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, 2010April 30, 2011 was 20,310,569.21,686,196.

 

 

 

 

 

 

 

 

 

eMagin Corporation (the “Company”) designs, develops, manufactures, and markets OLED (organic light emitting diode) on silicon microdisplays and 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 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, 2009.2010.  The results of operations for the period ended September 30, 2010March 31, 2011 are not necessarily indicative of the results to be expected for the full year.

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.  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.  Revenues relating to firm fixed-price contracts and cost-type contracts are generally recognized on the percentage-of-completion method of accounting as costs are incurred (cost-to-cost basis).  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 Company offers a one-year product replacement warranty. In general, the standard policy is to repair or replace the defective products. The Company accrues for estimated returns of defective products at the time revenue is recognized based on historical activity as well as for specific known product issues. The determination of these accruals requires the Company to make estimates of the frequency and extent of warranty activity and estimate future costs to replace the products under warranty. If the actual warranty activity and/or repair and replacement costs differ significantly from these estimates, adjustments to cost of revenue may be required in future periods.

Research and development costs are expensed as incurred.

In April 2010,During the 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 development transactions.  Considerationthree months ended March 31, 2011, there were no new accounting pronouncements that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the 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 interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted.  As the Company plans to implement the guidance prospectively, the effect of this guidance will be limi ted to future transactions. The Company does not expect adoption of this standard towould have had a material impacteffect on itsour unaudited condensed consolidated financial position or results of operations as it has no material research and development arrangements which are accounted for under the milestone method.statements.

The majority of the Company’s commercial accounts receivable isare due from Original Equipment Manufacturers ("OEM’s”). Credit is extended based on an 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 allowance for doubtful accounts reflects an estimate of probable losses inherent in the accounts receivable balance.  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.position, or deterioration in the customer’s credit history. If circumstances related to customers change, the Company would further adjust estimates of the recoverability of receivables.

The net (loss) income per common share ("basic EPS") is computed by dividing net (loss) income by the weighted average number of common shares outstanding and excluding any potential dilution.  Net (loss) income per common share assuming dilution ("diluted EPS") is computed by reflecting potential dilution from the exercise of stock options, warrants, and 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, 2011, the Company has excluded stock options, warrants and convertible preferred stock to acquire 14,195,375 shares of our common stock from the computation of diluted loss per share because their effect would be antidilutive.  For the three months ended March 31, 2010, the Company has excluded stock options and warrants to acquire 1,271,817 and 1,282,817503,221 shares respectively, of the Company’sour common stock sinceas their effect would be anti-dilutive.  For the threeantidilutive and nine months ended September 30, 2010 and 2009, the convertible preferred stock is included in the calculation of diluted earnings per share as all shares are assumed converted.   For the three and nine months ended September 30, 2009, the Company has excluded stock options and warrants to acquire 3,498,592 and 10,226,638 shares, respectively, of the Company’s common stock since their effect would be anti-dilutive.  

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 Company’s suppliers, and the estimated utility of the inventory. If the Company review indicates a reduction in utility below carrying value, the inventory is reduced to 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):

Effective September 1, 2010,At March 31, 2011, the Company renewed itshad available a credit facility with Access Business Finance, LLC (“Access”) under which the Company may borrow up to a maximum of $3 million based on a borrowing base equivalent of 75% of eligible accounts receivable.  The interest on the line of credit is equal to the Prime Rate plus 4.00% but may not be less than 7.25% with a minimum monthly interest payment of $5,000.  The term of the agreement with Access is for one year and automatically renews for successive one year terms unless, at least 60 days prior to the end of the current term, the Company gives Access prior written notice of its intent not to renew or if Access, at least ten days prior to the end of the current term, gives the Company written notice of its intent not to renew. The Compa ny’srenewal date is September 1, 2011.  The Company paid $30,000 in loan fees to Access which were charged to prepaid expense and will be amortized over the life of the Agreement.  As of March 31, 2011, $17,500 has been amortized to interest expense.  The Company’s obligations under the agreement are secured by its assets.    The Company paid $30,000 in annual loan fees to Access which were charged to prepaid expenses and amortized over the one year term.  As of September 30, 2010, $2,500 had been amortized to interest expense.  As of September 30, 2010,March 31, 2011, the Company had not borrowed on its line of credit.

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 our expense categories for the three and nine month periods ended September 30,March 31, 2011 and 2010 and 2009 (in thousands):

 

At September 30, 2010,March 31, 2011, total unrecognized compensation costs related to stock options was approximately $0.4$4.3 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 1.32.8 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.   There were no options granted to consultants in the three and nine months ended September 30, 2010.  For the nine months ended September 30, 2009, there were 60,000 options granted to consultants.March 31, 2011.  In May 2009, there were 60,000 options granted to consultants, of which the unvested options were remeasured to the current fair market value at September 30, 2010.March 31, 2011.  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 – 0.64 %0.64% to 1.70%; expected volatility – 68.4%68.4 % to 84.1%; and expected term – 3 years.

During the three and nine month periodsperiod ended September 30, 2010,March 31, 2011, there were 236,200 and 853,0851,294,177 stock options respectively, granted to employees and directors.  During the ninethree month period ended September 30, 2009,March 31, 2010, there were 411,600 and 1,278,841448,185 stock options granted to employees and directors.employees.  The following key assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:

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.

 

For the nine month periodthree months ended September 30, 2010, 10,500March 31, 2011, 200,000 options were granted to employees from the 2008 Plan with a fair value of approximately $12 thousand$0.8 million and 842,5851,094,177 options were granted to employees and directors from the 2003 Plan with a fair value of approximately $1.4$4.3 million.  The weighted average fair value per share for options granted in the first nine monthsquarter of 20102011 was $1.67.$3.92.

A summary of the Company’s stock option activity for the ninethree months ended September 30, 2010March 31, 2011 is presented in the following tables:

 

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 3,206,7453,447,796 options in-the-money at September 30, 2010.March 31, 2011.   The Company’s closing stock price was $3.19$7.15 as of September 30, 2010.March 31, 2011. 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 (“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 declaresdeclare 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

The Preferred Stock –Series B votes with holders of Common Stock upon the election of directors and upon any other matter submitted to a vote of shareholders, except those matters required by law to be submitted to a vote of holders of Preferred Stock of the Company or Series B Convertible Preferred Stock voting separately as a class or series, and except as provided in the  Certificate of Designations of Series B Convertible Preferred Stock.  Fractional votes shall not, however, be permitted.  The holder of 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 t hethe number of shares for all of such holder’s shares of outstanding Preferred Stock – Series B to be redeemed.  

For the three months ended September 30,March 31, 2011 and 2010, no shares of common stock were issued for payment of services rendered and for the nine months ended September 30, 2010, 15,363 shares of common stock were issued for payment of $55 thousand for services rendered.  For the three and nine months ended September 30, 2009, the Company issued approximately issued 42,857 and 498,533 shares of common stock, respectively, for payment of approximately $45 thousand and $304 thousand, respectively, for services rendered and to be rendered in the future.  The Company recorded the fair value of the services rendered in selling, general and administrative expenses in the accompanying unaudited condensed consolidated financial statements for the nine months ended September 30, 2010 and the three and nine months ended September 30, 2009.

The Company’sFor the three months ended March 31, 2011, the Company recorded a current income tax provision was $56,000 and $75,000, respectively,benefit of approximately $158 thousand based upon the projected effective income tax rate for the year, as the Company expects to have taxable income for the year ending December 31, 2011.  For the three and nine months ended September 30,March 31, 2010, which represents alternative minimumthe Company recorded income tax expense.expense of approximately $1,000.

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.  Historically, the Company has incurred significant losses, however recently the Company has had a number of consecutive quarters of net income.  Notwithstanding this positive trend, management does not believe that it is more likely than not that the benefits of the net operating losses carryforwards and other deferred tax assets will be realized. Accordingly, the Company has recognized the benefits of the deferred tax assets only to the extent of current taxable income.

Due to the Company’s operating loss carryforwards, all tax years 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 tax expense.

 

The Company signed a license agreement on March 29, 1999 with Eastman Kodak (“Kodak’), under which it wasis obligated to make royalty payments. Under this agreement, the Company must pay to 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 was notified that Kodak sold substantially all rights and obligations under the Company’s license agreement to Global OLED Technology, owned by LG Electronics, , as of December 30, 2009.

 

In late 2008, the Company began evaluating the status of its manufacturing process and the use of the IP associated with its license agreement.  After this analysis and after making a few changes to its manufacturing process, the Company determined it was no longer using the IP covered under the license agreement.  As the Company has determined it is no longerstopped using the IP covered under the license agreement by year end 2008.  The last royalty payment under the license agreement was made in its manufacturing process, theNovember 2009.  The Company believesdetermined that it is no longer required to pay the minimum annual royalty payment of $125,000 and as such has not paid or accrued this amount in 2010.  Going forward,2010 or to date in 2011.  

In April 2011, the Company will continue to recognizereceived a request for royalty payments from a representative of Global OLED Technology, LLC, the reduced royalty liability on salescurrent owner of product produced prior to the manufactur ing process change. There can be no assuranceold Kodak OLED patent portfolio. The Company has responded stating, that the licensor will not challengelicenses are no longer in force and that in any event, the Company’s position.request for royalties is untimely.

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, Bellevue, Washington, and Bellevue, Washington.Santa Clara, California.  

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 expires May 31, 2014 and contains anwith the option of extending the lease for five years.   The corporate headquarters are located in Bellevue, Washington where eMagin leases approximately 5,1006,300 square feet.   The lease expires on August 31, 2014. RentOn April 14, 2011, the Company signed an eighteen month lease agreement for approximately 2,400 square feet of office space in Santa Clara, California effective May 1, 2011.    The Company’s monthly rent expense will increase by  approximately $3.5 thousand.  The California location will be a research and development facility.

For the three months ended March 31, 2011and 2010, rent expense was approximately $289 thousand and $283 thousand, and $850 thousand, respectively, for the three and nine months ended September 30, 2010 and $336 thousand and $1.1 million, respectively, for the three and nine months ended September 30, 2009.respectively.

 

On January 19, 2011, the Company signed an executive employment agreement (the “Employment Agreement”) with Susan R. Taylor to serve as the Company’s Corporate Secretary, Senior Vice President and General Counsel effective February 1, 2011.  Pursuant to the Employment Agreement, betweenMs. Taylor is paid a base salary of $175,000 and was granted 225,000 options which are exercisable at $6.82 per share, the Company and Susan Jones (as previously amended and extended,market price on the “Employment Agreement”),date of the termgrant, of which one third will vest annually on the subsequent three anniversary dates. If Ms. Jones’ contract with the Company ended May 12, 2010 andTaylor voluntarily terminates her employment with the Company, ceasedother than for Good Reason as defined in the Employment Agreement, she shall cease to accrue salary, personal time off, benefits and other compensation on the date of voluntary termination.  The Company may terminate Ms. Taylor’s employment with or without cause.  If the Company terminates without cause, Ms. Taylor will be entitled to, at the Company’s sole discretion, either (i) monthly salary payments for twelve (12) months, based on her monthly rate of base salary at the date of such termination, or (ii) a lump-sum payment of her salary for such 12 month period, based on her monthly rate of base salary at the date of such termination. Ms. Taylor shall also be entitled to receive (i) payment for accrued and unpaid vacation pay and (ii) all bonuses that time. Underhave accrued during the termsterm of the Employment Agreement, between Susan Jones andbut not been paid.   All non-vested options shall vest immediately.

On March 15, 2011, the Company Ms. Jonessigned an executive employment agreement (the “Employment Agreement”) with Jerry Carollo to serve as the Company’s Senior Vice President Business Development effective March 21, 2011.  Pursuant to the Employment Agreement, Mr. Carollo is paid a base salary of $270,000 and was granted 100,000 options which are exercisable at $6.89 per share, the market price on the date of the grant, of which one third will vest annually on the subsequent three anniversary dates. If Mr. Carollo 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. Carollo’s employment with or without cause.  If the Company terminates without cause, Mr. Carollo will be entitled to the lesser of (i) the total amount of base salary that remains unpaid under the Employment Agreement which shall be paid monthly or (ii) monthly salary payments for twelve (12) months, based on his monthly rate of base salary at the date of such termination, or in lieu of the aforementioned monthly payments, the Company may in its sole discretion pay such payments in a lump- sum. Mr. Carollo 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 eighteenthe Employment Agreement, but not been paid.   All non-vested options shall vest immediately.

The following is a schedule of revenue paid quarterly for a period of eighteen months, continuation of health insurance for twenty four months and a moving allowance for personal effects of $7.5 thousand. In addition, 12,696 unvested options immediately vested and became exercisable upon termination.  As a result, the Company took a one time non-cash compensation charge of $28 thousand in the second quarter of 2010.by geographic location (in thousands):

The Company accounted for the incentive payments under guidance that benefits providedpurchases principally all of its silicon wafers from a single supplier located in accordance with an agreement be recorded as a liability when it is probable that the employee is entitled to the benefits and the amount can be reasonably estimated.  The Company estimated that $440 thousand is a reasonable estimate of the eighteen months of incentive payments and approximately $21 thousand is a reasonable estimate for the continuation of health insurance for twenty four months.  In the second quarter of 2010, the Company recorded a liability of approximately $469 thousand which included the incentive payments, health insurance coverage, and the moving allowance in the condensed consolidated balance sheets and the associated expense as a sales, general and administrative expense in the condensed consolidated state ments of operations.  At September 30, 2010, the Company reviewed the estimates and assessed there was no material change.Taiwan.

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 sta tementsstatements 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 technolo giestechnologies 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 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, market, and marketproduce in significant quantities full-color small molecule OLED-on-silicon microdisplays.

A detailed discussion of our operating expenses are labor related and semi-fixed.business may be found in Part I, “Business,” of our 2010 Annual Report on Form 10-K for the year ended December 31, 2010.

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. 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 and cost-type contracts are generally recognized on the percentage-of-completion method of accounting as costs are incurred (cost-to-cost basis). 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.

We offer a one-year product replacement warranty. In general, our standard policy is to repair or replace the defective products. We accrue for estimated returns of defective products at the time revenue is recognized based on historical activity as well as for specific known product issues. The determination of these accruals requires us to make estimates of the frequency and extent of warranty activity and estimate future costs to replace the products under warranty. If the actual warranty activity and/or repair and replacement costs differ significantly from these estimates, adjustments to cost of revenue may be required in future periods.

 

eMagin maintains several stock equity incentive plans.  The 2005 Employee Stock Purchase Plan (the “ESPP”) provideswould, once implemented, provide our employees with the opportunity to purchase common stock through payroll deductions.  Employees could then purchase stock semi-annually at a price that is 85% of the fair market value at certain plan-defined dates.  As of September 30, 2010,March 31, 2011, the number of shares of common stock available for issuance was 300,000.  As of September 30, 2010,March 31, 2011, 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 grantincentive stock option (“ISO”) is granted at the market value of our common stock at the date of the grant and a non-ISO is granted at a price not to be less than 85% of the market value of the common stock.  These options have a term of up to 10 years and vest over a schedule determined by the Board of Directors, generally over a five year period.  The amended 2003 Plan provides for an annual increase in common stock available for issuance by 3% of the diluted shares outstanding on January 1 of each year for a period of 9 years which commenced January 1, 2005.  For the three and nine months e nded September 30, 2010,ended March 31, 2011, there were 236,200 and 842,5851,094,177 options respectively, granted from thisthe 2003 plan.

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 ninethree months ended September 30, 2010, 10,500March 31, 2011, there were 200,000 options were granted from thisthe 2008 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 9 of the Condensed Consolidated Financial Statements – Stock Compensation for a further discussion on stock-based compensation.

 

See Note 2 ofDuring the Condensed Consolidated Financial Statements in Item 1 for a description of recentthree months ended March 31, 2011, there were no new accounting pronouncements including the expected dates of adoption and estimated effectsthat would have had a material effect on results of operations andour unaudited condensed consolidated financial condition.statements.

 

Revenues for the three and nine months ended September 30, 2010March 31, 2011 were approximately $8.3$5.4 million, and $22.5 million, respectively, as compared to approximately $6.1$5.9 million and $17.1 million, respectively, for the three and nine months ended September 30, 2009, an increaseMarch 31, 2010, a decrease of approximately 36%8%.  Lower revenue for the three month period was due primarily to production issues which caused R&D engineering resources to be allocated to production issues causing a shortfall in work on R&D contracts, and 32%, respectively.  a lower average sales price due to product mix sold.

Product revenue is comprised of sales of displays, Z800 systems, and other hardware.  For the three and nine months ended September 30, 2010,March 31, 2011, product revenue increaseddecreased approximately $1.7 million$176 thousand or 32% and $3.3 million or 23%, respectively,4% as compared to the three and nine months ended September 30, 2009 whichMarch 31, 2010.  The decrease was primarily a result ofdriven by the product mix sold.  We had an increase in customer demand for our OLED microdisplays.sales volume however the average sales price per display was lower than the first quarter of 2010.  In addition, we had unfilled orders during the three months ended March 31, 2011 due to production issues.

Contract revenue is comprised of revenue from research and development or non-recurring engineering (“NRE”) contracts.  For the three and nine months ended September 30, 2010,March 31, 2011, contract revenue increaseddecreased approximately $0.5 million$310 thousand or 56% and $2.1 million or 84%, respectively, as compared to the three and nine months ended September 30, 2009 which was a result of an increase in the number of active projects in the first nine months of 201022% as compared to the first nine monthsquarter of 2009.2010.   We had more active contracts in the first quarter of 2011 however we allocated R&D engineering resources to our production issues which impacted contract revenue.

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 performing onperformance of contracts.  Cost of goods sold for the three and nine months ended September 30, 2010March 31, 2011 was approximately $2.8$3.2 million and $9.0 million, respectively, as compared to approximately $2.6 million and $7.3 million for the three and nine months ended September 30, 2009,March 31, 2010, an increase of approximately $0.2 million  and $1.7 million, respectively,  for the three and nine months ended September, 2010.

The following table outlines product, contract and total gross profit and related gross margins for both the three and nine months ended September 30,March 31, 2011 and 2010 and 2009 (dollars in thousands):

The gross profit for the three and nine months ended September 30, 2010March 31, 2011 was approximately $5.5 million and $13.5$2.2 million as compared to approximately $3.5$3.3 million and $9.8 million for the three and nine months ended September 30, 2009, an increase of $2.0 million and $3.7 million, respectively.  Gross margin was 66 % for the three months ended SeptemberMarch 31, 2010, up from 57%a decrease of $1.1 million.  Gross margin was 41% for the three months ended September 30, 2009.  Gross margin was 60 %March 31, 2011 down from 56% for the ninethree months ended September 2010 up from 57% for the nine months ended September 30, 2009.March 31, 2010.

The product gross profit for the three and nine months ended September 30, 2010March 31, 2011 was approximately $4.8 million and $11.2$1.7 million as compared to approximately $3.3$2.6 million and $8.7 million for the three and nine months ended September, 2009, an increase of $1.5 million and $2.5 million, respectively.  Product gross margin was 70% for the three months ended September 30,March 31, 2010, up from 62%a decrease of $0.9 million.  Product gross margin was 39% for the three months ended September 30, 2009.  ProductMarch 31, 2011 down from 59% for the three months ended March 31, 2010.   The gross margin was 63% for the nine months ended September 30, 2010 up from 60% for the nine months ended September 30, 2009.  Theunfavorably impacted by an increase in product gross profit and gross margin wascosts due to higher sales volumesproduction issues being spread over a lower revenue base and improved product mix resulting in a higherlower effective average selling price in conjunction with lowerper display costs which were a result of the of increased production volume and improved manufacturing utilization.  The higher average selling price was a result of thedue to product mix of products sold which included custom displays with a higher sales price.

The contract gross profit for the three and nine months ended September 30, 2010March 31, 2011 was approximately $0.6 million and $2.3$0.5 million as compared to $0.2 million and $1.0approximately $0.7 million for the three and nine months ended September 30, 2009, an increaseMarch 31, 2010, a decrease of $0.4 million and $1.3 million, respectively.$0.2 million.  Contract gross margin was 48% for the three months ended September 30, 2010March 31, 2011 up slightly from 28%47% for the three months ended September 30, 2009.  Contract gross margin was 49% for the nine months ended September 30, 2010 up from 40% for the nine months ended September 30, 2009.March 31, 2010.   The contract gross margin is dependent upon the mix of costs, internal versus external third party costs, with external third party costs causing a lower gross margin and reducing the contract gross profit.

For the three and nine months ended September 30, 2010,March 31, 2011, interest expense was approximately $21$29 thousand and $79 thousand, respectively, as compared to approximately $76$28 thousand and $417 thousand, respectively, for the three and nine months ended September 30, 2009.March 31, 2010.   For the three and nine months ended September 30, 2010,March 31, 2011, the majority of the interest expense was associated with debt.   The breakdown of the interest expense for the three and nine month period in 2009 is as follows: interest expense associated with debt of approximately $7was $22 thousand and $48 thousand, respectively, and the amortization of the deferred costs associated with the debtaccrued interest on liquidated damages was $62 thousand and $362 thousand, respectively.   The decrease in interest$7 thousand. Interest expense for the three and nine months ended September 30,March 31, 2010, as compared to the threeinterest expense associated with debt was $21 thousand and nine months ended September 30, 2009the accrued interest on liquidated damages was primarily a result of the Company not having any outstanding debt.$7 thousand.    

Other income for the three and nine months ended September 30, 2010March 31, 2011 was approximately $2 thousand and $10$16 thousand as compared to $1 thousand and $41$7 thousand for the three and nine months ended September 30, 2009.March 31, 2010.  The other income for the three and nine months ended September 30, 2010March 31, 2011 was interest income of approximately $2$4 thousand and $4$12 thousand respectively, and $0 and $6 thousand, respectively, from equipment salvage.  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 $0 and $38 thousand, respectively, for a settlement of a liability.from equipment salvage.  

 

Cash flow provided by operating activities during the ninethree months ended September 30,March 31, 2011 was approximately $0.8 million, approximately $0.6 million was from the change in operating assets and liabilities and net non-cash expenses of $0.5 million offset by the net loss of $0.3 million.  Cash flow provided by operating activities during the three months ended March 31, 2010 was approximately $6.6$1.5 million, attributable to our net income of approximately $4.6$0.9 million, non-cash expenses of $1.2$0.3 million and approximately $0.8 million from the change in operating assets and liabilities.  Cash flow provided by operating activities during the nine months ended September 30, 2009 was approximately $3.5 million, attributable to our net income of approximately $2.9 million, non-cash expenses of $1.1 million and approximately $0.6$0.3 million from the change in operating assets and liabilities. 

Cash used in investing activities during the ninethree months ended September 30, 2010March 31, 2011 was approximately $5.8$0.9 million to purchaseof which $0.6 million purchased CDs and approximately $0.3 million for equipment of $2.3 million and purchase certificates of deposit (“CDs”) of $3.5 million.purchases primarily for upgrading our production line.  Cash used in investing activities during the ninethree months ended September 30, 2009March 31, 2010 was approximately $0.5$0.8 million to purchase equipment.equipment for the Company’s production line.

Cash provided by financing activities during the ninethree months ended September 30, 2010March 31, 2011 was approximately $0.6was $0.1 million, representing proceeds from the exercise of stock options and warrants. CashThere was no cash provided by or used by financing activities during the ninethree months ended September 30, 2009 was approximately $1.7 million to pay down the line of credit.March 31, 2010.  

Not applicable.

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 Rule 13a-15 under the Securities Exchange Act of 1934 (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 concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and 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 have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were sufficiently effective to provide reasonable assurance that the objectives of our disclosure control system were met.

There were no changes in our internal controls over financial reporting during the fiscal quarter ended September 30, 2010March 31, 2011 that have materially affected, or are 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, 2009.2010.  There were no material changes from the risk factors during the ninethree months ended September 30, 2010.March 31, 2011.

None.

None.

 

(1)  Filed herewith.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on this 12th day of November 2010.May 2011.