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):

The number of shares of common stock outstanding as of October 31, 2009April 30, 2010 was 16,961,902.19,668,835.

 

 

 

 

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

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of eMagin Corporation and its subsidiary reflect all adjustments, including normal recurring accruals, necessary for a fair presentation.  Certain information and footnote disclosure normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to instructions, rules and regulations prescribed by the Securities and Exchange Commission (“SEC”).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, 2008.2009.  The results of operations for the period ended September 30, 2009March 31, 2010 are not necessarily indicative of the results to be expected for the full year.

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

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

Research and development costs are expensed as incurred.

In June 2009,April 2010, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“Codification”FASB amended the authoritative guidance on the milestone method of revenue recognition.  The amendment defines a milestone and determines when it may be appropriate to apply the milestone method of revenue recognition for research or “ASC”) became the single sourcedevelopment transactions.  Consideration that is contingent on achievement of authoritative nongovernmental U.S. generally accepted accounting principles (“GAAP”) except for additional authoritative rules and interpretive releases issued by the SEC. The Codification did not create any new GAAP standards but incorporated existing accounting and reporting standards into a new topical structure with a new referencing system to identify authoritative accounting standards, replacing the prior references to Statement of Financial Accounting Standards (“SFAS”), Emerging Issues Task Force (“EITF”), FASB Staff Position (“FSP”), etc.  Authoritative standards includedmilestone in its entirety may be recognized as revenue in the Codification are designated by their ASC topical reference,period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. This new guidance permits prospective adoption for milestones achieved in fiscal years and new standardsinterim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted.  The Company is evaluating the impact the adoption of this update will be designated as Accounting Standards Updates (“ASU”), with a year and assigned sequence number.  Beginning with the interim report for this third quarter, the Company adopted the Codification and it had no effecthave on its condensed consolidat ed financial position, results of operations, or cash flows.statements.

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

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

Receivables consisted of the following (in thousands):

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

 

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

For the three and nine months ended September 30,March 31, 2010 and 2009, there werethe Company has excluded stock options and warrants outstanding to acquire 3,498,592503,221 and 10,226,63820,427,204 shares, respectively, of the Companyour common stock which were excluded from the calculation of its diluted earnings per share assince their effect would be anti-dilutive.  TheFor the three months ended March 31, 2010 and 2009, the convertible preferred stock is included in the calculation of diluted earnings per share as all shares are assumed converted.

Inventory is stated at the lower of cost or market. Cost is determined using the first-in first-out method.  Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. The Company regularly reviews inventory quantities on hand, future purchase commitments with the valueCompany’s suppliers, and the estimated utility of its inventory and reducesthe inventory. If the Company review indicates a reduction in utility below carrying value, the inventory valueis reduced to its net realizable value based upon current market prices and contracts for future sales. a new cost basis.

The components of inventories are as follows (in thousands):

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

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

The following table summarizes the allocation of non-cash stock-based compensation to theour expense categories for the three and nine month periods ended September 30,March 31, 2010 and 2009 and 2008 (in thousands):

 

At September 30, 2009,March 31, 2010, total unrecognized non-cash compensation costcosts related to stock options was approximately $415 thousand,$0.4 million, net of estimated forfeitures.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and is expected to be recognized over a weighted average period of approximately 1.20.9 years.

Options granted to non-employees are measured at the grant date using a fair value options pricing model and remeasured to the current fair market value at each reporting period as the underlying options vest and services are rendered.   ForThere were no options granted to consultants in the ninethree months ended September 30,March 31, 2010.  In May 2009, there were 60,000 options granted to consultants.consultants, of which the unvested options were remeasured to the current fair market value at March 31, 2010.  The following assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:  dividend yield – 0%; risk free interest rates – 1.44% to 1.64%1.60%; expected volatility – 71.4%73.7% to 84.1%83.6-%; and expected term – 3 years.

ThereDuring the three month period ended March 31, 2010, there were 411,600 and 1,278,841448,185 stock options granted to employees.  During the three month period ended March 31, 2009, there were no stock options granted to employees and directors during the three and nine months ended September 30, 2009 and 171,000 and 919,253 options granted to employees and directors during the three and nine months ended September 30, 2008.directors.  The following key assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:

The Company hasWe 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 the Company’sour stock-based awards are expected to be outstanding and was determined based on historical experience and vesting schedules of similar awards.

The 2008 Incentive Stock Plan (“For the 2008 Plan”) adopted and approved by the Board of Directors on November 5, 2008 provides for  shares of common stock and options to purchase shares of common stock to employees, officers, directors and consultants.  The 2008 Plan has an aggregate of 2,000,000 shares. As of September 30, 2009, 1,278,841three months ended March 31, 2010, 10,500 options were granted to employees from this planthe 2008 Plan with a fair value of approximately $814$12 thousand and 498,533 shares437,685 options were issuedgranted to employees from the 2003 Plan with a fair value of approximately $304$500 thousand.  At September 30, 2009, there were 222,626 shares availableThe weighted average fair value per share for grant.options granted in the first quarter of 2010 was $1.16.

A summary of the Company’s stock option activity for the ninethree months ended September 30, 2009March 31, 2010 is presented in the following tables:

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

The aggregate intrinsic value in the table above represents the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock.  There were 2,417,9703,177,446 options in-the-money at September 30, 2009.March 31, 2010.   The Company’s closing stock price was $1.65$3.76 as of September 30, 2009.March 31, 2010. The Company issues new shares of common stock upon exercise of stock options.

The Company has designated 10,000 shares of the Company’s preferred stock as Series B Convertible Preferred Stock – Series B(“the Preferred -Series B”) at a stated value of $1,000 per share.  The Preferred Stock – Series B is convertible into common stock at a conversion price of $0.75 per share.  The Preferred Stock – Series B does not pay interest.  The holders of the Preferred Stock – Series B are not entitled to receive dividends unless the Company’s Board of Directors declare a dividend for holders of the Company’s common stock and then the dividend shall be equal to the amount that such holder would have been entitled to receive if the holder converted its Preferred Stock – Series B into shares of the Company’s common stock. Each share of Preferred Stock – Series B has voting rights equal to (i) the number of shares of Common Stock issuable upon conversion of such shares of Preferred Stock – Series B at such time (determined without regard to the shares of Common Stock so issuable upon such conversion in respect of accrued and unpaid dividends on such share of Preferred Stock) when the Preferred Stock – Series B votes together with the Company’s Common Stock or any other class or series of stock of the Company and (ii) one vote per share of Preferred Stock when such vote is not covered by the immediately preceding clause.  In the event of a liquidation, dissolution, or winding up of the Company, the Preferred Stock – Series B is entitled to receive liquidation preference before the Common Stock.  The Company may at its option redeem the Preferred Stock – Series B by providing the required notice to the holders of the Preferred Stock – Series B and paying an amount equal to $1,000 multiplied by theth e number of shares for all of such holder’s shares of outstanding Preferred Stock – Series B to be redeemed.  As of September 30, 2009,March 31, 2010, there were 5,739 shares of Preferred Stock – Series B issued and outstanding.

For the three and nine months ended September 30,March 31, 2010 and 2009, and 2008, there were no stock options exercised.  For the three and nine months ended September 30, 2009,March 31, 2010, there were 2.9 million669,717 warrants exercised on a cashless basis resulting in 727 thousand334,608 shares of common stock issued. No warrants were exercised forFor the three and nine months ended September 30, 2008.March 31, 2009, there were no warrants exercised.

For the three and nine months ended September 30, 2009, the Company issued 42,857 and 498,533March 31, 2010, no shares of common stock respectively,were issued for payment of approximately $45 thousand and $304 thousand, respectively, for services rendered and to be rendered in the future.  For the three and nine months ended September 30, 2008,March 31, 2009, the Company issued 629,400 and 811,400approximately 216,000 shares of common stock respectively, for payment of approximately $441$115 thousand and $643 thousand, respectively, for services to be rendered and to be rendered in the future.  The Company recorded the fair value of the services rendered and to be rendered in the future in prepaid expenses and selling, general and administrative expenses in the accompanying unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2009 and 2008.March 31, 2009.

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

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

 

The Company in accordance withsigned a royaltylicense agreement on March 29, 1999 with Eastman Kodak (“Kodak’), under which it is obligated to make royalty payments. Under this agreement, the Company must pay to Eastman Kodak a minimum royalty plus 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.

The Company leases office facilities and office, lab and factory equipment under operating leases.  Certain leases provide for payments of monthly operating expenses. The Company currently has lease commitments for space in Hopewell Junction, New York and Bellevue, Washington.  In May 2009, the Company renewed

The Company’s manufacturing facilities are leased from IBM in Hopewell Junction, New York.  eMagin leases approximately 37,000 square feet to house its equipment for OLED microdisplay fabrication and for research and development, an assembly area and administrative offices. The lease with IBM untilexpires May 31, 2014 with the option of extending the lease for five years.   The Company’s prior leasecorporate headquarters are located in Bellevue, Washington expiredwhere eMagin leases approximately 5,100 square feet.   The lease expires on August 31, 2009.  The Company signed a lease agreement for 5,100 square feet of office space effective September 1,2014.  For the three months ended March 31, 2010 and 2009, through August 31, 2014 which will reduce the Company’s monthly rent by approximately $26 thousand. Rent expense was approximately $336$283 thousand and $1.1 million, respectively, for the three and nine months ended September 30, 2009 and $332 thousand, and $996 thousand, respectively, for the three and nine months ended September 30, 2008.respectively.

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

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

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

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

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

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

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

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

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

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

eMagin maintains several stock equity incentive plans.  The 2005 Employee Stock Purchase Plan (the “ESPP”) provides our employees with the opportunity to purchase common stock through payroll deductions.  Employees purchase stock semi-annually at a price that is 85% of the fair market value at certain plan-defined dates.  As of September 30, 2009,March 31, 2010, the number of shares of common stock available for issuance was 300,000.  As of September 30, 2009, no shares haveMarch 31, 2010, the plan had not been issued from this plan.implemented.

The 2008 Incentive Stock Plan (“the 2008 Plan”) adopted and approved by the Board of Directors on November 5, 2008 provides for the issuance of shares of common stock and options to purchase shares of common stock to employees, officers, directors and consultants.  The 2008 Plan has an aggregate of 2,000,000 shares.  For the three and nine months ended September 30, 2009,March 31, 2010, there were 42,857 and 498,533 shares of common stock, respectively, issued to consultants. In addition, there10,500 options were 411,600 and 1,278,841 options granted from the plan for the three and nine months ended September 30, 2009.this plan.

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

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

 

Revenues for the three and nine months ended September 30, 2009March 31, 2010 were approximately $6.1$5.9 million, and $17.1 million, respectively, as compared to approximately $5.2 million and $13.5$5.1 million for the three and nine months ended September 30, 2008, respectively,March 31, 2009, an increase of approximately 18% and 27%, respectively.15%.  Higher revenue for the three and nine month periodsperiod was due primarily to increased customer demand and product availability.

For the three and nine months ended September 30, 2009,March 31, 2010, product revenue increased approximately $1.1 million and $3.4 million, respectively, as compared to the three and nine months ended September 30, 2008.  The increase was due to higher customer demand and increased product availability for our OLED displays in the first nine months of 2009 as compared to the first nine months of 2008. For the three months ended September 30, 2009, contract revenue decreased approximately $0.2 million$130 thousand or 3% as compared to the three months ended September 30, 2008 and forMarch 31, 2009.  The slight increase was driven by the nine months ended September 30, 2009 increased approximately $0.2 millionmix of products sold in the first quarter of 2010 as compared to the ninefirst quarter of 2009.  For the three months ended September 30, 2008.  The change inMarch 31, 2010, contract revenue isincreased approximately $0.7 million or 83% as compared to the first quarter of 2009 which was a result of fluctuationsan increase in contract activity.the number of active projects in the first quarter of 2010 as compared to the first quarter of 2009.

Cost of goods sold is comprised of costs of product revenue and contract revenue.  Cost of product revenue includes materials, labor and manufacturing overhead related to our products.  Cost of contract revenue includes direct and allocated indirect costs associated with production.performing on contracts.  Cost of goods sold for the three and nine months ended September 30, 2009 wereMarch 31, 2010 was approximately $2.6 million and $7.3 million as compared to approximately $2.8 million and $8.1$2.7 million for the three and nine months ended September 30, 2008,March 31, 2009, a decrease of approximately $0.2 million and $0.8 million, respectively.$0.1 million.  Cost of goods sold as a percentage of revenues improved from 54%was 44% for the three months ended September 30, 2008March 31, 2010 as compared to 43%52% for the three months ended September 30,March 31, 2009. Cost of goods sold as a percentage of revenues improved from 60% for the nine months ended September 30, 2008 to 43% for the nine months ended September 30, 2009. Cost of goods is comprised primarily of material and labor cost. The labor portion of cost of goods is mostly fixed. Improved manufacturing yield, lower royalty expense and lower warranty expense resulted in a lower cost of goods sold percentage.

The following table outlines product, contract and total gross profit and related gross margins for the three and nine months ended September 30,March 31, 2010 and 2009 and 2008 (dollars in thousands):

The gross profit for the three and nine months ended September 30, 2009March 31, 2010 was approximately $3.5 million and $9.8$3.3 million as compared to approximately $2.4$2.5 million and $5.4 million for the three and nine months ended September 30, 2008, an increase of $1.1 million and $4.4 million, respectively.  Gross margin was 57% for the three months ended September 30,March 31, 2009, up from 46%an increase of $0.8 million.  Gross margin was 56% for the three months ended September 30, 2008.  Gross margin was 57%March 31, 2010 up from 48% for the ninethree months ended September 30, 2009 up from 40% for the nine months ended September 30, 2008.  The increase was mainly attributed to the fuller utilization of our fixed production overhead due to improved yields and a reduction in royalty and warranty expenses.  See Note 11 of the Condensed Consolidated Financial Statements - Commitments and Contingencies for further discussion on the royalty payments.March 31, 2009.

The product gross profit for the three and nine months ended September 30, 2009March 31, 2010 was approximately $3.3 million and $8.7$2.6 million as compared to approximately $1.8$2.1 million and $4.1 million for the three and nine months ended September 30, 2008, an increase of $1.5 million and $4.6 million, respectively.  Product gross margin was 62% for the three months ended September 30,March 31, 2009, up from 42%an increase of $0.5 million.  Product gross margin was 59% for the three months ended September 30, 2008.  ProductMarch 31, 2010 up from 48% for the three months ended March 31, 2009.   The gross margin was 60% forfavorably impacted by an increase in the nine months ended September 30, 2009 up from 37% for the nine months ended September 30, 2008.  The increase was attributed to the fuller utilizationheadset inventory as of our fixed production overhead due to improved yieldsMarch 31, 2010 and a reduction in royalty expense in the first quarter of 2010 and warranty expenses. See Note 11 of the Condensed Consolidated Financial Statements - Commitments and Contingencies for further discussion on the royalty payments.offset by an increase in personnel expenses, including stock-based compensation.

The contract gross profit for the three and nine months ended September 30, 2009March 31, 2010 was approximately $0.2 million and $1.0$0.7 million as compared to approximately $0.6 million and $1.3 million for the three and nine months ended September 30, 2008, a decrease of $0.4 million and $0.3 million, respectively.  Contract gross margin was 28% for the three months ended September 30,March 31, 2009, down from 61%an increase of $0.3 million.  Contract gross margin was 47% for the three months ended September 30, 2008.  Contract gross margin was 40%March 31, 2010 up slightly from 46% for the ninethree months ended September 30, 2009 down from 54% for the nine months ended September 30, 2008.March 31, 2009.   The contract gross margin is dependent upon the mix of costs, internal versus external third party costs, with the external third party costs causing a lower gross margin and reducing the contract gross profit.

 

For the three and nine months ended September 30, 2009,March 31, 2010, interest expense was approximately $76$28 thousand and $417 thousand, respectively, as compared to $508$175 thousand and $1.7 million, respectively, for the three and nine months ended September 30, 2008.March 31, 2009.   For the three and nine months ended September 30, 2009,March 31, 2010, the interest expense associated with debt was $7$21 thousand and $48, respectively, loan feesthe accrued interest on liquidated damages was $7 thousand.  The breakdown of the interest expense for the three month period in 2009 is as follows:  interest expense associated with the new linedebt of credit was $7approximately $25 thousand and the amortization of the deferred costs associated with the debt was $62 thousand and $362 thousand, respectively.  The breakdown of the interest expense for the three and nine month period in 2008 was as follows:  interest expense associated with debt of approximately $177 thousand and $501 thousand, respectively; the amortization of the deferred costs and waiver fees associated with the debt of approximately $331 thousand and $1.2 million, respectively; and the amortization of the debt discount associated with the debt of approximately $0 and $25 thousand, respectively.$150 thousand.   The decrease in interest expense for the three and nine months ended September 30, 2009March 31, 2010 as compared to the three and nine months ended September 30, 2008March 31, 2009 was primarily a result of carrying a lower balance on our line of credit, the repayment and conversion of the 8% Senior Secured Convertible Notes in December 2008, and lower deferred debt issuance costs.Company not having any outstanding debt.

Other income for the three and nine months ended September 30, 2009March 31, 2010 was approximately $1$7 thousand and $41 thousand, respectively,for the three months ended March 31, 2010 as compared to $84$1 thousand and $294 thousand, respectively, for the three and nine months ended September 30, 2008.March 31, 2009.  The other income for the three and nine months ended September 30, 2009March 31, 2010 was interest income of approximately $1 thousand and $3$6 thousand respectively, and for a settlement of a liability, $0 and $38 thousand, respectively. Otherfrom equipment salvage.  The other income for the three and nine months ended September 30, 2008March 31, 2009 was interest income of approximately $2 thousand and $6 thousand, respectively; $142 thousand and $396 thousand, respectively, was income from a gain on the license of intangible assets; $0 and $18 thousand, respectively, of income from equipment salvage; and is offset by approximately $60 thousand and $126 thousand, respectively, of expense from registration payment arrangements.    See Note 11:  Commitments and Contingencies – Royalty Payments for additional information.

As of September 30, 2009,March 31, 2010, we had approximately $3.7$6.0 million of cash and cash equivalents as compared to $2.4$5.3 million as of December 31, 2008.2009.  The change in cash and investmentsof $0.7 million was primarily due to cash provided by operations of approximately $3.5$1.5 million offset by cash used for financing and investing activities of approximately $2.2$0.8 million.

Cash flow provided by operating activities during the ninethree months ended September 30, 2009March 31, 2010 was approximately $3.5$1.5 million, attributable to our net income of approximately $2.9$0.9 million, non-cash expenses of $1.1$0.3 million offset byand approximately $0.6$0.3 million from the change in operating assets and liabilities.  Cash flow used inprovided by operating activities during the ninethree months ended September 30, 2008March 31, 2009 was approximately $1.9$1.0 million primarily attributable to our net lossincome of $2.4approximately $0.4 million, and an increase in accounts receivable of $1.9 million offset by non-cash expenses of $2.5 million.$0.3 million and approximately $0.3 million from the change in operating assets and liabilities.  

Cash used in investing activities during the ninethree months ended September 30,March 31, 2010 and 2009 and 2008 was approximately $492$763 thousand and $236$33 thousand, respectively, used for equipment purchases.to purchase equipment.

CashThere was no cash used inby financing activities during the ninethree months ended September 30,March 31, 2010.  Cash used by financing activities during the three months ended March 31, 2009 was approximately $1.7$1.0 million to pay down the line of credit.  Cash provided by financing activities during the nine months ended September 30, 2008 was approximately $2.7 million and was comprised of approximately $1.6 million from the sale of common stock, $1.8 million from the line of credit, and offset by payments on debt of $0.7 million.

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

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.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofRule 13a-15 under the Securities Exchange Act of 1934 as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15,(the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were notare designed at a reasonable assurance level and are effective in ensuringto provide reasonable assurance that information we are required to be disclosed by usdisclose 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’sSecurities and Exchange Commission rules and forms.forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Our Chief Executive Officer and Chief Financial Officer alsohave concluded, that,based on their evaluation 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 determinedreport, that there were two general categories of material weaknesses (described below) in eMagin’s internal control over financial reporting.  As a result of our assessment that material weaknesses in our internal control over financial reporting existed as of September 30, 2009, management has concluded that our internal control over financial reporting was not effective as of September 30, 2009.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

There were no changes in our internal controlcontrols over financial reporting identified in connection withduring the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15fiscal quarter ended March 31, 2010 that hashave materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting.

In addition to other information set forth in this Report, you should carefully consider the risk factors previously disclosed in “Item 1A to Part 1” of our Annual Report on Form 10-K for the year ended December 31, 2008.2009.  There were no material changes from the risk factors during the three and nine months ended September 30, 2009.March 31, 2010.

None.

None.

None.