UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549








Form
10-Q


(Mark
One)
 xQUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
  For
the quarterly period ended June 30, 2008
 or
 oTRANSITION 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 incorporation
      or organization)
            (I.R.S.
      EmployerIdentification
      No.)





10500
NE 8th 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 £         Smaller
reporting company 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, 2008 was
14,389,439.


eMagin
Corporation


Form
10-Q


For
the Quarter ended June 30, 2008





Table
of Contents


PagePART
      I   FINANCIAL INFORMATIONItem
      1
            Condensed
      Consolidated Financial StatementsCondensed
      Consolidated Balance Sheets as of June 30, 2008 (unaudited) and December
      31, 2007
            3Condensed
      Consolidated Statements of Operations for the Three and Six Months ended
      June 30, 2008 and 2007 (unaudited)
            4Condensed
      Consolidated Statements of Changes in Capital Deficit for the Six Months
      ended June 30, 2008 (unaudited)
            5Condensed
      Consolidated Statements of Cash Flows for the Six Months ended June 30,
      2008 and 2007 (unaudited)
            6Notes
      to Condensed Consolidated Financial Statements (unaudited)
            7Item
      2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            15Item
      3
            Quantitative
      and Qualitative Disclosures About Market
      Risk
            19Item
      4T
            Controls
      and
      Procedures
            20PART
      II OTHER INFORMATIONItem
      1
            Legal
      Proceedings
            21Item
      1A
            Risk
      Factors
            21Item
      2
            Unregistered
      Sales of Equity Securities and Use of
      Proceeds
            21Item
      3
            Defaults
      Upon Senior
      Securities
            21Item
      4
            Submission
      of Matters to a Vote of Security
      Holders
            21Item
      5
            Other
      Information
            21Item
      6
            Exhibits
            22SIGNATURESCERTIFICATIONS





2


ITEM
1.  Condensed Consolidated Financial Statements





eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED BALANCE SHEETS


(In
thousands, except share data)




June
      30,2008
              (unaudited)
            
            
            December
      31, 2007ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            1,038
            
            
            $
            713Investments
      – held to maturity
            
            
            94
            
            
            
            94Accounts
      receivable, net
            
            
            3,601
            
            
            
            2,383Inventory
            
            
            1,726
            
            
            
            1,815Prepaid
      expenses and other current assets
            
            
            750
            
            
            
            850Total
      current assets
            
            
            7,209
            
            
            
            5,855Equipment,
      furniture and leasehold improvements, net
            
            
            401
            
            
            
            292Intangible
      assets, net
            
            
            49
            
            
            
            51Other
      assets
            
            
            232
            
            
            
            232Deferred
      financing costs, net
            
            
            135
            
            
            
            218Total
      assets
            
            $
            8,026
            
            
            $
            6,648LIABILITIES
      AND CAPITAL DEFICITCurrent
      liabilities:Accounts
      payable
            
            $
            1,135
            
            
            $
            620Accrued
      compensation
            
            
            962
            
            
            
            891Other
      accrued expenses
            
            
            704
            
            
            
            729Advance
      payments
            
            
            13
            
            
            
            35Deferred
      revenue
            
            
            80
            
            
            
            179Current
      portion of  debt
            
            
            8,148
            
            
            
            7,089Other
      current liabilities
            
            
            596
            
            
            
            1,020Total
      current liabilities
            
            
            11,638
            
            
            
            10,563Long-term
      debt
            
            
            41
            
            
            
            60Total
      liabilities
            
            
            11,679
            
            
            
            10,623Commitments
      and contingenciesCapital
      deficit:Preferred
      stock, $.001 par value: authorized 10,000,000 shares; no shares issued and
      outstanding
            
            
            —
            
            
            
            —Series
      A Senior Secured Convertible Preferred stock, stated value $1,000 per
      share, $.001 par value:  3,198 shares designated and none
      issued
            
            
            —
            
            
            
            —Common
      stock, $.001 par value: authorized 200,000,000 shares, issued and
      outstanding, 14,389,439 shares as of June 30, 2008 and 12,620,900 shares
      as of December 31, 2007
            
            
            14
            
            
            
            12Additional
      paid-in capital
            
            
            198,442
            
            
            
            195,326Accumulated
      deficit
            
            
            (202,109
            )
            
            
            (199,313
            )Total
      capital deficit
            
            
            ( 3,653
            )
            
            
            ( 3,975
            )Total
      liabilities and capital deficit
            
            $
            8,026
            
            
            $
            6,648




See notes
to Condensed Consolidated Financial Statements.


3


eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(In
thousands, except share and per share data)


(unaudited)





Three
      Months Ended
              June
      30,
            
            
            Six
      Months Ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Revenue:Product
      revenue
            
            $
            4,496
            
            
            $
            4,144
            
            
            $
            6,958
            
            
            $
            7,667Contract
      revenue
            
            
            1,123
            
            
            
            88
            
            
            
            1,326
            
            
            
            174Total
      revenue, net
            
            
            5,619
            
            
            
            4,232
            
            
            
            8,284
            
            
            
            7,841Cost
      of goods sold
            
            
            2,996
            
            
            
            2,946
            
            
            
            5,309
            
            
            
            6,061Gross
      profit
            
            
            2,623
            
            
            
            1,286
            
            
            
            2,975
            
            
            
            1,780Operating
      expenses:Research
      and development
            
            
            634
            
            
            
            887
            
            
            
            1,308
            
            
            
            1,740Selling,
      general and administrative
            
            
            1,697
            
            
            
            1,543
            
            
            
            3,504
            
            
            
            3,764Total
      operating expenses
            
            
            2,331
            
            
            
            2,430
            
            
            
            4,812
            
            
            
            5,504Income
      (loss) from operations
            
            
            292
            
            
            
            (1,144
            )
            
            
            (1,837
            )
            
            
            (3,724
            )Other
      income (expense):Interest
      expense
            
            
            (537
            )
            
            
            (1,333
            )
            
            
            (1,168
            )
            
            
            (2,174
            )Gain
      on warrant derivative liability
            
            
            —
            
            
            
            182
            
            
            
            —
            
            
            
            643Other
      income, net
            
            
            123
            
            
            
            567
            
            
            
            209
            
            
            
            590Total
      other expense
            
            
            (414
            )
            
            
            (584
            )
            
            
            (959
            )
            
            
            (941
            )Net
      loss
            
            $
            (122
            )
            
            $
            (1,728
            )
            
            $
            (2,796
            )
            
            $
            (4,665
            )Loss
      per share, basic and diluted
            
            $
            (0.01
            )
            
            $
            (0.15
            )
            
            $
            (0.21
            )
            
            $
            (0.42
            )Weighted
      average number of shares outstanding:Basic
      and diluted
            
            
            14,320,570
            
            
            
            11,175,888
            
            
            
            13,470,735
            
            
            
            10,983,981


See notes
to Condensed Consolidated Financial Statements.


4


eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENT OF CHANGES IN CAPITAL DEFICIT


(In
thousands)








Additional
            
            
            
            
            
            TotalCommon
      Stock
            
            
            Paid-In
            
            
            Accumulated
            
            
            Shareholders’Shares
            
            
            Amount
            
            
            Capital
            
            
            Deficit
            
            
            DeficitBalance,
      December 31, 2007
            
            
            12,621
            
            
            $
            12
            
            
            $
            195,326
            
            
            $
            (199,313
            )
            
            $
            (
      3,975
            )Sale
      of common stock, net of issuance costs
            
            
            1,587
            
            
            
            2
            
            
            
            1,578
            
            
            
            —
            
            
            
            1,580Issuance
      of common stock for services
            
            
            181
            
            
            
            —
            
            
            
            202
            
            
            
            —
            
            
            
            202Stock-based
      compensation
            
            
            —
            
            
            
            —
            
            
            
            607
            
            
            
            —
            
            
            
            607Fair
      value of warrants issued
            
            
            —
            
            
            
            —
            
            
            
            729
            
            
            
            —
            
            
            
            729Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,796
            )
            
            
            (2,796
            )Balance,
      June 30, 2008 (unaudited)
            
            
            14,389
            
            
            $
            14
            
            
            $
            198,442
            
            
            $
            (202,109
            )
            
            $
            (3,653
            )







See notes
to Condensed Consolidated Financial Statements.




5





eMAGIN
CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(In
thousands)





Six
      months EndedJune
      30,2008
            
            
            2007(unaudited)Cash
      flows from operating activities:Net
      loss
            
            $
            (2,796
            )
            
            $
            (4,665
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            129
            
            
            
            227Amortization
      of deferred financing and waiver fees
            
            
            821
            
            
            
            265Increase
      in (reduction of) provision for sales returns and doubtful
      accounts
            
            
            146
            
            
            
            (35
            )Stock-based
      compensation
            
            
            607
            
            
            
            899Amortization
      of common stock issued for services
            
            
            88
            
            
            
            677Amortization
      of discount on notes payable
            
            
            25
            
            
            
            1,452Gain
      on warrant derivative liability
            
            
            —
            
            
            
            (643
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (1,364
            )
            
            
            (329
            )Inventory
            
            
            89
            
            
            
            675Prepaid
      expenses and other current assets
            
            
            214
            
            
            
            55Deferred
      revenue
            
            
            (99
            )
            
            
            (45
            )Accounts
      payable, accrued compensation, other accrued expenses, and advance
      payments
            
            
            539
            
            
            
            323Other
      current liabilities
            
            
            (424
            )
            
            
            (7
            )Net
      cash used in operating activities
            
            
            (2,025
            )
            
            
            (1,151
            )Cash
      flows from investing activities:Purchase
      of equipment
            
            
            (236
            )
            
            
            —Purchase
      of investments – held to maturity
            
            
            —
            
            
            
            (4
            )Net
      cash used in investing activities
            
            
            (236
            )
            
            
            (4
            )Cash
      flows from financing activities:Proceeds
      from sale of common stock, net of issuance costs
            
            
            1,580
            
            
            
            —Proceeds
      from exercise of warrants
            
            
            —
            
            
            
            3Proceeds
      from debt
            
            
            1,700
            
            
            
            500Payments
      related to deferred financing costs
            
            
            (9
            )
            
            
            (40
            )Payments
      of debt and capital leases
            
            
            (685
            )
            
            
            (33
            )Net
      cash provided by financing activities
            
            
            2,586
            
            
            
            430Net
      increase (decrease) in cash and cash equivalents
            
            
            325
            
            
            
            (725
            )Cash
      and cash equivalents beginning of period
            
            
            713
            
            
            
            1,415Cash
      and cash equivalents end of period
            
            $
            1,038
            
            
            $
            690Cash
      paid for interest
            
            $
            314
            
            
            $
            180Cash
      paid for taxes
            
            $
            21
            
            
            $
            46During
      the six months ended June 30, 2008, the Company:


●
              Entered into amended Loan and Security Agreement and issued
      warrants that are exercisable at $1.50 per share into 1.0 million shares
      of common stock valued at    approximately $0.7
      million.


See notes
to Condensed Consolidated Financial Statements.


6





eMAGIN
CORPORATION


NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS


(Unaudited)





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





The
Business





eMagin
Corporation (the “Company”) designs, develops, manufactures, and markets virtual
imaging products for consumer, commercial, industrial and military
applications.  The Company’s products are sold mainly in North
America, Asia, and Europe.





Basis
of Presentation





In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements of eMagin Corporation and its subsidiary reflect all
adjustments, including normal recurring accruals, necessary for a fair
presentation.  Certain information and footnote disclosure normally
included in annual financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to instructions, 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,
2007.  The results of operations for the period ended June 30, 2008
are not necessarily indicative of the results to be expected for the full
year.





The
unaudited 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
the foreseeable future.  The Company’s cash requirements over the next
twelve months are greater than the Company’s current cash, cash equivalents, and
investments at June 30, 2008. In addition,
the Company's line of credit was temporarily extended (see Notes 8 and
15). The Company has working capital and capital deficits as
of June 30, 2008. These factors raise substantial doubt regarding the Company’s
ability to continue as a going concern without continuing to obtain additional
funding.  The Company does 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 the Company is unable
to obtain sufficient funds during the next twelve months, the Company will
further reduce the size of its organization and/or curtail operations which will
have a material adverse impact on the Company’s business prospects. The Company
is reviewing its cost structures for cost efficiencies and is taking measures to
reduce costs. The unaudited 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 of
America, management utilizes certain estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. On an on-going basis, management evaluates its estimates and
judgments. Management bases its estimates and judgments on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results could differ from those estimates.





Revenue
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.
Revenue is recognized when persuasive evidence of
an arrangement exists, delivery has occurred, selling price is
fixed or determinable and collection is reasonably
assured.





The
Company 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 on
cost-plus-fee contracts include costs incurred plus a portion of
estimated fees or profits based on the relationship of costs incurred to total
estimated costs. Contract costs include all direct material and labor costs
and an allocation of allowable indirect costs as defined by each
contract, as periodically adjusted to reflect revised agreed upon
rates. These rates are subject to audit by the other party.




7




Note
2:  Recently Issued Accounting Pronouncements





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, “Fair Value Measurements,” (“SFAS 157”), which defines fair value,
establishes a framework for measuring fair value under generally accepted
accounting principles and expands disclosures about fair value measurements.
SFAS 157 does not require any new fair value measurements, but provides guidance
on how to measure fair value by providing a fair value hierarchy used to
classify the source of the information. In February 2008, the FASB issued
FASB Staff Position No. FSP 157-2, “Effective Date of FASB Statement
No. 157”, which provides a one year deferral of the effective date of SFAS
157 for non-financial assets and non-financial liabilities, except those that
are recognized or disclosed in the financial statements at fair value on a
recurring basis. The Company adopted SFAS 157 as of January 1, 2008, with
the exception of the application of the statement to non-recurring non-financial
assets and non-financial liabilities which it will defer the adoption until
January 1, 2009. The adoption of SFAS 157 did not have a material impact on the
Company’s consolidated results of operations, financial condition or cash
flows.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities — including an amendment of FASB
Statement No. 115,” (“SFAS 159”) which is effective for fiscal years
beginning after November 15, 2007. This statement permits entities to
choose to measure many financial instruments and certain other items at fair
value. This statement also establishes presentation and disclosure requirements
designed to facilitate comparisons between entities that choose different
measurement attributes for similar types of assets and liabilities. Unrealized
gains and losses on items for which the fair value option is elected would be
reported in earnings. The Company has adopted SFAS 159 and has elected not to
measure any additional financial instruments and other items at fair value and
therefore the adoption of SFAS 159 did not have a material impact on the
Company’s condensed consolidated results of operations, financial condition or
cash flows.





In March 2008, the FASB
issued Statement of Financial Accounting Standards No. 161, Disclosures
about Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133 (“SFAS 161”). SFAS 161 requires entities to provide
greater transparency about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, results of operations, and cash flows. SFAS 161 is effective
prospectively for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
permitted. The Company is currently evaluating the disclosure implications of
this statement.




In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles, (“SFAS 162”), which identifies the sources of
accounting principles and the framework for selecting principles to be used in
the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles in the
United States. This statement shall be effective 60 days following the
SEC's approval of the Public Company Accounting Oversight Board's amendments to
AU section 411, The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles. The Company is currently evaluating the impact
of SFAS 162, but does not expect the adoption of this pronouncement will
have a material impact on the Company's financial statements.





Note
3:  Receivables




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





The
Company determines the allowance for doubtful accounts
by considering a number of factors, including the length of time the
trade accounts receivable are past due, 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
      30,2008
              (unaudited)
            
            
            December
      31, 2007Accounts
      receivable
            
            $
            4,105
            
            
            $
            2,741Less
      allowance for doubtful accounts
            
            
            (504
            )
            
            
            (358
            )Net
      receivables
            
            $
            3,601
            
            
            $
            2,383





Note
4:  Research and Development Costs





Research
and development costs are expensed as incurred.





Note
5:  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.  As of June 30, 2008 and
2007, there were stock options, warrants and convertible notes outstanding to
acquire 11,508,295 and 5,297,927 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
6:  Inventory





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





June
      30,2008
              (unaudited)
            
            
            December
      31, 2007Raw
      materials
            
            $
            945
            
            
            $
            1,069Work
      in process
            
            
            260
            
            
            
            370Finished
      goods
            
            
            521
            
            
            
            376Total
      inventory
            
            $
            1,726
            
            
            $
            1,815





Note
7:  Prepaid Expenses and Other Current Assets:





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


June
      30,2008
              (unaudited)
            
            
            December
      31, 2007Vendor
      prepayments
            
            $
            339
            
            
            $
            537Other
      prepaid expenses *
            
            
            408
            
            
            
            310Other
      assets
            
            
            3
            
            
            
            3Total
      prepaid expenses and other current assets
            
            $
            750
            
            
            $
            850


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





9


Note
8:  Debt





Debt is
as follows (in thousands):


June
      30,2008
              (unaudited)
            
            
            December
      31,
              2007Current
      portion of long-term debt:Other
      debt
            
            $
            38
            
            
            $
            44Line
      of credit
            
            
            2,148
            
            
            
            1,1088%
      Senior Secured Convertible Notes
            
            
            5,962
            
            
            
            5,962Less:  Unamortized
      discount on notes payable
            
            
            —
            
            
            
            (25
            )Current
      portion of long-term debt, net
            
            
            8,148
            
            
            
            7,089Long-term
      debt:Other
      debt
            
            
            41
            
            
            
            60Long-term
      debt, net
            
            
            41
            
            
            
            60Total
      debt, net
            
            $
            8,189
            
            
            $
            7,149





On August
7, 2007, the Company enteredinto a loan agreement
with Moriah Capital, L.P. (“Moriah)and established a
revolving line of credit (the “Loan”) of $2.5 million.  The Company is
permitted to borrow an amount not to exceed 90% of its domestic eligible
accounts receivable and 50% of its eligible inventory capped at $600
thousand.  As part of the transaction, the Company issued 162,500
shares of unregistered common stock valued at $195 thousand and paid a servicing
fee of $82,500 to Moriah which are amortized to interest expense over the life
of the agreement. In conjunction with entering into this loan and issuing
unregistered common stock, the Company granted Moriah registration
rights.  The Loan can be converted into shares of the Company’s common
stock pursuant to the terms of the Loan Conversion agreement.  The
Loan matures on August 8, 2008 with an option to extend it an additional year if
the Company meets certain requirements.  On August 8, 2008, Moriah
granted to the Company an extension of the Loan with the same terms for 8
days.




On
January 30, 2008, the Company amended and restated its Loan and Security
Agreement (“Amended Loan Agreement”) with Moriah.  The Amended Loan
Agreement’s borrowing base calculation was modified to include 70% of eligible
foreign accounts.  The Amended Loan Agreement eliminated the optional
conversion of principal up to $2.0 million into common stock at
$1.50.  In connection with the amendment, the Company issued a Warrant
to purchase 750,000 shares of its common stock at a price of $1.50 per share
with an expiration date of January 29, 2013.





The
Amended Loan Agreement has specific terms to which the Company must comply
including (a) maintaining a lockbox account into which payments from related
accounts receivable must be deposited, (b) periodic certifications as to
borrowing base amounts equaling or exceeding net balances outstanding under the
Line of Credit, and (c) a requirement that a registration statement with respect
to shares held or to be issued to the lender be filed within thirty days of
January 30, 2008.  A delay in establishing the required lockbox
account created a technical default under the Line of Credit
agreement.  Similarly, the production and subsequent discovery of
defective displays resulted in an inadvertent overstatement of inventory during
December, January and early February that created a technical default under the
agreement.  Finally, the Company was not able to complete the
registration of shares within the thirty day timeframe mandated in the amended
agreement.  On March 25, 2008 the Company received a waiver from the
lender (a) waiving compliance with the lockbox account requirement through March
14, 2008, (b) waiving compliance with the borrowing base requirement in so far
as it related exclusively to the defective displays inadvertently included in
inventory, and (c) extending the period for filing a registration statement for
certain shares held or to be issued to the lender until April 29,
2008.  The Company established a lockbox account by March 14, 2008 and
filed a registration statement with the SEC on April 29, 2008.





Effective March 25, 2008, the Company
amended the Warrant Issuance Agreement (“Amended Warrant Agreement”) with
Moriah. In connection with such amendment, the Company issued a Warrant to
purchase an additional 250,000 shares of its common stock at a price of $1.50
expiring March 25, 2013.





The
Company determined the fair value of the 1,000,000 warrants to be $729 thousand
which was recorded as deferred debt issuance and waiver fees of which $168
thousand was expensed immediately and $561 thousand will be amortized over the
life of the loan.  The following assumptions were used to determine
the fair value of the warrants:  dividend yield of 0%; risk free
interest rates of 2.61 % and 2.96%; expected volatility of 90.9% and 92.3%; and
expected contractual term of 5 years.  The deferred debt issuance
costs are being amortized to interest expense over the life of the
loan.




10




In the
three and six months ended June 30, 2008, approximately $373 thousand and $821
thousand, respectively, of deferred debt issuance and waiver fees were amortized
to interest expense.  For the three and six months ended June 30,
2008, interest expense includes interest paid or accrued on outstanding debt of
approximately $164 thousand and $323 thousand, respectively.





The 8%
Senior Secured Convertible Notes can also convert into the Company’s Series A
convertible Preferred Stock (the “Preferred Stock”).  See Note
10:  Shareholders’ Equity for additional information.





Note
9:  Stock-based Compensation





The
Company accounts for the measurement and recognition of compensation expense for
all share-based payment awards made to employees and directors under Statement
of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS
123(R)). Under SFAS 123(R), the fair value of stock awards is estimated at the
date of grant using the Black-Scholes option valuation
model.  Stock-based compensation expense is reduced for estimated
forfeitures and is amortized over the vesting period using the straight-line
method.





The
following table summarizes the allocation of non-cash stock-based compensation
to our expense categories for the three and six month periods ended June 30,
2008 and 2007 (in thousands):





Three
      Months Ended June 30,
            
            
            Six
      Months Ended June 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Cost
      of revenue
            
            $
            23
            
            
            $
            61
            
            
            
            75
            
            
            $
            130Research
      and development
            
            
            52
            
            
            
            97
            
            
            
            134
            
            
            
            200Selling,
      general and administrative
            
            
            176
            
            
            
            227
            
            
            
            398
            
            
            
            569Total
      stock compensation expense
            
            $
            251
            
            
            $
            385
            
            
            $
            607
            
            
            $
            899





At June
30, 2008, total unrecognized non-cash compensation cost related to stock options
was approximately $964 thousand, net of forfeitures.  Total
unrecognized compensation cost will be adjusted for future changes in estimated
forfeitures and is expected to be recognized over a weighted average period of
approximately 1.7 years.





The
Company recognizes compensation expense for options granted to non-employees in
accordance with the provisions 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 and
services are rendered.





There
were approximately 588,000 and 748,000 options granted to employees and
directors during the three and six months ended June 30, 2008. The following key
assumptions were used in the Black-Scholes option pricing model to determine the
fair value of stock options granted:




For
      the Six Months Ended
              June
      30, 2008Dividend
      yield
            
            0
            %Risk
      free interest rates
            
            2.46
      to 3.28%Expected  volatility
            
            89.6
      to 92.3%Expected
      term (in years)
            
            5








There
were no stock options granted during the three and six month period ended June
30, 2007.  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 option pricing model is based on the implied
yield currently available on U.S. Treasury securities with an equivalent
term.   Expected volatility is based on the weighted average
historical volatility of the Company’s common stock for the most recent five
year period.  The expected term of options represents the period that
our stock-based awards are expected to be outstanding and was determined based
on historical experience and vesting schedules of similar awards.




11




On
February 20, 2008, the Board of Directors authorized the establishment of the
2008 Incentive Stock Plan with 2,000,000 options available for
grant.  The 2008 Incentive Stock Plan is intended to provide long-term
performance incentives to directors, executives, selected employees and
consultants and reward them for making major contributions to the success and
well being of the Company.  No options were granted from this plan as
of June 30, 2008.





A summary
of the Company’s stock option activity for the six months ended June 30, 2008 is
presented in the following tables:




Number
      of Shares
            
            
            Weighted
      Average Exercise Price
            
            
            Weighted
      Average Remaining Contractual Life (In Years)
            
            
            Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2008
            
            
            894,323
            
            
            $
            2.62Options
      granted
            
            
            748,153
            
            
            
            0.94Options
      exercised
            
            
            —Options
      forfeited
            
            
            (167,953
            )
            
            
            2.60Options
      cancelled
            
            
            —Outstanding
      at June 30, 2008
            
            
            1,474,523
            
            
            $
            1.77
            
            
            
            6.50
            
            
            $
            15,000Vested
      or expected to vest at June 30, 2008 (1)
            
            
            1,434,149
            
            
            $
            1.68
            
            
            
            6.50
            
            
            $
            14,200Exercisable
      at June 30, 2008
            
            
            969,855
            
            
            $
            1.96
            
            
            
            6.60
            
            
            $
            5,000





Options
      Outstanding
            
            
            Options
      ExercisableNumber
      Outstanding
            
            
            Weighted
      Average Remaining Contractual Life (In Years)
            
            
            Weighted
      Average Exercise Price
            
            
            Number
      Exercisable
            
            
            Weighted
      Average Exercisable Price$
            0.81
      - $1.51
            
            
            
            976,730
            
            
            
            8.04
            
            
            $
            1.05
            
            
            
            592,397
            
            
            $
            1.19$
            2.60
      - $2.70
            
            
            
            456,593
            
            
            
            3.49
            
            
            
            2.61
            
            
            
            345,358
            
            
            
            2.60$
            3.50
      - $5.80
            
            
            
            12,000
            
            
            
            4.18
            
            
            
            5.61
            
            
            
            12,000
            
            
            
            5.61$
            6.60
      - $22.50
            
            
            
            29,200
            
            
            
            3.07
            
            
            
            10.91
            
            
            
            20,100
            
            
            
            11.231,474,523
            
            
            
            6.50
            
            
            $
            1.77
            
            
            
            969,855
            
            
            $
            1.96





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





The
aggregate intrinsic value in the table above represents the difference between
the exercise price of the underlying options and the quoted price of the
Company’s common stock.  There were 500,000 options in-the-money at
June 30, 2008.   The Company’s closing stock price was $0.84 as
of June 30, 2008. The Company issues new shares of common stock upon exercise of
stock options.





Note
10:  Shareholders’ Equity





Preferred
Stock





The
Company has designated but not issued 3,198 shares of the Company’s Preferred
Stock at a stated value of $1,000 per share.  The Preferred Stock is
entitled to cumulative dividends which accrue at a rate of 8% per annum, payable
on December 21, 2008.  Each share of the Preferred Stock has voting
rights equal to (1)  in any case in which the Preferred Stock votes
together with the Company's Common Stock or any other class or series of stock
of the Company, the number of shares of Common Stock issuable upon conversion of
such shares of Preferred Stock at such time (determined without regard to the
shares of Common Stock so issuable upon such conversion in respect of accrued
and unpaid dividends on such share of Preferred Stock) and (2) in any case not
covered by the immediately preceding clause one vote per share of Preferred
Stock.  The Preferred Stock, if issued, has a mandatory redemption at
December 21, 2008.




12




Common
Stock





On
January 30, 2008, the Company amended and restated its Loan and Security
Agreement (“Amended Loan Agreement”) with Moriah.   As part of the
amended agreement, the Loan Conversion agreement was terminated which eliminated
the optional conversion of principal up to $2.0 million into common stock at
$1.50.  In connection with the Amended Loan agreement, the Company
issued a Warrant to purchase 750,000 shares of its common stock at a price of
$1.50 per share with an expiration date of January 29, 2013.





Effective March 25, 2008, the Company
amended the Warrant Issuance Agreement (“Amended Warrant Agreement”) with
Moriah. In connection with such amendment, the Company issued a Warrant to
purchase an additional 250,000 shares of its common stock at a price of $1.50
expiring March 25, 2013.





On April
2, 2008, the Company entered into a Securities Purchase Agreement (“Purchase
Agreement”), pursuant to which the Company sold and issued 1,586,539 shares of
common stock, par value of $0.001 per share, at a price of $1.04 per share and
warrants to purchase an additional 793,273 shares of common stock for an
aggregate purchase price of approximately $1.65 million.  The net
proceeds received after expenses were approximately $1.58
million.  The warrants are exercisable at a price of $1.30 per share
and expire on April 2, 2013.





As a
result of the Purchase Agreement, the outstanding 650,000 Series F Common Stock
Purchase Warrants that were issued to participants of the Securities Purchase
Agreement dated October 25, 2004, were repriced from $4.09 to
$3.45.





A
registration rights agreement was entered into on April 2, 2008 in
connection with the private placement which required the Company to file a
registration statement for the resale of the common stock and the shares
underlying the warrants within 45 days of the signing of the
agreement.  The Company must use its best efforts to have the
registration statement declared effective within 90 days of the signing of the
agreement or if a SEC review, 120 days.  In addition, the Company must
use its best efforts to maintain the effectiveness of the registration statement
until all common stock have been sold or may be sold without volume restrictions
pursuant to Rule 144(k) of the Securities Act.





If the
registration statement is not effective within the grace periods (“Event Date”)
or the Company cannot maintain its effectiveness (“Event Date”), the Company
must pay partial liquidated damages (“damages”) in cash to each investor equal
to 2% of the aggregate purchase price paid by each investor under the Purchase
Agreement on the Event Date and each monthly anniversary of the Event Date (or
on a pro-rata basis for any portion of a month) until the registration statement
is effective.  The Company is not liable for any damages with respect
to the warrants or warrant shares.  The maximum damages payable to
each investor is 36% of the aggregate purchase price.  If the Company
fails to pay the damages to the investors within 7 days after the date payable,
the Company must pay interest at a rate of 15% per annum to each investor which
accrues daily from the date payable until damages are paid in full.




The
Company filed the registration statement within the 45 day period however the
Company was notified that the registration statement was under review by the
SEC.  The Company failed to file the amended registration statement by
August 2, 2008 which was the 120th day from the signing of the purchase
agreement and therefore the registration statement is not
effective.





The
Company accounted for the registration payment arrangement under the guidance of
EITF 00-19-2, “Accounting for Registration Payment Arrangements”, (“EITF
00-19-2”) which requires the contingent obligation to make future payments be
recognized and measured in accordance with FASB Statement No. 5, “Accounting for
Contingencies”, (“Statement 5”) and FASB Interpretation No. 14, “Reasonable
Estimation of the Amount of a Loss”, (“Interpretation 14”). The Company
estimated $399 thousand to be the maximum potential damages that the Company may
be required to pay the investors if the registration statement is not effective
within three years of the signing of the agreement. The Company estimated $66
thousand to be a reasonable estimate of the potential damages that may be due to
the investors.  As a result, the Company recorded a liability of $66
thousand in the condensed consolidated balance sheets and the associated
expense in other income in the condensed consolidated statements of
operations for the
three and six months ended June 30, 2008.





For the
three and six months ended June 30, 2008 and 2007, there were no stock options
exercised.  For the three and six months ended June 30, 2008, there
were no warrants exercised and for the three and six months ended June 30, 2007,
the Company received approximately $3 thousand in proceeds for warrants
exercised.




13




For the
three and six months ended June 30, 2008, the Company issued approximately
182,000 shares of common stock for payment of approximately $202 thousand for
services rendered or to be rendered in the future.  For the three and
six months ended June 30, 2007, the Company issued approximately 206,000 and
914,000 shares of common stock, respectively, for payment of approximately $138
thousand and $758 thousand, respectively, for services rendered and to be
rendered in the future.  As such, the Company recorded the fair value
of the services to be rendered in prepaid expenses and rendered in selling,
general and administrative expenses in the accompanying unaudited condensed
consolidated statement of operations for the three and six months ended June 30,
2008 and 2007, respectively.





Note
11:  Income Taxes





The
Company adopted the provisions of Financial Standards Accounting Board
Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) an
interpretation of FASB Statement No. 109 (“SFAS 109”) on January 1, 2007. As a
result of the implementation of FIN 48, we did not recognize any adjustment in
the liability for unrecognized income tax benefits. The tax years 2004-2007
remain open to examination by the major taxing jurisdictions to which we are
subject. In the event that the Company is assessed interest or penalties at some
point in the future, they will be classified in the financial statements as
general and administrative expense.  The Company has not provided for
income taxes in the three and six months ended June 30, 2008 as the Company
expects its effective interest rate to be zero due to continuing
losses.




Note
12:  Commitments and Contingencies





Royalty
Payments





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





Effective
May 30, 2007, Kodak and eMagin entered into an intellectual property agreement
where eMagin has assigned Kodak the rights, title, and interest to a Company
owned patent currently not being used by the Company and in consideration, Kodak
waived the royalties due under the existing licensing agreements for the first
six months of 2007, and reduced the royalty payments by 50% for the second half
of 2007 and for the entire calendar year of 2008. In addition, the minimum
royalty payment is delayed until December 1st for the
years 2007 and 2008.  The Company recorded approximately $170 thousand
and $254 thousand for the three and six months ended June 30, 2008,
respectively, and $560 thousand for the three and six months ended June 30, 2007
as income from the license of intangible assets and included this amount as
other income in the condensed consolidated statements of
operations.  The income from the license of intangible assets is
equivalent to the royalty payments that have been waived by Kodak.





Royalty
expense(including
amounts imputed-see above)was approximately $341 thousand and $509
thousand, respectively, for the three and six months ended June 30, 2008
and approximately $304 thousand and $560 thousand, respectively, for the three
and six months ended June 30, 2007.





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 thousand and $664 thousand, respectively, for the three
and six months ended June 30, 2008 and 2007.





Note
13:  Legal Proceedings





A former
employee (“plaintiff”) of the Company commenced legal action in the United
States District Court for the Southern District of New York, on or about October
12, 2007, alleging that the plaintiff was subject to gender based discrimination
and retaliation in violation of Title VII of the Civil Rights Act of 1964 ( Case
No. 07-CV-8827 (KMK)). The plaintiff seeks unspecified compensatory damages,
punitive damages and attorneys’ fees.  On November 26, 2007, the
Company served and filed its Answer, in which it denied the material allegations
of the Complaint and asserted numerous affirmative defenses.  This
action is presently in the discovery stage.  The Company disputes the
allegations of the Complaint and intends on vigorously defending this
action.





Note
14:  Separation and Employment Agreements





Effective
April 14, 2008, Michael D. Fowler, the Company’s Interim Chief Financial
Officer, resigned his position with the Company. There was no separation
agreement executed between Mr. Fowler and the Company. On April 15, 2008, Paul
Campbell was appointed as Interim Chief Financial Officer of the
Company.  There is no employment agreement between the Company and Mr.
Campbell.




On May
13, 2008, the Company signed an executive employment agreement with Andrew
Sculley, Jr. to serve as the Company’s Chief Executive Officer and President
effective June 1, 2008.  Pursuant to the Employment Agreement, Mr.
Sculley is paid a salary of $300,000.  The salary will increase to
$310,000, per annum, after six months and to $320,000 per annum at the end of
the first year.   If Mr. Sculley voluntarily terminates his employment
with the Company, other than for Good Reason as defined in the Employment
Agreement, he shall cease to accrue salary, personal time off, benefits and
other compensation on the date of voluntary termination.  The Company may
terminate Mr. Sculley’s employment with or without cause.  If the Company
terminates without cause, Mr. Sculley will be entitled to, at the Company’s sole
discretion, either (i) monthly salary payments for twelve (12) months, based on
his monthly rate of base salary at the date of such termination, or (ii) a
lump-sum payment of his salary for such 12 month period, based on his monthly
rate of base salary at the date of such termination. Mr. Sculley shall also be
entitled to receive (i) payment for accrued and unpaid vacation pay and (ii) all
bonuses that have accrued during the term of the Employment Agreement, but not
been paid.Mr.
Sculley was granted 500,000 options of which one third vested immediately and
one third will vest annually on the subsequent two anniversary
dates.





Effective
June 1, 2008, Admiral Thomas Paulsen resigned from his position as Interim Chief
Executive Officer.   Admiral Paulsen continues to serve as the
Company’s Chairman of the Board.





Note 15:  Subsequent
Events





On August
8, 2008, Moriah granted to the Company an extension of the Loan with the same
terms for 8 days.




14




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 of 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).





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





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




15




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
is recognized when products are shipped to customers, net of allowances for
anticipated returns.  The Company’s revenue-earning
activities generally involve delivering products.
Revenue is recognized when persuasive evidence of
an arrangement exists, delivery has occurred, selling price is
fixed or determinable and collection is reasonably assured.





The
Company 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 on firm fixed-price contracts are recognized 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.





Use
of Estimates





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





Fair
Value of Financial Instruments





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





Stock-based
Compensation





We
maintain several stock incentive plans.  The 2005 Employee Stock
Purchase Plan 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, 2008, 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 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
February 20, 2008, the Board of Directors authorized the establishment of the
2008 Incentive Stock Plan with 2,000,000 options available for
grant.  The 2008 Incentive Stock Plan is intended to provide long-term
performance incentives to directors, executives, selected employees and
consultants and reward them for making major contributions to the success and
well being of the Company.  As of June 30, 2008, no options have been
issued from this plan.




16




The
Company accounts for its stock based compensation in accordance with the
provisions of SFAS No. 123R, “Share-Based Payment”, which requires the Company
to recognize expense related to the fair value of the Company’s share-based
compensation issued to employees and directors. SFAS 123R requires companies to
estimate the fair value of share-based payment awards on the date of grant using
an option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as expense over the requisite service
periods in the Company’s condensed consolidated statement of operations. The
Company uses the straight-line method for recognizing compensation expense. An
estimate for forfeitures is included in compensation expense for awards under
SFAS 123R.  See Note 9 to the Condensed Consolidated Financial
Statements for a further discussion on stock-based compensation.





NEW
ACCOUNTING PRONOUNCEMENTS





See Note
2 of the Condensed Consolidated Financial Statements in Item 1 for a description
of recent accounting pronouncements, including the expected dates of adoption
and estimated effects on results of operations and financial
condition.





SUBSEQUENT
EVENTS





On August
8, 2008, Moriah granted to the Company an extension of the Loan with the same
terms for 8 days as the two parties are in negotiations to extend the Loan for
an additional year.





RESULTS
OF OPERATIONS





THREE
MONTHS AND SIX MONTHS ENDED JUNE 30, 2008 COMPARED TO THREE MONTHS AND SIX
MONTHS ENDED JUNE 30, 2007





Revenues




Revenues
for the three and six months ended June 30, 2008 were approximately $5.6
million and $8.3 million, respectively, as compared to approximately $4.2
million and $7.8 million for the three and six months ended June 30, 2007,
respectively, an increase of approximately 33% and 6%,
respectively.  Higher revenue for the three and six month periods was
due to increased availability of finished displays as a result of increased
production volume and improved yields.  In addition, an increase in
the number of contracts the Company is currently performing has resulted in
increased contract revenue.





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,
2008 were approximately $3.0 million and $5.3 million as compared to
approximately $2.9 million and $6.1 million for the three and six months ended
June 30, 2007.  There was an increase of $0.1 million for the three
months ended June 30, 2008 as compared to the three months ended June 30, 2007
and there was a decrease of approximately $0.8 million for the six months ended
June 30, 2008 as compared to the six months ended June 30, 2007.  The
gross margin for the three and six months ended June 30, 2008 was
approximately $2.6 million and $3.0 million as compared to approximately $1.3
million and $1.8 million for the three and six months ended June 30, 2007. As a
percentage of revenue this translates to a gross margin for the three and six
months ended June 30, 2008 of 46% and 36%, respectively, as compared to 30% and
23%, respectively, for the three and six months ended June 30,
2007.  The increase in the gross margin was attributed to fuller
utilization of our fixed production overhead due to higher unit production
volume and improved yields.





Operating
Expenses





Research and
Development.  Research and development expenses include salaries,
development materials and other costs specifically allocated to the development
of new microdisplay products, OLED materials and subsystems.  Research
and development expenses for the three and six months ended June 30,
2008 were approximately $0.6 million and $1.3 million, respectively, as compared
to $0.9 million and $1.7 million for the three and six months ended June
30, 2007, a decrease of approximately $0.3 million and $0.4 million,
respectively.  The decrease was due to the re-deployment of research and
development personnel to production contract services which are included in cost
of goods sold.




17




Selling, General and
Administrative.  Selling, general and administrative
expenses consist principally of salaries, fees for professional services
including legal fees, as well as other marketing and administrative
expenses.  Selling, general and administrative expenses for the three
and six months ended June 30, 2008 were approximately $1.7 million and $3.5
million, respectively, as compared to approximately $1.5 million and $3.8
million for the three and six months ended June 30, 2007, an increase of $0.2
million and a decrease of $0.3 million, respectively. The increase of
approximately $0.2 million for the three months ended June 30, 2008 was
primarily related to an increase in the reserve for allowance for bad debts and
professional services associated with additional SEC filings and SOX
compliance.  The decrease of approximately $0.3 million for the six
months ended June 30, 2008 was primarily related to decreases in personnel costs
and service paid in equity offset by increases in reserve for allowance for bad
debts and professional services.





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





For the
three and six months ended June 30, 2008, interest income was approximately $2
thousand and $4 thousand as compared to approximately $8 thousand and $23
thousand for the three and six months ended June 30, 2007.   The
decrease in interest income was primarily a result of lower cash balances
available for investment.





For the
three and six months ended June 30, 2008, interest expense was approximately
$0.6 million and approximately $1.2 million, respectively, as compared to
approximately $1.3 million and approximately $2.2 million, respectively, for the
three and six months ended June 30, 2007.   The breakdown of the
interest expense for the three and six month period in 2008 is as
follows:  interest expense associated with debt of approximately $164
thousand and $323 thousand, respectively; the amortization of the deferred costs
and waiver fees associated with the debt of approximately $373 thousand and $821
thousand, respectively; and the amortization of the debt discount associated
with the debt of approximately $0 and $25 thousand, respectively.  The
breakdown of the interest expense for the three and six month period in 2007 is
as follows:  interest expense associated with debt of approximately
$305 and $457 thousand, respectively; the amortization of the deferred costs
associated with the notes payable of approximately $133 thousand and $266
thousand, respectively; and the amortization of the debt discount of
approximately $878 thousand and $1.5 million, respectively.





The gain
from the change in the derivative liability was $0 for the three and six months
ended June 30, 2008 as compared to $182 thousand and $642 thousand,
respectively, for the three and six months ended June 30, 2007.





Other
income, net (excluding interest income), for the three and six months ended June
30, 2008 was approximately $121 thousand and $205, respectively,  as
compared to approximately $560 thousand and $567 thousand, respectively, for the
three and six months ended June 30, 2007. Other income primarily consists of
income from the licensing of intangible assets.  See Note
12:  Commitments and Contingencies – Royalty Payments for additional
information.





Liquidity
and Capital Resources





As of
June 30, 2008, we had approximately $1.1 million of cash and investments as
compared to $0.8 million as of December 31, 2007.  The change in cash
and investments was primarily due to cash provided by financing activities of
$2.6 million offset by cash used for operating activities and financing
activities of $2.3 million.





Cash flow
used in operating activities during the six months ended June 30, 2008 was
approximately $2.0 million primarily attributable to our net loss of $2.8
million and an increase in accounts receivable of $1.4 million offset by
non-cash expenses of $1.9 million. During the six months ended June 30, 2007,
operating activities used cash of $1.2 million attributable to our net loss of
$4.7 million and primarily offset by non-cash expenses of $2.8
million.





Cash used
in investing activities during the six months ended June 30, 2008 was
approximately $236 thousand used for equipment purchases.  During the
six months ended June 30, 2007, the cash used in investing activities was $4
thousand used for investment purchases.





Cash
provided by financing activities during the six months ended June 30, 2008 was
approximately $2.6 million and was comprised of approximately $1.6 million from
the sale of common stock, $1.7 million from the line of credit, and offset by
payments on debt of $0.7 million.  The cash provided by financing
activities during the six months ended June 30, 2007 was approximately $ 0.4
million primarily consisted of $0.5 million, net, from debt issuance and offset
by payments against debt of approximately $33 thousand.




18




Our
condensed consolidated financial statements as of June 30, 2008 have been
prepared under the assumption that we will continue as a going concern. Our
independent registered public accounting firm has issued a report dated April 9,
2008 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 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.





We
anticipate our business to experience revenue growth during the year ended
December 31, 2008. This trend may result in higher accounts receivable levels
and may require increased production and/or higher inventory
levels.  In addition, in December 2008, we will be obligated to repay
approximately $6.0 million to the note holders.  If the funds are not
available, we will negotiate with the note holders to defer the payment but no
assurances can be made that they will agree. We anticipate that our cash
requirements to fund these requirements as well as other operating or investing
cash requirements over the next twelve months will be greater than our current
cash on hand.  We anticipate that we will still require additional
funds over the next twelve months.  We do not currently have
commitments for these funds and no assurance can be given that additional
financing will be available, or if available, will be on acceptable
terms.





The
Company’s ability to obtain additional funding is impacted by its present
indebtedness.  The Company’s notes payable have covenants which the
Company currently is in compliance with and the covenants contain certain
restrictive components that materially limit our ability to raise additional
secured debt which is presently limited to a maximum of $2.5 million. The
Company has a line of credit with a maximum of $2.5 million which is secured by
accounts receivable and inventory which effectively eliminates any additional
secured indebtedness under the note covenants. The Company's line of credit was
temporarily extended (see Notes 8 and 15).  In addition, pursuant to
the notes payable agreement, the Company cannot enter into a consolidation,
merger, or acquisition under certain conditions without consent of the note
holders.  The Company may raise additional unsecured debt under the
note covenants given certain restrictions.  In addition, the notes
payable allow for additional equity financing.





If we are
unable to obtain sufficient funds during the next twelve months, we will further
reduce the size of our organization and may be forced to reduce and/or curtail
our production and operations, all of which could have a material adverse impact
on our business prospects. The Company is reviewing its cost structures for cost
efficiencies and is taking measures to reduce non-production costs.





In
addition to the foregoing, as previously reported, we have retained CIBC World
Markets Corporation and Larkspur Capital Corporation to assist us in
investigating and evaluating various strategic alternatives, ranging from
investment to acquisition.




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.




19




ITEM
4T.  Controls and Procedures





(a)  Evaluation of Disclosure Controls
and Procedures. Based on an evaluation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended) required by paragraph (b) of
Rule 13a-15 or Rule 15d-15, as of the end of the period covered by
this Report, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were not effective in
ensuring that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Commission’s rules and
forms. Our Chief Executive Officer and Chief Financial Officer also concluded
that, as of the end of the period covered by this Report, there were material
weaknesses in both the design and effectiveness of our internal control over
financial reporting.  Management has assessed these deficiencies and
has determined that there were four general categories of material weaknesses in
eMagin’s internal control over financial reporting.  As a result of
our assessment that material weaknesses in our internal control over financial
reporting existed as of June 30, 2008, management has concluded that our
internal control over financial reporting was not effective as of June 30,
2008.  A material weakness is a deficiency, or a combination of
deficiencies, in internal control over financial reporting such that there is a
reasonable possibility that a material misstatement of our annual or interim
financial statements will not be prevented or detected on a timely
basis.





In
management’s opinion, our assessment as of June 30, 2008 regarding the existence
of material weaknesses in our internal control over financial reporting relates
to (1) the absence of adequate staffing, proper role descriptions, inadequate
training and excessive employee turnover, (2) the lack of controls or
ineffectively designed controls, (3) the failure in design and operating
effectiveness of information technology controls over financial reporting, and
(4) failures in operating control effectiveness identified during the testing of
the internal control over financial reporting.  Management and our
audit committee have assigned a high priority to the short-term and long-term
improvement of our internal control over financial reporting.





The
material weaknesses we have identified include:





Deficiencies pertaining to a lack of
human resources within our finance and accounting
functions.  During the latter part of 2007 we experienced
significant turnover of personnel in our finance and accounting department,
including the positions of Chief Financial Officer and Staff
Accountant.  The reduced staffing resulted in instances of altered
responsibilities and improper role definition leading to lapses in proper
segregation of duties.  The lack of appropriately skilled personnel
and less effective monitoring activities related to employee turnover could
result in material misstatements to financial statements not being detected in a
timely manner.





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





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





Deficiencies related to failures in
operating effectiveness of the internal control over financial
reporting.  Certain internal control procedures were developed
during the latter part of 2007.  When testing occurred to confirm the
effectiveness of the internal control over financial reporting, controls were
not operating effectively.





(b)  Changes in Internal
Controls.  During the quarter ended June 30, 2008, there were
no changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule
15d-15 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.





20


PART
II - OTHER INFORMATION





ITEM
1.  Legal Proceedings







Other
than the  legal proceeding pending against the company as described in
the company’s Annual Report on Form 10-K for the year ended December 31,
2007, through June 30, 2008, there have been no material developments in any
legal proceedings reported in such Annual Report.





ITEM
1A.  Risk Factors





In
addition to other information set forth in this Report, you should carefully
consider the risk factors previously disclosed in “Item 1A to Part 1” of our
Annual Report on Form 10-KSB for the year ended December 31,
2007.  There were no material changes from the risk factors during the
three and six months ended June 30, 2008.





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





On April
2, 2008, the Company entered into a Securities Purchase Agreement (“Purchase
Agreement”), pursuant to which the Company sold and issued 1,586,539 shares of
common stock, par value of $0.001 per share, at a price of $1.04 per share and
warrants to purchase an additional 793,273 shares of common stock for an
aggregate purchase price of approximately $1.65 million.  The warrants
are exercisable at a price of $1.30 per share and expire on April 2,
2013.





ITEM
3.  Defaults Upon Senior Securities





None.





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





None.





ITEM
5.  Other Information





None.





21





ITEM
6.  Exhibits




EXHIBITNUMBER
            DESCRIPTION10.1
            Securities
      Purchase Agreement, dated on April 2, 2008, by and among the Company and
      purchasers signatory thereto (2)





10.2
            Registration
      Rights Agreement, dated on April 2, 2008, by and among the Company and
      purchasers signatory thereto (2)





10.3
            Executive
      Services Agreement, dated on April 2, 2008, by and between the Company and
      Tatum, LLC (3)







31.1
              Certification
      by Chief Executive Officer pursuant to Sarbanes Oxley Section 302 (1)
 31.2
                Certification by
      Chief Financial Officer pursuant to Sarbanes Oxley Section 302 (1)
 32.1
                  Certification by
      Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (1)
 32.2
                    Certification by
      Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (1)


(1)         Filed
herewith.


(2)
            Incorporated
      by reference to the Current Report on Form 8-K, as filed by the Company
      with the SEC on April 4, 2008.


(3)         Incorporated
by reference to the Current Report on Form 8-K, as filed by the Company with the
SEC on April 18, 2008.




22




SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized on this 14th day of
August 2008.






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


By:
              /s/ Paul
      CampbellPaul
      CampbellInterim Chief Financial
      OfficerPrincipal Accounting and
      Financial Officer
    23