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PART I   FINANCIAL INFORMATION
Item 1	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008	3
	Condensed Consolidated Statements of Operations for the Three Months ended March 31, 2009 and 2008 (unaudited)	4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Months ended March 31, 2009 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2009 and 2008 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4T	Controls and Procedures	17
PART II OTHER INFORMATION
Item 1	Legal Proceedings	18
Item 1A	Risk Factors	18
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	18
Item 3	Defaults Upon Senior Securities	18
Item 4	Submission of Matters to a Vote of Security Holders	18
Item 5	Other Information	18
Item 6	Exhibits	18
SIGNATURES		19
CERTIFICATIONS

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 (Unaudited)

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

The Business

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

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of eMagin Corporation and its subsidiary reflect all adjustments, including normal recurring accruals, necessary for a fair presentation.  Certain information and footnote disclosure normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States 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, 2008.  The results of operations for the period ended March 31, 2009 are not necessarily indicative of the results to be expected for the full year.

Reclassifications

Certain items in the prior period’s condensed consolidated financial statements have been reclassified to conform to the current period’s presentation.

Use of Estimates

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

Revenue and Cost Recognition

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

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

Research and Development Costs

Research and development costs are expensed as incurred.

 

 

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Note 2:  Recently Issued Accounting Pronouncements

 In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires entities to provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. SFAS 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application permitted. The adoption of SFAS 161 did not have a material impact on the Company’s condensed consolidated financial statements.

In June 2008, the FASB ratified EITF No. 07-5, "Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity's Own Stock " ("EITF 07-5"). EITF 07-5 provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and must be applied to all instruments outstanding on the date of adoption.  The adoption of EITF 07-5 did not have a material impact on the Company’s condensed consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position SFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” which requires disclosures about fair value of financial instruments in interim financial information for periods ending after June 15, 2009. The Company believes the adoption of this Staff Position will not have a material impact on our condensed consolidated financial statements.

Note 3:  Receivables

 

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

The Company determines the allowance for doubtful accounts by considering a number of factors, including the length of time the trade accounts receivable are past due, 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):

		March 31, 2009  (unaudited)				December 31, 2008
Accounts receivable		$	3,692			$	4,500
Less allowance for doubtful accounts			(742	)			(857	)
Net receivables		$	2,950			$	3,643

 

 

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Note 4:  Net Income (Loss) per Common Share

In accordance with SFAS No. 128, net income (loss) per common share amounts ("basic EPS") is computed by dividing net income (loss) by the weighted average number of common shares outstanding and excluding any potential dilution.  Net income (loss) per common share assuming dilution ("diluted EPS") is computed by reflecting potential dilution from the exercise of stock options, warrants, convertible preferred stock and redeemable stock.

 

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

		Three Months Ended March 31,
		2009				2008
Numerator:
Net income (loss)		$	394			$	(2,674	)
Denominator:
Weighted average shares outstanding for basic earning per share			15,860,517				12,620,900
Effective of dilutive shares:
Dilution from stock options and warrants			120,540				—
Redeemable stock			266,198				—
Convertible preferred stock			7,652,000				—
Dilutive potential common shares			8,038,738				—
Weighted –average shares outstanding for diluted earnings per share			23,899,255				12,620,900

For the three months ended March 31, 2009 and 2008, the Company has excluded options, warrants, convertible notes outstanding, and convertible preferred stock to acquire 20,427,204 and 10,359,106 shares of our common stock, respectively, since their effect would be anti-dilutive.

The Company excludes options and warrants with exercise prices that are greater than the average market price from the calculation of diluted EPS whose effect would be anti-dilutive.  For the three months ended March 31, 2009, the Company excluded 12,775,204 options and warrants from its diluted EPS calculation as their effect would be anti-dilutive.

The Company issued 522,500 shares of common stock which are redeemable.  As all of the 522,500 shares are “in the money”, 266,198 incremental shares are included as dilutive shares.

The convertible preferred stock is convertible at the option of the holders into common stock.  The convertible preferred stock does not pay interest or dividends.  The convertible preferred stock is included in the calculation of diluted earnings per share as all shares are assumed converted.

Note 5:  Inventory

Inventory is stated at the lower of cost or market. Cost is determined using the first-in first-out method.  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):

		March 31, 2009  (unaudited)				December 31, 2008
Raw materials		$	1,085			$	1,109
Work in process			163				280
Finished goods			966				985
Total inventory		$	2,214			$	2,374

 

 

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Note 6:  Prepaid Expenses and Other Current Assets:

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

 

		March 31, 2009  (unaudited)				December 31, 2008
Vendor prepayments		$	466			$	180
Other prepaid expenses *			767				383
Other assets			—				233
Total prepaid expenses and other current assets		$	1,233			$	796

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

Note 7:  Debt

Debt is as follows (in thousands):

 

		March 31, 2009 (unaudited)				December 31, 2008
Line of credit, net of deferred debt issuance costs		$	632			$	1,631
Other debt			50				60
Total debt, net		$	682			$	1,691

The total debt will mature on or before December 31, 2009.  In the three months ended March 31, 2009, approximately $150 thousand of deferred debt issuance costs were amortized to interest expense.  For the three months ended March 31, 2009, interest expense includes interest paid or accrued of $25 thousand on outstanding debt.

The Company renewed its loan agreement with Moriah Capital, L.P. in August 2008 and the maturity date on its line of credit is August 7, 2009.  As of March 31, 2009, the Company was in compliance with the financial covenants of the loan agreement.

Note 8:  Stock-based Compensation

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

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

		Three Months Ended March 31,
		2009				2008
Cost of revenue		$	24			$	52
Research and development			58				82
Selling, general and administrative			71				222
Total stock compensation expense		$	153			$	356

 

At March 31, 2009, total unrecognized compensation costs related to stock options was approximately $0.5 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 1.2 years.  

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

 

 

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During the three month period ended March 31, 2009, there were no stock options granted to employees and directors.  During the three month period ended March 31, 2008, the Company granted 160,000 stock options to employees and directors.  The following key assumptions were used in the Black-Scholes option pricing model to determine the fair value of stock options granted:

 

		For the Three Months Ended March 31, 2008
Dividend yield			0	%
Risk free interest rates			2.46 – 2.82	%
Expected  volatility			90.9 – 92.3	%
Expected term (in years)			5

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.

 

The 2008 Incentive Stock Plan (“the 2008 Plan”) adopted and approved by the Board of Directors on November 5, 2008 provides for  shares of common stock and options to purchase shares of common stock to employees, officers, directors and consultants.  The 2008 Plan has an aggregate of 2,000,000 shares.  As of March 31, 2009, no options were granted from this plan.

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

 

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (In Years)				Aggregate Intrinsic Value
Outstanding at January 1, 2009			1,615,673			$	1.63
Options granted			—
Options exercised			—
Options forfeited			(290	)			2.60
Options cancelled			—
Outstanding at March 31, 2009			1,615,383			$	1.63				6.18			$	2,640
Vested or expected to vest at March 31, 2009 (1)			1,569,799			$	1.50				6.18			$	2,376
Exercisable at March 31, 2009			1,159,546			$	1.80				6.34			$	—

(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 8,000 options in-the-money at March 31, 2009.   The Company’s closing stock price was $0.67 as of March 31, 2009. The Company issues new shares of common stock upon exercise of stock options.

 

 

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Note 9:  Shareholders’ Equity

Preferred Stock - Series B Convertible Preferred Stock (“the Preferred Stock – Series B”)

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

Common Stock

For the three months ended March 31, 2009 and 2008, there were no stock options or warrants exercised.

For the three months ended March 31, 2009, the Company issued approximately 216,000 shares of common stock for payment of approximately $115 thousand for services rendered and to be rendered in the future.  For the three months ended March 31, 2008, the Company did not issue any shares of common stock for payment of services rendered or 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 statement of operations for the three months ended March 31, 2009.

Note 10:  Income Taxes

The Company adopted the provisions of Financial Standards Accounting Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109 (“SFAS 109”), on January 1, 2007. As a result of the implementation of FIN 48, we did not recognize any adjustment in the liability for unrecognized income tax benefits. The tax years 2005-2008 remain open to examination by the major taxing jurisdictions to which we are subject. In the event that the Company is assessed interest or penalties at some point in the future, they will be classified in the financial statements as general and administrative expense.

 

Note 11:  Commitments and Contingencies

Royalty Payments

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

 

Effective May 30, 2007, Kodak and eMagin entered into an intellectual property agreement where eMagin has assigned Kodak the rights, title, and interest to a Company owned patent currently not being used by the Company and in consideration, Kodak waived the royalties due under existing licensing agreements for the first six months of 2007, and reduced the royalty payments by 50% for the second half of 2007 and for the entire calendar year of 2008. In addition, the minimum royalty payment was delayed until December 1st for the years 2007 and 2008.  The Company recorded approximately $84 thousand for the three months ended March 31, 2008 as income from the license of intangible assets and included this amount as other income in the condensed consolidated statements of operations.

Effective January 1, 2009, the Company royalty payments are back to 100%.  The minimum royalty payment of $125 thousand was paid in January 2009.

Royalty expense was approximately $308 thousand and $168 thousand, respectively, for the three months ended March 31, 2009 and 2008.

 

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Contractual Obligations

The Company leases office facilities and office, lab and factory equipment under operating leases expiring through 2009.  Certain leases provide for payments of monthly operating expenses. The Company currently has lease commitments for office space in Bellevue, Washington which will expire August 31, 2009.  The Company is currently reviewing potential office spaces for lease.  The Company is currently in negotiations to extend the lease on its space in Hopewell Junction, New York which expires May 31, 2009.  Rent expense was approximately $332 thousand for the three months ended March 31, 2009 and 2008.

Note 12:  Legal Proceedings

 A former employee (“Plaintiff”) of the Company commenced legal action in the United States District Court for the Southern District of New York, on or about October 12, 2007, alleging that the plaintiff was subject to gender based discrimination and retaliation in violation of Title VII of the Civil Rights Act of 1964 (Case No. 07-CV-8827 (KMK).  The plaintiff sought unspecified compensatory damages, punitive damages and attorneys’ fees.   The Company and the plaintiff have settled this action in April 2009.  This settlement did not have a material effect on the Company’s results from operations.

Note 13:  Subsequent Events

On May 8, 2009 (the “Effective Date”), the Company and Paul Campbell entered in an Employment Agreement (the “Employment Agreement”).  Pursuant to the Employment Agreement, Mr. Campbell, who is currently serving as the Company’s interim Chief Financial Officer, will serve as the Company’s Chief Financial Officer, Senior Vice President and Treasurer.  The Employment Agreement terminates 36 months from the Effective Date.  Pursuant to the Employment Agreement, Mr. Campbell’s salary is $282,000 per annum.  The Company’s board may also award a bonus to Mr. Campbell.  Pursuant to the Employment Agreement, the Company shall issue Mr. Campbell options to purchase up to 340,000 shares of the Company’s common stock, which are exercisable at $1.09 per share, the market price on the date of grant.  The options vest as follows:  one third of the options vest as of the Effective Date, one third of the options vest on the first anniversary of the Employment Agreement and one third of the options vest on the second anniversary of the Employment Agreement.

In connection with the employment of Paul Campbell, the Company is entering into an agreement with Tatum LLC (“Tatum”).  Pursuant to the agreement with Tatum, the Company will pay Tatum a signing fee of $97,700 and shall pay Tatum $1,000 per month for as long as Mr. Campbell is employed by eMagin.  In addition, the Company will grant Tatum 60,000 options with the same vesting and exercise price as Mr. Campbell's and will pay Tatum 15% of any cash bonus that is paid to Mr. Campbell.

 

 

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