Management's Discussion and Analysis of
Financial Condition and Results of Operations

Critical Accounting Policies

The following accounting policies are important to understanding our financial condition and results of operations and should be read as an integral part of the discussion and analysis of the results of our operations and financial position. For additional accounting policies, see note 2 to our consolidated financial statements, "Summary of Significant Accounting Policies" contained in the Company's Annual Report on Form 10-K.

The Company has entered into a number of license agreements covering potential products using the Company's SPD technology. The Company receives minimum annual royalties under certain license agreements and records fee income on a ratable basis each quarter. In instances when sales of licensed products by its licensees exceed minimum annual royalties, the Company recognizes fee income as the amounts have been earned. Certain of the fees are accrued by, or paid to, the Company in advance of the period in which they are earned resulting in deferred revenue.

The Company expenses costs relating to the development or acquisition of patents due to the uncertainty of the recoverability of these items.

All of our research and development costs are charged to operations as incurred. Our research and development expenses consist of costs incurred for internal and external research and development. These costs include direct and indirect overhead expenses.

The Company has historically used the Black-Scholes option- pricing model to determine the estimated fair value of each option grant. The Black-Scholes model includes assumptions regarding dividend yields, expected volatility, expected lives, and risk-free interest rates. These assumptions reflect our best estimates, but these items involve uncertainties based on market conditions generally outside of our control. As a result, if other assumptions had been used in the current period, stock-based compensation expense could have been materially impacted. Furthermore, if management uses different assumptions in future periods, stock-based compensation expense could be materially impacted in future years.

On occasion, the Company may issue to consultants either options or warrants to purchase shares of common stock of the Company at specified share prices. These options or warrants may vest based upon specific services being performed or performance criteria being met. In accordance with Emerging Issues Task Force Issue 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, the Company would be required to record consulting expenses based upon the fair value of such options or warrants on the date that such options or warrants vest as determined using a Black- Scholes option pricing model. Depending upon the difference between the exercise price and the market price of the Company's common stock on the date that such options or warrants vest, the amount of non-cash expenses that could be recorded as a result of the vesting of such options or warrants can be material.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us 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, and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. An example of a critical estimate is the full valuation allowance for deferred taxes that was recorded based on the uncertainty that such tax benefits will be realized in future periods.

Results of Operations for the Nine Month Periods Ended September 30, 2008 and 2007

The Company's fee income from licensing activities for the first nine months of 2008 was $1,476,131 as compared to $237,810 for the first nine months of 2007. This difference in fee income was primarily due to the receipt of a one-time payment from a former licensee in full settlement of past due minimum annual royalties for several years, the timing and amount of minimum annual royalties paid, and the date of receipt of such payment on certain license agreements, by end-product licensees, and the Company entering into an agreement in 2007 with Hitachi Chemical regarding payments made by Hitachi Chemical to the Company for guaranteed access to future improvements in the Company's technology. Certain license fees, which are paid to the Company in advance of the accounting period in which they are earned resulting in the recognition of deferred revenue for the current accounting period, will be recognized as fee income in future periods. Also licensees may offset some or all of their royalty payments on sales of licensed products for a given period by applying these advance payments towards such earned royalty payments. Because the Company's license agreements typically provide for the payment of royalties by a licensee on product sales within 45 days after the end of the quarter in which a sale of a licensed product occurs (with some of the Company's more recent license agreements providing for payments on a monthly basis), and because of the time period which typically will elapse between a customer order and the sale of the licensed product and installation in a home, office building, automobile, aircraft, boat, or any other product, there could be a delay between when economic activity between a licensee and its customer occurs and when the Company gets paid its royalty resulting from such activity.

Operating expenses decreased by $1,580,013 for the first nine months of 2008 to $2,263,206 from $3,843,219 for the first nine months of 2007. This decrease was principally the result of decreased non-cash charges to operating expenses ($1,587,000) resulting from the expensing of options granted during the first and third quarters of 2007, lower payroll ($130,000) and marketing expenses ($39,000), partially offset by higher patent costs ($68,000) and professional fees ($40,000).

Research and development expenditures decreased by $735,947 to $1,039,526 for the first nine months of 2008 from $1,775,473 for the first nine months of 2007. This decrease was principally the result of decreased non-cash charges to research and development expenses ($789,000) resulting from the expensing of options granted during the first and third quarters of 2007 to the Company's scientific personnel, as well as lower material costs ($95,000) partially offset by higher payroll ($89,000), insurance ($25,000) and consulting expenses ($17,000), and higher allocated rent and building maintenance costs ($15,000).

The Company's net investment income for the first nine months of 2008 was $135,268, as compared to net investment income of $246,482 for the first nine months of 2007. This difference was primarily due to lower cash balances available to invest as well as lower interest rates.

As a consequence of the factors discussed above, the Company's net loss was $1,691,333 ($0.11 per common share) for the first nine months of 2008 as compared to $5,134,400 ($0.34 per common share) for the first nine months of 2007. The difference is primarily due to higher non-cash charges of $2,376,000 resulting from the issuance of stock options during the first and third quarters of 2007 as well as $1,238,000 in higher fee income.

Results of Operations for the Three Month Periods Ended September 30, 2008 and 2007

The Company's fee income from licensing activities for the third quarter of 2008 was $1,171,187 as compared to $150,809 for the third quarter of 2007. This difference in fee income was primarily due to the receipt of a one-time payment from a former licensee in full settlement of past due minimum annual royalties for several years, the timing and amount of minimum annual royalties paid, and the date of receipt of such payment on certain license agreements, by end-product licensees, and the Company entering into an agreement in 2007 with Hitachi Chemical regarding payments made by Hitachi Chemical to the Company for guaranteed access to future improvements in the Company's technology. Certain license fees, which are paid to the Company in advance of the accounting period in which they are earned resulting in the recognition of deferred revenue for the current accounting period, will be recognized as fee income in future periods. Also, licensees may offset some or all of their royalty payments on sales of licensed products for a given period by applying these advance payments towards such earned royalty payments. Because the Company's license agreements typically provide for the payment of royalties by a licensee on product sales within 45 days after the end of the quarter in which a sale of a licensed product occurs (with some of the Company's more recent license agreements providing for payments on a monthly basis), and because of the time period which typically will elapse between a customer order and the sale of the licensed product and installation in a home, office building, automobile, aircraft, boat, or any other product, there could be a delay between when economic activity between a licensee and its customer occurs and when the Company gets paid its royalty resulting from such activity.

Operating expenses decreased by $1,084,768 for the third quarter of 2008 to $754,739 from $1,839,507 for the third quarter of 2007. This decrease was principally the result of decreased non-cash charges to operating expenses ($1,200,000) resulting from options granted for the third quarter of 2007, partially offset by higher patent costs ($69,000).

Research and development expenditures decreased by $582,576 to $294,565 for the third quarter of 2008 from $877,141 for the second quarter of 2007. This decrease was principally the result of decreased non-cash charges to research and development expenses ($548,000), lower materials costs ($76,000) partially offset by higher payroll expenses ($25,000) and higher insurance costs ($7,000).

The Company's net investment income for the third quarter of 2008 was $34,772, as compared to net investment income of $95,558 for the third quarter of 2007. This difference was primarily due to lower cash balances available to invest as well as lower interest rates.

As a consequence of the factors discussed above, the Company's net income was $156,655 ($0.01 per common share) for the third quarter of 2008 as compared to a net loss of $2,470,281 ($0.16 per common share) for the third quarter of 2007. The difference is primarily due to lower non-cash charges of $1,748,000 resulting from the issuance of stock options during the third quarter of 2007 as well as $1,020,000 in higher fee income.

Financial Condition, Liquidity and Capital Resources

During the first nine months of 2008, the Company's cash and cash equivalent balance decreased by $4,825,595 principally as a result of the net investment in US Treasury Securities of $3,032,389 as well as cash used to fund the Company's operating activities of $1,642,598. At September 30, 2008, the Company had working capital of $5,416,999 and its shareholders' equity was $5,751,456.

The Company occupies premises under an operating lease agreement which expires on January 31, 2014 and requires minimum annual rent which rises over the term of the lease to approximately $138,269.

The Company expects to use its cash to fund its research and development of SPD light valves and for other working capital purposes. The Company's working capital and capital requirements depend upon numerous factors, including the results of research and development activities, competitive and technological developments, the timing and cost of patent filings, the development of new licensees and changes in the Company's relationships with its existing licensees. The degree of dependence of the Company's working capital requirements on each of the foregoing factors cannot be quantified; increased research and development activities and related costs would increase such requirements; the addition of new licensees may provide additional working capital or working capital requirements, and changes in relationships with existing licensees would have a favorable or negative impact depending upon the nature of such changes. Based upon existing levels of cash expenditures, existing cash reserves and budgeted revenues, the Company believes that it would not require additional funding until the second quarter of 2010. There can be no assurance that expenditures will not exceed the anticipated amounts or that additional financing, if required, will be available when needed or, if available, that its terms will be favorable or acceptable to the Company. Eventual success of the Company and generation of positive cash flow will be dependent upon the extent of commercialization of products using the Company's technology by the Company's licensees and payments of continuing royalties on account thereof.