Note 1: Summary of Significant Accounting Policies

The Business

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.

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. All significant intercompany balances and transactions have been eliminated in consolidation. 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, 2011. The results of operations for the period ended September 30, 2012 are not necessarily indicative of the results to be expected for the full year. The consolidated condensed financial statements of December 31, 2011 are derived from audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

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 related to, among others, allowance for doubtful accounts, warranty reserves, inventory reserves, stock-based compensation expense, deferred tax asset valuation allowances, litigation and other loss contingencies. 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. 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 research and development (“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). Progress is generally based on a cost-to-cost approach however an alternative method may be used such as physical progress, labor hours or others depending on the type of contract. Physical progress is determined as a combination of input and output measures as deemed appropriate by the circumstances. 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.

Recently Issued Accounting Pronouncements

There are no recently issued accounting pronouncements that are expected to have a material impact on the Company’s consolidated results of operations, financial position and cash flows.

Investments

Investments consist of debt securities including corporate obligations and FDIC-insured certificates of deposit with maturities up to eighteen months. The Company classifies these securities as held-to-maturity since it has the positive intent and ability to hold them until maturity. These securities are carried at amortized cost.

The held-to-maturity investments consist of the following as of September 30, 2012 and December 31, 2011(in thousands):


	September 30, 2012				December 31, 2011
	Amortized Cost	Gross Unrecognized Gains	Gross Unrecognized Losses	Aggregate Fair Value	Amortized Cost	Gross Unrecognized Gains	Gross Unrecognized Losses	Aggregate Fair Value
Current investments:

Corporate debt securities	$ 1,267	$—	$—	$ 1,267	$—	$—	$—	$—

Long-term investments:

Corporate debt securities	$ 261	$—	$—	$ 261	$—	$—	$—	$—

The current investments mature within one year and the long-term investments mature between one and two years.

Net Income per Common Share

Basic income per share is computed using the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of common stock equivalent shares, such as stock options, warrants, and convertible preferred stock. Diluted income per share is computed using the weighted average number of common shares outstanding and potentially dilutive common stock equivalent shares outstanding during the period. Common stock equivalent shares are excluded from the computation if their effect is anti-dilutive.

The Company’s Series B Convertible Preferred stock (“Preferred Stock – Series B”) is considered a participating security as the preferred stock participates in dividends with the common stock, which requires the use of the two-class method when computing basic and diluted earnings per share. The Preferred Stock – Series B is not required to absorb any net loss. The Company does not intend to pay dividends on its common or preferred stock.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share and per share data):



		Three Months Ended					Three Months Ended
		September 30, 2012					September 30, 2011
		(unaudited)					(unaudited)
		Income	Shares		Per Share Amount		Income	Shares		Per Share Amount
Basic EPS
Net Income	$	340				$	4,119
Income allocated to participating securities	$	83				$	1,015
Income allocated to common shares	$	257	23,444,361	$	0.01	$	3,104	23,084,229	$	0.13
Diluted EPS
Less: Change in fair value of warrant liability allocated to common shares		—					2,268
Diluted potential common shares (1)			1,948,674					2,238,691
Income allocated to common shares	$	257	25,393,035	$	0.01	$	836	25,322,920	$	0.03



		Nine Months Ended					Nine Months Ended
		September 30, 2012					September 30, 2011
		(unaudited)					(unaudited)
		Income	Shares		Per Share Amount		Income	Shares		Per Share Amount
Basic EPS
Net Income	$	466				$	3,752
Income allocated to participating securities	$	113				$	954
Income allocated to common shares	$	353	23,473,770	$	0.02	$	2,798	22,153,525	$	0.13
Diluted EPS
Less: Change in fair value of warrant liability allocated to common shares		—					2,247
Diluted potential common shares (1)			1,887,094					3,488,580
Income allocated to common shares	$	353	25,360,864	$	0.01	$	551	25,642,105	$	0.02

(1) Dilutive potential common shares consist of stock options and warrants.

For the three and nine months ended September 30, 2012, there were stock options and warrants to acquire 2,657,398 and 3,024,398 shares, respectively, of the Company’s common stock which were excluded from the computation of its diluted earnings per share as their effect would be antidilutive.

For the three and nine months ended September 30, 2011, there were stock options outstanding to acquire 1,545,086 and 1,463,086 shares of the Company’s common stock which were excluded from the computation of its diluted earnings per share as their effect would be antidilutive.