 2007 for previously vested options and over the
        remaining vesting period for unvested options.




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 "Management's Discussion
      and
      Analysis or Plan Operations" 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 or our industry's 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, develop, manufacture, and market virtual imaging products which utilize
      OLEDs, or organic light emitting diodes, OLED-on-silicon microdisplays and
      related information technology solutions. We integrate OLED technology with
      silicon chips to produce high-resolution microdisplays smaller than one-inch
      diagonally which, when viewed through a magnifier, create virtual images that
      appear comparable in size to that of a computer monitor or a large-screen
      television. Our products enable our original equipment manufacturer, or OEM,
      customers to develop and market improved or new electronic products. We believe
      that virtual imaging will become an important way for increasingly mobile people
      to have quick access to high-resolution data, work, and experience new more
      immersive forms of communications and entertainment .





Our
      first
      commercial product, the SVGA+ (Super Video Graphics Array of 800x600 plus 52
      added columns of data) OLED microdisplay, was initially offered for sampling
      in
      2001, and our first SVGA-3D (Super Video Graphics Array plus built-in
      stereovision capability) OLED microdisplay was shipped in early 2002. We are
      in
      the process of completing development of 2 additional OLED microdisplays, namely
      the SVGA 3DS (SVGA 3D shrink, a smaller format SVGA display with a new cell
      architecture with embedded features) and an SXGA (1280 x 1024).





In
      January 2005, we announced the world's first personal display system to combine
      OLED technology with head-tracking and 3D stereovision, the Z800 3DVisor(tm),
      which was first shipped in mid-2005. This product received a CES Design and
      Innovations Award for the electronic gaming category and also received the
      coveted Best of Innovation Awards for the entire display category. The product
      was also recognized as a Digital Living Class of 2005 Innovators.





We
      license our core OLED technology from Eastman Kodak and we have developed our
      own technology to create high performance OLED-on-silicon microdisplays and
      related optical systems. We believe our technology licensing agreement with
      Eastman Kodak, coupled with our own intellectual property portfolio, gives
      us a
      leadership position in OLED and OLED-on-silicon microdisplay technology. We
      believe we are the only company to sell full-color active matrix small molecule
      OLED-on-silicon microdisplays.





**Company
      History**





From
      inception through January 1, 2003, we were a developmental stage company. We
      have transitioned to manufacturing our products and intend to significantly
      increase our marketing, sales, and research and development
      efforts, and expand our operating infrastructure. Most of our operating
      expenses are fixed in the near term. 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
      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 selling price is fixed, title 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.  Revenue is recognized at shipment and we
      record a reserve for estimated sales returns, which
      is reflected as a reduction of revenue at the time of revenue recognition.
      We defer revenue on products sold directly to the consumer with a fifteen day
      right of return. Revenue is recognized upon the expiration of the right of
      return.





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**





In
      accordance with accounting principles generally accepted in the United States,
      management utilizes 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, stock-based compensation expense and other factors. Management
      believes it has exercised reasonable judgment in deriving these estimates.
      Consequently, a change in conditions could affect these estimates.





**Fair
      Value of Financial Instruments**





The
      Company's cash, cash equivalents, investments, accounts receivable and accounts
      payable are stated at cost which appropriates fair value due to the short-term
      nature of these instruments.





**Stock-based
      Compensation**





We
      maintain 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
      June 30, 2006, the number of shares of common stock available for issuance
      was
      1,500,000. As of June 30, 2006, the plan had not been implemented.






15


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 of 3% of the diluted shares outstanding on
        January 1 of each year for a period of 9 years which commenced January 1,
        2005.
 
 On
        January 1, 2006, we adopted the provisions of Financial Accounting Standards
        Board (“FASB”) Statement No. 123(R), “ *Share-Based
        Payment”* ,
        and
        (“SFAS No. 123R”), which requires us to recognize expense related to the fair
        value of our share-based compensation issued to employees and directors.
        Prior
        to the January 1, 2006, we accounted for share-based compensation under the
        recognition and measurement provisions of Accounting Principles
        Board Opinion No. 25 ("APB No. 25"), “ *Accounting for Stock Issued
        to Employees”,* and
        related interpretations, as permitted by FASB Statement No. 123, "Accounting
        for
        Stock-Based Compensation" (“SFAS No. 123”). In accordance with APB No. 25, no
        compensation cost was required to be recognized for options granted that
        had an
        exercise price equal to the market value of the underlying common stock on
        the
        date of grant.
 
 We
        adopted SFAS No. 123R using the modified prospective transition method and
        consequently have not retroactively adjusted results for prior periods. Under
        this transition method, compensation cost associated with stock options
        includes: a) compensation cost for all share-based compensation granted prior
        to, but not vested as of January 1, 2006, based on the grant-date fair value
        estimated in accordance with the provisions of SFAS No.123 and b) compensation
        cost for all share-based compensation granted beginning January 1, 2006,
        based
        on the grant-date fair value estimated in accordance with the original
        provisions of SFAS No.123R. We use the straight-line method for recognizing
        compensation expense. Compensation expense for awards under SFAS 123R includes
        an estimate for forfeitures.
 
 **NEW
        ACCOUNTING PRONOUNCEMENT**
 
 The
        Financial Accounting Standards Board (“FASB”) has issued interpretation No. 48,
“Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement
        No. 109” (“FIN 48”), regarding accounting for, and disclosure of, uncertain tax
        positions. FIN 48 clarifies the accounting for uncertainty in income taxes
        recognized in an enterprise’s financial statements in accordance with FASB
        Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a
        recognition threshold and measurement attribute for the financial statement
        recognition and measurement of a tax position taken or expected to be taken
        in a
        tax return. FIN 48 also provides guidance on derecognition, classification,
        interest and penalties, accounting in interim periods, disclosure, and
        transition. FIN 48 is effective for fiscal years beginning after December
        15,
        2006. We do not anticipate that the adoption of this statement will have
        a
        material effect on our financial position or results of operation.
  **RESULTS
        OF OPERATIONS**
  **THREE
        AND SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE AND SIX MONTHS ENDED
        JUNE
        30, 2005**
 
 **Revenues**
 
 Revenues
        for the three and six months ended June 30, 2006 were approximately $1.7
        million and $3.3 million, respectively, as compared to approximately $0.7
        million and $1.3 million, respectively, for the three and six months ended
        June
        30, 2005, an increase of approximately 157% and 147%, respectively. The increase
        in revenue was due to increased unit shipments of our microdisplays due to
        increased, reliable manufacturing output and a broadening of our product
        revenue through sales of the Z800 3DVisor.
 
 **Cost
        of Goods Sold**
 
 Cost
        of
        goods sold includes direct and indirect costs associated with
        production.  Cost of goods sold for the three and six months ended June 30,
        2006 was approximately $3.0 million and $6.0 million, respectively, as
        compared to approximately $2.4 million and $4.3 million, respectively, for
        the
        three and six months ended June 30, 2005, an increase of approximately $0.6
        million and $1.7 million, respectively.  The gross loss for the three
        and six months ended June 30, 2006 was approximately ($1.3) million and ($2.7)
        million, respectively, as compared to approximately ($1.7) million and $(3.0)
        million, respectively, for the three and six months ended June 30, 2005.
        This
        translates to a gross loss of (77%) and (81%), respectively, for the three
        and
        six months ended June 30, 2006 as compared to a gross loss of (266%) and
        (224%),
        respectively, for the three and six months ended June 30, 2005. The increase
        to
        cost of goods sold for the three and six months 2006 was attributed to higher
        staffing levels and materials usage to support increased production as well
        as
        approximately $123,000 and $258,000 for the three and six month periods of
        non
        cash stock compensation expense reflected in accordance with SFAS No. 123R
        in
        2006.
 
 16
 **Operating
        Expenses**
 
 *Research
        and Development* . 
        Research and development expenses included salaries, development materials
        and
        other costs specifically allocated to the development of new microdisplay
        products, OLED materials and subsystems.  Gross research
        and development expenses for the three and six months ended June 30,
        2006 were approximately $1.3 million and $2.5 million, respectively, as
        compared to approximately $1.1 million and $2.0 million, respectively, for
        the
        three and six months ended June 30, 2005, increases of approximately
        $175,000 and $526,000, respectively.  The increases were due to increased
        personnel costs related to additional headcount and stock-based compensation
        expense of approximately $131,000 and $259,000, respectively, for the three
        and
        six months ended June 30, 2006 reflected in accordance with SFAS No. 123R
        in
        2006.
 
 *Selling,
        General and Administrative* .
        Selling, general and administrative expenses consist principally of
        salaries and fees for professional services, legal fees incurred in
        connection with patent filings and related matters, as well as other
        marketing and administrative expenses.  Selling, general and
        administrative expenses for the three and six months ended June 30,
        2006 were approximately $2.2 million and $4.8 million, respectively, as
        compared to approximately $1.8 million and $3.1 million, respectively, for
        the
        three and six months ended June 30, 2005.  The increases of approximately
        $0.4 million and $1.7 million, respectively, were primarily due to an increase
        in advertising expenses related to our Z800 3DVisor, trade show participation
        and increased personnel costs related to additional headcount as well as
        stock-based compensation expense of approximately $536,000 and $1,065,000,
        respectively, for the three and six months ended June 30, 2006 reflected
        in
        accordance with SFAS No. 123R in 2006.
 
 *Other
        Income, net* .
        Other
        income, net consists primarily of interest income earned on investments.
        For the
        three and six months ended June 30, 2006 interest income was $5,000 and $59,000,
        respectively, as compared to $130,000 and $149,000, respectively, for the
        three
        and six months ended June 30, 2005. The decrease in net other income was
        primarily a result of lower cash balances available for investment.
 
 **Liquidity
        and Capital Resources**
 
 As
        of
        June 30, 2006, we had approximately $0.9 million of working capital as compared
        to approximately $8.9 million as of December 31, 2005. This decrease of
        approximately $8.0 million was due primarily to uses of working capital to
        fund
        operations.
 
 Cash
        flow
        used in operating activities during the first six months of 2006 was
        approximately $6.3 million as compared to cash used of approximately $8.6
        million during the first six months of 2005. This decrease was primarily
        attributable to approximately $1.5 million used to increase inventory during
        the
        first six months of 2005 and not repeated in 2006 as well as increases in
        liabilities in 2006 which lowered the use of cash during the period. In June
        of
        2006 we took steps to reduce our use of cash for operating activities by
        approximately $4 million annually by reducing our headcount by 28 employees
        and
        lowering discretionary spending.
 
 Cash
        used
        in investing activities during the first half of 2006 was approximately $0.2
        million as compared to approximately $0.5 million during the first half of
        2005.
        The reduction of cash used in investing activities was primarily due to lower
        purchases of equipment.
 
 Cash
        used
        in financing activities during the first half of 2006 was $15,000 as compared
        to
        cash provided from financing activities of approximately $1.6 million during
        the
        first half of 2005. We received approximately $1.6 million of proceeds from
        the
        exercise of employee stock options and warrants during the first half of
        2005.
 
 Our
        condensed consolidated financial statements as of June 30, 2006 have been
        prepared under the assumption that we will continue as a going concern for
        the
        year ending December 31, 2006. Our independent registered public accounting
        firm
        have issued their report dated March 15 , 2006
        that included an explanatory paragraph expressing substantial doubt in our
        ability to continue as a going concern without additional capital becoming
        available. Our
        ability to continue as a going concern is  dependent upon our ability
        to obtain additional equity or debt financing, attain further operating
        efficiencies and, ultimately, to achieve profitable operations. The financial
        statements do not include any adjustments that might result from the outcome
        of
        this uncertainty.
 
 17
 Our
        business is currently experiencing significant revenue growth during the
        first
        half of 2006 which if it continues may result in higher accounts receivable
        levels and higher inventory levels. To fund these requirements as well as
        other
        operating or investing cash requirements over the next 12 months, we anticipate
        that our cash requirements will be greater than our current cash on hand. On
        July
        21, 2006, we entered into several Note Purchase agreements for the sale of
        approximately $6.5 million of senior secured debentures and warrants. We
        purchased $5.97 million principal amount of notes and an additional $0.5
        million
        will be purchased prior to December 14, 2006. Please see Note 11: Subsequent
        Events in Notes to Condensed Consolidated Financial Statements for additional
        information. However based on growth expectations, we anticipate that additional
        capital will be required. We do not have commitments for such financing and
        no
        assurance can be given that additional financing will be available, or if
        available, will be on acceptable terms. If we
        are unable to obtain sufficient funds during the next 12 months we will further
        reduce the size of our organization 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**
 
 ***Market
        Rate Risk***
 
 We
        are
        exposed to market risk related to changes in interest rates and foreign currency
        exchanges rates.
 
 ***Interest
        Rate Risk***
 
 We
        hold
        our assets in cash and cash equivalents. We do not hold derivative financial
        instruments or equity securities.
 
 ***Foreign
        Currency Exchange Rate Risk***
 
 Our
        revenue and expenses are denominated in U.S. dollars. We have conducted some
        transactions in foreign currencies and expect to continue to do so; we do
        not
        anticipate that foreign exchange gains or losses will be significant. We
        have
        not engaged in foreign currency hedging to date.
 
 Our
        international business is subject to risks typical of international activity,
        including, but not limited to, differing economic conditions; change in
        political climates; differing tax structures; and other regulations and
        restrictions. Accordingly, our future results could be impacted by changes
        in
        these or other factors.
 
 **ITEM
        4. Controls and Procedures**
  a) *Evaluation
        of Disclosure Controls and Procedures.* As of
        the end of the period covered by this report, we conducted an evaluation,
        under
        the supervision and with the participation of our chief executive officer
        and
        chief financial officer of our disclosure controls and procedures (as defined
        in
        Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this
        evaluation, our chief executive officer and chief financial officer concluded
        that our disclosure controls and procedures are effective to ensure 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.
 
 (b) *Changes
        in Internal Controls.* There
        was no change in our internal controls or in other factors that could affect
        these controls during our last fiscal quarter that has materially affected,
        or
        is reasonably likely to materially affect, our internal control over financial
        reporting.
 
 
  18
  **PART
        II - OTHER INFORMATION**
 
 **ITEM
        1. Legal Proceedings**
 
 On
        December 6, 2005, New York State Urban Development Corporation commenced
        action
        in the Supreme Court of the State of New York, County of New York against
        eMagin, asserting breach of contract and seeking to recover a $150,000 grant
        which was made to eMagin based on goals set forth in the agreement for
        recruitment of employees *.* ****** On
        July
        13, 2006, the Company agreed to a settlement with the New York State Urban
        Development Corporation to repay $112,200 of a $150,000 grant made to the
        Company based on goals set forth in an agreement for recruitment of employees.
        The repayment will be made through monthly payments of $3,117 per month
        commenting August 1, 2006 and ending on July 1, 2009.
 
 **ITEM
        1A. Risk Factors**
 
 In evaluating our
        business, prospective investors and shareholders should
        carefully consider the risks factors, any of which could have a material
        adverse
        impact on our business, operating results and financial condition and
        result in a complete loss of your investment.
 
 **RISKS
        RELATED TO OUR FINANCIAL RESULTS**
 
 ***We
        have a history of losses since our inception and may incur losses for the
        foreseeable future*** **.**
 
 Accumulated
        losses excluding non-cash transactions as of June 30, 2006 were $74 million
        and
        acquisition related non-cash transactions were $102 million, which resulted
        in
        an accumulated net loss of $176 million. We have not yet achieved profitability
        and we can give no assurances that we will achieve profitability within the
        foreseeable future as we fund operating and capital expenditures in areas
        such
        as establishment and expansion of markets, sales and marketing, operating
        equipment and research and development. We cannot assure investors that we
        will
        ever achieve or sustain profitability or that our operating losses will not
        increase in the future.
 
 ***We
        may not be able to execute our business plan and may not generate cash from
        operations.***
 
 In
        the
        event that cash flow from operations is less than anticipated and we are
        unable
        to secure additional funding to cover our expenses, in order to preserve
        cash,
        we would be required to reduce expenditures and effect reductions in our
        corporate infrastructure, either of which could have a material adverse effect
        on our ability to continue our current level of operations. To the extent
        that
        operating expenses increase or we need additional funds to make acquisitions,
        develop new technologies or acquire strategic assets, the need for additional
        funding may be accelerated and there can be no assurances that any such
        additional funding can be obtained on terms acceptable to us, if at all.
        If we
        were not able to generate sufficient capital, either from operations or through
        additional debt or equity financing, to fund our current operations, we would
        be
        forced to significantly reduce or delay our plans for continued research
        and
        development and expansion. This could significantly reduce the value of our
        securities.
 
 ***Our
        independent registered public accounting firm has expressed substantial doubt
        about our ability to continue as a going concern, which may hinder our ability
        to obtain future financing.***
  Our
        consolidated financial statements as of June 30, 2006 have been prepared
        under
        the assumption that we will continue as a going concern for the year ending
        December 31, 2006. Our independent registered public accounting firm have
        issued
        their report dated March 15, 2006 that included an explanatory paragraph
        expressing substantial doubt in our ability to continue as a going concern
        without additional capital becoming available. Our
        ability to continue as a going concern ultimately is dependent on our ability
        to
        generate a profit which is likely dependant upon our ability to obtain
        additional equity or debt financing, attain further operating efficiencies
        and,
        ultimately, to achieve profitable operations. The financial statements do
        not
        include any adjustments that might result from the outcome of this
        uncertainty.
  19
  
 ***The
        manufacture of*** **OLED** ***-on-silicon
        is new and*** **OLED** ***microdisplays have not been produced in significant quantities.***
 
 If
        we are
        unable to produce our products in sufficient quantity, we will be unable
        to
        maintain and attract new customers. In addition, we cannot assure you that
        once
        we commence volume production we will attain yields at high throughput that
        will
        result in profitable gross margins or that we will not experience manufacturing
        problems which could result in delays in delivery of orders or product
        introductions.
 
 ***We
        are dependent on a single manufacturing line.***
 
 We
        currently manufacture our products on a single manufacturing line. If we
        experience any significant disruption in the operation of our manufacturing
        facility or a serious failure of a critical piece of equipment, we may be
        unable
        to supply microdisplays to our customers. For this reason, some OEMs may
        also be
        reluctant to commit a broad line of products to our microdisplays without
        a
        second production facility in place. However, we try to maintain product
        inventory to fill the requirements under such circumstances. Interruptions
        in
        our manufacturing could be caused by manufacturing equipment problems, the
        introduction of new equipment into the manufacturing process or delays in
        the
        delivery of new manufacturing equipment. Lead-time for delivery of manufacturing
        equipment can be extensive. No assurance can be given that we will not lose
        potential sales or be unable to meet production orders due to production
        interruptions in our manufacturing line. In order to meet the requirements
        of
        certain OEMs for multiple manufacturing sites, we will have to expend capital
        to
        secure additional sites and may not be able to manage multiple sites
        successfully.
 
 ***We
        could experience manufacturing interruptions, delays, or inefficiencies if
        we
        are unable to timely and reliably procure components from single-sourced
        suppliers.***
 
 We
        maintain several single-source supplier relationships, either because
        alternative sources are not available or the relationship is advantageous
        due to
        performance, quality, support, delivery, capacity, or price considerations.
        If
        the supply of a critical single-source material or component is delayed or
        curtailed, we may not be able to produce our products in desired quantities
        and
        in a timely manner. Even where alternative sources of supply are available,
        qualification of the alternative suppliers and establishment of reliable
        supplies could result in delays and a possible loss of sales, which could
        harm
        operating results.
 
 ***We
        expect to depend on semiconductor contract manufacturers to supply our silicon
        integrated circuits and other suppliers of key components, materials and
        services.***
 
 We
        do not
        manufacture the silicon integrated circuits on which we incorporate our OLED
        technology. Instead, we expect to provide the design layouts to semiconductor
        contract manufacturers who will manufacture the integrated circuits on silicon
        wafers. We also expect to depend on suppliers of a variety of other components
        and services, including circuit boards, graphic integrated circuits, passive
        components, materials and chemicals, and equipment support. Our inability
        to
        obtain sufficient quantities of high quality silicon integrated circuits
        or
        other necessary components, materials or services on a timely basis could
        result
        in manufacturing delays, increased costs and ultimately in reduced or delayed
        sales or lost orders which could materially and adversely affect our operating
        results.
 
 **RISKS
        RELATED TO OUR INTELLECTUAL PROPERTY**
 
 ***We
        rely on our license agreement with Eastman Kodak for the development of our
        products.***
 
 We
        rely
        on our license agreement with Eastman Kodak for the development of our products,
        and the termination of this license, Eastman Kodak's licensing of its OLED
        technology to others for microdisplay applications, or the sublicensing by
        Eastman Kodak of our OLED technology to third parties, could have a material
        adverse impact on our business.
 
 Our
        principal products and those under development utilize OLED technology that
        we
        license from Eastman Kodak. We rely upon Eastman Kodak to protect and enforce
        key patents, relating to OLED display technology. Eastman Kodak's patents
        expire
        at various times in the future. Our license with Eastman Kodak could terminate
        if we fail to perform any material term or covenant under the license agreement.
        Since our license is non-exclusive, Eastman Kodak could also elect to become
        a
        competitor itself or to license OLED technology for microdisplay applications
        to
        others who have the potential to compete with us. The occurrence of any of
        these
        events could have a material adverse impact on our business.
 
 20
 ***We
        may not be successful in protecting our intellectual property and proprietary
        rights.***
 
 We
        rely
        on a combination of patents, trade secret protection, licensing agreements
        and
        other arrangements to establish and protect our proprietary technologies.
        If we
        fail to successfully enforce our intellectual property rights, our competitive
        position could suffer, which could harm our operating results. Patents may
        not
        be issued for our current patent applications, third parties may challenge,
        invalidate or circumvent any patent issued to us, unauthorized parties could
        obtain and use information that we regard as proprietary despite our efforts
        to
        protect our proprietary rights, rights granted under patents issued to us
        may
        not afford us any competitive advantage, others may independently develop
        similar technology or design around our patents, our technology may be available
        to licensees of Eastman Kodak, and protection of our intellectual property
        rights may be limited in certain foreign countries. We may be required to
        expend
        significant resources to monitor and police our intellectual property rights.
        Any future infringement or other claims or prosecutions related to our
        intellectual property could have a material adverse effect on our business.
        Any
        such claims, with or without merit, could be time consuming to defend, result
        in
        costly litigation, divert management's attention and resources, or require
        us to
        enter into royalty or licensing agreements. Such royalty or licensing
        agreements, if required, may not be available on terms acceptable to us,
        if at
        all. Protection of intellectual property has historically been a large yearly
        expense for eMagin. We have not been in a financial position to properly
        protect
        all of our intellectual property, and may not be in a position to properly
        protect our position or stay ahead of competition in new research and the
        protecting of the resulting intellectual property.
  **RISKS
        RELATED TO THE MICRODISPLAY INDUSTRY**
  
 ***The
        commercial success of the microdisplay industry depends on the widespread
        market
        acceptance of microdisplay systems products.***
 
 The
        market for microdisplays is emerging. Our success will depend on consumer
        acceptance of microdisplays as well as the success of the commercialization
        of
        the microdisplay market. As an OEM supplier, our customer's products must
        also
        be well accepted. At present, it is difficult to assess or predict with any
        assurance the potential size, timing and viability of market opportunities
        for
        our technology in this market. The viewfinder microdisplay market sector
        is well
        established with entrenched competitors with whom we must compete.
 
 ***The
        microdisplay systems business is intensely competitive.***
 
 We
        do
        business in intensely competitive markets that are characterized by rapid
        technological change, changes in market requirements and competition from
        both
        other suppliers and our potential OEM customers. Such markets are typically
        characterized by price erosion. This intense competition could result in
        pricing
        pressures, lower sales, reduced margins, and lower market share. Our ability
        to
        compete successfully will depend on a number of factors, both within and
        outside
        our control. We expect these factors to include the following:
 
 ·
              our
                  success in designing, manufacturing and delivering expected new
                  products,
                  including those implementing new technologies on a timely basis;
 
 ·
              our
                  ability to address the needs of our customers and the quality of
                  our
                  customer services;
 
 ·
              the
                  quality, performance, reliability, features, ease of use and pricing
                  of
                  our products;
 
 ·
              successful
                  expansion of our manufacturing capabilities;
 
 ·
              our
                  efficiency of production, and ability to manufacture and ship products
                  on
                  time;
 
 ·
              the
                  rate at which original equipment manufacturing customers incorporate
                  our
                  product solutions into their own products;
 
 ·
              the
                  market acceptance of our customers' products; and
 
 ·
              product
                  or technology introductions by our competitors.
 
 Our
        competitive position could be damaged if one or more potential OEM customers
        decide to manufacture their own microdisplays, using OLED or alternate
        technologies. In addition, our customers may be reluctant to rely on a
        relatively small company such as eMagin for a critical component. We cannot
        assure you that we will be able to compete successfully against current and
        future competition, and the failure to do so would have a materially adverse
        effect upon our business, operating results and financial condition.
 
 21
 ***The
        display industry is cyclical*** *.*
 
 The
        display industry is characterized by fabrication facilities that require
        large
        capital expenditures and long lead times for supplies and the subsequent
        processing time, leading to frequent mismatches between supply and demand.
        The
        OLED microdisplay sector may experience overcapacity if and when all of the
        facilities presently in the planning stage come on line leading to a difficult
        market in which to sell our products.
 
 ***Competing
        products may get to market sooner than ours.***
 
 Our
        competitors are investing substantial resources in the development and
        manufacture of microdisplay systems using alternative technologies such as
        reflective liquid crystal displays (LCDs), LCD-on-Silicon ("LCOS")
        microdisplays, active matrix electroluminescence and scanning image systems,
        and
        transmissive active matrix LCDs. Our competitive position could be damaged
        if
        one or more of our competitors’ products get to the market sooner than our
        products. We cannot assure you that our product will get to market ahead
        of our
        competitors or that we will be able to compete successfully against current
        and
        future competition. The failure to do so would have a materially adverse
        effect
        upon our business, operating results and financial condition.
 
 ***Our
        competitors have many advantages over us.***
 
 As
        the
        microdisplay market develops, we expect to experience intense competition
        from
        numerous domestic and foreign companies including well-established corporations
        possessing worldwide manufacturing and production facilities, greater name
        recognition, larger retail bases and significantly greater financial, technical,
        and marketing resources than us, as well as from emerging companies attempting
        to obtain a share of the various markets in which our microdisplay products
        have
        the potential to compete. We cannot assure you that we will be able to compete
        successfully against current and future competition, and the failure to do
        so
        would have a materially adverse effect upon our business, operating results
        and
        financial condition.
 
 ***Our
        products are subject to lengthy OEM development periods.***
 
 We
        plan
        to sell most of our microdisplays to OEMs who will incorporate them into
        products they sell. OEMs determine during their product development phase
        whether they will incorporate our products. The time elapsed between initial
        sampling of our products by OEMs, the custom design of our products to meet
        specific OEM product requirements, and the ultimate incorporation of our
        products into OEM consumer products is significant. If our products fail
        to meet
        our OEM customers' cost, performance or technical requirements or if unexpected
        technical challenges arise in the integration of our products into OEM consumer
        products, our operating results could be significantly and adversely affected.
        Long delays in achieving customer qualification and incorporation of our
        products could adversely affect our business.
 
 ***Our
        products will likely experience rapidly declining unit prices.***
 
 In
        the
        markets in which we expect to compete, prices of established products tend
        to
        decline significantly over time. In order to maintain our profit margins
        over
        the long term, we believe that we will need to continuously develop product
        enhancements and new technologies that will either slow price declines of
        our
        products or reduce the cost of producing and delivering our products. While
        we
        anticipate many opportunities to reduce production costs over time, there
        can be
        no assurance that these cost reduction plans will be successful nor is there
        any
        assurance that our costs can be reduced as quickly as any reduction in unit
        prices. We may also attempt to offset the anticipated decrease in our average
        selling price by introducing new products, increasing our sales volumes or
        adjusting our product mix. If we fail to do so, our results of operations
        would
        be materially and adversely affected.
  22
  
 **RISKS
        RELATED TO OUR BUSINESS**
 
 ***Our
        success depends on attracting and retaining highly skilled and qualified
        technical and consulting personnel.***
 
 We
        must
        hire highly skilled technical personnel as employees and as independent
        contractors in order to develop our products. The competition for skilled
        technical employees is intense and we may not be able to retain or recruit
        such
        personnel. We must compete with companies that possess greater financial
        and
        other resources than we do, and that may be more attractive to potential
        employees and contractors. To be competitive, we may have to increase the
        compensation, bonuses, stock options and other fringe benefits offered to
        employees in order to attract and retain such personnel. The costs of retaining
        or attracting new personnel may have a materially adverse affect on our business
        and our operating results. In addition, difficulties in hiring and retaining
        technical personnel could delay the implementation of our business plan.
 
 ***Our
        success depends in a large part on the continuing service of key personnel.***
 
 Changes
        in management could have an adverse effect on our business. We are dependent
        upon the active participation of several key management personnel, including
        Gary W. Jones, our chief executive officer. We will also need to recruit
        additional management in order to expand according to our business plan.
        The
        failure to attract and retain additional management or personnel could have
        a
        material adverse effect on our operating results and financial performance.
 
 ***Our
        business depends on new products and technologies.***
 
 The
        market for our products is characterized by rapid changes in product, design
        and
        manufacturing process technologies. Our success depends to a large extent
        on our
        ability to develop and manufacture new products and technologies to match
        the
        varying requirements of different customers in order to establish a competitive
        position and become profitable. Furthermore, we must adopt our products and
        processes to technological changes and emerging industry standards and practices
        on a cost-effective and timely basis. Our failure to accomplish any of the
        above
        could harm our business and operating results.
 
 ***We
        generally do not have long-term contracts with our customers.***
 
 Our
        business has primarily operated on the basis of short-term purchase orders.
        We
        are now receiving longer term purchase agreements and procurement contracts,
        but
        we cannot guarantee that we will continue to do so. Our current purchase
        agreements can be cancelled or revised without penalty, depending on the
        circumstances. We plan production on the basis of internally generated forecasts
        of demand, which makes it difficult to accurately forecast revenues. If we
        fail
        to accurately forecast operating results, our business may suffer and the
        value
        of your investment in our company may decline.
 
 ***Our
        business strategy may fail if we cannot continue to form strategic relationships
        with companies that manufacture and use products that could incorporate our
        OLED-on-silicon technology.***
 
 Our
        prospects will be significantly affected by our ability to develop strategic
        alliances with OEMs for incorporation of our OLED-on-silicon technology into
        their products. While we intend to continue to establish strategic relationships
        with manufacturers of electronic consumer products, personal computers,
        chipmakers, lens makers, equipment makers, material suppliers and/or systems
        assemblers, there is no assurance that we will be able to continue to establish
        and maintain strategic relationships on commercially acceptable terms, or
        that
        the alliances we do enter in to will realize their objectives. Failure to
        do so
        would have a material adverse effect on our business.
 
 ***Our
        business depends to some extent on international transactions.***
 
 We
        purchase needed materials from companies located abroad and may be adversely
        affected by political and currency risk, as well as the additional costs
        of
        doing business with a foreign entity. Some customers in other countries have
        longer receivable periods or warranty periods. In addition, many of the OEMs
        that are the most likely long-term purchasers of our microdisplays are located
        abroad exposing us to additional political and currency risk. We may find
        it
        necessary to locate manufacturing facilities abroad to be closer to our
        customers which could expose us to various risks, including management of
        a
        multi-national organization, the complexities of complying with foreign laws
        and
        customs, political instability and the complexities of taxation in multiple
        jurisdictions.
 
 23
 ***Our
        business may expose us to product liability claims.***
 
 Our
        business may expose us to potential product liability claims. Although no
        such
        claims have been brought against us to date, and to our knowledge no such
        claim
        is threatened or likely, we may face liability to product users for damages
        resulting from the faulty design or manufacture of our products. While we
        plan
        to maintain product liability insurance coverage, there can be no assurance
        that
        product liability claims will not exceed coverage limits, fall outside the
        scope
        of such coverage, or that such insurance will continue to be available at
        commercially reasonable rates, if at all.
 
 ***Our
        business is subject to environmental regulations and possible liability arising
        from potential employee claims of exposure to harmful substances used in
        the
        development and manufacture of our products.***
 
 We
        are
        subject to various governmental regulations related to toxic, volatile,
        experimental and other hazardous chemicals used in our design and manufacturing
        process. Our failure to comply with these regulations could result in the
        imposition of fines or in the suspension or cessation of our operations.
        Compliance with these regulations could require us to acquire costly equipment
        or to incur other significant expenses. We develop, evaluate and utilize
        new
        chemical compounds in the manufacture of our products. While we attempt to
        ensure that our employees are protected from exposure to hazardous materials,
        we
        cannot assure you that potentially harmful exposure will not occur or that
        we
        will not be liable to employees as a result.
  **RISKS
        RELATED TO OUR STOCK**
  
 ***The
        substantial number of shares that are or will be eligible for sale could
        cause
        our common stock price to decline even if the company is successful.***
 
 Sales
        of
        significant amounts of common stock in the public market, or the perception
        that
        such sales may occur, could materially affect the market price of our common
        stock. These sales might also make it more difficult for us to sell equity
        or
        equity-related securities in the future at a time and price that we deem
        appropriate. As of June 30, 2006, we have outstanding (i) options to purchase
        16,727,278 shares and (ii) warrants to purchase 19,354,471 shares of common
        stock.
 
 ***We
        have a staggered board of directors and other anti-takeover provisions, which
        could inhibit potential investors or delay or prevent a change of control
        that
        may favor you.***
 
 Our
        Board
        of Directors is divided into three classes and our Board members are elected
        for
        terms that are staggered. This could discourage the efforts by others to
        obtain
        control of the company. Some of the provisions of our certificate of
        incorporation, our bylaws and Delaware law could, together or separately,
        discourage potential acquisition proposals or delay or prevent a change in
        control. In particular, our board of directors is authorized to issue up
        to
        10,000,000 shares of preferred stock (less any outstanding shares of preferred
        stock) with rights and privileges that might be senior to our common stock,
        without the consent of the holders of the common stock.
 
 **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**
  24
     **EXHIBIT
                NUMBER**
              
              **DESCRIPTION**31.1
              
              Certification by Chief Executive Officer
                pursuant to Sarbanes Oxley Section 302*31.2
              
              Certification by Chief Financial Officer
                pursuant to Sarbanes Oxley Section 302*32.1
              
              Certification by Chief Executive Officer
                pursuant to 18 U.S.C. Section 1350*32.2
              
              Certification by Chief Financial Officer
                pursuant to 18 U.S.C. Section 1350*
  
 *Filed
        herewith.
  25
  **SIGNATURES**
 
 In
        accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
        this report to be signed on its behalf by the undersigned, thereunto duly
        authorized on this 14th day of August, 2006.
  **eMAGIN
                CORPORATION**By:
              /s/ Gary
                W.
                JonesGary
                W. Jones*Chief Executive Officer*
                *Principal
                    Executive Officer*
  By:
              /s/ John
                AtherlyJohn
                  Atherly*Chief
                  Financial Officer*
                *Principal Accounting and Financial
                  Officer*
      26