UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 20042005

Commission file number    0-21221

Microvision, Inc.
(Exact name of Registrant as Specified in its Charter)

 

Delaware	91-1600822
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

19910 North Creek Parkway6222 185th Avenue NE
Bothell,Redmond, Washington    98011-300898052
(Address of Principal Executive Offices including Zip Code)

(425) 415-6847
(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Act). Yeso Nox

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso Nox

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant'sregistrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.¨x

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):

Large accelerated filer   o          Accelerated filer   x          Non-accelerated filer   o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes oNox    No  ¨

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 20042005 was approximately $175,047,000$106,307 (based on the closing price for the registrant's Common Stock on the NasdaqNASDAQ National Market of $8.40$5.10 per share).

The number of shares of the registrant's Common Stock outstanding as of March 1, 20052006 was 21,481,000.

Documents Incorporated by Reference

Portions of the registrant's definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A in connection with the Registrant's Annual Meeting of Shareholders to be held on June 30, 20052006 are incorporated herein by reference into Part III of this report.

PDF provided as courtesy

Microvision, Inc.
20042005 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

Part I.		Page
Item 1.	Description of Business	**
Item 1A.	Risk Factors	**
Item 1B.	Unresolved Staff Comments	**
Item 2.	Properties	**
Item 3.	Legal Proceedings	**
Item 4.	Submission of Matters to a Vote of Security Holders	**
Part II.
Item 5.	Market for Registrant's Common Stock and Related Stockholder Matters	**
Item 6.	Selected Financial Data	**
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	**
Item 7a.	Quantitative and Qualitative Disclosures About Market Risks	**
Item 8.	Financial Statements and Supplementary Data	**
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	**
Item 9A.	Controls and Procedures	**
Item 9B.	Other Information	**
Part III.
Item 10.	Directors and Executive Officers	**
Item 11.	Executive Compensation	**
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	**
Item 13.	Certain Relationships and Related Transactions	**
Item 14.	Principal Accounting Fees and Services	**
Part IV.
Item 15.	Exhibits, Financial Statement Schedules	**
Signatures		**

Portions of the registrant's definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A in connection with the Registrant's Annual Meeting of Shareholders to be held on June 30, 2005 are incorporated herein by reference into Part III of this report.

PART I

Preliminary Note Regarding Forward-Looking Statements

The information set forth in this report in Item 1 "Description of Business""Business" and in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is subject to the safe harbor created by that section.those sections. Such statements may include, but are not limited to, projections of revenues, income or loss, capital expenditures, plans for product development and cooperative arrangements, future operations, financing needs or plans of the Company, as well as assumptions relating to the foregoing. The words "believe," "expect," "will," "anticipate," "estimate," "target," "project," "plan," and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Certain factors that realistically could cause actual results to differ materially from those projected in the forward-looking statements are set forth in Item 1 "Description of Business - Risk1A. "Risk Factors RelatedRelating to the Company'sMicrovision Business."

ITEM 1. DESCRIPTION OF BUSINESS

Overview

The company has historically included both Microvision, Inc. ("Microvision" or the "Company") and Lumera Corporation ("Lumera"), a subsidiary that was consolidated prior to July 2004. In July 2004, Lumera completed an initial public offering of its common stock. After July 2004, due to the change in ownership percentage, Microvision changed to the equity method of accounting for its investment in Lumera. Microvision designs and markets informationscanned beam display and image capture products.

Scanned Beam Displays

Microvision is producing and selling the Nomad® Expert Technician System, a wireless, wearable computer with a head-worn see-through display. Microvision introduced this second generation version of the Nomad Augmented Vision System in March 2004 and is initially targeting the automotive repair market and military applications. Microvision has also developed prototype color scanned beam displays, including hand-held, head-worn and projection versions, and is currently refining and further developing its scanned beam display technology for potential automotive, defense, aerospace, industrial, medical and consumer applications. Microvision also produces and sells the Nomad® Expert Technician System, a wireless, wearable computer with a head-worn see-through display. The Nomad is targeted at truck and automotive repair and military applications. Microvision believes the scanned beam display technology may be useful in a variety of applications, including mobile communications, head-up displays for vehicles, entertainment and consumer displays, and computing and visual simulation applications. Microvision expects that, in contrast to display solutions that use non- scanningnon-scanning technologies, its scanned beam display technology will enable the production of high quality displays that are small and lightweight, use low power, can be held or worn comfortably, and are competitively priced.

Microvision's scanned beam technology portfolio includes a combination of proprietary technology it has developed, technology licensed from other companies and the Virtual Retinal Display ™ technology licensed from the University of Washington.

Image Capture Devices

Microvision has also developed and sells the Flic® Laser Bar Code Scanner, a hand-held bar code scanner products that usesuse its proprietary scanning technology. Microvision has introduced a Bluetooth wireless version, the Flic Cordless Laser Bar Code Scanner. Microvision believes that some of the basic scanning components of the scanned beam display technology may also be used to develop image capture products, such as miniature high-resolution laser cameras and 1D and 2D bar code readers that may have higher performance and lower cost than those currently available.available in the market.

Display Technology

Microvision's scanned beam display technology is fundamentally different from existing commercialized display technologies in that it uses a fast-moving beam of light to create an image. By continuously scanning a rapidly moving low power beam of light, theThe scanned beam display creates a high resolution, full motion image inat the eye or on an intermediate surface when projected onto a screen.

The drive electronics of the scanned beam display acquire and process signals from the image or data source to control and synchronize the color mix and placement.placement of individual picture elements (pixels). Color pixels are generated by combining modulated red, green and blue light sources. The intensity of each of the light sources is varied to generate a complete palette of colors and shades. Optical elements direct the beam of light intotoward the viewer's eye or onto an intermediate screen.a screen depending on the application. The pixels are arranged by a repetitive horizontal scanner motion that rapidly sweeps the light beam to place the pixels into a row and arows; vertical scanner motion that moves the light beam up/downward to points where successive rows of pixels are drawn. This process is continued until an entire field of rows has been placed and a full image appears to the user.

The scannedScanned beam technology can be used to create an augmented vision display that allows the user to annotate the user's normal view with electronically displayed information. The useruser's vision is able to retain full binocular vision andunobstructed, allowing full hand-eye coordination while having access to electronic information that is displayed on the user's field of view. The image, in the form of light, is directed to the eye in much the same way as light is commonly reflected from our natural environment. With the scanned beam technology an image can be overlaid on a user's field of view.

The scannedScanned beam display technology can also be used to achieve a more conventional front or rear projection display. The screen may be transparent, providing for example, the user with a head-up display capability and overlayingthat overlays the digital information on the view of the outside world. Projection could be used for head-up display applications that demand high brightness, high-resolution and long life in a rugged environment, such as automotive displays. Scanned beam display technology could also be incorporated into other products such as video projectors, large-screen monitors, or rear-projection televisions.

Display Components

Scanned beam display technology consists of the following primary components:

Scanners. To produce an image, a horizontal and a vertical scanner orThe Company uses a single micro-electro- mechanicalmicro-electro-mechanical system ("MEMS") bi-axial scanner directsto direct the light beam that creates the image. Microvision currently uses these scanners in Nomadits commercial display products and in other prototype displays. Microvision expects to continue development to reduce the size, cost and power consumption of the bi-axial MEMS scanner for use in miniature displays. Microvision believes its MEMS scanning technology is a key technical asset and its MEMS design capability is a core competence. The Company believes that it has a leading position in the development and supply of optical MEMS technology that provides it with a competitive advantage in the marketplace.

Continued development of the scanning sub-system will be required to allow scanning capability to meet standard video formats, including high definition television, HDTV, as well as new digital video standards.

Optics. For applications where the scanned beam display is to be worn, it is desirable to have an exit pupil (the range within which the viewer's eye can move and continue to see the image) of 10 to 15 millimeters. Microvision has developed optics and system designs that produce exit pupils up to 15 millimeters. Additional design and engineering of the optics and systems designs will improve Microvision's competitive position for commercial applications. Microvision has refined optics designs for both monocular (one-eye) and biocular (two-eye) systems. Microvision also has developed a full binocular system, which incorporates two separate video channels (one for each eye) to provide the user with full stereoscopic viewing of three-dimensional imagery. Microvision's ongoing optics development is directed at the creation of optical systems that exhibit lower distortion, are lighter weight and are more cost-effective to manufacture than previous optical systems.

Light Sources. The light source creates the light beam that paints the image on a screen or on the viewer's eye. In a full-color scanned beam display, red, green and blue light sources are modulated and mixed to generate the desired color and brightness. Low power solid-state lasers, laser diodes and light-emitting diodes are suitable light sources for the scanned beam display. Blue and green solid-state lasers are currently available but are useful only for scanned beam display applications where cost and size are less important. Miniaturized laser diodes are commercially available in red, and a number of companies are developing blue laser diodes in anticipation of high volume consumer electronics applications. Miniaturized light-emitting diodes are less expensive and consume less power than laser diodes. Microvision is working with companies that have developed custom red, blue and green light-emitting diodes that provide sufficient brightness for many scanned beam display applications. Microvision has built working prototype full- color scanned beam displays with these light-emitting diodes.

Microvision expects to continue using laser diodes for augmented vision and projection display applications that require enhanced brightness. Microvision intends to rely on third party developments or to contract with other companies to continue development of the desired wavelengths of blue and green laser diodes.

Drive Electronics. The drive electronics of the scanned beam display are the components that convert an image to a signal to drive the light sources and scanner to create the image. Microvision has identifiedis undertaking efforts in three areas where additional development of the drive electronics is necessary:

• Further miniaturization using integrated circuits or ASICs and improved packaging techniques,
• Refining the techniques of driving the light sources and scanners to improve display quality and reduce power consumption and,
• Improving the compatibility of the drive electronics with existing and emerging video standards. Microvision's current product and demonstration units are compatible with North American video format standards and accommodate output from most personal computers.

Human Factors, ErgonomicsLight Sources. The light source creates the light beam that paints the image on a screen or on the viewer's eye. In a full-color scanned beam display, red, green and Safetyblue light sources are modulated and mixed to generate the desired color and brightness. Low power solid-state lasers, laser diodes and light- emitting diodes are suitable light sources for the scanned beam display. Blue and green solid-state lasers are currently available but are useful only for scanned beam display applications where cost and size are less important. Miniaturized laser diodes are commercially available in red, and a number of companies are developing blue laser diodes in anticipation of high volume consumer electronics applications. Microvision is working with companies that have developed suitable green lasers to build prototype automotive head up displays and miniature projectors as well as other potential product offerings. Miniaturized light-emitting diodes are less expensive and consume less power than laser diodes. Microvision is working with companies that have developed custom red, blue and green light-emitting diodes that provide sufficient brightness for many scanned beam display applications. Microvision has built working prototypes of full-color scanned beam displays with these light-emitting diodes.

As partMicrovision expects to continue using laser diodes and compact lasers for augmented vision and projection display applications that require enhanced brightness. Microvision intends to rely on third party developments or to contract with other companies to continue development light sources necessary to enable its planned products.

Optics. For applications where the scanned beam display is to be worn, it is desirable to have an exit pupil (the range within which the viewer's eye can move and continue to see the image) that is large enough to allow comfortable and consistent viewing of the display. Microvision has developed optics and system designs that accomplish this design objective. The company anticipates additional design and engineering of the optics and systems designs will improve the competitiveness of its researchdisplay offerings from commercial applications. Microvision has refined optics designs for both monocular (one-eye) and biocular (two-eye) systems. Microvision also has developed a full binocular system, which incorporates two separate video channels (one for each eye) to provide the user with full stereoscopic viewing of three-dimensional imagery. Microvision's ongoing optics development activities, Microvision conducts ongoing researchis directed at the creation of optical systems that exhibit lower distortion, are lighter weight and are more cost-effective to manufacture than previous optical systems.

Current and Prospective Display Products

Integrated Photonics Module

The Company is developing a modular integrated photonics module that will be a common integrated subsystem in future display products. The integrated photonics module consists of a MEMS scanner, electronics to drive the MEMS scanner, a light source module, and electronics to drive the video input and output, system controller and buffer memory component. The Company believes that the modular integrated photonics module could be readily modified to meet OEM product requirements for different display product configurations. These product configurations may require modification of the integrated photonics module for a specific OEM product. The following are some of the potential products the Company is planning to develop based on the cognitive, physiologicalintegrated photonics module.

Automotive Head-Up Display

During 2005, Microvision continued to improve upon its prototype head-up displays for automotive manufacturers and ergonomic factorsTier 1 suppliers to automotive companies. These prototypes demonstrate that scanned beam display technology can be used in a head-up display that projects a day-light or night-time readable image onto the windscreen of an automobile to provide the vehicle operator with a variety of information related to the car's operation. The Company believes that its technology provides three distinct advantages over competing technologies for head- up display applications:

• Size- The Microvision prototype display is less than half the size of current competitive offerings. Total package size is a primary consideration in the design of an instrument panel for an automobile.
• Contrast Ratio - The Microvision prototype has a contrast ratio an order of magnitude higher than current competitive offerings. The high contrast ratio allows the driver to see the display in bright daylight and see though the display at night.
• Installation Cost - The Microvision prototype can be electronically optimized to the unique curvature of a particular automobile's windshield. The current competitive offerings must be addressedmanually adjusted during installation to match the varying curvature tolerances of different windshields.

Microvision's goal is to enter into an agreement with at least one Tier 1 supplier to develop and manufacture a head up display during 2006. The Tier 1 supplier would work with Microvision and the automobile manufacturers to integrate Microvision's head up display into an automotive instrument panel.

The automotive head up display market is highly competitive. The current competitive products are based on liquid crystal display or vacuum fluorescent display technology which is more mature than the scanned beam display technology. The Company's competitors in the head up display market have substantially greater financial, technical and other resources than Microvision and may develop further improvements that could reduce or eliminate the anticipated advantages of Microvision's proposed products.

Pico Projector

During 2005, the Company developed a prototype micro projector. The Company believes that the target of this development is a commercial hand held device or an embedded solution that can project full color images from a portable media source or mobile computer onto a surface chosen by products incorporatingthe user. Several large consumer electronics companies are developing and conducting consumer trials of micro projectors based on very small display panel technologies. In January 2006, the Company demonstrated its prototype "pico projector" at the Consumer Electronics Show in Las Vegas. The Company's goal is to enter into an agreement that would result in development, manufacture and distribution of a pico projector based on the Company's planned integrated photonic module. The Company believes its scanned beam display technology will provide a smaller form factor than small projectors based on competing display technologies.

The consumer display market is highly competitive. The Company believes that the pico projector will compete with other projection display technologies as well as traditional flat panel displays. The Company's competitors in the consumer display market have substantially greater financial, technical and other resources than Microvision and may develop further improvements of screen display technology that could reduce or eliminate the anticipated advantages of Microvision's proposed products.

Full Color Eyewear

The Company believes that the integrated photonic module it is developing can be customized to enable displays that more closely resemble eyewear than other technologies allow. The Company is evaluating the market and technical risk associated with three distinct color eyewear solutions.

• Highly mobile "Glance-able" display: In this configuration, the user could glance down occasionally at a worn display. This device would be suitable for light business use such as mobile web surfing and reading e-mail. The Company believes that high resolution, high contrast, and small package size could be important differentiators between its scanned beam display solution and competing solutions.
• Look-around or see-through display: In this configuration, the user could view a full screen display in see-through or occluded mode. This configuration would be suitable for viewing longer pieces of streaming video for entertainment or business applications.
• Fully occluded immersive display: In this configuration, the user could view a very wide screen high resolution video stream. This configuration would be suitable for interactive gaming applications and simulators.

In any of these configurations, the Company believes that high resolution, high brightness, small package size, and lower cost could be important differentiators between its scanned beam display solution and competing solutions. The Company plans to evaluate potential designs for one or more of these potential solutions during 2006. The Company is working with potential partners in the consumer electronics industry to define the customer requirements for these solutions and determine if the scanned beam display technology andhas advantages over existing technologies for these potential product offerings. The Company expects that if it can be shown that the safety of scanned beam display technology including such issues ashas significant advantage over existing technologies it will be able to attract partners to further develop, manufacture and distribute its potential products.

The consumer display market is highly competitive. The Company believes that any color eye wear product will compete primarily with LCD and OLED based solutions. The Company's competitors in the maximum permissible laser exposure limits established by American National Standards Institute ("ANSI") and others. Researchers from the University of Washington Human Interface Technology Labconsumer display market have substantially greater financial, technical and other independent institutions have concludedresources than Microvision and may develop further improvements of screen display technology that laser exposure tocould reduce or eliminate the eye resulting from useanticipated advantages of the scanned beam displays under normal operating conditions would be below the calculated maximum permissible exposure level set by ANSI. The Nomad display has been certified as a Class 1 laser product ("safe for eye viewing") by Underwriters Laboratories.

ProductsMicrovision's proposed products.

Nomad

In March 2004, Microvision introduced a new version of the Nomad System. The Nomad Expert Technician System, ("Nomad") is a hands free wearable computer with a head wornhead-worn display that enables technicians and other mobile workers to overlay relevant information on their task thereby reducing task time. The new version is about 40% smaller, lighter and costs less to manufacture than the prior version. Microvision is working closely with automotivetransportation and manufacturing companies to develop the Nomad for truck and automotive maintenance applications. In maintenance applications, the automotive technician uses the Nomad to providereceive repair instructions and other information directly ininto his or her field of view while he or she is performing the repair. The Nomad functions as a wireless thin client computer and is linked to a remote server computer. In trials, technicians using

The Nomad has not gained the commercial acceptance the Company had planned when the Nomad have reported substantial efficiency gainswas introduced. The Company has reduced its cost in performing repairs.

manufacturing overhead, sales and marketing relating to Nomad, until it develops a go to market strategy that will be more successful. The U.S. Army has deployed 100 Nomad systems in the US Army's Stryker Brigade Combat Team in Iraq. The helmet-mounted Nomad Augmented Vision System provides the vehicle commanderCompany is working with a head- up, daylight-readable, remote display fromsmall number of potential customers to define business cases for the Stryker vehicle's onboard battlefield computer while allowingNomad. Defining the commanderbusiness case consists of studying the potential user's work environment, identifying operations that could be performed more economically using Nomad, conducting trials to operate fromdemonstrate the hatch opening.cost savings, getting user feedback, making improvements to the Nomad, and then developing sales strategy and tools to demonstrate the advantage of the proven benefit. The Nomad allowsCompany expects it will require at least the commanderfirst half of 2006 to observe the surroundings, while choosing the optimum path ahead, commanding the vehicle and using tactical information.define business cases for Nomad.

Microvision is producing Nomad at its headquarters facility in Washington State. Microvision is distributing the Nomad to end customers in the United States through its sales force, through independent manufacturers' representatives and through original equipment manufacturers.force. Microvision is also selling Nomad in Europe and Asia through a small number of independent manufacturer's representatives.

Microvision believesThe Nomad will competecompetes with other products that bring information to the point of task, including laptop and notebook computers, tablet computers, and personal digital assistants. These other devices must be held, wrist mounted, or placed on a stationary object to be used and the user must look away from the task to get information. In contrast, the Nomad is head-worn (i.e. hands free) and allowsprovides images to be painted on the viewer'suser's eye with no screen to block the viewer's field of vision. Other companies are marketing head-worn displays, but the displays are generally occluded and typically provide a fraction of the full-page view provided by the Nomad. Microvision believes that Nomad provides higher brightness higher resolution, and higher contrast than competing devices and provides true "see through" capability with lower power consumption.capability. Microvision also believes that the manufacturing cost in high volume of Nomad and potential future displays using its scanned beam display technology could be less than that of competing technologies, due principally to the lower cost of scanned beam display components and lower capital investment to build high volume manufacturing capacity compared to other competing technologies.

Current and Prospective Imaging Products

Flic

Microvision sells the Flic Scanner,laser bar cod scanner, a hand held laser bar code scanner and the Flic Cordless Scanner, a Bluetooth version of the Flic Scanner. All Flic Scanners feature a proprietary design that provides for lower power consumption and total operating cost than many other bar code scanners currently available. Microvision expects that the sales volume for Flic Scanner will grow as potential customers complete their trials and application developersmore companies release solutionsproducts incorporating Flic Scanners.the Flic.

Flic Scanners are manufactured for Microvision by a contract manufacturer located in Batam, Indonesia. Microvision distributes branded and private-labeled Flic Scannersprivate- labeled scanners directly to end users through value added resellers, original equipment manufacturers and phone and internet orders.

The bar code scanning industry is highly competitive. Flic Scanners compete with existing laser wand and CCD imager scanners produced by established bar code scanner companies. Flic Scanners compete on the basis of price, form factor, and performance. The bar code industry is dominated by Symbol Technologies, which sells products that directly compete with the Flic and Flic cordlessCordless products.

Image capture

Microvision is applying its scanned beam and other proprietary technology to develop products that capture images and other information. Such products include bar code readers and miniature high-resolution "laser cameras".cameras. In December 2004, Microvision entered into an agreement with Ethicon Endo-Surgery Inc. a subsidiary of Johnson & Johnson to integrate Microvision's scanned beam technology into certain medical products for human medical applications. Under the agreement, Microvision is developing prototype units that will be used in product evaluation. The agreement includes terms for product development and a supply agreement for certain products.

Microvision believes that certain components of the scanned beam technology can also be used to develop two-dimensional bar code readers as well as high resolution laser cameras that have cost and performance advantages over existing imaging technologies for certain applications.

Automotive Head-Up Displays

During 2004, Microvision continued to improve upon its prototype automotive head-up displays for automotive companies and Tier 1 suppliers to automotive companies. These head-up displays use scanners, light sources and electronic components similar to those in the Nomad display, but use optics that are unique for this head-up display application. These prototypes demonstrate that scanned beam display technology can be used in a head-up display that projects a day-light or night- light readable image onto the windscreen of an automobile to provide the vehicle operator with a variety of information related to the car's operation. Microvision believes that it can further develop these prototypes into products that will meet the automotive companies' specifications for size, brightness, image quality and cost. Microvision plans to continue this sponsored research and development work in 2005.

Microdisplays

Microvision continues to develop color prototype microdisplays that could be integrated into an electronic viewfinder in a digital still camera, a digital video camera or a cell phone. Microvision continues to reduce the size, cost and power requirements of its prototype microdisplays. Microvision believes that the advances in the scanned beam display technology that are achieved for the microdisplay platform will migrate to Nomad and other products resulting in lower cost. Microvision is performing sponsored and internally funded research and development to improve the performance and reduce the cost of its color microdisplay product development.

Business Strategy

Microvision's objective is to be a leading provider of personal displayscanned beam displays and imagingimage capture products and related technologies for a broad range of professional and consumer applications. Key elements of Microvision's strategy to achieve this objective include:

Strategic Partnering to Extend Marketing and Technical Reach

Microvision's key technologies have applications in several markets and products. Microvision has contracted with, and plans to continue to pursue, strategic partners who can provide distribution channels, resources and services that otherwise would require substantial time and additional cost for Microvision to develop independently. Microvision will select strategic partners to provide support depending on the specific requirements of markets and products. Examples

Sale of activitiesComponents or "Engines" Containing Scanning Technology. Certain potential applications of the scanned beam display technology, such as automotive HUD or pico projector could require integration of Microvision's technology with other related technologies. In markets requiring high volume production of scanned beam components or subsystems that can be integrated with other components, Microvision plansmay provide designs for or the supply of components, subsystems and systems to continue to pursue through strategic partnering are:original equipment manufacturers under licensing and/or agreements.

Engineering Services to Develop Custom Products. Microvision expects that some customers will require unique designs for displays. Microvision expects that such relationships will generally involve a period of co-developmentco- development during which engineering and marketing professionals from potential customers or original equipment manufacturers would work with Microvision's technical staff to specify, design and develop a product appropriate for the targeted market and application. Microvision would charge fees to its customers or original equipment manufacturers to fund the costs of the engineering effort incurred on such development projects. The nature of the relationships with such customers or original equipment manufacturers may vary from partner to partner depending on the proposed specifications for the scanned beam technology, the product to be developed, and the customers' or original equipment manufacturers' design, manufacturing and distribution capabilities. Microvision believes that by limiting its own direct manufacturing investment for consumer products, it will reduce the capital requirements and risks inherent in taking the scanned beam technology to the consumer market.

Manufacture and Sale of High Performance Products. Microvision anticipates providing high performance products to professional end-users in markets with lower product volume requirements. Microvision expects that end-users in this category will include professionals in defense, industry and medicine. Depending upon the circumstances, Microvision may manufacture these products using standard component suppliers and contract manufacturers as required, may license its technology to original equipment manufacturers or may seek to form one or more joint ventures to manufacture the products.

Sale of Components or "Engines" of Scanning Technology. Certain potential applications of the scanned beam display technology, such as electronic viewfinders, cellular phones or two-dimensional bar code readers could require integration of Microvision's technology with other unrelated technologies. In markets requiring high volume production of scanned beam components or subsystems that can be integrated with other components, Microvision may provide designs for components, subsystems and systems to original equipment manufacturers under licensing agreements.

Licensing of Proprietary Technology to Original Equipment Manufacturers for Volume Manufacture of Products. Microvision believes that, in consumer markets, the ability of personal display products to compete effectively is largely driven by the ability to price aggressively for maximum market penetration. Significant economies of scale in volume purchasing, manufacturing and distribution are important factors in driving costs down to achieve pricing objectives and profitability. Microvision may seek both initial license fees from such arrangements as well as ongoing per unit royalties.

Platform Model to Leverage Core Technologies and Components

Microvision is developing the scanned beam display technology as a platform technology. Microvision believes that modularized scanning components or subsystems could be integrated with a variety of other interchangeable system components to more efficiently create a wide range of commercial and defense products. Such products could use the same platform scanning component or subsystem but would be configured for a particular application by using other interchangeable system components. Microvision has currently identified the following key product categories that could benefit from further modular scanning component development:

• High Performance Helmet-Mounted Displays
• Augmented Vision and Augmented Reality Displays
• Near-Eye, Mass-Market Color Displays
• Image Capture / Professional Cameras
• Projection Systems (Front- or Rear-Projection)

For example, products in any of these categories could utilize a common MEMS scanner to direct the beam of light. A wearable Nomad display and a projection display could use the same MEMS scanner combined with different optics, light source or drive electronics components. Microvision believes that this leverage of the MEMS scanner with other components will allow greater economies of scale in its fabrication.

Development of an Intellectual Property Portfolio

MicrovisionPortfolio.Microvision believes that it can enhance its competitive position by reducing the cost and improving the performance of its scanned beam technology and by developing an extensive portfolio of intellectual property and proprietary rights. A key part of Microvision's technology development strategy includes developing and protecting (i) concepts relating to the function, design and application of the scanned beam display system;systems; (ii) component technologies and integration techniques essential to the commercialization of the scanned beam display technologyand image capture technologies that are expected to reduce the cost and improve the performance of the system; and (iii) component technologies and integration techniques that reduce technical requirements and accelerate the pace of commercial development. Microvision is continuing to develop a portfolio of patents and proprietary processes and techniques that relate directly to the functionality and commercial viability of the scanned beam technology.technologies.

Additional InformationHuman Factors, Ergonomics and Safety

Microvision performsAs part of its research and development to achieve advances necessary for large-scale application, full-color capability in highly miniaturized versionsactivities, Microvision conducts ongoing research on the cognitive, physiological and design of new architectures for specific applications. Research and development expense for the Company for the fiscal years ended December 31, 2004, 2003 and 2002 was $14.7 million, $23.3 million and $25.5 million respectively. Excluding Lumera, research and development expense was $13.6 million, $16.8 million, and $18.4 million respectively.

Prior to 2004, substantially all of Microvision's revenue has been generated from development contracts to developergonomic factors that must be addressed by products incorporating the scanned beam display technology to meet customer specifications. Microvision's customers have included both the United States government and commercial enterprises. In 2004, 42% of revenue was derived from performance on development contracts with the United States government, 35% from performance on development contracts with commercial customers and the remaindersafety of scanned beam display technology, including such issues as the maximum permissible laser exposure limits established by American National Standards Institute ("ANSI") and others. Researchers from salesthe University of NomadWashington Human Interface Technology Lab and Flic units. In 2004, one commercial customer accounted for 11% of total of total revenue. In 2003, 27% of Microvision's revenue was earnedother independent institutions have concluded that laser exposure to the eye resulting from development contracts with a single commercial customer. Each of Microvision's contracts with the United States government can be terminated for convenience by the United States government at any time. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Microvision had a backlog of $7.1 million at December 31, 2004 compared to a backlog of $2.6 million at December 31, 2003. The backlog is composed of $7.0 million in development contracts, including amendments, entered into through December 31, 2004 and $114,000 and $43,000 in orders for Nomad and Flic respectively. Microvision plans to complete alluse of the backlog contracts during 2005.scanned beam displays under normal operating conditions would be below the calculated maximum permissible exposure level set by ANSI. The Nomad display has been certified as a Class 1 laser product ("safe for eye viewing") by Underwriters Laboratories.

Competitive Conditions

The information display industry is highly competitive. Microvision's products and the scanned beam display technology will compete with established manufacturers of miniaturized cathode ray tube and flat panel display devices. Microvision's competitors include companies such as Sony Corporation and Texas Instruments Incorporated, most of which competitors have substantially greater financial, technical and other resources than Microvision and many of which are developing alternative miniature display technologies. Microvision will also compete with other developers of miniaturized display devices. Microvision's competitors may succeed in developing information display technologies and products that could render the scanned beam display technology or Microvision's proposed products commercially infeasible or technologically obsolete.

The electronic information display industry has been characterized by rapid and significant technological advances. The scanned beam display technology and Microvision's proposed products may not remain competitive with such advances, and Microvision may not have sufficient funds to invest in new technologies, products or processes. Although Microvision believes that its scanned beam display technology and proposed display products could deliver images of a quality and resolution substantially better than those of commercially available miniaturized liquid crystal displays and cathode ray tube based display products, manufacturers of liquid crystal displays and cathode ray tubes may develop further improvements of screen display technology that could reduce or eliminate the anticipated advantages of Microvision's proposed products.

Microvision competes with other companies in the display industry and other technologies for government funding. In general, Microvision's government customers plan to integrate Microvision's technology into larger systems. Ongoing contracts are awarded based on Microvision's past performance on government contracts, the customer's progress in integrating Microvision's technology into the customer's overall program objectives, and the status of the customer's overall program.

The image capture industry is also highly competitive. Microvision's current and planned bar code products will compete with existing laser and wand type scanners produced by established bar code companies. Microvision's current products compete on the basis of price and performance. The bar code industry is dominated by Symbol Technologies. Symbol Technologies sells products that directly compete with Microvision's current and planned bar code products.

Intellectual Property and Proprietary Rights

University of Washington

In 1993, Microvision acquired the exclusive rights to the Virtual Retinal Display technology under a license agreement with the University of Washington. Additional development of the Virtual Retinal Display technology took place at the University of Washington Human Interface Technology Laboratory pursuant to Microvision's research agreement. The University of Washington has received forty-fiveeighty-seven patents including forty-six U.S. patents on the Virtual Retinal Display technology and has an additional fourteenfour U.S. patent applications pending in the United States and twenty-fourtwenty-three foreign counterpart applications in certain foreign countries.

Microvision's ability to compete effectively in the information display market will depend, in part, on its ability and the ability of the University of Washington and other licensors to maintain the proprietary nature of the Virtual Retinal Display technology or other technologies, including claims related to the ability to superimpose images on the user's field of view, a Virtual Retinal Display using optical fibers, an expanded exit pupil and the mechanical resonance scanner.

The Virtual Retinal Display technology comprises a substantial part of Microvision's scanned beam display technology. The Virtual Retinal Display technology was originally developed at the University of Washington's Human Interface Technology Lab. The scope of the license covers all commercial uses of the Virtual Retinal Display technology worldwide, including the right to grant sublicenses. The license expires upon the expiration of the last of the University of Washington's patents that relate to the Virtual Retinal Display, unless sooner terminated by Microvision or the University of Washington as discussed below. In granting the license, the University of Washington retained limited, non-commercial rights with respect to the Virtual Retinal Display technology, including the right to use the technology for non-commercial research and for instructional purposes and the right to comply with applicable laws regarding the non-exclusive use of the technology by the United States government. The University of Washington also has the right to consent to Microvision's sublicensing arrangements and to the prosecution and settlement by Microvision of infringement disputes. In addition, the University of Washington retains the right to publish for academic purposes information it creates regarding the Virtual Retinal Display technology.

Microvision could lose the exclusivity under the license agreement if it fails to respond to any infringement action relating to the Virtual Retinal Display technology within 90 days of learning of such claim. In the event of the termination of its exclusivity, Microvision would lose its rights to grant sublicenses and would no longer have the first right to take action against any alleged infringement. In addition, each of Microvision or the University of Washington has the right to terminate the license agreement in the event that the other party fails to cure a material breach within 30 days of written notice. Microvision may terminate the license agreement at any time by serving 90 days prior written notice on the University of Washington. In the event of any termination of the license agreement, the license granted to Microvision would terminate.

Under the terms of the license agreement, Microvision agreed to pay a non-refundablenon- refundable fee of $5.1 million, which was fully paid in August 1997, and to issue to the University of Washington shares of Microvision's common stock, which shares have been issued. In addition, the University of Washington is entitled to receive ongoing royalties. Microvision also entered into a research agreement with the University of Washington to further develop the Virtual Retinal Display technology, payments of which were credited to the license fee.

Other Licenses and Intellectual Property

During 1998, Microvision entered into a license agreement with a third party whereby it acquired the exclusive license to certain intellectual property related to the design and fabrication of micro miniature devices using semiconductor fabrication techniques. The licensor has received thirteenthirty-eight patents including eighteen U.S. patents and has twenty-ninethree patent applications pending pertaining to the Microvision field of use.

Microvision also generates intellectual property as a result of its ongoing performance on development contracts and as a result of its internal research and development activities. Microvision has filed fifty-fourover one hundred and twenty patent applications and received thirtyfifty patents including thirty-four U.S. patents in its own name resulting from these activities. The inventions covered by such applications generally relate to component miniaturization, specific implementation of various system components and design elements to facilitate mass production.

Microvision considers protection of these key enabling technologies and components to be a fundamental aspect of its strategy to penetrate diverse markets with unique products. As such, it intends to continue to develop its portfolio of proprietary and patented technologies at the system, component and process levels.

Microvision also relies on unpatented proprietary technology. To protect its rights in these areas, Microvision requires all employees and, where appropriate, contractors, consultants, advisors and collaborators, to enter into confidentiality and non-compete agreements. There can be no assurance, however, that these agreements will provide meaningful protection for Microvision's trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.

Microvision has registered the mark "Microvision" with its associated "tri- curve" logoword trademarks "NOMAD", "FLIC", "FLICPRINT", "FLICWARE", "MICROHUD", and the design marks "NOMAD" (stylized) and "O" (design) with the United States Patent and Trademark Office. Microvision has filed for trademark registration of various other marks including "Virtual Retinal Display," "VRD," "Nomad," and "Flic" infor the "tri-curve" logo design mark with the United States Patent and Trademark Office. TheseMicrovision has registered the word marks were examined"NOMAD", "FLIC", and "MICROHUD"; and the design trademarks "NOMAD" (stylized) and "O" (design) with various foreign jurisdictions. Microvision has filed for registration of various other marks with various foreign jurisdictions.

Additional Information

Microvision performs research and development to design and develop the integrated photonics module and modifications to the integrated photonics module that will be required for specific applications. Research and development expense for the Company for the fiscal years ended December 31, 2005, 2004 and 2003 was $6.6 million, $14.7 million, and $23.3 million, respectively. Excluding Lumera, research and development expense was $6.6 million, $13.6 million and $16.8 million, respectively.

Prior to 2004, substantially all of Microvision's revenue has been generated from development contracts to develop the scanned beam display technology to meet customer specifications. Microvision's customers have included both the United States government and commercial enterprises. In 2005, 35% of revenue was derived from performance on development contracts with the United States government, 42% from performance on development contracts with commercial customers and the remainder from sales of Nomad and Flic units. In 2005, Ethicon Endo-Surgery Inc. accounted for 33%, and a U. S. government customer accounted for 27% of total revenue. In 2004, 42% of revenue was derived from performance on development contracts with the United States government, 35% from performance on development contracts with commercial customers and the remainder from sales of Nomad and Flic units. In 2004, one commercial customer accounted for 11% of total of total revenue. Each of Microvision's contracts with the United States government can be terminated for convenience by the United States government at any time. See Management's Discussion and Analysis of Financial Condition and Results of Operations.

Microvision had a backlog of $3.4 million at December 31, 2005 compared to a backlog of $7.1 million at December 31, 2004. The backlog at December 31, 2005, is composed of $2.8 million in development contracts, including amendments, entered into the opposition phase, where an opposition was filed against the Virtual Retinal Display mark.through December 31, 2005 and $579,000 in product orders. Microvision believes the opposition filing is without merit and that it should prevail in the proceedings. Regardlessplans to complete all of the outcome, Microvision believes that it will be entitled to continue to use the terms "Virtual Retinal Display," "VRD," "Nomad," and "Flic".backlog contracts during 2006.

Employees

As of March 1, 2005,2006, Microvision had 166142 employees.

Further Information

Microvision was founded in 1993 as a Washington corporation and reincorporated in 2003 under the laws of the State of Delaware. Our principal office is located at 19910 North Creek Parkway, Bothell, Washington 980116222 185^th Avenue NE, Redmond WA 98052 and our telephone number is (425) 415-6847.425-415-6847.

Microvision's Internet address is www.microvision.com. Microvision makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC. Investors can access this material by visiting Microvision's website, clicking on "Investors," and then clicking on "SEC Filings."

ITEM 1A. RISK FACTORS.

Risk Factors Relating to the Microvision Business

We have a history of operating losses and expect to incur significant losses in the future.

We have had substantial losses since our inception and we anticipate an operating loss at least through the year ending December 31, 2005.inception. We cannot assure you that we will ever become or remain profitable.

• As of December 31, 2004,2005, we had an accumulated deficit of $187.5$215.7 million.
• We incurred consolidated net losses of $100.9$128.1 million from inception through 2001, $27.2 million in 2002, $26.2 million in 2003, and $33.2 million in 2004.2004 and $28.2 million in 2005.

The likelihood of our success must be considered in light of the expenses, difficulties and delays frequently encountered by companies formed to develop and market new technologies. In particular, our operations to date have focused primarily on research and development of the scanned beam technology and development of demonstration units. We introduced our first two commercial products during 2002. We are unable to accurately estimate future revenues and operating expenses based upon historical performance.

We cannot be certain that we will succeed in obtaining additional development contracts or that we will be able to obtain substantial customer orders for our products. In light of these factors, we expect to continue to incur substantial losses and negative cash flow at least through 20052006 and likely thereafter. We cannot be certain that we will achieve positive cash flow at any time in the future.

We will require additional capital to continue to fund our operations and to implement our business plan. If we do not obtain additional capital, we may be required to limitcurtail our operations substantially. Raising additional capital may dilute the value of current shareholders' shares.

Based on our current operating plan and budgeted cash requirements, we believe that we canexpect our cash to fund our operations from existing sources of liquidity though 2005.through July 2006. We will require additional capital to continue to fund our operations, including to:

• Further develop the scanned beam technology,
• Add manufacturing capacity,technology.  
• Develop and protect our intellectual property rights, andrights.
• Fund long-term marketing and business development opportunities.opportunities; and
• Add manufacturing capacity.

WeThe Company can raise limited additional cash through the sale of its Lumera common stock in the public market under Rule 144 of the Securities Act of 1933 or through a private placement. As of March 1, 2006, Microvision owns approximately 322,000 shares of Lumera common stock that have not been pledged as collateral for the Company's convertible notes issued as of March 11, 2005 and December 1, 2005. Based on the March 1, 2006 closing price of $4.10, the Lumera shares that have not been pledged as collateral have a market value of approximately $1.3 million. The Company may be deemed to be an affiliate of Lumera. Under Rule 144 of the Securities Act, an affiliate is entitled to sell within any three-month period a number of shares of Lumera common stock that does not exceed the greater of 1% of the then outstanding shares of Lumera common stock or the average weekly trading volume of Lumera common stock on the NASDAQ National Market during the four calendar weeks preceding the filing of a notice of the sale on Form 144. The immediate sale of Lumera stock in the public market could have a negative impact on the Lumera stock price.

Our capital requirements will require additional capitaldepend on many factors, including, but not limited to, fund our operations in 2006.the rate at which we can, directly or through arrangements with original equipment manufacturers, introduce products incorporating the scanned beam and image capture technologies and the market acceptance and competitive position of such products. If revenues are less than we anticipate, if the level and mix of revenues vary from anticipated amounts and allocations or if expenses exceed the amounts budgeted, we may require additional capital earlier than July 2006 to further the development of our technologies, for expenses associated with product development, and to respond to competitive pressures or to meet unanticipated development difficulties. In addition, our operating plan provides for the development of strategic relationships with systems and equipment manufacturers that may require additional investments by us.

Additional financing may not be available to us or, if available, may not be available on terms acceptable to us on a timely basis. If adequate funds are not available to satisfy either short-term or long-term capital requirements, we may be required to limit our operations substantially. Our capital requirements will depend on many factors, including, but not limited to, the rate at which we can, directly or through arrangements with original equipment manufacturers, introduce products incorporating the scanned beam and optical material technologies and the market acceptance and competitive position of such products. Raising additional capital may involve issuing securities with rights and preferences that are senior to our common stock and may dilute the value of current shareholders' shares. If adequate funds are not available to satisfy either short-term or long-term capital requirements, we may be required to limit our operations substantially. This limitation of operations may include reductions in staff and operating costs as well as reductions in capital expenditures and investment in research and development.

The value of our investment in Lumera may decrease.

Lumera's stock price is subject to fluctuation and may decrease, lowering the value of our investment. As of March 1, 2006 we own approximately 12% of Lumera's common stock. Since we hold a large percentage of Lumera's common stock, if an active market does not develop or is not sustained, it may be difficult for us to sell our shares of Lumera's common stock at an attractive price or at all. The likelihood of Lumera's success, and the value of the common stock we hold, must be considered in light of the risks frequently encountered by early stage companies, especially those formed to develop and market new technologies. These risks include Lumera's potential inability to establish product sales and marketing capabilities to establish and maintain markets for their potential products; and to continue to develop and upgrade their technologies to keep pace with changes in technology and the growth of markets using polymer materials. If Lumera is unsuccessful in meeting these challenges, its stock price, and the value of our investment, could decrease.

Our Senior Secured Exchangeable Convertible Notesconvertible notes may adversely impact our common stockholders or limit our ability to obtain additional financing.

In March 2005 and December 2005, we issued the Senior Secured Exchangeable Convertible Notes (the "Notes") described in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources.convertible notes. Among other provisions, the Notesthese notes include material limitations on our ability to incur additional debt or incur liens while the Notesconvertible notes are outstanding. These limitations could materially adversely affect our ability to raise funds we expect to need in 2006.2006 and 2007.

We cannot be certain that the scanned beam technology or products incorporating this technology will achieve market acceptance. If the scanned beam technology does not achieve market acceptance, our revenues may not grow.

Our success will depend in part on customer acceptance of the scanned beam technology. The scanned beam technology may not be accepted by manufacturers who use display technologies in their products, by systems integrators who incorporate our products into their products or by consumersend users of these products. To be accepted, the scanned beam technology must meet the expectations of our potential customers in the defense, industrial, medical and consumer markets. If our technology fails to achieve market acceptance, we may not be able to continue to develop the scanned beam technology.

It may become more difficult to sell our stock in the public market.

Our common stock is listed for quotation on theThe NASDAQ National Market. To keep our listing on this market, we must meet NASDAQ's listing maintenance standards. If we are unable to continue to meet NASDAQ's listing maintenance standards, our common stock could be delisted from theThe NASDAQ National Market. If our common stock were delisted, we likely would seek to list the common stock on the NASDAQ SmallCap Market, the American Stock Exchange or on a regional stock exchange. Listing on such other market or exchange could reduce the liquidity for our common stock. If our common stock were not listed on the SmallCap Market or an exchange, trading of our common stock would be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities or directly through market makers in our common stock. If our common stock were to trade in the over-the-counter market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the common stock. A delisting from theThe NASDAQ National Market and failure to obtain listing on such other market or exchange would subject our securities to so- calledso-called penny stock rules that impose additional sales practice and market-making requirements on broker-dealers who sell or make a market in such securities. Consequently, removal from theThe NASDAQ National Market and failure to obtain listing on another market or exchange could affect the ability or willingness of broker-dealers to sell or make a market in our common stock and the ability of purchasers of our common stock to sell their securities in the secondary market. In addition, when the market price of our common stock is less than $5.00 per share, we become subject to penny stock rules even if our common stock is still listed on theThe NASDAQ National Market. While the penny stock rules should not affect the quotation of our common stock on theThe NASDAQ National Market, these rules may further limit the market liquidity of our common stock and the ability of investors to sell our common stock in the secondary market. During the second, third and fourth quarters of 2002, the first and second quarter of 2003, and the third quarter of 2004, the second quarter and fourth quarter of 2005, and the first quarter of 2006, the market price of our stock traded below $5.00 per share. On March 1, 20052006 the closing price of our stock was $5.59.$3.46.

Our lack of the financial and technical resources relative to our competitors may limit our revenues, potential profits, overall market share or value.

Our current products and potential future products will compete with established manufacturers of existing products and companies developing new technologies. Many of our competitors have substantially greater financial, technical and other resources than us. Because of their greater resources, our competitors may develop products or technologies that are superior to our own. The introduction of superior competing products or technologies could result in reduced revenues, lower margins or loss of market share, any of which could reduce the value of our business.

We may not be able to keep up with rapid technological change and our financial results may suffer.

The information display industry has been characterized by rapidly changing technology, accelerated product obsolescence and continuously evolving industry standards. Our success will depend upon our ability to further develop the scanned beam technology and to cost effectively introduce new products and features in a timely manner to meet evolving customer requirements and compete with competitors' product advances.

We may not succeed in these efforts because of:

• delays in product development,
• lack of market acceptance for our products, or
• lack of funds to invest in product development and marketing.

The occurrence of any of the above factors could result in decreased revenues, market share and value.

We could face lawsuits related to our use of the scanned beam technology or other technologies. Defending these suits would be costly and time consuming. An adverse outcome in any such matter could limit our ability to commercialize our technology and products, reduce our revenues and increase our operating expenses.

We are aware of several patents held by third parties that relate to certain aspects of scanned beam displays and image capture products. These patents could be used as a basis to challenge the validity, limit the scope or limit our ability to obtain additional or broader patent rights of our patents or patents we have licensed. A successful challenge to the validity of our patents or patents we have licensed could limit our ability to commercialize the scanned beam technology and other technologies and, consequently, materially reduce our revenues. Moreover, we cannot be certain that patent holders or other third parties will not claim infringement by us with respect to current and future technology. Because U.S. patent applications are held and examined in secrecy, it is also possible that presently pending U.S. applications will eventually be issued with claims that will be infringed by our products or the scanned beam technology. The defense and prosecution of a patent suit would be costly and time consuming, even if the outcome were ultimately favorable to us. An adverse outcome in the defense of a patent suit could subject us to significant cost, to require others and us to cease selling products that incorporate scanned beam technology, to cease licensing scanned beam technology or to require disputed rights to be licensed from third parties. Such licenses, if available, would increase our operating expenses. Moreover, if claims of infringement are asserted against our future co-development partners or customers, those partners or customers may seek indemnification from us for damages or expenses they incur.

Our planned future products are dependent on advances in technology by other companies.

We rely on and will continue to rely on technologies, such as light sources and optical components that are developed and produced by other companies. The commercial success of certain of our planned future products will depend in part on advances in these and other technologies by other companies. Due to the current business environment, many companies that are developing new technologies are reducing expenditures on research and development. This may delay the development and commercialization of components we would use to manufacture certain of our planned future products.

Our products may be subject to future health and safety regulations that could increase our development and production costs.

Products incorporating scanned beam display technology could become subject to new health and safety regulations that would reduce our ability to commercialize the scanned beam display technology. Compliance with any such new regulations would likely increase our cost to develop and produce products using the scanned beam display technology and adversely affect our financial results.

If we cannot manufacture products at competitive prices, our financial results will be adversely affected.

To date, we have produced limited quantities of our Nomad and Flic products and demonstration units for research, development and demonstration purposes. The cost per unit for these units currently exceeds the level at which we could expect to profitably sell these products. If we cannot lower our cost of production, we may face increased demands on our financial resources, possibly requiring additional equity and/or debt financing to sustain our business operations.

Our future growth will suffer if we do not achieve sufficient market acceptance of our products to compete effectively.

Our success depends, in part, on our ability to gain acceptance of our current and future products by a large number of customers. Achieving market-basedmarket- based acceptance for our products will require marketing efforts and the expenditure of financial and other resources to create product awareness and demand by potential customers. We may be unable to offer products consistently or at all that compete effectively with products of others on the basis of price or performance. Failure to achieve broad acceptance of our products by potential customers and to effectively compete would have a material adverse effect on our operating results.

Because we plan to continue using foreign contract manufacturers, our operating results could be harmed by economic, political, regulatory and other factors in foreign countries.

We currently use a contract manufacturer in Asia to manufacture our Flic product, and we plan to continue using foreign manufacturers to manufacture some of our other products where appropriate. These international operations are subject to inherent risks, which may adversely affect us, including:

• political and economic instability;
• high levels of inflation, historically the case in a number of countries in Asia;
• burdens and costs of compliance with a variety of foreign laws;
• foreign taxes; and
• changes in tariff rates or other trade and monetary policies.

If we experience delays or failures in developing commercially viable products, we may have lower revenues.

We began production of the current version of our Nomad product in the first quarter of 2004. In September 2002, we introduced Flic.our Flic product. In addition, we have developed demonstration units incorporating the scanned beam technology. However, we must undertake additional research, development and testing before we are able to develop additional products for commercial sale. Product development delays by us or our potential product development partners, or the inability to enter into relationships with these partners, may delay or prevent us from introducing products for commercial sale.

If we cannot supply products in commercial quantities, we will not achieve commercial success.

We are developing our capability to manufacture products in commercial quantities. Our success depends in part on our ability to provide our components and future products in commercial quantities at competitive prices. Accordingly, we will be required to obtain access, through business partners or contract manufacturers, to manufacturing capacity and processes for the commercial production of our expected future products. We cannot be certain that we will successfully obtain access to sufficient manufacturing resources. Future manufacturing limitations of our suppliers could result in a limitation on the number of products incorporating our technology that we are able to produce.

If our licensors and we are unable to obtain effective intellectual property protection for our products and technology, we may be unable to compete with other companies.

Intellectual property protection for our products is important and uncertain. If we do not obtain effective intellectual property protection for our products, processes and technology, we may be subject to increased competition. Our commercial success will depend in part on our ability and the ability of the University of Washington and our other licensors to maintain the proprietary nature of the scanned beam display and other key technologies by securing valid and enforceable patents and effectively maintaining unpatented technology as trade secrets. We try to protect our proprietary technology by seeking to obtain United States and foreign patents in our name, or licenses to third-party patents, related to proprietary technology, inventions, and improvements that may be important to the development of our business. However, our patent position and the patent position of the University of Washington and other licensors involve complex legal and factual questions. The standards that the United States Patent and Trademark Office and its foreign counterparts use to grant patents are not always applied predictably or uniformly and can change. Additionally, the scope of patents are subject to interpretation by courts and their validity can be subject to challenges and defenses, including challenges and defenses based on the existence of prior art. Consequently, we cannot be certain as to the extent to which we will be able to obtain patents for our new products and technology or the extent to which the patents that we already own or license from others protect our products and technology. Reduction in scope of protection or invalidation of our licensed or owned patents, or our inability to obtain new patents, may enable other companies to develop products that compete with ours on the basis of the same or similar technology.

We also rely on the law of trade secrets to protect unpatented know-how and technology to maintain our competitive position. We try to protect this know-how and technology by limiting access to the trade secrets to those of our employees, contractors and partners with a need to know such information and by entering into confidentiality agreements with parties that have access to it, such as our employees, consultants and business partners. Any of these parties could breach the agreements and disclose our trade secrets or confidential information, or our competitors might learn of the information in some other way. If any trade secret not protected by a patent were to be disclosed to or independently developed by a competitor, our competitive position could be materially harmed.

We could be exposed to significant product liability claims that could be time-consuming and costly, divert management attention and adversely affect our ability to obtain and maintain insurance coverage.

We may be subject to product liability claims if any of our product applications are alleged to be defective or cause harmful effects. For example, because our scanned beam displays are designed to scan a low power beam of colored light into the user's eye, the testing, manufacture, marketing and sale of these products involve an inherent risk that product liability claims will be asserted against us. Product liability claims or other claims related to our products, regardless of their outcome, could require us to spend significant time and money in litigation, divert management time and attention, require us to pay significant damages, harm our reputation or hinder acceptance of our products. Any successful product liability claim may prevent us from obtaining adequate product liability insurance in the future on commercially desirable or reasonable terms. An inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of our products.

We rely heavily on a limited number of development contracts with the U.S. government, which are subject to immediate termination by the government for convenience at any time, and the termination of one or more of these contracts could have a material adverse impact on our operations.

During 2005 and 2004, 35% and 2003, 42%, and 49% respectively, of Microvision's consolidated revenue was derived from performance on a limited number of development contracts with the U.S. government. Therefore, any significant disruption or deterioration of our relationship with the U.S. government would significantly reduce our revenues. Our government programs must compete with programs managed by other contractors for limited amounts and uncertain levels of funding. The total amount and levels of funding are susceptible to significant fluctuations on a year-to-year basis. Our competitors continuously engage in efforts to expand their business relationships with the government and are likely to continue these efforts in the future. Our contracts with the government are subject to immediate termination by the government for convenience at any time. The government may choose to use contractors with competing display technologies or it may decide to discontinue any of our programs altogether. In addition, those development contracts that we do obtain require ongoing compliance with applicable government regulations. Termination of our development contracts, a shift in government spending to other programs in which we are not involved, a reduction in government spending generally, or our failure to meet applicable government regulations could have severe consequences for our results of operations.

Our products have long sales cycles, which make it difficult to plan our expenses and forecast our revenues.

Our products have lengthy sales cyclecycles that involve numerous steps including discussiondetermination of a product application, exploring the technical feasibility of a proposed product, evaluating the costs of manufacturing a product and manufacturing or contracting out the manufacturing of the product. Our long sales cycle, which can last several years, makes it difficult to predict the quarter in which sales will occur. Delays in sales could cause significant variability in our revenues and operating results for any particular quarterly period.

Our exploratory arrangementsdevelopment contracts may not lead to products that will be profitable.

Our developmental contracts, including our relationships with parties such as the U.S. government, Ethicon Endo-Surgery, Inc., Canon, BMW and Volkswagen of America,without limitation those discussed in this document are exploratory in nature and are intended to develop new types of products for new applications. These efforts may prove unsuccessful and these relationships may not result in the development of products that will be profitable.

Our revenues are highly sensitive to developments in the defense industry.

Our revenues to date have been derived principally from product development research relating to defense applications of the scanned beam display technology. We believe that development programs and sales of potential products in this market will represent a significant portion of our future revenues. Developments that adversely affect the defense sector, including delays in government funding and a general economic downturn, could cause our revenues to decline substantially.

Our Virtual Retinal Display technology depends on our licenses from the University of Washington. If we lose our rights under the licenses, our operations would be adversely affected.

We have acquired the exclusive rights to the Virtual Retinal Display under a license from the University of Washington. The license expires upon expiration of the last of the University of Washington's patents that relate to this technology, which we currently anticipate will not occur until after 2011. We could lose our exclusivity under the license if we fail to respond to an infringement action or fail to use our best efforts to commercialize the licensed technology. In addition, the University of Washington may terminate the license upon our breach and has the right to consent to all sublicense arrangements. If we were to lose our rights under the license, or if the University of Washington were to refuse to consent to future sublicenses, we would lose a competitive advantage in the market, and may even lose the ability to commercialize our products completely. Either of these results could substantially decrease our revenues.

We are dependent on third parties in order to develop, manufacture, sell and market our products.

Our strategy for commercializing the scanned beam technology and products incorporating the scanned beam technology includes entering into cooperative development, manufacturing, sales and marketing arrangements with corporate partners, original equipment manufacturers and other third parties. We cannot be certain that we will be able to negotiate arrangements on acceptable terms, if at all, or that these arrangements will be successful in yielding commercially viable products. If we cannot establish these arrangements, we would require additional capital to undertake such activities on our own and would require extensive manufacturing, sales and marketing expertise that we do not currently possess and that may be difficult to obtain. In addition, we could encounter significant delays in introducing the scanned beam technology or find that the development, manufacture or sale of products incorporating the scanned beam technology would not be feasible. To the extent that we enter into cooperative development, sales and marketing or other joint venture arrangements, our revenues will depend upon the performance of third parties. We cannot be certain that any such arrangements will be successful.

Loss of any of our key personnel could have a negative effect on the operation of our business.

Our success depends on our executive officers and other key personnel and on the ability to attract and retain qualified new personnel. Achievement of our business objectives will require substantial additional expertise in the areas of sales and marketing, research and product development and manufacturing. Competition for qualified personnel in these fields is intense, and the inability to attract and retain additional highly skilled personnel, or the loss of key personnel, could reduce our revenues and adversely affect our business.

We are dependent on a small number of customers for our revenue. Our quarterly performance may vary substantially and this variance, as well as general market conditions, may cause our stock price to fluctuate greatly and potentially expose us to litigation.

Our revenues to date have been generated primarily from a limited number of development contracts with U.S. government entities and commercial partners. Our quarterly operating results may vary significantly based on:

• reductions or delays in funding of development programs involving new information display technologies by the U.S. government or our current or prospective commercial partners;
• changes in evaluations and recommendations by any securities analysts following our stock or our industry generally;
• announcements by other companies in our industry;
• changes in business or regulatory conditions;
• announcements or implementation by our competitors of technological innovations or new products;
• the status of particular development programs and the timing of performance under specific development agreements;
• economic and stock market conditions; or
• other factors unrelated to our company or industry.

In one or more future quarters, our results of operations may fall below the expectations of securities analysts and investors and the trading price of our common stock may decline as a consequence. In addition, following periods of volatility in the market price of a company's securities, shareholders often have instituted securities class action litigation against that company. If we become involved in a class action suit, it could divert the attention of management, and, if adversely determined, could require us to pay substantial damages.

If we fail to manage expansion effectively, our revenue and expenses could be adversely affected.

Our ability to successfully offer products and implement our business plan in a rapidly evolving market requires an effective planning and management process. We have significantly expanded the scope of our operations. The growth in business and relationships with customers and other third parties has placed, and will continue to place, a significant strain on our management systems and resources. We will need to continue to improve our financial and managerial controls, reporting systems and procedures and will need to continue to train and manage our work force.

The value of our investment in Lumera may decrease.ITEM 1B. UNRESOLVED STAFF COMMENTS

A significant portion of our assets and present source of liquidity are constituted by our investment in Lumera. Lumera's stock price is subject to fluctuation and may decrease, lowering the value of our investment. We own approximately 33% of Lumera's common stock. Since we hold a large percentage of Lumera's common stock, if an active market does not develop or is not sustained, it may be difficult for us to sell our shares of Lumera's common stock at an attractive price or at all. The likelihood of Lumera's success, and the value of the common stock we hold, must be considered in light of the risks frequently encountered by early stage companies, especially those formed to develop and market new technologies. These risks include Lumera's potential inability to establish product sales and marketing capabilities; to establish and maintain markets for their potential products; and to continue to develop and upgrade their technologies to keep pace with changes in technology and the growth of markets using polymer materials. If Lumera is unsuccessful in meeting these challenges, its stock price, and the value of our investment, could decrease. None

ITEM 2. DESCRIPTION OF PROPERTYPROPERTIES

The Company currently leases approximately 67,000 square feet of combined use office, laboratory and manufacturing space at its headquarters facility in Redmond, Washington. The 90 month lease expires in 2013.

The Company also currently leases approximately 92,500 square feet of combined use office, laboratory and manufacturing space at its former headquarters facility in Bothell, Washington. The seven-year lease expires in April 2006.

Lumera rentssubleases approximately 16,00018,000 square feet of space from Microvision within the Company's headquarters facility in Bothell, Washington.

The Company also leases approximately 5,200 square feet of combined use office and laboratory spaceWashington which will expire in San Mateo, California. The 42 month lease expires in 2005. Microvision closed its branch office in San Mateo, California during 2003 and currently subleases this office space.April 2006.

ITEM 3. LEGAL PROCEEDINGS

The Company is subject to various claims and pending or threatened lawsuits in the normal course of business. The Company is not currently party to any legal proceedings that management believes the adverse outcome of which would have a material adverse effect on the Company's financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of shareholders during the fourth quarter of the year ending December 31, 2004.2005.

ITEM 4A EXECUTIVE OFFICERS

Executive officers are appointed by our Board of Directors and hold office until their successors are elected and duly qualified. Messrs. RutkowskiTokman and Willey, also serve as directors of Microvision. The following persons serve as executive officers of Microvision:

Richard F. Rutkowski,Alexander Tokman, age 49,44, has served as President, Chief Executive Officer and a director of Microvision since September 1995 and as a director since August 1995.January 2006. Mr. Rutkowski alsoTokman served as Microvision's President and Chief Operating Officer from July 19962005 to August 2002.January 2006. From April 1995 to July 2005, Mr. Tokman served in various cross- functional and cross-business leadership positions at GE Healthcare, a subsidiary of General Electric most recently as a General Manager of its Global Molecular Imaging and Radiopharmacy unit from May 2003 to June 2005. From November 19921989 to May 1994,March 1995 Mr. RutkowskiTokman served as Executive Vice Presidenttechnical programs lead and a head of Medialink Technologies Corporation (formerly Lone Wolf Corporation),I&RD at Tracor Applied Sciences a developersubsidiary of high-speed digital networking technology for multimedia applicationsthen Tracor, Inc. Mr. Tokman has both a M.S. and B.S. in audio-video computing, consumer electronicsElectrical Engineering from the University of Massachusetts, Dartmouth. He also is a certified Six Sigma & DFSS Black Belt and telecommunications. From February 1990 to April 1995, Mr. Rutkowski was a principal of Rutkowski, Erickson, Scott, a consulting firm. Mr. Rutkowski also serves as a director of CMT Crimble Microtest.Master Black Belt.

Stephen R. Willey, age 51,52, has served as president, of Sales and Marketing for Asia of Microvision since August 2002January 2006, President, Consumer Solutions from July 2005 to January 2006 and a director since June 1995. Mr. Willey served as Microvision's Executive Vice President from October 1995 to August 2002. Prior to that, he served as an outside consultant to the company through The Development Group (DGI) a business and technology consulting firms that he founded. As principal of DGI, Willey had also provided senior management consulting services to CREO Products, Inc., an electro-optics equipment manufacturer, between June 1989 and December 1992. In 1993, Willey co- foundedco-founded PRO.NET Communications, Inc., an Internet service company. Willey holds an M.B.A. from the University of California, Los Angeles, and an M.A.Sc. in Electronics from the University of British Columbia, Vancouver. He earned a B.Sc., Engineering (Physics) from McMaster University, Hamilton.

Richard A. Raisig,Todd R. McIntyre, age 57,44, has served as Chief Financial Officer of Microvision since August 1996 and Vice President, Operations from August 1996 to August 2002. Mr. Raisig served as Microvision's Secretary from April 1998 to May 2002 and as a director of Microvision from March 1996 to August 2002. From June 1995 to August 1996, Mr. Raisig was Chief Financial Officer of Videx Equipment Corporation, a manufacturer and rebuilder of wire processing equipment for the cabling industry. From July 1992 to May 1995, Mr. Raisig was Chief Financial Officer and Senior Vice President-Finance for Killion Extruders, Inc., a manufacturer of plastic extrusion equipment. From February 1990 to July 1992, Mr. Raisig was Managing Director of Crimson Capital Company, an investment banking firm. Prior to 1990, Mr. Raisig was a Senior Vice President of Dean Witter Reynolds, Inc.Global Strategic Marketing and Business Development of Microvision since January 2006. Mr. Raisig is a Certified Public Accountant. Mr. Raisig holds an MBA from the University of Southern California and a BS in Social Sciences from the University of California, Irvine.

Todd R. McIntyre age 43, has served as Senior Vice President of Business Development sincefrom November 2003 until January 2006, and Vice President of Business Development of Microvision from January 1996 to November 2003. Mr. McIntyre's experience in emerging markets includes business development and marketing with development stage companies in a variety of technology segments including wireless telecommunications products and services, internet software products, and digital and print media. Mr. McIntyre holds an M.B.A. from Stanford University and a B.A. from Hendrix College.

Dr. V. G. Veeraraghavan, age 54, has served as Senior Vice President, Research & Product Development of Microvision since July 2001. Prior to joining Microvision, from 1998 to 2001, Dr. Veeraraghavan served in senior management with Standard MEMS, a MEMS semiconductor fabrication, end- product packaging and systems integration firm. During his service with Standard MEMS, Dr. Veeraraghavan was, first, Vice President of its operations wafer foundry responsible for engineering and production of MEMS wafers and, second, was Vice President Business Development. From 1991 to 1998, Dr. Veeraraghavan served in various management positions at Lexmark International, Inc., a developer and manufacturer of novel color laser and inkjet solutions. Dr. Veeraraghavan holds an M.S. and a Doctorate in Materials Engineering from Purdue University and an M.B.A. from the University of Kentucky. He also received a B.S. in Science from the University of Madras (India) and a B.S. in Metallurgy from the Indian Institute of Science.

Thomas M. Walker, age 40,41, joined Microvision in May 2002 and serves as Vice President, General Counsel and Secretary. Prior to joining Microvision, Mr. Walker served as Senior Vice President, General Counsel and Secretary of Advanced Radio Telecom Corp., a publicly held technology and services company where he managed domestic and international legal affairs from April 1996 to April 2002. Prior to that, Mr. Walker advised publicly and privately held businesses while practicing in the Los Angeles offices of the law firms of Pillsbury Winthrop and Buchalter, Nemer Fields and Younger. Mr. Walker holds a B.A. from Claremont McKenna College and a J.D. from the University of Oregon.

Andrew U. Lee,Ian D. Brown, age 53,43, has served as Vice President, Sales and Marketing of Microvision since 1997.February 2006. Prior to joining Microvision, from 1992March 1994 to 1997,February 2006, Mr. Lee was Senior Director, National Systems Sales for AEI Music Network, Inc., the largest audio-visual systems integratorBrown served in the United States. From 1988 to 1991, Mr. Lee was Vice President ofvarious Sales and Marketing for ADB Industries, Inc., a manufacturerpositions with General Electric Healthcare, Americas. Most recently from April 2004 to February 2006 Mr. Brown served as the Sales and Marketing Manager - Nuclear Medicine. From April 1989 to March 1994 Mr. Brown served as Technical Author - Nuclear Medicine Operator Documentation with IGE Medical Systems, Radlett, UK. Mr. Brown holds Ordinary & Higher National Certificates in Medical Physics & Physiological Measurements from Paddington College, London, Post Graduate Diploma in Management studies, University of precision mechanical assemblies for the medical, defense and aerospace industries. Mr. LeeHertfordshire. He also holds a B.S. in Political Science from the University of California at Berkeley.

Thomas E. Sanko, age 50, has served as Vice President of Marketing and Product Management at Microvision since February 2001. Prior to joining Microvision, from 1999 to 2001, Mr. Sanko was a consultant to Guidant Corp., a manufacturer of cardiovascular surgery products. From 1996 to 1999, Mr. Sanko was Business Manager at InControl, Inc., a manufacturer of electrophysiology products. Prior to 1996, Mr. Sanko served as Director of Marketing for Heart Technology, Inc., and earlier, for Davis and Geck. Both companies are medical device manufacturers. Mr. Sanko has a M.B.A. from the University of Michigan and a B.S. in Mechanical Engineering from the University of Pittsburgh.Six Sigma Black Belt.

Jeff T. Wilson, age 44,45, has served as Vice President, Accounting of Microvision since April 2002, Principal Financial Officer since January 2006 and Principal Accounting Officer of Microvision since August 1999 and as Director of Accounting of Microvision from August 1999 to March 2002. Prior to joining Microvision, from 1991 to 1999 Mr. Wilson served in various accounting positions for Siemens Medical Systems, Inc., a developer and manufacturer of medical imaging equipment. Prior to 1991, Mr. Wilson served as a manager with the accounting firm Price Waterhouse (currently PricewaterhouseCoopers LLP). Mr. Wilson is a Certified Public Accountant. Mr. Wilson holds a B.S. in Accounting from Oklahoma State University.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK ANDEQUITY RELATED SHAREHOLDER MATTERS.MATTERS AND ISSUER PURCHASES OF EQUITY SECURITES.

The Company's common stock trades on theThe NASDAQ National Market under the symbol "MVIS." As of March 1, 2005,2006, there were 375377 holders of record of 21,481,00025,243,000 shares of common stock outstanding. The Company has never declared or paid cash dividends on the common stock. The Company currently anticipates that it will retain all future earnings to fund the operation of its business and does not anticipate paying dividends on the common stock in the foreseeable future.

The Company's common stock began trading publicly on August 27, 1996. The quarterly high and low sales prices of the Company's common stock for each full quarterly period in the last two fiscal years and the year to date as reported by theThe NASDAQ National Market are as follows:

                                                            Common Stock
                                                       --------------------
Quarter Ended                                            HIGH        LOW
                                                       ---------  ---------
2003
March 31, 2003                                        $    8.20  $    3.43
June 30, 2003                                              6.76       3.85
September 30, 2003                                         9.38       5.89
December 31, 2003                                          9.09       6.50
2004
March 31, 2004                                        $   10.93  $    7.34
June 30, 2004                                             10.00       5.06
September 30, 2004                                         8.95       3.75
December 31, 2004                                          8.00       5.04

2005                                                                       
January 1, 2005 to March 1,31, 2005                                        $    7.70  $    5.03
June 30, 2005                                              6.77       4.15
September 30, 2005                                         6.49       5.04
December 31, 2005                                          6.53       3.02

2006                                                                       
January 1, 2006 to March 1, 2006                      $    4.25  $    3.05

ITEM 6. SELECTED FINANCIAL DATA

A summary of selected financial data as of and for the five years ended December 31, 20042005 is set forth below:

                                                                                         Years Ended December 31,
                                                                 ---------- ----------- ----------- ----------- -----------
                                                                    2005        2004        2003        2002        2001        2000
                                                                 ----------  ----------  ----------  ----------  ----------
                                                                              (in thousands, except per share data)        
Statement of Operations Data:                                                                                              
Revenue                                                         $   14,746  $   11,418  $   14,652  $   15,917  $   10,762
$    8,121
Net loss available for common shareholders                         (30,284)    (33,543)    (26,163)    (27,176)    (34,794)    (26,601)
Basic and diluted net loss per share                                 (1.35)      (1.56)      (1.46)      (1.93)      (2.85)      (2.33)
Weighted average shares outstanding basic and diluted               22,498      21,493      17,946      14,067      12,200      11,421 
Balance Sheet Data:                                                                                                        
Cash and cash equivalents                                       and investments available-for-sale$    6,860  $    1,268  $   21,77810,700  $    15,1769,872  $   33,652  $   40,71715,587
Investments available-for-sale                                          --          --      11,078       5,304      18,065
Working capital                                                     (4,723)        903      19,781      14,511      33,098
40,551
Total assets                                                        23,363      25,538      33,918      32,267      54,055
56,172
Long-term liabilities                                                4,412          52       2,204       1,480         552
714
Mandatorily redeemable preferred stock                               4,166       7,647          --          --          --          --
Total shareholders' equity                                          (3,509)      7,190      23,295      17,416      32,326      50,042

Lumera was deconsolidated in July 2004.:

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Company commenced operations in May 1993 to develop and commercialize technology for displaying images and information onto the retina of the eye. In 1993, the Company acquired an exclusive license to the Virtual Retinal Display technology from the University of Washington and entered into a research agreement with the University of Washington to further develop the Virtual Retinal Display technology. The Company has continued to develop the Virtual Retinal Display technology as part of its broader research and development efforts relating to the scanned beam technology.

In February 2004, Microvision introduced a new version of its see-through monochrome head-worn display called Nomad Expert Technician System. The Company also produces and sells Flic, a hand-held bar code scanner. The Company has also developed demonstration scanned beam displays, including hand-held and head-worn color versions and is currently refining and developing its scanned beam display technology for potential medical, defense, industrial, aerospace and consumer applications. The Company expects to continue funding prototype and demonstration versions of products incorporating the scanned beam technology at least through 2005.2006. Future revenues, profits and cash flow and the Company's ability to achieve its strategic objectives as described herein will depend on a number of factors, including acceptance of the scanned beam technology by various industries and original equipment manufacturers, market acceptance of products incorporating the scanned beam technology and the technical performance of such products.

The Company has incurred substantial losses since its inception and expects to incur a substantial loss during the year ended December 31, 2005.2006.

Key Accounting Policies and Estimates

The Company's discussions and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, contract losses, bad debts, investments and contingencies and litigation. The Company bases its estimates on historical experience, terms of existing contracts, its evaluation of trends in the display and image capture industries, information provided by its current and prospective customers and strategic partners, information available from other outside sources, and on various other assumptions management believes 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 may differ from these estimates under different assumptions or conditions.

The Company believes the following key accounting policies require its more significant judgments and estimates used in the preparation of its consolidated financial statements:

Revenue Recognition. The Company recognizes contract revenue as work progresses on long-term, cost plus fixed fee and fixed price contracts using the percentage-of-completion method, which relies on estimates of total expected contract revenue and costs. The Company uses this revenue recognition methodology because it can make reasonably dependable estimates of the revenue and costs. Recognized revenues are subject to revisions as the contract progresses to completion and actual revenue and cost become certain. Revisions in revenue estimates are reflected in the period in which the facts that give rise to the revision become known.

The Company'sRevenue from product sales generally include acceptance provisions. The Company recognizes revenueshipments is recognized in accordance with Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue is recognized when there is sufficient evidence of an arrangement, the selling price is fixed and determinable and collection is reasonably assured. Revenue for product shipments is recognized upon acceptance of the product by the customer or expiration of the contractual acceptance period.period, after which there are no rights of return. Provisions are made for warranties at the time revenue is recorded. Warranty expense was not material for any periods presented.

Losses on Uncompleted Contracts. The Company maintains an allowance for estimated losses if a contract has an estimated cost to complete that is in excess of the remaining contract value. The entire estimated loss is recorded in the period in which the loss is first determined. The Company determines the estimated cost to complete a contract through a detail review of the work to be completed, the resources available to complete the work and the technical difficulty of the remaining work. If the actual cost to complete the contract is higher than the estimated cost, the entire loss is recognized. The actual cost to complete a contract can vary significantly from the estimated cost, due to a variety of factors including availability of technical staff, availability of materials and technical difficulties that arise during a project. Most of the Company's development contracts are cost plus fixed fee type contracts. Under these types of contracts, the Company is not required to spend more than the contract value to complete the contracted work.

Allowance for uncollectible receivables. The Company maintains general allowances for uncollectible receivables, including accounts receivable, cost and estimated earnings in excess of billings on uncompleted contracts and receivables from related parties. The Company reviews several factors in determining the allowances including the customer's past payment history and financial condition. If the financial condition of our customers or the related parties with whom the Company has receivables were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.

Inventory. The Company values inventory at the lower of cost or market with cost determined on a weighted average cost basis. The Company reviews several factors in determining the market value of its inventory including evaluating the replacement cost of the raw materials and the net realizable value of the finished goods. If we do not achieve our targeted sales prices, or if market conditions for our components or products were to decline or if we do not achieve our sales forecast, additional reductions in the carrying value of the inventory would be required.

Warrants and Derivatives. The Company has issued convertible notes that include rights to convert the notes into Microvision common stock. The Company also issued warrants to purchase common stock in connection with the notes. The Company accounts for these derivatives and warrants under the guidance provided by FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities and Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.The Company uses the Black Scholes option pricing model to estimate the value of these instruments. The Company uses the Black Scholes model because it is widely accepted and provides comparability across a wide range of similar companies. The use of the Black Scholes model requires management to evaluate a range of estimates and determine the reasonable estimate of future stock volatility and interest rates. Changes in these estimates could result in a materially different valuation of the instruments. Other models for valuing these instruments exist and the use of an alternative model could result in a materially different valuation of the instruments.

Litigation. The Company believes that the probability of an unfavorable outcome to any potential pending or threatened litigation is low and therefore has not recorded an accrual for any potential loss. The Company's current estimated range of liability related to any potential pending litigation is based on claims for which our management can estimate the amount and range of potential loss. As additional information becomes available, the Company will assess the potential liability related to any pending litigation and, if appropriate, revise its estimates. Such revisions in the Company's estimates of the potential liability could materially impact our results of operation and financial position.

The key accounting policies described above are not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management to apply its judgment or make estimates. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result to the Company's consolidated financial statements. Additional information about Microvision's accounting policies, and other disclosures required by generally accepted accounting principles, are set forth in the notes to the Company's consolidated financial statements, which begin on page 37 of this Annual Report on Form 10-K.statements.

Inflation has not had a material impact on the Company's net sales, revenues, or income from continuing operations over the Company's three most recent fiscal years.

Results of Operations

UntilSince 2000, Microvision has held an investment in Lumera. From inception to July 2004, Lumera was a consolidated subsidiary and treated as a separate segment within the Company. Subsequent to July 2004, Lumera became an equity method investment and the Company now operates under one segment.

Prior to Lumera's initial public offering in July 2004, the Company was organized into two segments - Microvision, which is engaged in scanned beam displays and related technologies, and Lumera, which is engaged in optical systems components technology. TheUp to the date of Lumera's initial public offering, the segments were determined based on how management viewsviewed and evaluatesevaluated the Company's operations.

A portion of each segments' administration expenses arose from shared services and infrastructure that Microvision had provided to both segments in order to realize economies of scale and to efficiently use resources. These efficiencies includedinclude costs of certain legal, accounting, human resources and other Microvision corporate and infrastructure costs. These expenses were allocated to the segments and the allocation was determined on a basis that the Company considered to be a reasonable reflection of the utilization of services provided to, or benefits received by, the segments.

In connection with the LumeraAfter Lumera's initial public offering, all Lumera Series A and Series B Preferred Stock was converted into Lumera common stock. Immediately after the offering, Microvision owned 5,434,000 shares, or 33%,became a significant unconsolidated equity investment of the common stock of Lumera. As a result of the change in ownership percentage, Microvision changed the method of accounting for its investment in Lumera to the equity method. Microvision recorded a non-cash change in ownership interest gain of $13.7 million to stockholders equity as a component of additional paid-in capital during the third quarter. Microvision consolidated Lumera's results through July 2004 in its consolidated financial statements.Microvision.

The following tables reflect the results of the Company's reportable segments for the years ended December 31, 2004 and 2003 under the Company's management system. The performance of each segment iswas measured based on several metrics. Since July 2004 Microvision has operated as one segment. These results were used, in part, by management, in evaluating the performance of, and in allocation of resources to, each of the segments (in thousands).:

                                                              Year Ended December 31, 2004
                                                 --------------------------------------------------
                                                 Microvision    Lumera     Elimination     Total
                                                 -----------  -----------  -----------  -----------
Contract Revenue                                $     8,135  $       686  $        --  $     8,821
Product  Revenue                                      2,597           --           --        2,597
Cost of Contract Revenue                              5,106          433           --        5,539
Cost of Product Revenue                               3,868           --           --        3,868
Research and development expense                     13,581        1,129                    14,710
Marketing, general and administrative expense        17,795        1,433           --       19,228
Non-cash compensation expense                           821        1,297           --        2,118
Interest income                                         270            2           --          272
Interest expense                                         31          120           --          151
Segment loss                                         32,257        3,724       (2,438)      33,543
Depreciation                                          1,711          695           --        2,406
Expenditures for capital assets                         970           70           --        1,040
Segment assets                                       25,538           --                    25,538

                                                              Year Ended December 31, 2003
                                                 --------------------------------------------------
                                                 Microvision    Lumera     Elimination     Total
                                                 -----------  -----------  -----------  -----------
Contract Revenue                                $    11,792  $     1,725  $        --  $    13,517
Product Revenue                                       1,135           --           --        1,135
Cost of Contract Revenue                              5,015        1,014                     6,029
Cost of Product Revenue                               1,017                                  1,017
Research and development expense                     16,755        6,561           --       23,316
Marketing, general and administrative expense        14,557        1,270           --       15,827
Non-cash compensation expense                         1,115        1,041           --        2,156
Interest income                                         342           39           --          381
Interest expense                                         51           --           --           51
Segment loss                                         25,205        8,083       (7,125)      26,163
Depreciation                                          1,924        1,185           --        3,109
Expenditures for capital assets                       1,094          455           --        1,549
Segment assets                                       37,224        4,058       (7,364)      33,918



                                                              Year Ended December 31, 2002
                                                 --------------------------------------------------
                                                 Microvision    Lumera     Elimination     Total
                                                 -----------  -----------  -----------  -----------
Contract Revenue                                $    14,443  $       946  $        --  $    15,389
Product Revenue                                         528           --           --          528
Cost of Contract Revenue                              6,139          330                     6,469
Cost of Product Revenue                                 528                                    528
Research and development expense                     18,362        7,157           --       25,519
Marketing, general and administrative expense        15,577        1,221           --       16,798
Non-cash compensation expense                           841        1,143           --        1,984
Interest income                                         860          199           --        1,059
Interest expense                                         59           --           --           59
Segment loss                                         26,219        8,698       (7,741)      27,176
Depreciation                                          1,894        1,049           --        2,943
Expenditures for capital assets                         792          562           --        1,354
Segment assets                                       30,144        8,589       (6,466)      32,267

YEAR ENDED DECEMBER 31, 20042005 COMPARED TO YEAR ENDED DECEMBER 31, 20032004

Contract Revenue.

Contract revenue decreasedincreased by $4.7$2.6 million, or 35%29%, to $11.4 million from $8.8 million from $13.5 million in 2003.2004. The decreaseincrease resulted from a lowerhigher level of development contract business performed in 20042005 than that performed in 20032004 on contracts entered into in both 20042005 and 2003.

2004. In 2005, 43% and 35% of contract revenue was earned from development contracts with a single commercial customer and a single U. S. government customer, respectively.

Contract revenue is earned from the Company's work on development contracts with the United States government and commercial enterprises. In 2004,2005, 46% of contract revenue was derived from performance on development contracts with the United States government and 54% from performance on development contracts with commercial customers. In comparison, 55% of contract revenue was derived from performance on development contracts with the United States government and 45% from performance on development contracts with commercial customers. In comparison to 53% of revenue was derived from performance on development contracts with the United States government and 47% from performance on development contracts with commercial customers in 2003. In 2003, 29% of consolidated contract revenue was earned from development contracts with a single commercial customer.2004. The Company expects contract revenue to fluctuate significantly from year to year.

In May 2004, MicrovisionJune 2005, the Company entered into a $3.9$4.4 million contract modificationwith General Dynamics C4 Systems to continue the development of a helmet-mounted display for the Air Warrior Block 3 system. General Dynamics is under contract with the U.S. Army's Aviation Applied Technology DirectorateProduct Manager -- Air Warrior in Huntsville, Ala., to continue work on an advanced helmet mounteddevelop and integrate the Air Warrior Block 3 system. The Microvision helmet-mounted display is being designed as a full-color, see-through, daylight and imaging system to be used in the Virtual Cockpit Optimization Program.

In December 2004, Microvision entered into a $6.2 million contract with Ethicon Endo-Surgery, Inc., a subsidiary of Johnson & Johnson, to integrate Microvision's technology into certain medical products. The contract includes an exclusive license for Microvision's technology for certain human medical applications during the term of the development agreement.night- readable, high-resolution display.

The Company had a contract revenue backlog of $7.0$2.8 million at December 31, 2004.2005. The backlog is composed of development contracts, including amendments, entered through December 31, 2004.2005. The Company plans to complete all of the contract backlog during 2005.2006.

Product Revenue.

Microvision earns product revenue from the sale of Nomad and Flic. Microvision recognizes revenue on product sales upon customer acceptance or when the right to return has expired. Product revenue increased $1.5$800,000 or 29% to $3.4 million or 129% tofrom $2.6 million from $1.1 million in 2003. The increase resulted from increased sales of both Flic and Nomad in 2004. Revenue from Nomad sales increased by approximately $900,000 in 2005 from 2004, while revenue from Flic sales decreased by approximately $100,000 over the same period.

During 2004,2005, Microvision earned $1.8 million from the sale of approximately 300 Nomads compared to $864,000 from the sale of 208 Nomads compared to $855,000 from the sale of 133approximately 200 Nomads in 2003.2004. Microvision introduced a new version of the Nomad in March 2004. The new version is 40% smaller than the previous version and cost less to produce. Microvision is targeting truck and automotive repair and military applications for the Nomad.

The Nomad has not gained the commercial acceptance the company had planned when the product was introduced. In January 2006 the Company took steps to reduce its cost in manufacturing, sales and marketing of Nomad until it develops a go to market strategy that will be more successful. The Company is currently installed in 62 automotive repair facilities.working with a small number of potential customers to define applications and business cases for the Nomad. Defining the business case consists of studying the potential customers work environment, identifying operations that could be performed more economically using Nomad, conducting trials to demonstrate the cost savings, collecting customer feedback, making modifications or improvements to the applications or the Nomad, and then developing sales tools to take advantage of the proven benefits. The company expects to take at least the first half of 2006 to develop a go to market strategy for Nomad. Until the go to market strategy is complete the Company expects limited sales of Nomad.

During 20042005 and 2003,2004, Microvision recorded $1,732,000$1.6 million and $280,000$1.7 million respectively, in revenue from sales of Flic barcode scanners. Revenue from Flic was negatively impacted in 2005 by delays in product shipments from the Company's contract manufacturer. The Company is working closely with its contract manufacturer to improve deliveries of Flic.

The Company had a product revenue backlog of $157,000$579,000 at December 31, 2004.2005. The backlog is composed primarily of orders for Nomad and Flic received through December 31, 2004.2005. The Company plans to deliver all products in backlog during 2005.2006.

Cost of Contract Revenue.

Cost of contract revenue includes both the direct and allocated indirect costs of performing on development contracts. Direct costs include labor, materials and other costs incurred directly in performing specific projects. Indirect costs include labor and other costs associated with operating the Company's research and product development department and building the technical capabilities of the Company. Cost of contract revenue is determined both by the level of direct costs incurred on development contracts and by the level of indirect costs incurred in managing and building the technical capabilities and capacity of the Company. The cost of contract revenue can fluctuate substantially from period to period depending on the level of both the direct costs incurred in the performance of projects and the level of indirect costs incurred.

Cost of contract revenue decreasedincreased by $449,000,$917,000, or 8%17%, to $5.5$6.5 million from $6.0$5.5 million. On a percentage of contract revenue basis, cost of contract revenue increased by 43 %decreased to 57% from 63% from 44% in 2003.2004. The change in cost of contract revenue as a percentage of contract revenue is primarily attributable to changes in the contract costs mix. Total direct costs in 2004 decreased2005 increased approximately 6%23% from 2003.2004. The direct labor cost portion of direct cost decreasedincreased by approximately 6%8% from 2003.2004. The decreaseincrease in direct labor cost resulted from a lowerhigher volume of contract work performed during 20042005 compared to 2003.

During 2004, the Company experienced unplanned technical difficulties on one significant project. As a result of the difficulties, more direct costs than planned were incurred in completing the project resulting in a lower gross margin during 2004 than in 2003.2004.

Research and development overhead is allocated to both cost of contract revenue and research and development expense based on the proportion of direct labor cost incurred in cost of contract revenue and research and development, respectively.

The Company expects that cost of contract revenue on an absolute dollar basis will increase in the future. This increase will likely result from planned additional development contract work that the Company expects to perform, and commensurate growth in the Company's personnel and technical capacity required to perform on such contracts. The cost of contract revenue, as a percentage of contract revenue, can fluctuate significantly from period to period depending on the contract mix and the level of direct and indirect cost incurred.

Cost of Product Revenue.

Cost of product revenue includes both the direct and allocated indirect costs of manufacturing Nomads and Flics sold to customers. Direct costs include labor, materials and other costs incurred directly in the manufacture of Flic and Nomad. Indirect costs include labor and other costs associated with maintaining Microvision manufacturing capabilities and capacity. Cost of product revenue increased $4.7 million or 123% to $8.6 million from $3.9 million in 2004.

Microvision's costs to produce Nomad units during 2005 were substantially higher than product revenue. Until October 2004, Microvision classified production cost in excess of product revenue as research and development expense. In October 2004, management determined that Nomad production and manufacturing processes were sufficiently mature to support "commercial production" as described in SFAS No. 2 "Accounting for Research and Development Costs". As a result of this determination Microvision began full absorption of manufacturing overhead cost.

Cost of product revenue in 2005 includes the write off of $3.0 million of Nomad inventory and $700,000 of Flic inventory. The write-off's were due to changes in product design and customer demand that caused components and accessories to become obsolete or excess to forecasted demand. Microvision values inventory at the lower of cost or market. Microvision also reduces the value of its raw material inventory to its estimated scrap value when management determines that it is not probable that the inventory will be utilized through normal production during the next 12 months.

Manufacturing overhead is allocated to inventory, cost of product revenue, cost of contract revenue, and research and development expense based on the proportion of direct material purchased for the respective activity. During 2005, the Company expensed approximately $1.5 million of manufacturing overhead associated with production capacity in excess of production requirements

In January 2006, the Company implemented a plan that included steps to reduce production costs. These steps included ongoing activities to improve product quality and reductions in overhead costs. The Company expects gross margins on product sales to improve in 2006.

The Company expects that cost of product revenue on an absolute dollar basis will increase in the future. This increase will likely result from increased shipments of commercial products. The Company expects that cost of product revenue will be higher than product revenue until the Company achieves sales volumes that match its production capability.

Research and Development Expense.

Research and development expense consists of:

• compensation related costs of employees and contractors engaged in internal research and product development activities,
• research fees paid to the University of Washington under the Lumera Sponsored Research Agreement (prior to July 2004),
• laboratory operations, outsourced development and processing work,
• fees and expenses related to patent applications, prosecution and protection,
• related operating expenses and
• costs relating to acquiring and maintaining licenses.

Research and development expense decreased by $8.1 million, or 55%, to $6.6 million from $14.7 million in 2004.

Research and development expense in 2004 included approximately $4.3 million in manufacturing overhead associated with Nomad production. The Company classified Nomad manufacturing expense in excess of Nomad product revenue as research and development expense until the Nomad design and production capabilities were sufficiently mature to support commercial production in the fourth quarter of 2004.

Research and Development expense attributable to Lumera was $1.1 million in 2004. The decrease in Research and Development expense attributable to Lumera accounts for 14% of the decrease in consolidated Research and Development expense.

The Company allocates research and development resources to customer funded projects and internally funded projects based on management's determination of customer requirements, product development requirement, and the availability of research and development resources to meet project objectives. During 2005 the Company allocated $917,000 more resources to customer funded projects than in 2004.

The Company believes that a substantial level of continuing research and development expense will be required to develop commercial products using the scanned beam technology. Accordingly, the Company anticipates that its research and development expenditures will continue to be significant. These expenses could be incurred as a result of:

• subcontracting work to development partners,
• expanding and equipping in-house laboratories,
• acquiring rights to additional technologies,
• incurring related operating expenses, and
• hiring additional technical and support personnel.

The Company expects that the amount of spending on research and product development will remain high in future quarters as we:

• continue development and commercialization of the Company's scanned beam technology,
• accelerate development of the integrated photonics module to meet emerging market opportunities, and
• pursue other potential business opportunities.

Sales, Marketing, General and Administrative Expense.

Sales, marketing, general and administrative expenses include compensation and support costs for sales, marketing, management and administrative staff, and for other general and administrative costs, including legal and accounting, consulting and other operating expenses.

The Company's marketing activities include corporate awareness campaigns, such as web site development and participation at trade shows, corporate communications initiatives, and working with potential customers and joint venture partners to identify and evaluate product applications in which the Company's technology could be integrated or otherwise used.

Sales, marketing, general and administrative expenses increased by $695,000, or 4%, to $19.9million from $19.2 million in 2004. The increase in sales, marketing, general and administrative expenses are due to the increase in sales and marketing activity related to Nomad and Flic sales. The Company has added sales staff, demonstration equipment and promotion materials to support increased sales of Nomad and Flic.

In 2000, the Board of Directors authorized Microvision to provide unsecured lines of credit to each of its three senior officers. No loans have been made under either Microvision's Executive Option Exercise Note Plan or the Executive Loan Plan since July 2002, and Microvision does not intend to make any additional loans under these plans. A total of $2,723,000 was issued and remains outstanding under the Executive Loan Plan. There are currently no outstanding loans under the Executive Option Exercise Note Plan.

In 2005, Microvision determined that certain of its senior officers may have had insufficient net worth and short-term earnings potential to repay their outstanding loans. As a result, Microvision recorded additional allowances for doubtful accounts for the receivables from senior officers of $1,031,000. The balance of the allowance for doubtful accounts for receivables from senior officers was $1.9 million at December 31, 2005. Two of the officers left the Company in January 2006. In accordance with the terms, the loans will be due in January 2007. Microvision has no plans to forgive any portion of the principal of the outstanding receivable balance.

In January 2006, the Company took the following steps to reduce sales, marketing, general and administrative expense:

• Reduced the number of executive officers and vice presidents by 50%.
• Reduced the sales and marketing costs for Nomad until the Company completes a new go to market strategy.

After the expected decline in 2006 compared to 2005, the Company anticipates sales, marketing, general and administrative expenses will increase as product revenue increases in future periods and as the Company:

• adds to its sales and marketing staff,
• makes additional investments in sales and marketing activities, and
• increases the level of corporate and administrative activity.

Non-Cash Compensation Expense.

Non-cash compensation expense includes the amortization of the value of stock options granted to individuals who are not employees or directors of the Company for services provided to the Company as well as employee stock based compensation expenses. Non-cash compensation expense decreased by $1.7 million or 80% to $429,000 from $2.1 million in 2004.

The following table shows the components of non-cash compensation expense for 2005 and 2004, respectively.

                                                                      2005         2004
                                                                   -----------  -----------
Microvision stock, options and warrants issued to third parties   $   335,000  $   587,000
Microvision stock options issued to employees                          59,000       54,000
Microvision stock and options issued to Independent Directors          35,000       46,000
Lumera options issued to Microvision employees                             --      134,000
Lumera non-cash compensation expense                                       --    1,297,000
                                                                   -----------  -----------
                                                                  $   429,000  $ 2,118,000
                                                                   ===========  ===========

At December 31, 2005, the Company had $85,000 of unamortized non-cash compensation expense that will be amortized over the next two years.

Interest Income and Expense.

Interest expense increased in 2005 by $3.1 million to $3.3 million from $151,000 in 2004. In March 2005, the Company raised $10 million before issuance costs of $423,000 from the issuance of convertible notes ("March Notes") and warrants to purchase an aggregate of 462,000 shares of Microvision common stock. In December 2005, the Company raised $10 million before issuance costs of $134,000 from the issuance of convertible notes ("December Notes"), 838,000 shares of Microvision common stock and warrants to purchase 1,089,000 shares of Microvision common stock. This increase in interest expense relates to the stated interest on the March Notes and December Notes, (together "the Notes") as well as the amortization of the discount recorded on the Notes due to the warrants and embedded derivative feature of the Notes. The Company expects interest expense will be substantially higher than in previous periods as a result of these transactions.

Loss on debt extinguishment.

In July 2005, the Company entered into an agreement to amend the Company's March Notes. In connection with the amendment, the Company issued three year warrants to purchase 750,000 shares of Microvision common stock with an exercise price of $6.84 per share. The conversion price of the amended notes and exercise price of the warrants are subject to anti-dilution adjustments. In addition, the price at which the note holder can convert the March Notes to Microvision common stock was reduced to $5.85 per share, and the price at which the Company can mandatorily convert the March Notes to Microvision common stock was reduced to $10.24. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the March Notes. As a result of the amendment, the amended notes are no longer exchangeable into Lumera common stock.

The Company has concluded that the amendment of the March Notes met the criteria of a debt extinguishment and recorded a charge of $3,313,000 for the change in the fair value of the debt in July 2005. The charge was measured as the value of the additional warrants that were issued to the note holders and the fair value of the reduced price at which the debt could be converted to Microvision common stock. The additional warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of three years. The warrants were initially valued at $2,295,000. The change in the conversion price was valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life equal to the length of the option. The change in the conversion price was valued at $1,018,000.

Gain on derivative feature of notes payable.

The following table summarizes the accounting for the Company's Notes:

                                                                                     Embedded     Common       Loss on
                                                                                    derivative  stock and   extinguishment
                                                                Notes    Warrants    feature       APIC         of debt        Total
                                                              ---------  ---------  ----------  ----------  ---------------  ---------
March 10, 2005 issuance                                      $   5,395  $   1,650  $    2,955  $       --  $            --  $  10,000
Debt restructuring at July 25, 2005                                         2,295       1,018                       (3,313)        --
Conversion of debt to common stock at October 11, 2005          (1,398)                  (439)      1,837                          --
December 1, 2005 issuance                                        3,667      2,200       1,116       3,017                      10,000
Principal payments on notes                                       (867)                               867                          --
Discount accretion for the year ended December 31, 2005          2,546                                                          2,546
Changes in market value for the year ended December 31, 2005               (2,693)     (3,282)                                 (5,975)
                                                              ---------  ---------  ----------  ----------  ---------------  ---------
Balances at December 31, 2005                                $   9,343  $   3,452  $    1,368  $    5,721  $        (3,313)
                                                              =========  =========  ==========  ==========  ===============

In connection with the issuance of the Company's March Notes, the Company concluded that the note holders' right to convert all or a portion of the notes into Microvision or Lumera common stock is an embedded derivative instrument as defined by FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities. Accordingly, $2,955,000 of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The derivative instrument was valued using the higher of the Microvision or Lumera conversion feature. The value was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 83%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of six months to two years, which corresponds to the principal repayment dates. Due to change in the stock price and remaining life, the fair value of the embedded derivative instrument decreased to $2,463,000 at July 25, 2005 the date of the extinguishment. The change in value of $492,000 for the period from issuance to July 25, 2005, was recorded as a non-operating gain and is included in "Gain on derivative features of note payable, net" in the consolidated statement of operations.

The Company issued warrants to purchase 462,000 shares of common stock in connection with the issuance of the March Notes. The warrants vested on the date of grant, have an exercise price of $6.84 per share and expire in March 2010. The initial exercise price is subject to adjustment in the event Microvision issues common stock or common stock equivalents at a price per share of common stock below the exercise price of the warrant. Under the terms of the restructuring of the notes in July 2005, the Company issued three year warrants to purchase 750,000 shares of Microvision common stock at a price of $6.84. The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $1,651,000 of the cash proceeds were allocated to the original warrants and an additional $2,295,000 was allocated to the warrant issued in July 2005. These amounts which represent the fair value of the warrants on the date of issuance have been included in current liabilities. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. As of December 31, 2005, the warrants were valued using the Black Scholes option- pricing model with the following assumptions: expected volatilities of 65%and 58%; expected dividend yield of 0%; risk free interest rates ranging from 4.36% to 4.39%; and contractual lives of 4.2 years and 2.6 years. The change in value of the warrants of$2,671,000 for the year ended December 31, 2005 was recorded as a non-operating gain and is included in "Gain on Derivative Features of Note Payable Net" in the consolidated statement of operations.

The amended conversion feature described above continued to meet the definition of a derivative under FAS 133 and accordingly was recorded at fair value at issuance and included within long term liabilities. The carrying amount of the derivative will be adjusted to fair value at each balance sheet date. The derivative feature was valued at $331,000 at December 31, 2005 and the change in the value from July 25, 2005 to December 31, 2005 of $2,712,000 was recorded as a non operating gain and is included in "Gain on derivative features of note payable, net" in the consolidated statement of operations.

In October 2005, the noteholder converted $1.8 million of the March Notes to 310,000 shares of common stock. The value of the embedded derivative feature associated with the converted shares of $439,000 was recorded to additional paid in capital.

In connection with the issuance of the December Notes, the Company concluded that the note holders' right to convert all or a portion of the notes into Microvision common stock is an embedded derivative instrument as defined by FASB Statement No. 133, accordingly $1.1 million of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The value of the derivative feature was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 58%; expected dividend yield of 0%; risk free interest rates ranging from 4.01% to 4.39%; and contractual life of four to sixteen months, which corresponds to the principal repayment dates. Due to change in the stock price and remaining life, the fair value of the embedded derivative instrument decreased to $1,038,000 at December 31, 2005. The change in value of $78,000 was recorded as a non-operating gain and is included in "Gain on derivative features of note payable, net" in the consolidated statement of operations.

The Company issued warrants to purchase 1,089,000 shares of common stock in connection with the issuance of the December Notes. The warrants vested on the date of grant, have an exercise price of $3.94 per share and expire in December 2010. The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $2.2 million of the cash proceeds were allocated to the original warrants which represent the fair value of the warrants on the date of issuance, and the amount was recorded as a current liability. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. As of December 31, 2005, the warrants were valued using the Black Scholes option- pricing model with the following assumptions: expected volatility of 65%; expected dividend yield of 0%; risk free interest rate of 4.35%; and contractual life of five years. The change in value of $22,000 was recorded as a non- operating gain and is included in "Gain on Derivative Features of Note Payable, Net" in the consolidated statement of operations.

Loss on equity in investment subsidiary.

In July 2004, Lumera completed an initial public offering of its common stock. In connection with the offering, all Lumera Series A and Series B Preferred Stock was converted to Lumera common stock. Immediately after the offering, Microvision owned 5,434,000 shares, or 33%, of the common stock of Lumera. As a result of the change in ownership percentage, Microvision has changed the method of accounting for its investment in Lumera to the equity method. Under the equity method, Microvision recorded its ownership interest in the net book value of Lumera immediately following the initial public offering as an investment in equity method subsidiary of $11.9 million. Microvision records its pro rata share of Lumera's income or loss as an adjustment in the value of its investment in Lumera. Microvision's share in Lumera's losses was $3.2 million for the year ended December 31, 2005 and $1.7 million for the period from July 2004 to December 31, 2004.

Gain on Sale of Securities of Equity Subsidiary.

During 2005 Microvision sold 812,000 shares of its Lumera common stock at prices between $4.04 and $5.00 per share. The total proceeds from the sales were $3,893,000. The sales price was higher than the average carrying value of the shares and the Company recognized a gain of $2.7 million in 2005.

Income Taxes.

No provision for income taxes has been recorded because the Company has experienced net losses from inception through December 31, 2005. At December 31, 2005, Microvision had net operating loss carry-forwards of approximately $191.0 million for federal income tax reporting purposes. In addition, Microvision has research and development tax credits of $2.6 million. The net operating losses begin expiring in 2008 if not previously utilized. In certain circumstances, as specified in the Internal Revenue Code, a 50% or more ownership change by certain combinations of Microvision's shareholders during any three-year period would result in a limitation on Microvision's ability to utilize a portion of its net operating loss carry-forwards. Microvision has determined that such a change of ownership occurred during 1995 and that the annual utilization of loss carry-forwards generated through the period of that change will be limited to approximately $761,000. An additional change of ownership occurred in 1996 and the annual limitation for losses generated in 1996 is approximately $1.6 million.

Inducement for Conversion of Preferred Stock.

In September 2004, Microvision raised $10.0 million before issuance costs of $90,000 from the sale of 10,000 shares of convertible preferred stock and a warrant to purchase 362,000 shares of common stock. The preferred stock terms include a dividend of 3.5% per annum, payable quarterly in cash or registered common stock, at the election of the Company, subject to certain conditions.

The net cash proceeds of $9,910,000 were allocated to the preferred stock and the warrant based on the relative fair values of the securities. The warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility, 75%; risk free interest rate, 3.4%, and contractual life five years. $1.3 million of the proceeds were allocated to the warrant and was recorded as an increase to additional paid-in capital.

Subsequent to the relative fair value allocation, the effective conversion price of the convertible preferred stock was less than the closing price of Microvision's common stock on the date of commitment to purchase the preferred stock, resulting in the recognition of a beneficial conversion feature in accordance with Emerging Issues Task Force No 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments." This beneficial conversion feature was measured as $1.2 million, which represents the difference between the fair value of the common stock and the effective conversion price. This beneficial conversion feature was recorded to additional paid-in capital and will be recorded as a deemed dividend to preferred stockholders (accretion) using the effective interest method, over the stated life of the preferred stock, which is three years. During 2005, the Company recorded $280,000 in dividends on the preferred stock and $303,000 in accretion of the beneficial conversion feature of the preferred stock.

In August 2005, the holder of the Company's preferred stock agreed to convert 5,000 shares of the Company's preferred stock into 734,000 shares of common stock. As an inducement to convert the preferred stock the Company issued 124,000 shares of its common stock to the preferred stock holder and adjusted the exercise price from $8.16 to $6.84 per share for the existing warrants to purchase 362,000 shares of common stock issued in connection with the original sale of the Company's preferred stock. The total value of the 124,000 common shares issued of $701,000, the change in the value of the warrants of $62,000 and the amount of unamortized beneficial conversion feature on the preferred stock of $421,000 was recorded as an inducement to convert the preferred stock and charged to common shareholders in 2005. The warrants were valued using the Black Scholes option pricing model with the following assumption: expected volatility 65%, risk free interest rate 4.25% and contractual life 4.1 years.

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

Contract Revenue.

Contract revenue decreased by $4.7 million, or 35%, to $8.8 million from $13.5 million in 2003. The decrease resulted from a lower level of development contract business performed in 2004 than that performed in 2003 on contracts entered into in both 2004 and 2003.

In 2004, 55% of contract revenue was derived from performance on development contracts with the United States government and 45% from performance on development contracts with commercial customers. In comparison to 53% of contract revenue was derived from performance on development contracts with the United States government and 47% from performance on development contracts with commercial customers in 2003. In 2003, 29% of consolidated contract revenue was earned from development contracts with a single commercial customer.

In May 2004, Microvision entered into a $3.9 million contract modification with the U.S. Army's Aviation Applied Technology Directorate to continue work on an advanced helmet mounted display and imaging system to be used in the Virtual Cockpit Optimization Program.

In December 2004, Microvision entered into a $6.2 million contract with Ethicon Endo-Surgery, Inc., a subsidiary of Johnson & Johnson, to integrate Microvision's technology into certain medical products. The contract includes an exclusive license for Microvision's technology for certain human medical applications during the term of the development agreement.

The Company had a contract revenue backlog of $7.0 million at December 31, 2004. The backlog was composed of development contracts, including amendments, entered through December 31, 2004.

Product Revenue.

Product revenue increased $1.5 million or 129% to $2.6 million from $1.1 million in 2003. The increase resulted from increased sales of both Flic and Nomad in 2004.

During 2004, Microvision earned $864,000 from the sale of 208 Nomads compared to $855,000 from the sale of 133 Nomads in 2003. Microvision introduced a new version of the Nomad in March 2004.

During 2004 and 2003, Microvision recorded $1,732,000 and $280,000, respectively, in revenue from sales of Flic barcode scanners.

The Company had a product revenue backlog of $157,000 at December 31, 2004. The backlog was composed of orders for Nomad and Flic received through December 31, 2004.

Cost of Contract Revenue.

Cost of contract revenue decreased by $449,000, or 8%, to $5.5 million from $6.0 million. On a percentage of contract revenue basis, cost of contract revenue increased to 63% from 44% in 2003. The change in cost of contract revenue as a percentage of contract revenue is primarily attributable to changes in the contract costs mix. Total direct costs in 2004 decreased approximately 6% from 2003. The direct labor cost portion of direct cost decreased by approximately 6% from 2003. The decrease in direct labor cost resulted from a lower volume of contract work performed during 2004 compared to 2003.

During 2004, the Company experienced unplanned technical difficulties on one significant project. As a result of the difficulties, more direct costs than planned were incurred in completing the project resulting in a lower gross margin during 2004 than in 2003.

Cost of Product Revenue.

Cost of product revenue increased $2.8 million or 266% to $3.9 million from $1.1 million in 2003.

Microvision's costs to produce Nomad units during 2004 were substantially higher than product revenue. Until October 2004, Microvision classified production cost in excess of product revenue as research and development expense. In October 2004, management determined that Nomad production and manufacturing processes were sufficiently mature to support "commercial production" as described in SFAS No. 2 "Accounting for Research and Development Costs". As a result of this determination Microvision began full absorption of manufacturing overhead cost. During the fourth quarter of 2004, the cost of product revenue exceeded product revenue for both the Flic and Nomad products.

Cost of product revenue in 2004 includes the write off of $764,000 of Flic inventory and $479,000 of Nomad inventory. The write off's were due to changes in product design and customer demand that caused components and accessories to become obsolete or slow moving. Microvision values inventory at the lower of cost or market. Microvision also reduces the value of its inventory to its estimated scrap value when management determines that it is not probable that the inventory will be utilized through normal production during the next 12 months.

The Company expects that cost of product revenue on an absolute dollar basis will increase in the future. This increase will likely result from increased shipments of commercial products. The Company expects that cost of product revenue will be higher than product revenue until the Company achieves sales volumes that match its production capability.moving

Research and Development Expense.

Research and development expense consists of:

• compensation related costs of employees and contractors engaged in internal research and product development activities,
• research fees paid to the University of Washington under the Lumera Sponsored Research Agreement,
• laboratory operations, outsourced development and processing work,
• fees and expenses related to patent applications, prosecution and protection,
• related operating expenses and
• cost relating to acquiring and maintaining licenses.

Research and development expense decreased by $8.6 million, or 37%, to $14.7 million from $23.3 million in 2003.

Research and Developmentdevelopment expense attributable to Lumera decreased $5.5 million, or 83%, to $1.1 million from $6.6 million in 2003. The decrease in Researchresearch and Developmentdevelopment expense attributable to Lumera accounts for 64% of the decrease in consolidated Researchresearch and Developmentdevelopment expense.

In April 2004, Lumera and the University of Washington entered into a fourth amendment to the Sponsored Research Agreement that requiresrequired payments of $125,000 for quarters ending March 31, 2004 and June 30, 2004 and eliminates the contingent payment of $2.0 million. For each of the quarters ending September 30, 2004 and December 31, 2004, Lumera was required to pay $250,000. The agreement will terminateterminated in 2005 after payments of $375,000 arewere made in quarters ending March 31, 2005 and June 30, 2005. Total payments under the Sponsored Research Agreement will bewere $5.8 million instead of the original $9.0 million. Lumera recognizes research and development expense under the Sponsored Research Agreement on a straight line basis over the term of the agreement. At the time of the fourth amendment to the Sponsored Research Agreement, Lumera had recognized $6.5 million in expense related to the Sponsored Research Agreement. In April 2004, Lumera recorded a reduction in its liability and an offsetting reduction in expense of $2.4 million to reduce the cumulative expense recognized under the Sponsored Research Agreement to the expense incurred under the fourth amendment on a straight line basis.

Research and development expense in 2003 included $645,000 for the closure of Microvision's research and development facility in San Mateo, California. Microvision consolidated its research and development activities in Bothell, Washington in May 2003.

The Company believes that a substantial level of continuing research and development expense will be required to develop commercial products using the scanned beam technology. Accordingly, the Company anticipates that its research and development expenditures will continue to be significant. These expenses could be incurred as a result of:

• subcontracting work to development partners,
• expanding and equipping in-house laboratories,
• acquiring rights to additional technologies,
• incurring related operating expenses, and
• hiring additional technical and support personnel.

The Company expects that the amount of spending on research and product development will remain high in future quarters as we:

• continue development and commercialization of the Company's scanned beam technology,
• accelerate development of microdisplays and imaging products to meet emerging market opportunities, and
• pursue other potential business opportunities.

Sales, Marketing, General and Administrative Expense.

Sales, marketing, general and administrative expenses include compensation and support costs for sales, marketing, management and administrative staff, and for other general and administrative costs, including legal and accounting, consulting and other operating expenses.

The Company's marketing activities include corporate awareness campaigns, such as web site development and participation at trade shows, corporate communications initiatives, and working with potential customers and joint venture partners to identify and evaluate product applications in which the Company's technology could be integrated or otherwise used.

Sales, marketing, general and administrative expenses increased by $3.4 million, or 22%, to $19.2 million from $15.8 million in 2003. The increase in Sales,sales, marketing, general and administrative expenses arewas due to the increase in sales and marketing activity related to Nomad and Flic sales. The Company has added sales staff, demonstration equipment and promotion materials to support increased sales of Nomad and Flic. The Company expects sales, marketing, general and administrative expenses to increase as product revenue increases in future periods as the Company:Flic

• adds to its sales and marketing staff,
• makes additional investments in sales and marketing activities, and
• increases the level of corporate and administrative activity.

Non-Cash Compensation Expense.

Non-cash compensation expense includes the amortization of the value of stock options granted to individuals who are not employees or directors of the Company for services provided to the Company as well as employee stock based compensation expenses. Non-cash compensation expense decreased by $38,000 or 2% to $2.1 million from $2.2 million in 2003.

In September 2003, Microvisionthe Company issued two warrants to purchase an aggregate of 70,000 shares of common stock to a third party in exchange for services provided to Microvision.the Company. One warrant grants the holder the right to purchase up to 60,000 shares of common stock at a price of $7.50 per share. The warrant vestedvests in three equal tranches on the date of grant, in December 2003, and in March 2004. The other warrant grants the holder the right to purchase up to 10,000 shares of common stock at a price of $12.00 per share vestedand vests in March 2004. The unvested warrants were subject to remeasurement at each balance sheet date until vested. The deferred compensation related to these warrants was being amortized to non- cash compensation expense over the fourteen month service period of the agreement. There is no amortization remaining at December 31, 2004. Non-cash amortization expense related to these warrants was $140,000 and $192,000 for 2004 and 2003 respectively. The total value of the warrants was estimated on December 31, 2003 and the grant date at $318,000 and $328,000, respectively. The fair values of the warrants were estimated on the date of grant and December 31, 2003, using the Black-ScholesBlack Scholes option-pricing model with the following weighted-average assumptions: expected volatilities of 83%, risk-freerisk- free interest rates of 2.7% and dividend yields of zero percent. The expectedcontractual lives used at the measurement dates above were 4 years and 3.9 years, respectively.

In August 2000, Microvision enteredthe Company issued warrants to purchase an aggregate of 200,000 shares of common stock to two consultants in connection with entering into five-yearcertain consulting agreements with two independent consultants to provide strategic business and financial consulting services. Under the termsCompany. One of the agreements,consultants subsequently became a director. The warrants grant each consultant received a warrantof the holders the right to purchase up to 100,000 shares of common stock at an exercisea price of $34.00 per share. The warrants to purchase an aggregate of 150,000 shares vested over three years and the unvested portions were subject to remeasurement at each balance sheet date during the vesting period untilperiod. The remaining warrants to purchase an aggregate of 50,000 shares had a measurement date at the endtime of the vesting period on June 7, 2003.grant. The original value of the warrants was estimated at $5.5 million, however, due to decreases in the Company stock price, the value in June 2003 was estimated to be $3.0 million. In 2004 and 2003, total non-cash amortization for these agreements was $447,000 and $595,000, respectively. The fair values of the warrants were determined in June 2003 and the issue date, using the Black-Scholes option-pricing model with the following weighted-average assumptions: dividend yield of zero percent, expected volatility of 83% for both measurement dates, risk-free interest rates of 4.0% and 5.9%, and expected lives of 7.4 and 9.2 years. Deferreddeferred compensation related to these warrants is being amortized to non-cash compensation expense over the five-year period of service under the agreements. The total original value of both warrants were estimated at December 31, 2004 was $270,000.$5,476,000.

During 2004, Lumera granted options to purchase 415,000 shares of Class A common stock to Lumera employees and directors with a weighted-average exercise price of $2.00. Lumera subsequently determined that the fair market value of its common stock was greater than the exercise price of the options. Lumera recorded aggregate charges of $216,000 during 2004 related to these grants.

During 2004, Lumera granted vested options to purchase 40,000 shares of Class A common stock to Microvision employees with a weighted-average exercise price of $2.00. Lumera subsequently determined that the fair market value of its common stock was greater than the exercise price of the options. The Company recorded aggregate charges of $134,000 during 2004 related to these grants.

The following table shows the components of non-cash compensation expense for 2004 and 2003, respectively.

                                                                      2004         2003
                                                                   -----------  -----------
Microvision stock, options and warrants issued to third parties   $   587,000  $   849,000
Microvision stock options issued to employees                          54,000      265,000
Microvision stock and options issued to Independent Directors          46,000        1,000
Lumera options issued to Microvision employees                        134,000           --
Lumera non-cash compensation expense                                1,297,000    1,041,000
                                                                   -----------  -----------
                                                                  $ 2,118,000  $ 2,156,000
                                                                   ===========  ===========

At December 31, 2004, the Company had $305,000 of unamortized non-cash compensation expense that will be amortized over the next year.

Interest Income and Expense.

Interest income in 2004 decreased by $109,000, or 29%, to $272,000 from $381,000 in 2003. This decrease resulted primarily from lower average cash and investment securities balances in 2004 than the average cash and investment securities balances in the prior year.

Interest expense was consistent with 2004 because the amount of borrowings did not change significantly.

Loss on equity in investment subsidiary.

In July 2004, Lumera completed an initial public offering of its common stock. In connection with the offering, all Lumera Series A and Series B Preferred Stock was converted to Lumera common stock. Immediately after the offering, Microvision owned 5,434,000 shares, or 33%, of the common stock of Lumera. As a result of the change in ownership percentage, Microvision has changed the method of accounting for its investment in Lumera to the equity method. Under the equity method, Microvision recorded its ownership interest in the net book value of Lumera immediately following the initial public offering as an investment in equity method subsidiary of $11.9 million. Microvision records its pro rata share of Lumera's income or loss as an adjustment in the value of its investment in Lumera. For the period from July 2004 to December 31, 2004 Microvision's share in Lumera's losses was $1.7 million.

Income Taxes.

No provision for income taxes has been recorded because the Company has experienced net losses from inception through December 31, 2004. At December 31, 2004, Microvision had net operating loss carry-forwards of approximately $168.0 million for federal income tax reporting purposes. In addition, Microvision hashad research and development tax credits of $2.2 million. The net operating losses begin expiring in 2008 if not previously utilized. In certain circumstances, as specified in the Internal Revenue Code, a 50% or more ownership change by certain combinations of Microvision's shareholders during any three-year period would result in a limitation on Microvision's ability to utilize a portion of its net operating loss carry-forwards. Microvision has determined that such a change of ownership occurred during 1995 and that the annual utilization of loss carry-forwards generated through the period of that change will be limited to approximately $761,000. An additional change of ownership occurred in 1996 and the limitation for losses generated in 1996 is approximately $1.6 million.

Non-cash Beneficial Conversion Feature of Preferred Stock.

In September 2004, Microvision raised $10.0 million before issuance costs of $90,000 from the sale of 10,000 shares of convertible preferred stock and a warrant to purchase 361,795362,000 shares of common stock. The preferred stock is convertible on demand by the holder into common stock at a conversion price of $6.91 per share of common stock. The initial conversion price is subject to adjustment in the event Microvision issues common stock or derivative securities at a price per share of common stock below the market price or the conversion price of the preferred stock. In addition, upon the request of the preferred stockholder, Microvision is required to redeem the preferred stock for cash in certain circumstances, including in the event of a material breach of our representations, warranties or covenants under the purchase agreement or a change in control. Accordingly, Microvision has classified the preferred stock as "mandatorily redeemable convertible preferred stock" in its consolidated balance sheet.

The preferred stock terms include a dividend of 3.5% per annum, payable quarterly in cash or registered common stock, at the election of the Company, subject to certain conditions. The preferred stock matures on September 10, 2007, at which time it is payable in cash or registered common stock, at the election of the Company, subject to certain conditions. Some of the conditions which would preclude the Company from paying in common stock are not within the Company's immediate control. The Company can elect to convert the preferred stock into common stock if the common stock price exceeds $12.09 per share, subject to certain conditions.

The warrant vested on the date of grant, has an exercise price of $8.16 per share and expires on September 10, 2009. The initial exercise price is subject to adjustment in the event the Company issues common stock or derivative securities at a price per share of common stock below the market price or the exercise price of the warrant.

The net cash proceeds of $9,910,000 were allocated to the preferred stock and the warrant based on the relative fair values of the securities. The warrants were valued using the Black-ScholesBlack Scholes option-pricing model with the following assumptions: expected volatility, 75%, risk free interest rate of 3.4%, and a contractual life 5 years. $1.3 million of the proceeds were allocated to the warrant and were recorded as an increase to additional paid-in capital.

Subsequent to the relative fair value allocation, the effective accounting conversion price of the convertible preferred stock was less than the closing price of Microvision's common stock on the date of commitment to purchase the preferred stock. This beneficial conversion feature was measured as $1.2 million, which represents the difference between the fair value of the common stock and the effective accounting conversion price. This beneficial conversion feature was recorded to additional paid-in capital and will be recorded as a deemed dividend to preferred stockholders (accretion) over the stated life of the preferred stock which is three years.

YEAR ENDED DECEMBERLiquidity and Capital Resources

Microvision has incurred significant losses since inception. The Company has funded operations to date primarily through the sale of common stock, convertible preferred stock, warrants, the issuance of convertible debt and, to a lesser extent, from development contract revenues and product sales. At December 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

Contract Revenue.

Contract revenue decreased by $1.9 million, or 12%, to $13.5 million from $15.42005, Microvision had $6.9 million in 2002. The decrease resulted from a lower level of development contract business in 2003 than that performed in 2002 on contracts entered into in both 2003cash and 2002.

cash equivalents. In 2003, 53% of contract revenue was derived from performance on development contracts with the United States government, 47% from performance on development contracts with commercial customers. In comparison, to 86% of revenue was derived from performance on development contracts with the United States government and 14% from performance on development contracts with commercial customers in 2002. In 2003, 29% of consolidated contract revenue was earned from development contracts with a single commercial customer.

During 2003,January 2006 the Company entered into several development contracts with both commercial and government entitiesraised $10.3 million through the sale of 2.6 million shares of its Lumera common stock equity method investment to a small group of private investors. The Company has sufficient cash to fund its operations through July 2006.

As discussed elsewhere in this report, the Company has received a report from our independent registered public accounting firm regarding the consolidated financial statements for further development of the scanned beam technology to meet specific customer applications.

• In February 2003,year ended December 31, 2005 that includes an explanatory paragraph stating that the financial statements have been prepared assuming Microvision extendedwill continue as a development agreement with Canon to further develop miniature displays for use in consumer products including digital cameras and digital video equipment.
• In April 2003, Microvision entered into a $2.2 million contract modification withgoing concern. The explanatory paragraph states the U.S. Army's Aviation Applied Technology Directoratefollowing conditions, which raise substantial doubt about our ability to continue work onas a going concern: (i) the Company has incurred operating losses since inception, including a net loss available for common shareholders of $30.3 million for the fiscal year ended December 31, 2005, and the Company has an advanced helmet mounted display and imaging system to be used in the Virtual Cockpit Optimization Program.
• In April 2003, Microvision entered into a $1.6 million contract modification with the U.S. Army's Medical Research Acquisition Activities, Telemedicine and Advanced Technology Research Center to continue developmentaccumulated deficit of a mobile wireless personal display system for medical applications.
• In October 2003, Microvision entered into a new agreement with Canon to further develop miniature displays for use in consumer products including digital cameras and digital video equipment.
• In December 2003, Lumera entered into a contract extension with a U.S. government agency to continue development of electro-optical polymer materials and devices for wideband optical modulators.
• During 2003, Microvision performed development work for several automotive companies including BMW and Volkswagen of America, to develop automotive displays using the scanned beam technology. The total value of these contracts was approximately $1.3 million.

The Company had a contract revenue backlog of $3.8$215.7 million at December 31, 2003.2005 and (ii) the Company anticipates requiring additional financial resources to enable it to fund its operations at least through December 31, 2006.

Product Revenue.

Product revenue increased by $607,000, or 115 %The Company plans to $1.1 million from $528,000 in 2002.

During 2003, Microvision recorded $855,000 in product revenue fromraise additional cash before July 2006 to fund its operations through the sale of 133 Nomads. its common stock, preferred stock or through the issuance of debt. The Company has taken the following actions to reduce its use of cash and improve the operations of the Company:

• Made significant changes to it senior management team including appointing a new Chief Executive Officer
• Announced a restructuring and realignment plan that targets a 30% reduction in operating loss
• Begun adding members to the Board of Directors with experience that directly supports the Company's business objectives
• Engaged an investment bank to assist the Company in pursuing financing alternatives

Cash used in operating activities totaled $19.7 million during 2005, compared to $30.8 million during 2004.

The Company had the following material gains and charges and changes in assets and liabilities during the year ended December 31, 2005.

• "Non cash interest expense, net"In September 2003, Microvision entered into a contractconnection with the Program Executive Office Soldier withinissuance of the U.S. ArmyCompany's notes in March 2005 and December 2005 the Company allocated proceeds to supply the Stryker Brigade Combat Team with 100 Nomads. In addition, Microvision continued developmentembedded derivative features and the warrants. The aggregate discount to the notes of a next generation Nomad that was launched in February 2004.

  During 2003, Microvision recorded $280,000 in product revenue from sales$7.9 million is amortized to noncash interest expense using the imputed interest method over the life of Flic barcode scanners. In January 2003, Microvision entered into a supply agreement to provide a private labeled Flic bar code scanner to NCR. During 2003, Microvision and NCR worked together to optimize the Flic performance for NCR's customers. NCR placed orders for $392,000 of product duringnotes. At December 31, 2005 the fourth quarter of 2003. Microvision ended the year with a backlog of $378,000 in Flic product and accessories

  Cost of Contract Revenue.

  Cost of contract revenue decreased by $481,000, or 7%, to $6.0 million from $6.5Company has $5.0 million in 2002. Onunamortized discount associated with the notes remaining.

• "Derivative feature of notes payable"In connection with the issuance of the Notes, the Company allocated a percentageportion of revenue basis, costthe proceeds to the embedded derivative features of contract revenue increased by 5 % to 44% from 42% in 2002. The change in cost of revenue as a percentage of revenue is primarily attributablethe Notes. Due to changes in the contract mix. Total direct costs decreased by approximately 14% from 2002. The direct labor cost portion of direct cost decreased by approximately 10% from 2002. The decrease in direct labor cost resulted from a lower volume of contract work performed during 2003 compared to 2002.

  Cost of Product Revenue.

  Cost of product revenue increased by $530,000, or 100%, to $1.1 million from $528,000 in 2002. Microvision's costs to produce Nomad units during 2003 were substantially higher than product revenue. In 2003, Microvision classified production cost in excess of product revenue as researchstock price and development expense. Through December 31, 2003, Nomad production andremaining life, the design and manufacturing processes had not become sufficiently mature to support "commercial production" as described in SFAS No. 2 "Accounting for Research and Development Costs."

  Management periodically assesses the need to provide for obsolescence of inventory and adjusts the carryingfair value of inventorythe embedded derivative instrument decreased to its net realizable value when required. During 2003, Microvision recorded a write down of Nomad inventory of approximately $450,000.

  Research and Development Expense

  Research and development expense decreased by $2.2 million, or 9%, to $23.3 million from $25.5 million in 2002. During 2002, the Company recorded $1.5 million in expense relating to light source research performed for the Company by Cree Inc. The Company's research agreement with Cree ended in April 2002, resulting in a $1.4 million expense reduction in 2003 from 2002.

  In 2003, Lumera recorded $1.9 million expense on its sponsored research agreement with the University of Washington compared to $2.4 million in 2002. The reduction in expense came as a result of two modifications to the sponsored research agreement with the University of Washington.

  In May 2003, Microvision closed its research and development facility in San Mateo, California and consolidated its research and development activities in Bothell, Washington. Research and development expense for 2003 included $540,000 for the closing of Microvision's approximately 5,200 square foot facility in San Mateo and $290,000 for severance and relocation of 11 employees. Microvision paid $270,000 in severance and relocation costs in 2003. The accrual related to the closing of the facility at December 31, 20032005. The aggregate change in value of $3.3 million for the year ended December 31, 2005 was recorded as a non-operating gain and is $431,000.

  Marketing, General and Administrative Expense.

  Marketing, general and administrative expenses decreased by $971,000, or 6%, to $15.8 million from $16.8 millionincluded in 2002. The decrease was primarily attributable to a reduction"Gain on derivative features of note payable, net" in the charge to the allowance for doubtful accountsconsolidated statement of operations.

• "Allowance for receivables from senior officers.

  Therelated parties" In 2000, the Board of Directors authorized Microvision to provide unsecured lines of credit to each of its three senior officers. No loans have been made under either Microvision's Executive Option Exercise Note Plan or the Executive Loan Plan since July 2002, and Microvision does not intend to make any additional loans under these plans.

  A total of $2,723,000 was issued and remains outstanding under the Executive Loan Plan. There are currently no outstanding loans under the Executive Option Exercise Note Plan.

In 2002 and again in 2003,2005, Microvision determined that certain of its senior officers may have had insufficient net worth and short-term earnings potential to repay their outstanding loans. As a result, Microvision recorded an allowanceadditional allowances for doubtful accounts for the receivables from senior officers of $200,000 and $700,000 during 2003 and 2002, respectively.$1.0 million. The balance of the allowance for doubtful accounts for receivables from senior officers was $900,000$1.9 million at December 31, 2003.2005. Two of the officers left the Company in January 2006, in accordance with the terms, the loans issued to these officers will be due in January 2007. Microvision has no plans to forgive any portion of the principal of the outstanding receivable balance.

Non-Cash Compensation Expense.

Non-cash compensation expense increased by $172,000

• "Equity losses in Lumera","Investment in Lumera"and"Gain on sale of securities of equity subsidiary" Microvision accounts for its investment in Lumera using the equity method. Microvision records its pro rata share of Lumera's income or 9% to $2.2 million from $2.0 millionloss as an adjustment in 2002.

  In September 2003, Microvision issued two warrants to purchase an aggregate of 70,000 shares of common stock to a third party for services provided to Microvision. The deferred compensation related to these warrants is being amortized to non-cash compensation expense over the fourteen month service period of the agreement. Non-cash amortization expense related to these warrants was $192,000 for 2003.

  In August 2003, Lumera issued options to purchase an aggregate of 164,000 sharesvalue of its Class A Common Stock to two consultantsinvestment in connection with entering into consulting agreements. Each holderLumera. Microvision's share in Lumera's losses was granted a warrant to purchase up to 82,000 shares of Class A Common Stock at a price of $3.65 per share with a ten year life. In aggregate, 41,000 of the options were vested on the grant date. The remaining 123,000 shares vest one-third on each subsequent annual anniversary of the grant date and are subject to remeasurement at each balance sheet date during the vesting period. The deferred compensation and liability related to these options is being amortized to non-cash compensation expense over the two year period of service under the agreements. The aggregate value of both options was estimated at $136,000 at the grant date and December 31, 2003. Total non-cash compensation expense was $32,000$3.2 million for the year ended December 31, 2003.2005 and $1.7 million for the period from July 2004 to December 31, 2004. During 2005, Microvision sold 812,000 shares of its Lumera common stock at prices between $4.04 and $5.00 per share. The fair valuestotal proceeds from the sales were $3,893,000. The aggregate carrying value of the options were estimated atshares sold was $1,192,000. The sales price was higher than the grant dateaverage carrying value of the shares and the Company recognized a gain of $2,700,000 in 2005. In March 2005 and December 2005, the Company issued convertible notes that are secured by 1,750,000 shares Lumera common stock with a book value of $2.2 million at December 31, 2003,2005. The value of the restricted Lumera common stock has been recorded as "Restricted investment in Lumera."

• "Loss on debt extinguishment" In July 2005, the Company entered into an agreement to amend the March Notes. In connection with the amendment, the Company issued three year warrants to purchase 750,000 shares of Microvision common stock with an exercise price of $6.84 per share. The conversion price of the amended notes and exercise price of the warrants are subject to anti-dilution adjustments. In addition, the price at which the note holder can convert the March Notes to Microvision common stock was reduced to $5.85 per share, and the price at which the Company can mandatorily convert the March Notes to Microvision common stock was reduced to $10.24. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the March Notes. As a result of the amendment, the March Notes are not currently exchangeable into Lumera common stock.
• The Company has concluded that the amendment of March Notes met the criteria of a debt extinguishment and recorded a charge of $3,313,000 for the change in the fair value of the debt in July 2005. The change in the value of the debt was measured as the value of the additional warrants that were issued to the note holders and the change in the price at which the debt could be converted to Microvision common stock. The additional warrants were valued using the Black-Scholes option pricingBlack Scholes option-pricing model with the following weighted-average assumptions: underlying security fair market valueexpected volatility of $0.98,75%; expected dividend yield of zero percent;0%; risk free interest rate of 3.66%; and contractual life of three years. The warrants were initially valued at $2,295,000. The change in the conversion price was valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 100% for both measurement dates, risk-free75%; expected dividend yield of 0%; risk free interest rates of 4.4% and 4.3%ranging from 3.25% to 3.58%; and expected lives of 10 and 9.7 years, respectively.

  In January 2001, Lumera issued 802,000 shares of its Class A Common Stockcontractual life equal to the Universitylength of Washington pursuant to the Sponsored Research Agreement.option. The shares werechange in the conversion price was valued at $1,018,000.

• "Accounts receivable" and "Billings in excess of costs and estimated earnings on uncompleted contracts"In December 2004 the fair market priceCompany recorded a receivable of $3.75 per share, as determined by the Board of Directors. The total value of the stock of $3.0$3.5 million was recorded asfrom a prepaid research expense and is being amortized over the term of the Sponsored Research Agreement. The total amortization expense relating to the Sponsored Research Agreement was $1.0 millioncustomer for an advance payment in both 2003 and 2002.

  In August 2000, Microvision entered into five-year consulting agreementsaccordance with two independent consultants to provide strategic business and financial consulting services. Under the terms of the agreements, each consultantdevelopment contract. The Company received a warrant to purchase 100,000 shares of common stock at an exercise price of $34.00 per share. In 2003, total non-cash amortization for these agreements was $595,000 compared to $542,000 recognizedthe payment in 2002.

  The following table showsJanuary 2005 and the components of non-cash compensation expense for 2003 and 2002, respectively.

  
                                                                        2003         2002
                                                                     -----------  -----------
  Lumera stock issued toCompany performed work on the University of Washington               $ 1,003,000  $ 1,003,000
  Microvision and Lumera stock options issued to third parties          882,000      571,000
  Lumera stock warrant issued to Arizona Microsystems                        --      133,000
  Microvision and Lumera stock options issued to employees              270,000      219,000
  Microvision stock and options issued to Independent Directors           1,000       58,000
                                                                     -----------  -----------
                                                                    $ 2,156,000  $ 1,984,000
                                                                     ===========  ===========
  
  

  Interest Income and Expense.

  Interest income in 2003contract during 2005.

• "Inventory" Inventory decreased by $678,000, or 64%,$2.4 million to $381,000 from $1.1 million in 2002. This decrease resulted primarily from lower average cash and investment securities balances in 2003 than the average cash and investment securities balances in the prior year.

  Interest expense was consistent with 2003 because the amount of borrowings did not change significantly.

  Income Taxes.

  No provision for income taxes was recorded because the Company has experienced net losses from inception through$759,000 at December 31, 2003. At December 31, 2003, Microvision had net operating loss carry-forwards of approximately $139.3 million for federal income tax reporting purposes. In addition, Microvision has research and development tax credits of $1.9 million.

  Liquidity and Capital Resources

  The Company has funded operations to date primarily through the sale of common stock, convertible preferred stock, warrants and, to a lesser extent,2005 from development contract revenues and product sales. At December 31, 2004, Microvision had $1.3 million in cash and cash equivalents. Microvision has incurred significant losses since inception

  Cash used in operating activities totaled $30.8 million during 2004, compared to $26.4 million during 2003. Cash used in operating activities for each period resulted primarily from the net loss for the period.

  The Company had the following material changes in assets and liabilities during the year ended December 31, 2004.

  • "Inventory" increased by $2.8 million to $3.2$ 3.2 million at December 31, 2004 from $331,000 at December 31, 2003.2004. The increasedecrease was primarily attributable to purchasesthe write off of raw materials to produce Nomad.excess and obsolete inventory. The Company had previously made commitments to purchase certain minimum quantities based on the economic order quantities, sales forecast and the availability of inventory at the start of Nomad production. Microvision has taken delivery of most of this inventory and plans for inventory as a percent of revenue to decline as Nomad product revenue is expected to increase.raw materials. The Company values inventory at the lower of cost or market with cost determined on a weighted average cost basis. The following table shows the composition of the inventory at December 31, 20042005 and December 31, 2003,2004, respectively:

  
                                                         December 31, December 31,
                                                            2005          2004
                                                         2003
                                                         -----------  -----------------------
  Raw materials                                         $   1,607,000267,000  $  98,0001,607,000
  Work in process                                           141,000        77,000           --
  Finished goods                                            351,000     1,483,000
                                                         233,000
                                                         -----------  -----------------------
                                                        $   759,000  $  3,167,000
                                                         $   331,000
                                                         ===========  =======================
  
  

  • "Investment in Lumera" In July 2004, Lumera completed an initial public offering of its common stock. In connection with the offering, all Lumera Series A and Series B Preferred Stock was converted to Lumera common stock. Immediately after the offering, Microvision owned 5,434,000 shares, or 33%, of the common stock of Lumera. As a result of the change in ownership percentage, Microvision has changed the method of accounting for its investment in Lumera to the equity method. Under the equity method, Microvision recorded it ownership interest in the net book value of Lumera immediately following the initial public offering as an investment in equity subsidiary of $11.9 million. Microvision records its pro rata share of Lumera's income or loss as an adjustment in the value of its investment in Lumera. Microvision recorded a non-cash change in ownership interest gain of $13.7 million to stockholders equity as a component of additional paid-in capital during the third quarter as a result of the public offering.
  • "Property and equipment, net" decreased $3.6 million to $2.3 million at December 31, 2004 from $6.0 million at December 31, 2003. The decline is principally due to the deconsolidation of Lumera in July 2004. Lumera had $2.2 million in net property and equipment at the time of the deconsolidation. Depreciation expense accounts for the remaining decrease.
  • "Accounts Payable" increased $1.4 million to $2.6 million at December 31, 2004 from $1.2 million at December 31, 2003. The increase in Accounts Payable is directly attributable to the increase in inventory.
  • "Research liability" decreased $1.9 million to $0 at December 31, 2004 from $1.9 million at December 31, 2003. The decline is due to the deconsolidation of Lumera in July 2004. The entire research liability was attributable to Lumera.

  Cash provided by investing activities totaled $1.0 million in 2005 compared to $10.0 million in 2004 compared to cash used in investing activities of $7.3 million in 2003.2004. During 2004,2005, the Company had net purchases of investment securities of $863,000 compared net sales of investment securities of $11.1 million compared to net purchases of investment securities of $5.8 million during 2003.2004. The proceeds from the sales of investment securities were used to fund the Company's operations.

  The Company used cash of $1.0$1.2 million for capital expenditures in 2004,2005, compared to $1.5$1.0 million in 2003.2004. Capital expenditures include leasehold improvements to leased office space and computer hardware and software, laboratory equipment and furniture and fixtures to support operations.

  Cash provided by financing activities totaled $24.3 million in 2005, compared to $12.8 million in 2004, compared to $34.5 million in 2003.2004. The following is a list of stock issuances during 2005 and 2004.

  • In MarchDecember 2005, Microvisionthe Company raised $10.0 million, before issuance costs of $134,000, from the issuance of senior secured exchangeable convertible notes (the "Notes"("December Notes"), 838,000 shares of common stock and warrants to purchase 1,089,000 shares of Microvision common stock. The December Notes are convertible on demand by the holders into Microvision common stock at a conversion price of $3.94 per share. The note holders may convert all or a portion of their notes. In addition, upon the request of the note holders, the Company is required to redeem the December Notes for cash upon a change of control or an event of default at a redemption price equal to 125% of the then outstanding balance of the notes. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the December Notes and the shares have been classified as a "Restricted investment in Lumera" on the Company's consolidated balance sheet.

  The terms of the December Notes include interest at LIBOR plus 3.0% provided that the interest rate shall not be less than 6% or greater than 8% payable quarterly in cash or Microvision common stock if the stock price is greater than $4.06 per share, at the election of the Company, subject to certain additional conditions. Under certain circumstances the interest rate increases to LIBOR plus 6% but not less than 12% or greater than 15%. If the Company chooses to pay interest in Microvision common stock as opposed to cash, the price will be based on 90% of the arithmetic average of the volume weighted average prices for the 20 trading days prior to the payment date. The December Notes are payable in five equal quarterly installments beginning in March 2006. The Company can elect to make the principal payments in common stock in lieu of cash if the stock price is greater than $4.06 per share, subject to certain other conditions. If the Company elects to pay principal in stock the stock will be issued at a 10% discount to the arithmetic average of the volume weighted average prices for the 15 trading days prior to the payment date. Additionally, the Company can elect to convert the December Notes into Microvision common stock if the stock price exceeds $6.90 per share for 20 out of any 30 consecutive trading days, subject to certain conditions.

  The Company concluded that the note holders' right to convert all or a portion of the December Notes into Microvision common stock is an embedded derivative instrument as defined by FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). Accordingly, $1.1 million of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The value was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 58%; expected dividend yield of 0%; risk free interest rate of 4.01% to 4.39%; and contractual life of four to sixteen months, which corresponds to the principal repayment dates. Due to changes in Microvision's stock price and remaining contractual life, the fair value of the embedded derivative feature decreased to $1,038,000 at December 31, 2005. The change in value of $78,000 was recorded as a non-operating gain and included in Gain on derivative features of note payable in the consolidated statement of operations. As of December 31, 2005 total principal payments of $7.0 million remain under the December Notes.

  The warrants vested on the date of grant, have an exercise price of $3.94 per share of common stock and expire in December 2010. The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $2.2 million of the cash proceeds were allocated to the warrants, which represents the fair value of the warrants on the date of issuance and the amount was recorded as a current liability. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. The warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 65%; expected dividend yield of 0%; risk free interest rate of 4.35%; and contractual life of five years.

  The Microvision common stock was valued at the closing price on the date of closing of $3.60 per share. Aggregate proceeds of $3.0 million were allocated to the common stock. The remaining gross proceeds of $3.7 million were allocated to the December Notes.

  • In August and September 2005 the Company raised $7.0 million before issuance costs through the sale of 1,333,000 shares of common stock at a price of $5.25 per share and five-year warrants to purchase 310,000 shares of common stock at a price of $6.50 to a holder of the Company's preferred stock and other investors.

  In March 2005, the Company raised $10.0 million, before issuance costs of $423,000, from the issuance of convertible notes ("March Notes") and warrants to purchase an aggregate of 462,330462,000 shares of Microvision common stock. The Notes are payable in six equal quarterly payments starting in December 2005. TheMarch Notes are convertible on demand by the holders into Microvision common stock at a conversion price of $6.84 per share of Microvision common stock and exchangeable on demand by the holders intoor Lumera common stock held by the Company at an exchangea conversion price of $5.64 per share of Lumera common stock. The terms includeup to a limit on the aggregate number of Lumera common shares that can be used to pay principal of 1,750,000 shares. The Notes are secured by the same 1,750,000 shares of Lumera common stock. The right to convert the March Notes into shares of Lumera common stock was removed pursuant to the amendment described below. The note holders may convert all or a portion of their notes. The initial conversion price is subject to adjustment in the event Microvision issues common stock or derivative securities, other than employee options,common stock equivalents at a price per share of common stock below the conversion price of the Note.March Notes. Due to below market issuances of Company's common stock the conversion price of the March Notes at December 31, 2005 was $5.54 per share of common stock. In addition, upon the request of the Notenote holders, Microvisionthe Company is required to redeem the March Notes for cash in certain circumstances, including in theupon a change of control or an event of default at a material breachredemption price equal to 125% of representations, warranties or covenants under the purchase agreement orthen outstanding balance of the March Notes. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the March Notes and the December Notes, described above. Those shares have been classified as a change"Restricted investment in control.Lumera" on the Company's consolidated balance sheet.

  The Note terms of the March Notes include variable interest at a rate of LIBOR plus 3% within a range of 6% to 8%,3.0% payable quarterly Each principal payment is payable in cash or registeredMicrovision common stock, at the election of the Company, subject to certain conditions. However, in no case shall the interest rate be less than 6.0% or greater than 8.0%. If the Company electschooses to pay principalinterest in registered common stock, the Note holder can elect to receive payment in either Microvision or Lumera common stock. Interest is payable in cash or Microvision common stock instead of cash, the price will be based on 92% of the arithmetic average of the volume weighted average prices for the 10 trading days prior to the payment date. The March Notes are payable in six equal quarterly installments beginning in December 2005. The Company can subject to certain conditions. Some ofconditions, elect to make the conditions which would preclude the Company from payingprincipal payments in common stock are not withinin lieu of cash. Payment in stock will be issued at a 10% discount to the Company's immediate control. Thearithmetic average of the volume weighted average prices for the 15 trading days prior to the payment date. Additionally, the Company can elect to convert the March Notes into Microvision common stock if the stock price equals or exceeds $11.97 per share for any 20 out of any 30 consecutive trading days, subject to certain conditions.

  The Company concluded that the note holders' right to convert all or a portion of the March Notes into Microvision or Lumera common stock is an embedded derivative instrument as defined by FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). Accordingly, $2,955,000 of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The derivative instrument was valued using the higher of the Microvision or Lumera conversion feature. The value was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 83%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of nine months to two years, which corresponds to the principal repayment dates. Due to changes in Lumera and Microvision's stock price and remaining contractual life, the fair value of the embedded derivative feature decreased to $2,463,000 at July 25, 2005 the date of the extinguishment. The changes in value of a decrease of $492,000 for the year ended December 31, 2005 was recorded as a non-operating gain and included in "Gain on derivative features of note payable" in the consolidated statement of operations. As of December 31, 2005 total principal payments of $7.3 million remain under the March Notes.

  The warrants are immediately exercisable,vested on the date of grant, have an exercise price of $6.84 per common share and expire in March 2010. The initial exercise price is subject to adjustment in the event Microvision issues common stock or derivative securitiescommon stock equivalents at a price per share of common stock below the exercise price of the warrant. Due to below market issuances of Company's common stock the exercise price of the warrants issued with the March Notes was adjusted to $6.29 as of December 31, 2005. The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $1,651,000 of the cash proceeds were allocated to the warrants, which represents the fair value of the warrants on the date of issuance and the amount was recorded as a current liability. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. The warrants were valued using the Black Scholes option- pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of five years. The remaining gross proceeds of $5,394,000 were allocated to the Notes.

  In July 2005, the Company entered into an agreement to amend the March Notes. In connection with the amendment, the Company issued three year warrants to purchase 750,000 shares of Microvision common stock at an exercise price of $6.84 per share. The conversion price of the amended March Notes and exercise price of the warrants are subject to anti-dilution adjustments, subject to conditions. In addition, the price at which the Note holders can convert the March Notes to Microvision common stock was reduced to $5.85 per share, and the price at which the Company can mandatorily convert the March Notes to Microvision common stock was reduced to $10.24. As a result of the amendment, the March Notes are no longer exchangeable into Lumera common stock.

  The Company has concluded that the amendment of the March Notes met the criteria of a debt extinguishment. The Company recorded a non cash charge of $3,313,000 for the change in the fair value of the debt and related consideration. The change in the value was measured as the value of the additional warrants that were issued to the note holders and the change in the price at which the debt could be converted to Microvision common stock. The additional warrants were valued using the Black Scholes option-pricing model with the following isassumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 3.66%; and contractual life of three years. The additional warrants were initially valued at $2,295,000. The change in the conversion feature was valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rates ranging from 3.25% to 3.58% and contractual life equal to the length of the option. The change in the conversion price was valued at $1,018,000.

  The amended conversion feature continued to meet the definition of a listderivative under FAS 133 and accordingly has been recorded at fair value and included within long-term liabilities. The carrying amount of stock issuancesthe derivative will be adjusted to fair value at each balance sheet date. An adjustment of $2,712,000 was recorded for the period from July 25, 2005 to December 31, 2005.

  In October 2005, the noteholder converted $1.8 million of the March Notes to 310,000 shares of common stock. The value of the embedded derivative feature associated with the converted shares of $439,000 was recorded to additional paid in capital.

  The liability for both the initial warrant and the additional warrant are adjusted to the fair market value of $1,273,000 at December 31, 2005. The combined adjustment during 2004 and 2003.the year ended December 31, 2005 was $2,672,000.

  • In September 2004, Microvision raised $10.0 million before issuance costs of $90,000 from the sale of 10,000 shares of convertible preferred stock and a warrant to purchase 361,795 shares of common stock. The preferred stock is convertible on demand by the holder into common stock at a conversion price of $6.91 per share of common stock. The initial conversion price is subject to adjustment in the event Microvision issues common stock or derivative securities at a price per share of common stock below the market price or the conversion price of the preferred stock. Due to below market issuances of Company's common stock the conversion price of the Preferred Stock as of December 31, 2005 was $6.36 per share of common stock. In addition, upon the request of the preferred stockholder, Microvision is required to redeem the preferred stock for cash in certain circumstances, including in the event of a material breach of representations, warranties or covenants under the purchase agreement or a change in control. Accordingly, Microvision has classified the preferred stock as "mandatorily redeemable convertible preferred stock" in its consolidated balance sheet. The preferred stock terms include a dividend of 3.5% per annum, payable quarterly in cash or registered common stock, at the election of the Company, subject to certain conditions. The preferred stock matures on September 10, 2007, at which time it is payable in cash or registered common stock, at the election of the Company, subject to certain conditions. Some of the conditions which would preclude the Company from paying in common stock are not within the Company's immediate control. The Company can elect to convert the preferred stock into common stock if the stock price exceeds $12.09 per share, subject to certain conditions. The warrant vested on the date of grant, has an exercise price of $8.16 per share and expires on September 10, 2009. The initial exercise price is subject to adjustment in the event Microvision issues common stock or derivative securities at a price per share of common stock below the market price or the exercise price of the warrant.

  Due to below market issuances of Company's common stock the exercise price of the warrants issued with the Preferred Stock was adjusted to $6.40 as of December 31, 2005.

  The net cash proceeds of $9.9 million were allocated to the preferred stock and the warrant based on the relative fair values of the securities. The warrants were valued using the Black-ScholesBlack Scholes option-pricing model with the following assumptions: expected volatility, 75%, risk free interest rate, 3.4%, and contractual life five years. $1.3 million of the proceeds were allocated to the warrant and were recorded as an increase to additional paid-in capital.

  Subsequent to the relative fair value allocation, the effective conversion price of the convertible preferred stock was less than the closing price of Microvision's common stock on the date of commitment to purchase the preferred stock. This beneficial conversion feature was measured as $1.2 million which represents the difference between the fair value of the common stock and the effective conversion price. This beneficial conversion feature was recorded to additional paid-in capital and will be recorded as a deemed dividend to preferred stockholders (accretion) over the stated life of the preferred stock which is three years.

  • In April 2004, Lumera raised $2.3 million from the issuance of convertible promissory notes. The notes accrue interest at a rate of 6.5% per annum and are payable on demand upon the closing of an underwritten public offering of Lumera's common stock. Lumera completed an initial public offering in July 2004. The principal amount and any accrued but unpaid interest in respect of each note is convertible at any time, at the option of the holder, into shares of Lumera's Class A common stock. The conversion price is $6.00 per share of common stock. In connection with the sale of these convertible notes, Lumera also issued warrants to purchase shares of common stock. The number of shares is based on a formula based on the exercise price of the warrant and the face amount of the holder's convertible note. The exercise price of the warrants is equal to $7.20 per share. All of the warrants are exercisable on the date of grant and expire in April 2009. The value of the warrants granted was estimated to be approximately $344,000 using the Black Scholes option pricing model. The relative fair value of the warrants of $299,000 was treated as a debt issuance cost and amortized to interest expense over the one year term of the convertible notes.
  • In March 2004 Lumera raised $500,000, before issuance costs, from the sale of 250,000 shares of Series B convertible preferred stock to a group of private investors. Microvision did not participate in the offering.
  • In November 2003, Microvision raised $22.3 million before issuance costs of $1.5 million from the sale of 3,560,000 shares of common stock.
  • In August 2003, Lumera raised $1.9 million before issuance costs of $34,000 from the sale of 944,000 shares of Series B convertible preferred stock to Microvision and other purchasers. Microvision purchased 434,000 of these shares of Series B preferred stock for an aggregate purchase price of $868,000. On October 30, 2003, Lumera raised $782,000, before issuance costs, from the sale of 391,000 shares of Series B preferred stock to a group of investors. Microvision did not purchase additional shares of the Series B preferred stock in the October 2003 offering.
  • In March 2003, Microvision raised $12.6 million before issuance costs of $970,000 from the sale of 2,644,000 shares of common stock and warrants to purchase 529,000 shares of common stock at an exercise price of $6.50 per share to a group of investors. Each share of common stock and accompanying partial warrant was sold for $4.75. The five year warrants are first exercisable in September 2003 and expire in March 2008.

  The Company's investment policy restricts investments to ensure principal preservation and liquidity. Generally, the Company invests cash that it expects to use within approximately sixty days in U.S. treasury-backed instruments. The Company invests the balance of its cash in high quality investment securities. The investment securities portfolio is limited to U.S. government and U.S. government agency debt securities and other high-grade securities generally with maturities of three years or less.

  Future operating expenditures and capital requirements will depend on numerous factors, including the following:

  • the progress of research and development programs,
  • the progress in commercialization activities and arrangements,
  • the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights,
  • competing technological and market developments, and
  • Microvision's ability to establish cooperative development, joint venture and licensing arrangements.

  In order to maintain its exclusive rights under the Company's license agreement with the University of Washington, the Company is obligated to make royalty payments to the University of Washington with respect to the Virtual Retinal Display technology. If the Company is successful in establishing original equipment manufacturer co-development and joint venture arrangements, the Company expects its partners to fund certain non-recurring engineering costs for technology development and/or for product development. Nevertheless, the Company expects its cash requirements to increase at a rate consistent with revenue growth as it expands its activities and operations with the objective of commercializing the scanned beam technology.

  The following table lists the Company's contractual obligations (in thousands):

  
                                                                             December 31,
                                                 ----------------------------------------------------------------
                                                   2005-----------------------------------------------------------------
                                                   2006       2007       2008       2009       2010     After 20092010    Total
                                                 ---------  ---------  ---------  ---------  ---------  -------------------  ---------
  Contractual Obligations:                                                                                                   
  Open purchase orders *                        $   1,7192,875  $      44--  $      34--  $      --  $      --  $           $   1,7972,875
  Minimum payments under senior secured
    convertable notes 1,667      6,667      1,666                                      10,000including interest           12,202      2,812         --                                       15,014
  Minimum payments under capital leases                42          6          4         --         --                    5241         39         33         27         20                    160
  Minimum payments under operating leases             1,985        473         46         --         --                 2,504741        850        834        837        867        2400      6,529
  Minimum payments under research, royalty                                                                                --
   and licensing agreements 215+                         390        390        215        215        t         1,425175                  1,385
                                                 ---------  ---------  ---------  ---------  ---------  -------------------  ---------
      Total                                     $  5,62816,249  $   7,5804,091  $   2,1401,082  $   2151,079  $   2151,062  $    --2,400  $  15,77825,963
                                                 =========  =========  =========  =========  =========  ===================  =========
  
  

  * Open purchase orders represent commitments to purchase inventory, materials, capital equipment and other goods used in the normal course of the Company's business.

  + License and royalty obligations continue through the lives of the underlying patents, which is currently at least 2017.

  Microvision's cash balance at December 31, 20042005 was $1.3$6.9 million. In addition, Microvision raised $10.0$10.3 million before issuance costs, in March 2005.January 2006 through the sale of 2.6 million shares of its Lumera common stock to a small group of investors. To the extent required to implement the Microvision's operating plan, Microvision may sell or pledge as collateral, its unpledged shares of Lumera common stock.  As of March 11, 20051, 2006, Microvision owns 3.7 millionapproximately 322,000 shares of unpledged Lumera common stock withthat have not been pledged as collateral for the Company's convertible notes issued as of March 11, 2005 and the notes issued in December 2005. Based on the March 1, 2006 closing price of $4.10, the Lumera shares that have not been pledged as collateral have a market value of $17.1 million basedapproximately $1.2 million.  Based on the closing price of $4.65 per share as of March 15, 2005.  Microvision believes that the combination of cashour current operating plan and Lumera common stock will satisfy its budgeted cash requirements, through 2005 based on Microvision's current operating plan.we expect to need additional cash to fund our operations in July 2006. Since we hold a large percentage of Lumera's common stock, if an active market is not sustained, it may be difficult for us to sell our shares of Lumera's common stock at a value sufficient to fund our operating plans.

  Microvision may also raise financing through future sales of Microvision preferred or common stock, issuance of debt securities or other borrowings,. In addition, thereborrowings. There can be no assurance that other additional financing will be available to Microvision or that, if available, it will be available on terms acceptable to Microvision on a timely basis. If adequate funds are not available to satisfy either short-term or long-term capital requirements, Microvision willmay be required to limit its operations substantially.  This limitation of operations may include reductionreductions in capital expenditures,staff and operating costs as well as reductions in staffcapital expenditures and operating costs.investment in research and development.  

  Should expenses exceed the amounts budgeted, the Company may require additional capital earlier than July 2006 to further the development of its technology, for expenses associated with product development, and to respond to competitive pressures or to meet unanticipated development difficulties. In addition, the Company's operating plan calls for the addition of sales, marketing, technical and other staff and the purchase of additional laboratory and production equipment.difficulties The operating plan also provides for the development of strategic relationships with systems and equipment manufacturers that may require additional investments by the Company. There can be no assurance that additional financing will be available to the Company or that, if available, it will be available on terms acceptable to the Company on a timely basis. If adequate funds are not available to satisfy either short-term or long-term capital requirements or planned revenues are not generated, the Company may be required to limit its operations substantially. This limitation of operations may include reduction in capital expenditures and reductions in staff and discretionary costs, which may include non-contractual research costs. The Company's capital requirements will depend on many factors, including, but not limited to, the rate at which the Company can, directly or through arrangements with original equipment manufacturers, introduce products incorporating the scanned beam technology and the market acceptance and competitive position of such products.

  Recently Issued Accounting Pronouncements - OnNew accounting pronouncements

  In December 16, 2004, the Financial Accounting Standards Board (''FASB''("FASB") issued SFAS No. 123(R), ''Share-Based Payment''"Share-Based Payment", which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all employee share-based payments to employees, including grants of employee stock options,awards granted after the effective date to be valued at fair value, on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all share-based awards granted on or after JulyJanuary 1, 2005.2006. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested employee awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123.  The first reporting period where employee share-based compensation will be recognized is March 31, 2006.  Share-based compensation expense in 2006 will be affected by our stock price at the time of grants are awarded, the number and structure of stock-based awards our board of directors may grant during the year, any other actions taken with respect to outstanding options, as well as a number of complex and subjective valuation assumptions. These valuation assumptions include, but are not limited to, the future volatility of our stock price and employee stock option exercise behaviors.The Company is currently evaluating the alternative methods for implementing SFAS No. 123(R).  If and there is sufficient uncertainty surrounding future share-based compensation actions and valuation estimates that the Company electsis not in a position to implementprovide a useful estimate of the financial statement impact of SFAS No. 123(R) in 2006 at this time.

  In November 2004 the FASB issued SFAS 151 Inventory Cost - an Amendment of ARP No. 43, chapter 4 ("SFAS 151") which provides clarifies accounting for abnormal manufacturing costs. The Company is required to adopt SFAS 151 for years beginning after June 30, 2005. The Company does not believe that adoption of SFAS 151 will have a material impact on July 1,its financial statements.

  In March 2005, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107"), "Share Based Payment," which expresses the SEC's views on the interaction between SFAS 123R and certain SEC rules and regulations. The Company is currently assessing the guidance in SAB 107 as part of its evaluation of the adoption of SFAS 123R.

  Subsequent Events

  In January 2006, the Company raised $10,324,000 from the sale of 2,550,000 shares of Lumera common stock. As a result of the sale, the Company will record a "gain on sale of equity subsidiary" of approximately $7.3 million. Subsequent to the sale, the Company owned 2,072,000 shares, or 12%, of the outstanding shares of Lumera common stock. After January 31, 2006, due to the change in ownership percentage, Microvision will account for its investment in Lumera using the modified prospective method it expects thatcost method.

  In January 2006 the impact on 2005 earnings will beChief Executive Officer's employment was terminated and the Chief Financial Officer resigned. The Company appointed Alexander Y. Tokman to Chief Executive Officer in the range of $0.6 to $1.6 million.January 2006.

  ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  Substantially all of the Company's cash equivalents and investment securities are at fixed interest rates and, as such, the fair value of these instruments is affected by changes in market interest rates. Due to the generally short-term maturities of these investment securities, the Company believes that the market risk arising from its holdings of these financial instruments is not significant.

  The Company's investment policy restricts investments to ensure principal preservation and liquidity. The Company invests cash that it expects to use within approximately sixty days in U.S. treasury-backed instruments. The Company invests cash in excess of sixty days of its requirements in high quality investment securities. The investment securities portfolio is limited to U.S. government and U.S. government agency debt securities and other high-grade securities generally with maturities of three years or less.

  The maturities of cash equivalents and investment securities, available-for-sale, as of December 31, 2004,2005, are as follows:

  
                                               Amount      Percent
                                            ------------  ---------  
  Cash                                     $  695,000       54.81,800,000       26.1 %
  Less than one year                          573,000       45.25,100,000       73.9
                                            ------------  ---------
                                           $  1,268,0006,900,000      100.0 %
                                            ============  =========
  
  

  Presently, the Company has one immaterial development contract denominated in yen; allAll of the Company's other development contract payments are made in U.S. dollars. However, in the future the Company may enter into additional development contracts in foreign currencies that may subject the Company to additional foreign exchange rate risk. The Company intends to enter into foreign currency hedges to offset the exposure to currency fluctuations when it can determine the timing and amounts of the foreign currency exposure.

  The Company owns 5.42.1 million shares of Lumera common stock with a market value of $25.3$8.5 million based on the closing price of $4.65$4.10 per share on March 15, 2005. This investment represents a significant portion of the Company's assets and present source of liquidity.1, 2006. Lumera's stock price is subject to fluctuation and may decrease, lowering the value of our investment. The Company owns approximately 33%12% of Lumera's common stock. Since the Company holds a large percentage of Lumera's common stock, if an active market does not develop or is not sustained, it may be difficult to sell the shares of Lumera's common stock at an attractive price or at all. The likelihood of Lumera's success, and the value of the Company's common stock, must be considered in light of the risks frequently encountered by early stage companies, especially those formed to develop and market new technologies. These risks include Lumera's potential inability to establish product sales and marketing capabilities; to establish and maintain markets for their potential products; and to continue to develop and upgrade their technologies to keep pace with changes in technology and the growth of markets using polymer materials. If Lumera is unsuccessful in meeting these challenges, its stock price, and the value of the Company's investment, could decrease.

  ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

  	Page
  Report of Independent Registered Public Accounting Firm	38
  ConsolidatedBalance Sheets as of December 31, 20042005 and 20032004	40
  ConsolidatedStatements of Operations for the years ended December 31, 2005, 2004 2003 and 20022003	41
  ConsolidatedStatements of Shareholders' Equity for the years ended December 31, 2005, 2004 2003 and 20022003	42
  ConsolidatedStatements of Comprehensive Loss for the years ended December 31, 2005, 2004 2003 and 20022003	44
  ConsolidatedStatements of Cash Flows for the years ended December 31, 2005, 2004 2003 and 20022003	45
  Notes to Consolidated Financial Statements	47
  Valuation and Qualifying Accounts and Reserves	69

  
  
  
  

  ---

  
  
  
  

  Report of Independent Registered Public Accounting Firm

  To the Board of Directors and Shareholders of Microvision, Inc.:

  We have completed an integrated auditaudits of Microvision's 2005 and 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits2005and an audit of its 2003and 20022003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

  Consolidated financial statements and financial statement schedule

  In our opinion, the consolidated financial statements listed in the accompanying index, present fairly, in all material respects, the financial position of Microvision Inc. and its subsidiary at December 31, 2005 and

  December 31, 2004, and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20042005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying indexpresents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidatedfinancial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedulebased on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

  The accompanying consolidated financial statements have been prepared assuming that Microvision, Inc. will continue as a going concern. As more fully described in Note 1, the Company has incurred losses since inception, including a net loss of $30.3 million for the year ended December 31, 2005 and its accumulated deficit was $215.7 million at December 31, 2005. Additionally, the Company anticipates requiring additional financial resources to fund its operations at least through December 31, 2006. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans as to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

  Internal control over financial reporting

  Also, in our opinion, management's assessment, included inManagement's Report on Internal Control Over Financial Reportingappearing inunder Item 9A (b) that the Company maintained effective internal control over financial reporting as of December 31, 20042005 based on criteria established inInternal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004,2005, based on criteria established inInternal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

  A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

  PricewaterhouseCoopers LLP

  Seattle, Washington
  March 15, 20052006

  
  
  
  

  ---

  
  
  
  

  Microvision, Inc.
  
  Consolidated Balance Sheets
  (in thousands, except share and per share amounts)

  
                                                                                              December 31,
                                                                                         ----------------------
                                                                                            2005        2004        2003
                                                                                         ----------  ----------
  Assets                                                                                                       
  Current assets
    Cash and cash equivalents                                                           $    1,2686,860  $    10,700
    Investment securities, available-for-sale                                                   --      11,0781,268
    Accounts receivable, net of allowances of $264 and $193                                  and $1091,380       5,227       1,896
    Costs and estimated earnings in excess of billings on uncompleted contracts              1,204         597
    664
    Inventory                                                                                  759       3,167
    331Current resricted cash and investments                                                   1,856          --
    Other current assets                                                                     1,512       1,293       1,684
                                                                                         ----------  ----------
      Total current assets                                                                  13,571      11,552      26,353
  
    Investment in Lumera                                                                     3,582      10,201          --
    Property and equipment, net                                                              2,902       2,318       5,958
    Restricted investments                                                                   1,000       1,238
    1,269Restricted investment in Lumera                                                          2,184          --
    Other assets                                                                               124         229         338
                                                                                         ----------  ----------
        Total assets                                                                    $   25,53823,363  $   33,91825,538
                                                                                         ==========  ==========
  
  Liabilities, Mandatorily Redeemable Convertible Preferred Stock and Shareholders' (Deficit) Equity           
  Current liabilities
    Accounts payable                                                                    $    2,6242,328  $    1,2232,624
    Accrued liabilities                                                                      4,513       4,538       5,164
    Allowance for estimated contract losses                                                     --          53          --
    Billings in excess of costs and estimated earnings on uncompleted contracts                 51       3,318
    53Liability associated with common stock warrants                                          3,452          --
    Current portion of notes payable                                                         7,896          --
    Current portion of capital lease obligations                                                32          39          62
    Current portion of long-term debt                                                           22          77          70
                                                                                         ----------  ----------
      Total current liabilities                                                             18,294      10,649
  
    6,572
  
    Research liability,Notes payable, net of current portion                                                    1,447          --
    1,948Liability associated with embedded derivative feature                                    1,368          --
    Capital lease obligations, net of current portion                                          105           9          34
    Long-term debt, net of current portion                                                      --          22          99
    Deferred rent, net of current portion                                                    1,492          21         107
    Other long-term liabilities                                                                 --          16
                                                                                         ----------  ----------
      Total liabilities                                                                     22,706      10,701       8,776
                                                                                         ----------  ----------
  
  Commitments and contingencies (note 14)                                                       --          --
  Minority interests                                                                            --       1,847
  Mandatorily redeemable convertible preferred stock, par value $.001$.001; 25,000
  shares authorized; 105 and 010 shares issued and outstanding
  (liquidation preference of $5,000 and $10,000)                                             4,166       7,647          --
                                                                                         ----------  ----------
  Shareholders' equity(Deficit) Equity
    Common stock, par value $.001; 73,000 shares authorized; 21,50925,138 and
    21,44921,509 shares issued and outstanding                                                        25          22          21
    Additonal paid-in capital                                                              212,993     196,929     180,354
    Deferred compensation                                                                      (85)       (305)       (846)
    Subscriptions receivable from related parties                                               (166)--        (166)
    Receivables from related parties, net                                                     (1,823)(792)     (1,823)
    Accumulated other comprehensive income                                                      --          25
    Accumulated deficit                                                                   (215,650)   (187,467)   (154,270)
                                                                                         ----------  ----------
      Total shareholders' (deficit) equity                                                  (3,509)      7,190      23,295
                                                                                         ----------  ----------
        Total liabilities, minority interestsmandatorily redeemable convertible preferred stock
        and shareholders' equity                                                            $23,363      25,538  $   33,918
                                                                                         ==========  ==========
  
  

  The accompanying notes are an integral part of these consolidated financial statements.
  
  
  

  ---

  
  
  
  

  Microvision, Inc.
  
  Consolidated Statements of Operations
  (in thousands, except per share amounts)

  
                                                                                                 Years Ended December 31,
                                                                                           ----------------------------------
                                                                                              2005        2004        2003        2002
                                                                                           ----------  ----------  ----------
  Contract revenue                                                                        $   11,386  $    8,821  $   13,517
  $   15,389
  Product revenue                                                                              3,360       2,597       1,135         528
                                                                                           ----------  ----------  ----------
  Total revenue                                                                               14,746      11,418      14,652      15,917
                                                                                           ----------  ----------  ----------
  
  Cost of contract revenue                                                                     6,456       5,539       5,988       6,469
  Cost of product revenue                                                                      8,636       3,868       1,058         528
                                                                                           ----------  ----------  ----------
  Total cost of revenue                                                                       15,092       9,407       7,046       6,997
                                                                                           ----------  ----------  ----------
      Gross margin                                                                              (346)      2,011       7,606       8,920
                                                                                           ----------  ----------  ----------
  
  Research and development expense (exclusive of non-cash compensationcompentsation expense
  of $0, $548, and $1,006 for 2005, 2004 and $1,138 for 2004, 2003, and 2002, respectively)                               6,587      14,709      23,316
  25,519
  Sales, Marketing,marketing, general and administrative expense  (exclusive of non-cash compensation
  expense of $429, $1,570 and $1,150 for 2005, 2004 and $846 for 2004, 2003 and 2002, respectively)                    19,923      19,228      15,827      16,798
  Non-cash compensation expense                                                                  429       2,118       2,156       1,984
  Loss (gain) on disposal of fixed assets, net                                                   1         (36)         --
                                                                                           ----------  ----------  ----------
        Total operating expenses                                                              36,056      41,263      44,30126,939      36,055      41,299
                                                                                           ----------  ----------  ----------
  Loss from operations                                                                       (34,045)    (33,657)    (35,381)(27,285)    (34,044)    (33,693)
  
  Interest income                                                                                263         272         381
  1,059
  Interest expense                                                                            (3,253)       (151)        (51)
  (59)
  Realized gainGain on salederivative features of investment securities                                                --          39          88
  Loss due to impairment of long-term investmentnotes payable, net                                            5,975          --          --
  (624)Loss on debt extinguishment                                                                 (3,313)         --          --
  Other income (expense)                                                                         (28)         (1)         75
                                                                                           ----------  ----------  ----------
  Loss before minority interests and equity in losses of Lumera                              (27,641)    (33,924)    (33,288)    (34,917)
  Minority interests in loss of consolidated subsidiary                                           --       2,438       7,125       7,741
  Equity in losses of Lumera                                                                  (3,242)     (1,711)         --
  Gain on sale of securities of equity subsidiary                                              2,700          --
                                                                                           ----------  ----------  ----------
  Net loss                                                                                $  (28,183) $  (33,197) $  (26,163) $  (27,176)
  
  Less:  Stated dividend on mandatorily redeemable convertible preferred stock                  (280)       (108)         --
  --
  Non-cash accretion onAccretion to par value of preferred stock                                                     (637)       (238)         --
  Inducement for conversion of preferred stock                                                (1,184)         --
                                                                                         ----------  ----------  ----------
  
  Net loss available for common shareholders                                              $  (30,284) $  (33,543) $  (26,163) $  (27,176)
                                                                                           ==========  ==========  ==========
  Net loss per share basic and diluted                                                    $    (1.35) $    (1.56) $    (1.46) $    (1.93)
                                                                                           ==========  ==========  ==========
  Weighted-average shares outstanding basic and diluted                                       22,498      21,493      17,946      14,067
                                                                                           ==========  ==========  ==========
  
  

  The accompanying notes are an integral part of these consolidated financial statements.
  
  
  

  ---

  
  
  
  

  Microvision, Inc.
  
  Consolidated Statements of Madatorily Redeemable Convertable Preferred Stock and Stockholders' Equity
  (in thousands)

  
  
  
                                                                                                                              Shareholders' Equity
                                                             Mandatorily     -----------------------------------------------------------------------------------------------------------------------
                                                             redeemable
                                                            convertible                                                       Paid in                  Subscriptions  Receivables   Accumulated
                                                           preferred stock       Common Stock      Capital andAdditional                  receivable       from          other
                                                         ------------------- -------------------     Common Stockpaid-in      Deferred    from related     related    comprehensive  Accumulated   Shareholders'
                                                          Shares   Par Value  Shares   Par Value     no par valuecapital     Compensation    parties       parties    (loss) income    defecit        Equity
                                                         --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
  Balances at December 31, 2001                               --  $      --   12,998  $      --  $     135,954  $    (2,803) $        (321) $        --            427  $   (100,931) $      32,326
  Exercise of warrants and options                                                 8                        15                                                                                   15
  Sales of common stock                                                        2,148                    11,560                                                                               11,560
  Revaluations of warrants and options                                                                    (471)         471                                                                      --
  Collection of subscriptions receivable                                                                                               155                                                      155
  Amortization of deferred compensation                                                                                 842                                                                     842
  Other comprehensive income                                                                                                                                      (306)                        (306)
  Net loss                                                                                                                                                                   (27,176)       (27,176)
                                                         --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
  Balance at December 31, 2002                                --  $      --   15,154  $      --  $     147,058  $    (1,490) $        (166) $        --  $         121  $   (128,107) $      17,416
  Issuance of options to board members for services                                                          1           (1)                                                                     --
  Issuance of stock, options and warrants to
   non-employees for services                                                      9                       252         (189)                                                                     63
  Exercise of warrants and options                                                82                       538                                                                                  538
  Sales of common stock                                                        6,204                    32,385                                                                               32,385
  Revaluations of warrants and options                                                                      (4)           4                                                                      --
  Extension of expiring employee options                                                                   145                                                                                  145
  Amortization of deferred compensation                                                                                 830                                                                     830
  Reclassification of receivables from related parties                                                                                           (1,823)                                     (1,823)
  Establishment of par value of common stock                                                 21            (21)                                                                                  --
  Other comprehensive income                                                                                                                                       (96)                         (96)
  Net loss                                                                                                                                                                   (26,163)       (26,163)
                                                         --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
  Balance at December 31, 2003                                --         --   21,449         21        180,354         (846)          (166)      (1,823)            25      (154,270)        23,295
  Issuance of options to board members for services                                                         81          (81)                                                                     --
  Issuance of stock, options and warrants to
    non-employees for services                                                                             143         (143)                                                                     --
  Issuance of Lumera options to Microvision employees                                                      134                                                                                  134
  Amortization of deferred compensation                                                                                 765                                                                     765
  Exercise of warrants and options                                                60          1            382                                                                                  383
  Sales of common stock                                                                                     (8)                                                                                  (8)
  Sales of preferred stock and warrants                       10      8,590                              1,281                                                                                1,281
  Beneficial conversion feature of mandatorily
    redeemable convertible preferred stock                           (1,181)                             1,181                                                                                1,181
  Dividend on preferred stock                                                                             (108)                                                                   --           (108)
  Non-cash accretion on mandatorily redeemable
    convertible preferred stock                                         238                               (238)                                                                                (238)
  Net change in interest gain on Lumera
    --
    initial public offering                                                                             13,727                                                                               13,727
  Other comprehensive income                                                                                                                                       (25)                         (25)
  Net loss                                                                                                                                                                   (33,197)       (33,197)
                                                         --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
  Balance at December 31, 2004                                10      $   7,647   21,509         22        196,929         (305)          (166)      (1,823)            --      (187,467)         7,190
  Issuance of stock, options and warrants to
    non-employees for services                                                     7                        65                                                                                   65
  Deferred compensation on stock options                                                                   144         (144)                                                                     --
  Amortization of deferred compensation                                                                                 364                                                                     364
  Exercise of warrants and options                                                 5         --             20                                                                                   20
  Sales of common stock                                                        2,171          2          9,908                                                                                9,910
  Conversion of preferred stock                               (5)    (4,539)     855          1          4,538                                                                                4,539
  Conversion of senior secured exchageable covertible notes                      310         --          1,837                                                                                1,837
  Stock received for subscriptions receivable                                    (28)        --           (169)                        166                                                       (3)
  Inducement to preferred shareholders                                                                    (763)                                                                                (763)
  Issuance of common stock and change in warrant value to
    preferred shareholders                                                                                 763                                                                                  763
  Beneficial conversion feature of mandatorily redeemable
    convertible preferred stock                                         421                               (421)                                                                                (421)
  Issuance of common stock for payment on senior
    exchangeable convertible notes                                               258         --            867                                                                                  867
  Issuance of common stock for payment of interest
    on senior secured exchangeable convertible notes                              40         --            130                                                                                  130
  Issuance of common stock on preferred dividend                                  11         --             62                                                                                   62
  Dividend on preferred stock                                                                             (280)                                                                                (280)
  Non-cash accretion on mandatorily redeemable
    convertible preferred stock                                         637                               (637)                                                                                (637)
  Allowance for doubtful accounts on receivables from related parties                                                                             1,031                                       1,031
  
  Net loss                                                                                                                                                                   (28,183)       (28,183)
                                                         --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
  Balance at December 31, 2005                                 5  $   224,166   25,138  $      196,92925  $     (305)212,993  $       (166) $    (1,823)(85) $          --  $      (187,467)(792) $          7,190--  $   (215,650) $      (3,509)
                                                         ========  ========= ========  =========  =============  ===========  =============  ===========  =============  ============  =============
  
  

  The accompanying notes are an integral part of these consolidated financial statements.
  
  
  
  

  ---

  
  
  
  
  

  Microvision, Inc.
  
  Consolidated StatementsStatemetns of Comprehensive Income
  (in thousands)

  
                                                                                                 Years Ended December 31,
                                                                                           ----------------------------------
                                                                                              2005        2004        2003        2002
                                                                                           ----------  ----------  ----------
  Net loss                                                                                $  (28,183) $  (33,197) $  (26,163) $  (27,176)
                                                                                           ----------  ----------  ----------
  Other comprehensive income (loss)loss
      Unrealized gain (loss)loss on investment securities, available-for-sale:
          Unrealized holding gains (losses)loss arising during period                                           --         (25)        (57)       (218)
          Less: reclassification adjustment for gains realized in net loss                        --          --         (39)        (88)
                                                                                           ----------  ----------  ----------
          Net unrealized gain (loss)loss                                                                     --         (25)        (96)       (306)
                                                                                           ----------  ----------  ----------
  Comprehensive loss                                                                      $  (28,183) $  (33,222) $  (26,259) $  (27,482)
                                                                                           ==========  ==========  ==========
  
  

  TheSee accompanying notes are an integral part of theseto consolidated financial statements

  statements.
  
  
  

  ---

  
  
  
  

  Microvision, Inc.
  
  Consolidated Statement of Cash Flows
  (in thousands)

  
                                                                                                Years Ended December 31,
                                                                                           -------------------------------
                                                                                             2005       2004       2003       2002
                                                                                           ---------  ---------  ---------
  Cash flows from operating activities                                                                                    
    Net loss                                                                              $ (28,183) $ (33,197) $ (26,163) $ (27,176)
    Adjustments to reconcile net loss to net cash used in operations
      Depreciation                                                                            1,602      2,406      3,113      2,943
      Loss (gain) on disposal of fixed assets                                                    net--          1        (36)        --
      Non-cash expenses related to issuance of stock, warrants, and options,
       and amortization of deferred compensation                                                429      2,118      2,156
      1,984
      Impairment of long-term investmentNon-cash interest expense, net                                                          2,730         --         --
      624Derivative features of notes payable                                                   (2,659)
      Inventory write-downs                                                                   3,732      2,084        500
      Allowance for receivables from related parties                                          1,031         --        200        700
      Realized gain on sale of investment securities                                             --         --        (39)        --
      Minority interests in loss of consolidated subsidiary                                      --     (2,438)    (7,125)    (7,741)
      Equity in losses of Lumera                                                              3,242      1,711         --
      Gain on sale of securities of equity subsidiary                                        (2,700)        --
      Loss on debt extinguishment                                                             3,313         --
      Non-cash deferred rent                                                                    (21)       (86)       (85)
      (9)
      Non-cash interestInterest on notes payable                                                                  --        125         --         --
      Allowance for estimated contract losses                                                   (53)        53         --       (155)
    Change in
      Accounts receivable                                                                     3,847     (3,420)      (581)
      397
      Intercompany receivable                                                                    --         38         --         --
      Costs and estimated earnings in excess of billings on uncompleted contracts              (607)        35        409
      511
      Inventory                                                                              (2,836)       416       (648)(1,324)    (4,920)       (84)
      Other current assets                                                                       61       (427)       (93)
      (46)
      Other assets                                                                              340         87         40
      (206)
      Accounts payable                                                                       (1,050)     2,631        (68)
      (325)
      Accrued liabilities                                                                      (190)       865        705        (47)
      Billings in excess of costs and estimated earnings on uncompleted contracts            (3,267)     3,265       (177)
      170Notes payable                                                                              --         --
      Research liability, current and long-term                                                  --     (1,762)       923      1,025
                                                                                           ---------  ---------  ---------
        Net cash used in operating activities                                               (19,727)   (30,831)   (26,405)   (27,999)
                                                                                           ---------  ---------  ---------
  Cash flows from investing activities                                                                                    
    Sales of investment securities                                                            1,248     12,053      3,249     12,701
    Purchases of investment securities                                                       (1,248)    (1,000)    (9,080)      (246)
    Sales of restricted investment securities                                                 1,238      1,269      1,356      1,536
    Purchases of restricted investment securities                                            (2,101)    (1,238)    (1,269)
    (1,356)Increase in restricted cash                                                                (755)        --
    Collections of receivables from related parties                                              --         --         20
    --
    Advances under receivables from related partiesSale of long term investment - Lumera                                                     3,893         --         --       (491)
    Purchases of property and equipment                                                      (1,239)    (1,040)    (1,549)    (1,354)
                                                                                           ---------  ---------  ---------
        Net cash provided by (used in)used in investing activities                                     1,036     10,044     (7,273)    10,790
                                                                                           ---------  ---------  ---------
  Cash flows from financing activities                                                                                    
    Principal payments under capital leases                                                     (46)       (63)       (90)      (180)
    Proceeds from issuance of short term notes                                                   --      2,300         --         --
    Principal payments under long-term debt                                                     (77)       (70)       (63)
    (57)Proceeds from inssuance of notes and warrants                                            14,148         --
    Payments on notes payable                                                                (1,000)        --
    Increase in deferred rent                                                                 1,492         --
    Payment of preferred dividend                                                              (173)      (108)        --         --
    Payments received on subscriptions receivable                                                --         --        155
    Net proceeds from issuanceinssuance of common stock                                               and warrants9,939        360         32,924     11,576--
    Net proceeds from issuance of preferred stock and warrants                                   --      9,886     --         --32,924
    Net proceeds from sale of subsidiary's equity to minority interests                          --        500      1,735         --
                                                                                           ---------  ---------  ---------
        Net cash provided by financing activities                                            24,283     12,805     34,506     11,494
                                                                                           ---------  ---------  ---------
  Net increase (decrease) in cash and cash equivalents                                        5,592     (7,982)       828     (5,715)
  Cash and cash equivalents at beginning of yearperiod                                            1,268     10,700      9,872     15,587
  Change in cash due to Lumera deconsolidation                                                   --     (1,450)        --        --
                                                                                           ---------  ---------  ---------
  Cash and cash equivalents at end of yearperiod                                              $   6,860  $   1,268     $  10,700      9,872
                                                                                           =========  =========  =========
                                                                                                                          
  Supplemental disclosure of cash flow information                                                                        
  Cash paid for interest                                                                  $     348  $     151  $      51  $      59
                                                                                           =========  =========  =========
                                                                                                                          
  Supplemental schedule of non-cash investing and financing activities                                                    
  Property and equipment acquired under capital leases                                    $     135  $      15  $       8  $     127
                                                                                           =========  =========  =========
  Other non-cash additions to property and equipment                                      $     812  $      18  $      66
                                                                                           =========  =========  =========
  Conversion of preferred stock into common stock                                         $   1734,117  $      --  $      --
                                                                                           =========  =========  =========
  Deferred compensation - warrants, options and stock grants                              $     209  $      --  $      --
                                                                                           =========  =========  =========
  Issuance of common stock for payment of principal and interest on senior
  secured exchangeable convertible notes                                                  $     997  $      --  $      --
                                                                                           =========  =========  =========
  Issuance of common stock and warrants for services                                      $      --  $      159--  $     --159
                                                                                           =========  =========  =========
  

  The accompanying notes are an integral part of these financial statements.
  
  
  

  ---

  
  
  
  

  Microvision, Inc.
  
  Notes to Consolidated Financial Statements

  1.The Company

  The consolidated financial statements include the accounts of Microvision, Inc. ("Microvision"), a Delaware corporation, and Lumera Corporation ("Lumera"), a Delaware corporation, (collectively the "Company"). Prior to July 2004, Lumera was a subsidiary thatand was consolidated prior to July 2004.into Microvision. In July 2004, Lumera completed an initial public offering of its common stock. stock and as a result of the change in ownership, ceased to be consolidated and became an equity method investment on Microvision.

  Microvision was established to acquire, develop, manufacture and market scanned beam technology, which projects images using a single beam of light. Microvision has entered into contracts with commercial and U.S. government customers to develop applications using the scanned beam technology. Microvision has introduced two commercial products, Nomad, a see through head-worn display, and Flic, a hand-held bar code scanner. In addition, Microvision has produced and delivered various demonstration units using Microvision's display technology. Microvision is working to commercialize additional products for potential medical, defense, industrial, aviation, and consumer applications.

  Lumera was established to develop, manufacture and market optical devices using organic non- linearnon-linear electro-optical chromophore materials. Lumera is working to commercialize the devices for potential wireless networking and optical networking applications.

  Microvision has incurred significant losses since inception. Microvision believesThe accompanying consolidated financial statements have been prepared assuming that itsthe Company continues as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed above.

  The Company's current cash resources are sufficient to fund operations through July 2006. The Company plans to raise additional cash equivalent and investment securities balances totaling $1,268,000 at December 31, 2004, in addition to proceeds of $10,000,000, frombefore July 2006 through the sale of convertible notes before issuance costs, raised in March 2005 and potential sales of Lumeraits common stock, will satisfypreferred stock or through the issuance of debt. The Company has taken the following actions to reduce its budgeteduse of cash requirements through December 31, 2005 based on its currentand improve the operations of the Company:

  • Made significant changes to it senior management team including appointing a new Chief Executive Officer.
  • Announced a restructuring and realignment plan that targets a 30% reduction in operating plan.
    loss
  • Begun adding members to the Board of Directors with experience that directly supports the Company's business objectives.
  • Engaged an investment bank to assist the Company in pursuing financing alternatives.

  The Company's operating plan calls for the addition of sales, marketing, technical and other staff and the purchase of additional laboratory and production equipment. The Company's future expenditures and capital requirements will depend on numerous factors, including the progress of its research and development program, the progress in commercialization activities and arrangements, the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, competing technological and market developments and the ability of the Company to establish cooperative development, joint venture and licensing arrangements. There can be no assurance that additional financing will be available to the Company or that, if available, it will be available on terms acceptable to the Company on a timely basis. If adequate funds are not available to satisfy either short-term or long-term capital requirements or planned revenues are not generated, the Company may be required to limit its operations substantially. This limitation of operations may include reduction in capital expenditures and reductions in staff and discretionary costs, which may include non-contractual research costs. The Company's capital requirements will depend on many factors, including, but not limited to, the rate at which the Company can, directly or through arrangements with original equipment manufacturers, introduce products incorporating the scanned beam technology and optical polymer based products and the market acceptance and competitive position of such products.

  2.Summary of significant accounting policies

  Use of estimates

  The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's management has identified the following areas where significant estimates and assumptions have been made in preparing the financial statements: revenue recognition, allowance for uncollectible receivables, management loans, inventory valuation and potential losses from litigation.

  Principles of consolidation

  The company has historically included both Microvision and Lumera Corporation ("Lumera"), a subsidiary that was consolidated through July 2004. In July 2004, Lumera completed an initial public offering of its common stock.

  In connection with the Lumera initial public offering, all Lumera Series A and Series B Preferred Stock was converted into Lumera common stock. Immediately after the offering, Microvision owned 5,434,000 shares, or 33%, of the common stock of Lumera. As a result of the change in ownership percentage, Microvision

  changed the method of accounting for its investment in Lumera to the equity method and after July 2004 recorded its share of Lumera income or losses. Microvision recorded a non-cash change in ownership interest gain of $13.7 million to stockholders equity as a component of additional paid-in capital during 2004. At December 31, 2004 and 2005, Microvision owned 33% and 28%, respectively, of Lumera's common stock.

  Cash, cash equivalents and investment securities

  The Company considers all investments that mature within 90 days of the date of purchase to be cash equivalents.

  Short-term At December 31, 2005, all short-term investment securities are primarily debt securities. Theheld by the Company haswere classified its entire investment portfolio as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses included in other comprehensive income (loss). Dividend and interest income are recognized when earned. Realized gains and losses are presented separately on the income statement. The cost of securities sold is based on the specific identification method.cash equivalents.

  Inventory

  Inventory consists of raw material; work in process and finished goods for the Company's Nomad and Flic products. Inventory is recorded at the lower of cost or market with cost determined on the weighted-average method. Management periodically assesses the need to provide for obsolescence of inventory and adjusts the carrying value of inventory to its net realizable value when required. In addition, Microvision reduces the value of its inventory to its estimated scrap value when management determines that it is not probable that the inventory will be consumed through normal production during the next twelve months.

  Restricted Investmentscash and investments

  RestrictedAs of December 31, 2005, restricted cash and investments representsincludes:

  • $1.0 million irrevocable letter of credit as security on a lease agreement for the corporate headquarters building in Redmond, WA. The required letter of credit balance decreases over the term of the lease, which expires in 2013.
  • $754,000 cash received in connection with a lease agreement for the corporate headquarters building in Redmond, WA. The use of the cash is restricted to the terms of the tenant improvement agreement associated with the lease.
  • $1.1 million certificates of deposit held as collateral for letters of credit issued in connection with a lease agreement for the former corporate headquarters building. Substantially all of thebuilding in Bothell, WA. The balance is required to be maintained for the remaining term of the lease, which expires in April 2006.

    Long-term investment

    In December 1999, the Company invested $624,000 in Gemfire Corporation ("Gemfire"), a privately held corporation. Gemfire is a developer

  • $1.0 million, 1,750,000 shares of diode laser components for display applications. The Company accountsLumera common stock pledged as collateral for the investment in Gemfire using the cost method.

    In June 2002, Gemfire announced a recapitalization plan that reduced the value of the Company's investment. As a result, in June 2002, the Company recorded an impairment for the entire value of the investment in Gemfire.

    Notes.

  Property and equipment

  Property and equipment is stated at cost and depreciated over the estimated useful lives of the assets (three(two to five years) using the straight-line method. Leasehold improvements are depreciated over the shorter of estimated useful lives or the lease term.

  Revenue recognition

  Revenue has primarily been generated from contracts for further development of the scanned beam technology and to produce demonstration units for commercial enterprises and the United States government. Revenue on such contracts is recorded using the percentage-of-completion method measured on a cost incurred basis. The percentage of completion method is used because the Company can make reasonably dependable estimates of the contract cost. Changes in contract performance, contract conditions, and estimated profitability, including those arising from contract penalty provisions, and final contract settlements, may result in revisions to costs and revenues and are recognized in the period in which the revisions are determined. Profit incentives are included in revenue when realization is assured.

  The Company recognizes losses, if any, as soon as identified. Losses occur when the estimated direct and indirect costs to complete the contract exceed unrecognized revenue. The Company evaluates the reserve for contract losses on a contract-by-contract basis.

  Revenue from product shipments is recognized in accordance with Staff Accounting Bulletin No. 104 "Revenue Recognition." Revenue is recognized when there is sufficient evidence of an arrangement, the

  selling price is fixed and determinable and collection is reasonably assured. Revenue for product shipments is recognized upon acceptance of the product by the customer or expiration of the contractual acceptance period, after which there are no rights of return. Provision isProvisions are made for warranties at the time revenue is recorded. Warranty expense was not material during 2004, 2003, or 2002.for any periods presented.

  Concentration of credit risk and sales to major customers

  Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash equivalents, investments and accounts receivable. The Company typically does not require collateral from its customers. The Company has a cash investment policy that generally restricts investments to ensure preservation of principal and maintenance of liquidity.

  The United States government accounted for approximately 42%35%, 49%42%, and 83%49% of total revenue during 2005, 2004 2003 and 2002,2003, respectively. Contracts with three commercial customers represented 25%38%, 35%25%, and 14%35% of total revenues during 2005, 2004, 2003, and 2002,2003, respectively. At December 31, 2004, one commercial customer accounted for 65% of the accounts receivable balance. The receivable was paid in full in January 2005. The United States government accounted for approximately 21%41% and 34%21% of the accounts receivable balance at December 31, 20042005 and 2003,2004, respectively. In 2004 and 2003, 11% and 27%, respectively,2005, 61% of consolidated revenue was earned from development contracts with two customers. In 2004, 11% of consolidated revenue was earned from a single commercialdevelopment contract with one customer.

  Income taxes

  Deferred tax assets and liabilities are recorded for differences between the financial statement and tax bases of the assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is recorded for the amount of income tax payable for the period increased or decreased by the change in deferred tax assets and liabilities during the period.

  Net loss per share

  Basic net loss per share is calculated on the basis of the weighted-averageweighted- average number of common shares outstanding during the periods. Net loss per share assuming dilution is calculated on the basis of the weighted-average number of common shares outstanding and the dilutive effect of all potentially dilutive

  securities, including common stock equivalents and convertible securities. Net loss per share assuming dilution for 2005, 2004 2003 and 20022003 is equal to basic net loss per share because the effect of dilutive securities outstanding during the periods including options and warrants computed using the treasury stock method, is anti-dilutive. The dilutive securities and convertible securities that were not included in earnings per share were 9,440,000, 6,836,000, 6,295,000, and 4,051,000,6,295,000, at December 31, 2005, 2004 2003 and 2002,2003, respectively.

  Research and development

  Research and development costs are expensed as incurred. As described in Note 9, Lumera issued shares of its common stock in connection with a research agreement. The value of these shares was amortized over the period of the research agreement.

  Fair value of financial instruments

  The Company's financial instruments include cash and cash equivalents, investment securities, accounts receivable, accounts payable, accrued liabilities and long-term debt.  The carrying amount of long-term debt at December 31, 20042005 and 20032004 was not materially different from the fair value based on rates available for similar types of arrangements.  The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to the short maturities.   The convertible notes are not publicly traded and it is no practicable for the Company to estimate the fair value of the convertible notes due to the absence of comparable publicly traded financial instruments.

  Long-lived assets

  The Company evaluates the recoverability of its long-lived assets when an impairment is indicated based on expected undiscounted cash flows and recognizes impairment of the carrying value of long-lived assets, if any, based on the fair value of such assets.

  Research liability

  The Company recognized expense under the Lumera Sponsored Research Agreement with the UW on a straight-line basis over the remaining term of the agreement. The Company has recorded a liability for the difference between the expense recognized and cash payments. As of December 31, 2003, the Company had recognized cumulative expense of $6.3 million and made cumulative cash payments of $4.4million.

  In April 2004, Lumera and the University of Washington entered into a fourth amendment to the Sponsored Research Agreement. Total payments under the Sponsored Research Agreement were reduced to $5.8 million instead of the original $9.0 million. Lumera recognizes research and development expense under the Sponsored Research Agreement on a straight line basis over the term of the agreement. At the time of the fourth amendment to the Sponsored Research Agreement, Lumera had recognized $6.5 million in expense related to the Sponsored Research Agreement. In April 2004, Lumera recorded a reduction in its liability and an offsetting reduction in expense of $2.4 million to reduce the cumulative expense recognized under the Sponsored Research Agreement to the expense incurred under the fourth amendment on a straight line basis. During 2004, the Company recognized a credit to expense of $1.8 million as a result of the changes to the agreement.

  Stock-based compensation

  The Company and its subsidiaryLumera each have stock-based employee compensation plans, which are more fully described in Note 12.13.

  The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related amendments and interpretations, including FASB Interpretation Number ("FIN") 44, "Accounting for Certain Transactions Involving Stock Compensation," and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18.

  Total non-cash stock option expense related to employee and director awards was $94,000, $1,057,000, $271,000, and $277,000$271,000 for the years ended December 31, 2005, 2004 2003 and 2002,2003, respectively. Had compensation cost for employee and director options been determined using the fair values at the grant dates consistent with the methodology prescribed under SFAS 123, the Company's consolidated net loss available to common shareholders and associated net loss per share would have increased to the pro forma amounts indicated below (in thousands):

  
                                                                            Year Ended December 31,
                                                                       -------------------------------
                                                                         2005       2004       2003       2002
                                                                       ---------  ---------  ---------
  Net loss available for common shareholders, as reported             $ (30,284) $ (33,543) $ (26,163) $ (27,176)
  Add: Stock-based employee compensation expense included in net loss
   available for common shareholders, as reported                            94        339        266        270
  Deduct: Total stock-based employee compensation expense determined
   under fair value based method for all awards                          (1,931)    (5,886)    (8,915)   (16,410)
                                                                       ---------  ---------  ---------
  Net loss available for common shareholders, pro forma               $ (32,121) $ (39,090) $ (34,812) $ (43,316)
                                                                       =========  =========  =========
  Net loss per share As reported                                      $   (1.35) $   (1.56) $   (1.46) $   (1.93)
                                                                       =========  =========  =========
    Basic and diluted Propro forma                                       $   (1.43) $   (1.82) $   (1.94) $   (3.08)
                                                                       =========  =========  =========
  
  

  New accounting pronouncements

  OnIn December 16, 2004, the Financial Accounting Standards Board (''FASB''("FASB") issued SFAS No. 123(R), ''Share-Based Payment''"Share-Based Payment", which is a revision of SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all employee share-based payments to employees, including grants of employee stock options,awards granted after the effective date to be valued at fair value, on the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective for all share-based awards granted on or after JulyJanuary 1, 2005.2006. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. Compensation expense for the unvested employee awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS No. 123.  The first reporting period where employee share-based compensation will be recognized is March 31, 2006.  Share-based compensationexpense in 2006 will be affected by our stock price at the time of grants are awarded, the number and structure of stock-based awards our board of directors may grant during the year, any other actions taken with respect to outstanding options, as well as a number of complex and subjective valuation assumptions. These valuation assumptions include, but are not limited to, the future volatility of our stock price and employee stock option exercise behaviors. The Company is currently evaluating the alternative methods for implementing SFAS No. 123(R).  If and there is sufficient uncertainty surrounding future share-based compensation actions and valuation estimates that the Company electsis not in a position to implementprovide a useful estimate of the financial statement impact of SFAS No. 123(R) on July 1, 2005 usingin 2006 at this time.

  In November 2004 the modified prospective method, it expectsFASB issued SFAS 151 Inventory Cost - an Amendment of ARP No. 43, chapter 4 ("SFAS 151") which provides clarifies accounting for abnormal manufacturing costs. The Company is required to adopt SFAS 151 for years beginning after June 30, 2005. The Company does not believe that theadoption of SFAS 151 will have a material impact on its financial statements.

  In March 2005, earnings will bethe Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107"), "Share Based Payment," which expresses the SEC's views on the interactionbetween SFAS 123R and certain SEC rules and regulations. The Company is currently assessing the guidance in SAB 107 as part of its evaluation of the rangeadoption of $600,000 to $1,600,000.SFAS 123R.

  3. Long-term contracts

  Cost and estimated earnings in excess of billings on uncompleted contracts comprises amounts of revenue recognized on contracts that the Company has not yet billed to customers because the amounts were not contractually billable at December 31, 20042005 and 2003.2004. The following table summarizes when the Company will be contractually able to bill the balance as of December 31, 20042005 and 2003.2004.

  
                                                                          Year Ended December 31,
                                                                        --------------------------
                                                                            2005          2004          2003
                                                                        ------------  ------------
  Billable within 30 days                                              $    577,000686,000  $    392,000577,000
  Billable between 31 and 90 days                                             3,000         2,000       204,000
  Billable after 90 days                                                    515,000        18,000        68,000
                                                                        ------------  ------------
                                                                       $  597,0001,204,000  $    664,000597,000
                                                                        ============  ============
  
  

  "Billable after 90 days" includes $496,000 of unbilled costs related to work on a development contract that are billable upon the completion of a contractual milestone that the Company plans to complete during the second quarter of 2006.

  The Company's current contracts with the U.S. government are primarily cost plus fixed fee type contracts. Under the terms of a cost plus fixed fee contract, the U.S. government reimburses the Company for negotiated actual direct and indirect cost incurred in performing the contracted services. The Company is under no

  obligation to spend more than the contract value to complete the contracted services. The period of performance is generally one year. Each of the Company's contracts with the United States government can be terminated for convenience by the government at any time.

  In June 2005, the Company entered into a $4,359,000 contract with General Dynamics C4 Systems to continue the development of a helmet-mounted display for the Air Warrior Block 3 system. General Dynamics is under contract with the U.S. Army's Product Manager -- Air Warrior in Huntsville, Ala., to develop and integrate the Air Warrior Block 3 system. The Microvision helmet-mounted display is being designed as a full-color, see-through, daylight and night- readable, high-resolution display.

  In May 2004, Microvision entered into a $3,900,000 contract modification with the U.S. Army's Aviation Applied Technology Directorate to continue work on an advanced helmet mounted display and imaging system to be used in the Virtual Cockpit Optimization Program.

  In December 2004, Microvision entered into a $6,200,000 contract with Ethicon Endo-Surgery, IncInc. a subsidiary of Johnson & Johnson to integrate Microvision's technology into certain medical products. The

  contract includes an exclusive license for Microvision's technology for certain human medical applications during the term of the development agreement.

  In April 2003, the Company entered into a $2,200,000 contract modification with the U.S. Army's Aviation Applied Technology Directorate to continue work on an advanced helmet mounted display and imaging system to be used in the Virtual Cockpit Optimization Program.

  In April 2003, the Company entered into a $1,600,000 contract modification with the U.S. Army's Medical Research Acquisition Activities, Telemedicine and Advanced Technology Research Center to continue development of a mobile wireless personal display system for medical applications.

  In May 2002, the Company entered into a $3,300,000 contract modification with the U.S. Army's Aviation Applied Technology Directorate to continue work on an advanced helmet-mounted display and imaging system to be used in the Virtual Cockpit Optimization Program.

  In July 2002, the Company entered into a $1,900,000 contract with the NASA Langley Research Center to deliver a prototype cockpit helmet display for the Synthetic Visions Systems project.

  In August 2002, the Company entered into a $1,100,000 contract modification with the U.S. Army's Medical Research Acquisition Activities Telemedicine and Advanced Technology Research Center to continue development of a mobile wireless personal display system for medical applications.

  In November 2002, Lumera entered into a $1,000,000 contract modification with the U.S. government to design new Optical Materials appropriate for the fabrication of a wideband optical modulator demonstration system.

  The following table summarizes the costs incurred on the Company's revenue contracts:

  
                                                                        December 31,  December 31,
                                                                            2005          2004          2003
                                                                        ------------  ------------
  Costs and estimated earnings incurred on uncompleted contracts       $ 6,410,00017,325,000  $  15,478,0006,410,000
  Billings on uncompleted contracts                                     (16,172,000)   (9,131,000)  (14,867,000)
                                                                        ------------  ------------
                                                                       $  (2,721,000)1,153,000  $ 611,000(2,721,000)
                                                                        ============  ============
  Included in accompanying balance sheets under the following captions:                           
  
  Costs and estimated earnings in excess of billings on uncompleted
   contracts                                                           $  597,0001,204,000  $    664,000597,000
  Billings in excess of costs and estimated earnings on uncompleted
   contracts                                                                (51,000)   (3,318,000)      (53,000)
                                                                        ------------  ------------
                                                                       $  (2,721,000)1,153,000  $ 611,000(2,721,000)
                                                                        ============  ============
  
  

  4. Investments available-for-sale

  The following table summarizes the composition of the Company's available-for-sale investment securities at December 31, 2004 and 2003.

  
                                                                          Year Ended December 31,
                                                                        --------------------------
                                                                            2004          2003
                                                                        ------------  ------------
  U.S. governmnet debt securites                                                 --     6,976,000
  U.S. corporate debt securites                                                  --     4,102,000
                                                                        ------------  ------------
                                                                       $         --  $ 11,078,000
                                                                        ============  ============
  
  

  The available-for-sale investment securities and December 31, 2003 consisted of the following:

  
                                                              Gross        Gross
                                               Amortized   Unrealized   Unrealized    Estimated
                                                 Cost         Gains       Losses      Fair Value
                                              -----------  -----------  -----------  ------------
  Type of security:
      Corporate debt securities              $ 4,080,000  $    24,000  $    (2,000) $  4,102,000
      U.S. government and agency securities    6,973,000        3,000           --     6,976,000
                                              -----------  -----------  -----------  ------------
                                             $11,053,000  $    27,000  $    (2,000) $ 11,078,000
                                              ===========  ===========  ===========  ============
  Maturity date:
      Less than one year                     $11,053,000  $        --  $        --  $ 11,078,000
      Due in 1-3 years                                --           --           --            --
                                              -----------  -----------  -----------  ------------
                                             $11,053,000  $        --  $        --  $ 11,078,000
                                              ===========  ===========  ===========  ============
  
  

  5. Inventory

  Inventory consists of the following:

  
                                                         December 31, December 31,
                                                            2005          2004
                                                         2003
                                                         -----------  -----------------------
  Raw materials                                         $   1,607,000267,000  $  98,0001,607,000
  Work in process                                           141,000        77,000           --
  Finished goods                                            351,000     1,483,000
                                                         233,000
                                                         -----------  -----------------------
                                                        $   759,000  $  3,167,000
                                                         $   331,000
                                                         ===========  =======================
  
  

  6.The inventory at December 31, 2005 and 2004 consisted of raw materials, work in process and finished goods for Nomad and Flic. Inventory is stated at the lower of cost or market, with cost determined on a weighted average basis. Management periodically assesses the need to provide for obsolescence of inventory and

  adjusts the carrying value of inventory to its net realizable value when required. In addition, Microvision reduces the value of its inventory to its estimated scrap value when management determines that it is not probable that the inventory will be consumed through the normal course of business during the next twelve months. In 2005, 2004 and 2003, Microvision recorded inventory write-downs of $3,732,000, $2,084,000and $500,000 respectively.

  5. Accrued liabilities

  Accrued liabilities consist of the following:

  
                                                                 December 31,
                                                         -------------------------------------------------
                                                            2005          2004
                                                         2003
                                                         -----------  -----------------------
  Bonuses                                               $ 1,600,0001,000,000  $  1,487,0001,600,000
  Payroll and payroll taxes                                 732,000       763,000      858,000
  Compensated absences                                      497,000       475,000      508,000
  Taxes other than income taxes                              12,000        43,000      429,000
  Facility closing cost                                          --       253,000      431,000
  Professional Fees                                         558,000       371,000
  236,000
  Relocation                                                166,000        90,000
  205,000
  Subcontractors                                                          81,000Consultants                                               525,000
  Other                                                   1,023,000       943,000
                                                         929,000
                                                         -----------  -----------------------
                                                        $ 4,513,000  $  4,538,000
                                                         $ 5,164,000
                                                         ===========  =======================
  
  

  7.6. Property and equipment, net

  Property and equipment consists of the following:

  
                                                                 December 31,
                                                         ----------------------------------------------------
                                                             2005           2004
                                                         2003
                                                         ------------------------  ------------
  Lab and production equipment                          $   4,455,0002,126,000  $  7,152,0004,455,000
  Leasehold improvements                                    3,990,000     2,165,000     4,666,000
  Computer hardware and software                            6,495,000     3,873,000     3,874,000
  Office furniture and equipment                            1,124,000     1,057,000
                                                         1,030,000
                                                         ------------------------  ------------
                                                           13,735,000    11,550,000    16,722,000
  Less: Accumulated depreciation                          (10,833,000)   (9,232,000)
                                                         (10,764,000)
                                                         ------------------------  ------------
                                                        $   2,902,000  $  2,318,000
                                                         $  5,958,000
                                                         ========================  ============
  
  

  The propertyDepreciation expense was $1,602,000, $2,406,000 and equipment balance at December 31,$3,113,000 in 2005, 2004 and 2003 included $6,105,000 and $3,238,000 of cost and accumulated depreciation, respectively, attributable to Lumera.respectively.

  8.7. Receivables from related parties

  In 2000, the Board of Directors authorized the Company to provide unsecured lines of credit to each of the Company's three senior officers. The limit of the line of credit is three times the executives' base salary less any amounts outstanding under the Executive Option Exercise Note Plan. In 2002 and 2001, the Board of Directors authorized a $200,000 and $500,000 addition, respectively, to the limit for one senior officer. The

  lines of credit carry interest rates of 5.4% to 6.2%. The lines of credit must be repaid within one year of the senior officer's termination or within thirty days of demand by the Company in the event of a plan termination, provided that in the event of such a demand the senior officer may elect to deliver a promissory note with a one-year term in lieu of payment. At December 31, 20042005 and 2003,2004, a total of $2,723,000 and $2,723,000, respectively, was outstanding under the lines of credit.

  TheIn 2005, the Company determined that onecertain of its senior officers may have insufficient net worth and short- termshort-term earnings potential to repay loans outstanding under the Company's lines of credit. In 2003 and 2002, the Company recorded an allowance for doubtful accounts for receivables from senior officers of $200,000 and $700,000, respectively. In January 2006, two senior officers left the Company. Because the lines of credit are unsecured and collection is uncertain, the Company recorded an additional allowance of $1,031,000 in December 2005. The balance of the allowance for doubtful accounts for receivables from senior officers was $900,000$1,931,000 and $900,000 at December 31, 20042005 and 2003,2004, respectively.

  Under current SEC rules, the Company is prohibited from changing the repayment terms of the lines of credit. No repayments have been made on the outstanding lines of credit. At December 31, 2003, the Company reclassified the loan balance to shareholder's equity under the guidance provided by the SEC for loans to shareholders due to the absence of any repayments of the loans to date. The Company has no plans to forgive the principal balance outstanding under the lines of credit.

  In 2000, three executive officers of the Company exercised a total of 128,284 stock options, in exchange for full recourse notes totaling $285,000. These notes bear interest at 4.6% to 6.2% per annum. Each note is payable in full upon the earliest of (1) a fixed date ranging from January 31, 2001 to December 31, 2004 depending on the expiration of the options exercised; (2) the sale of all of the shares acquired with the note; (3) on a pro rata basis upon the partial sale of shares acquired with the note, or (4) within 90 days of the officer's termination of employment. At both December 31, 20042005 and 2003,2004, a total of $0 and $165,600, respectively, was outstanding under the full recourse notes. The $165,600 plus accrued interest was paid in full in February 2005. The notes are included as subscriptions receivable from related parties in shareholders' equity on the consolidated balance sheet.

  The interest on both the lines of credit and the full recourse notes is forgiven if the executive is an employee of the Company at December 31 of the respective year. Compensation expense of $156,000, $163,000 and $163,000 was recognized in both2005, 2004 and 2003, respectively, for interest forgiven.

  9.8. Lumera Subsidiary Equity Transactions

  In March 2000, Lumera issued 4,700,000 shares of its Class B common stock to the Company for services provided by the Company to Lumera valued at $94,000. At the same time, Lumera issued 670,000 shares of its Class B common stock to certain Microvision employees for $12,000 in cash.

  In January 2001, Lumera issued 802,000 shares of Lumera Class A common stock to the UWUniversity of Washington ("UW") at a value of $3.75 per share in connection with the research agreement. The valuation of the shares issued to the UW was more than the per share carrying amount of the Company's interest in Lumera. Although the Company's percentage ownership in Lumera was reduced as a result of this transaction, the increased value of Lumera stock on the change in ownership interest resulted in a gain for the Company. The amount of the gain of $3,001,000 resulting from the revaluation of the Company's interest in Lumera was credited to paid-in capital.

  In March 2001, Lumera issued 2,400,000 shares of its Series A preferred stock at a price of $10.00 per share. Included in this total were 264,000 shares issued to the Company in repayment of intercompany borrowings.

  In September 2001, Lumera issued fully vested options to purchase 33,000 shares of Class A common stock at an exercise price of $10.00 per share to a consultant for services completed. The options expire 10 years following the date of issue. The options were valued at $137,000 on the grant date, are not subject to remeasurement and were fully expensed in the period granted. The estimated fair value was determined using the Black-Scholes option-pricing model with the following assumptions: underlying security fair market value

  of $5.34, dividend yield of zero percent, expected volatility of 80%, risk-free interest rate of 4.0%, expected life of 10 years.

  In October 2002, Lumera paid $200,000 and issued a warrant to purchase 164,000 shares of Lumera Class A Common Stock at an exercise price of $3.65 per share to Arizona Microsystems, Inc. in exchange for a license of certain Arizona Microsystems, Inc. technology. The warrant expires 10 years following the date of grant, and vests 25% on the date of grant and 25% annually from the date of grant. The warrant was valued at the date of grant at $133,000. The total purchase price of $333,000 was recorded as capitalized licensing costs .costs. The fair value of the warrant was estimated using the Black Scholes option pricing model with a stock price of $0.98 per share, dividend yield of zero percent; expected volatility of 100%; risk-free interest rate of 4.0% and expected life of ten years.

  In August 2003, Lumera raised $1,900,000, before issuance costs of $34,000, from the sale of 944,000 shares of Series B convertible preferred stock to Microvision and other purchasers. Microvision purchased 434,000 of these shares for an aggregate purchase price of $868,000. In October 2003, Lumera raised $782,000 before

  issuance costs of $32,000, from the sale of 391,000 shares of Series B convertible preferred stock. Microvision did not purchase additional shares of Series B preferred stock in the October 2003 offering.

  In August 2003, Lumera issued options to purchase an aggregate of 164,000 shares of its Class A Common Stock to two consultants in connection with entering into certain consulting agreements. Each holder was granted a warrant to purchase up to 82,000 shares of Class A Common Stock at a price of $3.65 per share with a ten year life. In aggregate, 41,000 of the options were vested on the grant date. The remaining 123,000 shares vest one-third on each subsequent annual anniversary of the grant date were subject to remeasurement at each balance sheet date during the vesting period. The deferred compensation and liability related to these options was amortized to non-cash compensation expense over the two year period of service under the agreements. The aggregate value of both options was estimated at $136,000 at the grant date and December 31, 2003. Total non-cash compensation expense was $315,000 for the period from January 1, 2004 through July 2004, and $32,000 for the year ended December 31,2003.31, 2003. The fair values of the options were estimated at the grant date and December 31, 2003, using the Black-ScholesBlack Scholes option pricing model with the following weighted-average assumptions: underlying security fair market value of $0.98, dividend yield of zero percent; expected volatility of 100% for both measurement dates; risk-free interest rates of 4.4% and 4.3%; and expected lives of 10 and 9.7 years, respectively.

  During 2004, Lumera granted options to purchase 415,000 shares of Class A common stock to Lumera employees and directors with a weighted-average exercise price of $2.00. Lumera subsequently determined that the fair market value of its common stock was greater than the exercise price of the options. Lumera recorded aggregate charges of $216,000 during 2004 related to these grants.

  During 2004, Lumera granted vested options to purchase 40,000 shares of Class A common stock to Microvision employees with a weighted-average exercise price of $2.00. Lumera subsequently determined that the fair market value of its common stock was greater than the exercise price of the options. The Company recorded aggregate charges of $134,000 during 2004 related to these grants.

  In July 2004, Lumera completed an initial public offering of its common stock. As a result of the offering, Microvision's ownership interest in Lumera was reduced to 33%. As a result of the reduction in ownership, Microvision changed to the equity method of accounting for its investment in Lumera. Microvision recorded a non-cash change in interest gain of $13.7 million during the third quarter. Because of uncertainty surrounding the ultimate realizability of the gain, the gain was recorded as an increase to stockholders' equity as a component of additional paid-in capital. As of December 31, 2004,2005, Microvision owned 5,434,0004,622,000 shares or 33%28% of Lumera's common stock.

  During the period from inception to July 2004, losses in Lumera were first allocated to the holders of the common stock and then to the holders of the preferred shareholders pro rata in accordance with their respective ownership interest. Losses were not allocated to the options and warrants until exercised.

  Lumera common stock, Series A preferred stock and Series B preferred stock were eliminated in consolidation with Microvision interests in Lumera common stock, Series A preferred stock, Series B preferred stock and options and warrants to purchase equity in Lumera held by investors other than the Company, and are presented as minority interests on the Company's consolidated balance sheet.

  A reconciliation of the changes in ownership interests through Lumera's initial public offering is as follows (in thousands):

  
                                                    Minority Interests
                                       ---------------------------------
                                         Common     Preferred    Total    Microvision    Total
                                       -----------  ---------  ---------  -----------  ---------
  Balance at December 31, 20012002        $       168308  $   14,6566,915  $   14,8247,223  $      517(440) $  15,341
  Options and warrants                        140         --        140           --        140
  Loss allocation for 2002                     --     (7,741)    (7,741)        (957)    (8,698)
                                       -----------  ---------  ---------  -----------  ---------
  Balance at December 31, 2002                308      6,915      7,223         (440)   6,783
  Issuance of preferred stock, net             --      1,735      1,735          868      2,603
  Options and warrants                         14         --         14           --         14
  Loss allocation for 2003                     --     (7,125)    (7,125)        (958)    (8,083)
                                       -----------  ---------  ---------  -----------  ---------
  Balance at December 31, 2003                322      1,525      1,847         (530)     1,317
  Issuance of preferred stock, net             --        500        500           --        500
  Preferred stock reallocation                 --        413        413         (413)
  Options and warrants                        342         --        342                     342
  Loss allocation for 2004                            (2,438)    (2,438)      (1,286)    (3,724)
                                       -----------  ---------  ---------  -----------  ---------
  Balance at July 2004                $       664  $      --  $     664  $    (2,229) $  (1,565)
                                       ===========  =========  =========  ===========  =========
  
  

  As a result of the Series B stock issuance, the allocations of Lumera losses changed between Microvision and other minority interests and resulted in an additional $413,000 of losses being allocated to minority interest during 2004, with a resultant change in interest loss allocated to Microvision. In July 2004, Microvision's ownership interest in Lumera was reduced to 33% as a result of Lumera completing an initial public offering of its common stock. As a result of the reduction in ownership, Microvision changed to the equity method of accounting for its investment in Lumera. Microvision recorded a non-cash change in interest gain of $14,139,000$14,138,000 during the third quarter as a result of the change to the equity method. The net change in interest gain for 2004 was $13,727,000Because$13,727,000. Because of uncertainty surrounding the ultimate realizability of the gain,gain; the gain was recorded as an increase to stockholders' equity as a component of additional paid-in capital.

  The following table shows the Lumera balances included in the consolidated balance sheet immediately prior to the change in interest and the reconciliation to the investment account shown at December 31, 2004.2005.

  
  Cash and cash equivalents                                    $     657
  Costs and estimated earnings in excess of billings on
     uncompleted contracts                                           117
  Other current assets                                             1,077
  Property and equipment, net                                      2,369
  Other assets                                                        33
  Accounts payable                                                  (434)
  Accrued liabilities                                             (1,315)
  Current portion of research liability                              (78)
  Notes payable - current                                         (2,386)
  Other long-term liabilities                                       (245)
                                                                ---------
  Net Assets                                                        (205)
  Less minority interest options and warrants                       (664)
  Cumulative losses in excess of investment                       (1,360)
                                                                ---------
                                                                  (2,229)
  Gain on change in interest                                      14,138
  Investment losses from July 2004 to December 31,200431, 2004           (1,708)
                                                                ---------
  Investment in Lumera at December 31, 2004                       10,201
  Investment losses from January 1, 2005 to December 31, 2005     (3,242)
  Sales of Lumera Stock                                           (1,193)
                                                                ---------
  Investment in Lumera at December 31, 2005                    $   10,2015,766
                                                                =========
  
  

  The difference between the amount at which an investment is carried at December 31, 2005 and the amount of underlying equity in net assets of Lumera is a result of equity transaction of Lumera for which Microvision does not recognize any change in interest gains or losses.

  9. Long-term Notes

  The following table summarizes the activity related to the issuance of convertible notes in 2005:

  
                                                                                       Embedded     Common       Loss on
                                                                                      derivative  stock and   extinguishment
                                                                  Notes    Warrants    feature       APIC         of debt        Total
                                                                ---------  ---------  ----------  ----------  ---------------  ---------
  March 10, 2005 issuance                                      $   5,395  $   1,650  $    2,955  $       --  $            --  $  10,000
  Debt restructuring at July 25, 2005                                         2,295       1,018                       (3,313)        --
  Conversion of debt to common stock at October 11, 2005          (1,398)                  (439)      1,837                          --
  December 1, 2005 issuance                                        3,667      2,200       1,116       3,017                      10,000
  Principal payments on notes                                       (867)                               867                          --
  Discount accretion for the year ended December 31, 2005          2,546                                                          2,546
  Changes in market value for the year ended December 31, 2005               (2,693)     (3,282)                                 (5,975)
                                                                ---------  ---------  ----------  ----------  ---------------  ---------
  Balances at December 31, 2005                                $   9,343  $   3,452  $    1,368  $    5,721  $        (3,313)
                                                                =========  =========  ==========  ==========  ===============
  
  

  December Notes

  In December 2005, the Company raised $10,000,000, before issuance costs of $134,000, from the issuance of notes ("December Notes"), 838,000 shares of common stock and warrants to purchase an aggregate of 1,089,000 shares of Microvision common stock. The December Notes are convertible on demand by the holders into Microvision common stock at a conversion price of $3.94 per share. The note holders may convert all or a portion of their December Notes. In addition, upon the request of the note holders, the Company is required to redeem the notes for cash upon a change of control or an event of default at a redemption price equal to 125% of the then outstanding balance of the December Notes. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the December Notes and the notes issued as of March 2005 ("March Notes") described below. Those shares have been classified as a "Restricted investment in Lumera" on the Company's consolidated balance sheet.

  The terms of the December Notes include interest at LIBOR plus 3.0%, provided that the interest rate shall not be less than 6% or greater than 8%payable quarterly in cash or Microvision common stock if the stock price is greater than $4.06 per share, at the election of the Company, subject to certain additional conditions. Under certain circumstances the interest rate increase to LIBOR plus 6% but not less than 12% or greater than 15%. If the Company chooses to pay interest in Microvision common stock as opposed to cash, the price will be based on 90% of the arithmetic average of the volume weighted average prices for the 20 trading days prior to the payment date. The December Notes are payable in five equal quarterly installments beginning in March 2006. The Company can elect to make the principal payments in common stock in lieu of cash if the stock price is greater than $4.06 per share, subject to certain other conditions. If the Company elects to pay principal in stock the stock will be issued at a 10% discount to the arithmetic average of the volume weighted average prices for the 15 trading days prior to the payment date. Additionally, the Company can elect to convert the December Notes into Microvision common stock if the stock price exceeds $6.90 per share for 20 out of any 30 consecutive trading days, subject to certain conditions.

  The Company concluded that the note holders' right to convert all or a portion of the December Notes into Microvision common stock is an embedded derivative instrument as defined by FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). Accordingly, $1.1 million of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The value was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 58%; expected dividend yield of 0%; risk free interest rates ranging from 4.01%to 4.39%; and contractual life of four to sixteen months , which corresponds to the principal repayment dates. Due to changes in Microvision's stock price and remaining contractual life, the fair value of the embedded derivative feature decreased to $1,038,000 at December 31, 2005. The change in value of $78,000 was recorded as a non-operating gain and included in Gain on derivative features of note payable in the consolidated statement of operations. At December 31, 2005 total principal payments of $7.0 million remain under the December Notes.

  The warrants issued with the December Notes vested on the date of grant, have an exercise price of $3.94 per share of common stock share and expire in December 2010. The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $2.2 million of the cash proceeds were allocated to the warrants, which represents the fair value of the warrants on the date of issuance and the amount was recorded as a current liability. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. The warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 65%; expected dividend yield of 0%; risk free interest rate of 4.35%; and contractual life of five years.

  The Microvision common stock was valued at the closing price on the date of closing of $3.60 per share. Aggregate proceeds of $3.0 million were allocated to the common stock. The remaining gross proceeds of $3.7 million were allocated to the notes.

  March Notes

  In March 2005, the Company raised $10,000,000, before issuance costs of $423,000, from the issuance of convertible March Notes ("March Notes") and warrants to purchase an aggregate of 462,000 shares of Microvision common stock. The March Notes are convertible on demand by the holders into Microvision common stock at a conversion price of $6.84 per share of Microvision common stock or Lumera common stock held by the Company at a conversion price of $5.64 per share up to a limit of 1,750,000 shares of Lumera common stock. The right to convert the March Notes into shares of Lumera common stock was removed pursuant to the amendment described below. The initial conversion price is subject to adjustment in the event Microvision issues common stock or common stock equivalents at a price per share of common stock below the conversion price of the March Notes. Due to below market issuances of Company's common stock the conversion price of the March Notes at December 31, 2005 was $5.54 per share of common stock. In addition, upon the request of the Note holders, the Company is required to redeem the March Notes for cash upon a change of control or an event of default at a redemption price equal to 125% of the then outstanding balance of the March Notes. The Company has pledged 1,750,000 shares of its Lumera common stock as collateral for the March Notes and the December Notes described above. Those shares have been classified as a "Restricted investment in Lumera" on the Company's consolidated balance sheet.

  The terms of the March Notes include interest at LIBOR plus 3.0% payable quarterly in cash or Microvision common stock, at the election of the Company, subject to certain conditions. However, in no case shall the interest rate be less than 6.0% or greater than 8.0%. If the Company chooses to pay interest in Microvision common stock as opposed to cash, the price will be based on 92% of the arithmetic average of the volume weighted average prices for the 10 trading days prior to the payment date. The March Notes are payable in six equal quarterly installments beginning in December 2005. The Company can subject to certain conditions, elect to make the principal payments in common stock in lieu of cash. If the Company elects to pay principal in common stock, the Note holders can elect to receive Microvision or Lumera common stock. Payment in stock will be issued at a 10% discount to the arithmetic average of the volume weighted average prices for the 15 trading days prior to the payment date. Additionally, the Company can elect to convert the March Notes into Microvision common stock if the stock price exceeds $11.97 per share for 20 out of any 30 consecutive trading days, subject to certain conditions.

  The Company concluded that the note holders' right to convert all or a portion of the March Notes into Microvision or Lumera common stock is an embedded derivative instrument as defined by FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). Accordingly, $2,955,000 of the cash proceeds were allocated to the embedded derivative instrument, which represents the fair value of the instrument on the date of issuance. The derivative instrument was valued using the higher of the Microvision or Lumera conversion feature. The value was determined using the Black Scholes option-pricing model with the following assumptions: expected volatility of 83%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of nine months to two years, which corresponds to the principal repayment dates. Due to changes in Lumera and Microvision's stock price and remaining contractual life, the fair value of the embedded derivative feature decreased to $2,463,000 at July 25, 2005 the date of the deemed extinguishment described below. The decrease in the fair value of $492,000 for the period from issuance to extinguishment was recorded as a non-operating gain and included in "Gain on derivative features of note payable" in the consolidated statement of operations. At December 31, 2005 total principal payments of $7.3 million remain under the March Notes.

  The warrants issued with the March Notes vested on the date of grant, have an exercise price of $6.84 per common share and expire in March 2010. The initial exercise price is subject to adjustment in the event Microvision issues common stock or common stock equivalents at a price per share of common stock below the exercise price of the warrant. Due to below market issuances of Company's common stock the exercise price of the warrants issued with the March Notes was adjusted to $6.29 as of December 31, 2005.

  The warrants met the definition of a derivative instrument that must be accounted for as a liability under the provisions of Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, because the Company cannot engage in certain corporate transactions affecting the common stock unless it makes a cash payment to the holders of the warrants. Accordingly, $1,651,000 of the cash proceeds were allocated to the warrants, which represents the fair value of the warrants on the date of issuance and the amount was recorded as a current liability. Subsequent changes in the fair value of the warrants will be recorded in the statement of operations each period. The warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 4.62%; and contractual life of five years. The remaining gross proceeds of $5,394,000 were allocated to the Notes.

  In July 2005, the Company entered into an agreement to amend the March Notes. In connection with the amendment, the Company issued three year warrants to purchase 750,000 shares of Microvision common stock at an exercise price of $6.84 per share. The conversion price of the amended March Notes and exercise price of the warrants are subject to anti-dilution adjustments, subject to conditions. In addition, the price at which the note holders can convert the March Notes to Microvision common stock was reduced to $5.85 per share, and the price at which the Company can mandatorily convert the March Notes to Microvision common stock was reduced to $10.24. The note holders may convert all or a portion of their March Notes. As a result of the amendment, the March Notes are no longer exchangeable into Lumera common stock.

  The Company has concluded that the amendment of the Notes met the criteria of a debt extinguishment. The Company recorded a charge of $3,313,000 for the change in the fair value of the debt and related consideration between the original and the amended March Notes. The change in the value was measured as the value of the additional warrants that were issued to the note holders and the change in the price at which the debt could be converted to Microvision common stock. The additional warrants were valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rate of 3.66%; and contractual life of three years. The additional warrants were initially valued at $2,295,000. The change in the conversion feature was valued using the Black Scholes option-pricing model with the following assumptions: expected volatility of 75%; expected dividend yield of 0%; risk free interest rates ranging from 3.25% to 3.58% and contractual life equal to the length of the option. The change in the conversion price was valued at $1,018,000.

  The amended conversion feature continued to meet the definition of a derivative under FAS 133 and accordingly has been recorded at fair value and included within long-term liabilities. The carrying amount of the derivative will be adjusted to fair value at each balance sheet date. An adjustment of in fair value $2,712,000 was recorded for the period from July 25, 2005 to December 31, 2005.

  In October 2005, the noteholder converted $1.8 million of the March Notes to 310,000 shares of common stock. The value of the embedded derivative feature associated with the converted shares of $439,000 was recorded to additional paid in capital.

  The liability for both the initial warrant and the additional warrant are adjusted to the fair market value of $1,273,000 at December 31, 2005. The combined adjustment during the year ended December 31, 2005 was $2,672,000.

  10. Convertible Preferred Stock

  In August 2005, the holder of the Company's preferred stock agreed to convert 5,000 shares of the Company's preferred stock into 734,000 shares of common stock. As an inducement to convert the preferred stock the Company issued 124,000 shares of its common stock to the preferred stock holder and adjusted the exercise price from $8.16 to $6.84 per share for the existing warrants to purchase 362,000 shares of common stock issued in connection with the original sale of the Company's preferred stock. The value of the common shares issued of $701,000, the change in the value of the warrants of $62,000 and the amount of unamortized beneficial conversion feature on the preferred stock of $421,000 was recorded as an inducement to convert the preferred stock and charged to common shareholders in 2005.

  In September 2004, Microvision raised $10,000,000 before issuance costs of $90,000 from the sale of 10,000 shares of convertible preferred stock and a warrant to purchase 361,795362,000 shares of common stock. The

  preferred stock is convertible on demand by the holder into common stock at a conversion price of $6.91 per share of common stock. The initial conversion price is subject to adjustment in the event Microvision issues common stock or derivative securities at a price per share of common stock below the market price or the conversion price of the preferred stock. Due to below market issuances of Company's common stock the conversion price of the Preferred Stock as of December 31, 2005 was $6.36 per share of common stock.

  In addition, upon the request of the preferred stockholder, Microvision is required to redeem the preferred stock for cash in certain circumstances, including in the event of a material breach of representations, warranties or covenants under the purchase agreement or a change in control. Accordingly, Microvision has classified the preferred stock as "mandatorily redeemable convertible preferred stock" in its consolidated balance sheet.

  The preferred stock terms include a dividend of 3.5% per annum, payable quarterly in cash or registered common stock, at the election of the Company, subject to certain conditions. The preferred stock matures on September 10, 2007, at which time it is payable in cash or registered common stock, at the election of the Company, subject to certain conditions. Some of the conditions which would preclude the Company from paying in common stock are not within the Company's immediate control. The Company can elect to convert the preferred stock into common stock if the stock price exceeds $12.09 per share, subject to certain conditions. The warrant was vested on the date of grant, has an exercise price of $8.16 per share and expires on September 10, 2009. The initial exercise price is subject to adjustment in the event Microvision issues

  common stock or derivative securities at a price per share of common stock below the market price or the exercise price of the warrant. Due to below market issuances of Company's common stock the exercise price of the warrants issued with the Preferred Stock was adjusted to $6.40 as of December 31, 2005.

  The net cash proceeds of $9,910,000 were allocated to the preferred stock and the warrant based on the relative fair values of the securities. The warrants were valued using the Black-ScholesBlack Scholes option-pricing model

  with the following assumptions: expected volatility of 75%, risk free interest rate of 3.4%, and contractual life of five years. Proceeds of $1.3 million of the proceeds were allocated to the warrant and were recorded as an increase to additional paid-in capital.

  Subsequent to the relative fair value allocation, the effective conversion price of the convertible preferred stock was less than the closing price of Microvision's common stock on the date of commitment to purchase the preferred stock.stock resulting in the recognition of a beneficial conversion feature in accordance with Emerging Issues Task Force No 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments.". This beneficial conversion feature was measured as $1,181,000 which represents the

  difference between the fair value of the common stock and the effective conversion price. This beneficial conversion feature was recorded to additional paid-in capital and will be recorded as a deemed dividend to preferred stockholders (accretion) over the stated life of the preferred stock which is three years.During 2005, the Company recorded $280,000 in dividends on the preferred stock and $303,000 in accretion of the beneficial conversion feature of the preferred stock.

  11. Common stock

  In August and September 2005, the Company raised $7,000,000, before issuance costs, through the sale of 1,333,000 shares of common stock at a price of $5.25 per share and five-year fully exercisable warrants to purchase 301,000 shares of common stock at an exercise price of $6.50 per share to a holder of the Company's preferred stock and other investors. The holder of the Company's preferred stock also agreed to convert 5,000 shares of the Company's preferred stock into 734,000 shares of common stock. (See Note 10).

  In November 2003, the Company raised $22,250,000, before issuance costs of $1,454,000, from the sale of 3,560,000 shares of common stock to a group of private investors.

  In August 2003, the Company issued 8,600 fully vested shares of Microvision common stock to a professional services firm in connection with consulting services provided to the Company. The shares were valued at $7.28, the closing price on the date of issuance, and the full value of the shares, $63,000, was charged to non-cash compensation at the time of issuance.

  In March 2003, the Company raised $12,560,000, before issuance costs of $970,000, from the sale of 2,644,000 shares of common stock and warrants to purchase 529,000 shares of common stock at an exercise price of $6.50 per share. Each share of common stock and accompanying partial warrant was sold for $4.75. The warrants are first exercisable in September 2003 and expire in March 2008. The exercise price of the warrants was greater than the fair market value of the common stock on the date of issue.

  In August 2002, the Company raised $3,000,000 (before issuance costs) upon issuance of 686,000 shares of common stock to a group of private investors. The investors also acquired fully vested warrants to purchase

  137,000 shares of common stock at a price of $6.56 per share, for a period of five years. The exercise price of the warrants was greater than the fair market value of the common stock on the date of issue.

  In July 2002, the Company raised $3,000,000 (before issuance costs) upon issuance of 938,000 shares of common stock to a group of private investors. The investors also acquired fully vested warrants to purchase 234,000 shares of common stock at a price of $4.80 per share, for a period of five years. The exercise price of the warrants was greater than the fair market value of the common stock on the date of issue.

  In March 2002, the Company raised $6,028,000 (before issuance costs) upon issuance of 524,000 shares of common stock to a group of private investors.

  12. Warrants

  In September 2003, the Company issued two warrants to purchase an aggregate of 70,000 shares of common stock to a third party in exchange for services provided to the Company. One warrant grants the holder the right to purchase up to 60,000 shares of common stock at a price of $7.50 per share. The warrant vests in three equal tranches on the date of grant, in December 2003, and March 2004. The other warrant grants the holder the right to purchase up to 10,000 shares at a price of $12.00 per share and vests in March 2004. The unvested warrants were subject to remeasurement at each balance sheet date.date until vested. The deferred compensation related to these warrants was being amortized to non- cash compensation expense over the fourteen month service period of the agreement. Non-cash amortization expense related to these warrants was $140,000 and $192,000 for 2004 and 2003 respectively. The total value of the warrants was estimated on December 31, 2003 and the grant date at $318,000 and $328,000, respectively. The fair values of the warrants were estimated on the date of grant and December 31, 2003, using the Black-ScholesBlack Scholes option-pricing model with the following weighted-average assumptions: expected volatilities of 83%, risk-freerisk- free interest rates of 2.7% and dividend yields of zero percent. The expectedcontractual lives used at the measurement dates above were 4 years and 3.9 years, respectively.

  In August 2000, the Company issued warrants to purchase an aggregate of 200,000 shares of common stock to two consultants in connection with entering into certain consulting agreements with the Company. One of the consultants subsequently became a director. The warrants grant each of the holders the right to purchase up to 100,000 shares of common stock at a price of $34.00 per share. The warrants to purchase an aggregate of 150,000 shares vested over three years and were subject to remeasurement at each balance sheet date during the vesting period. The remaining warrants to purchase an aggregate of 50,000 shares had a measurement date at the time of grant. The deferred compensation related to these warrants is being amortized to non-cash compensation expense over the five-year period of service under the agreements. The total original value of

  both warrants waswere estimated at $5,476,000. Due to stock price fluctuations, the subsequent values for those warrants subject to remeasurement.

  On June 7, 2003, the warrants became fully vested and the value of both warrants was fixed. Total non-cash amortization expense was $270,000, $447,000, $595,000, and $542,000$595,000 for the years ended

  December 31, 2005, 2004 2003 and 2002,2003, respectively. The fair values of the warrants were estimated at June 7, 2003 and December 31, 2002 using the Black-ScholesBlack Scholes option-pricing model with the following weighted-averageweighted- average assumptions: dividend yield of zero percent, and expected volatility of 83% for all measurement dates; risk-free interest rates of 4.0%, and 5.0% and expected lives of 7.4 and 8.1 years. Deferred compensation related to these warrants at December 31, 2004 was $270,000.

  The following summarizes activity with respect to Microvision common stock warrants during the three years ended December 31, 2004:2005:

  
                                             Warrants to   Weighted-
                                               purchase     average
                                                common     excercise
                                                Shares       price
                                             ------------  ---------
  Outstanding at December 31, 2001               615,000  $   25.55
  Granted:
    Exercise price greater than fair value       372,000       5.45
    Exercised                                     (5,000)      8.00
  Canceled/expired                                (7,000)      8.00
                                             ------------
  Outstanding at December 31, 2002               975,000  $   18.10
  Granted:
  Exercise price greater than fair value         539,000       6.60
  Exercise price less than fair value             60,000       7.50
  Exercised                                           --         --
  Canceled/expired                                    --         --
                                             ------------
  Outstanding at December 31, 2003             1,574,000      13.76
  Granted:
  Exercise price greater than fair value         362,000       8.16
  Exercised                                      (22,000)      6.50
  Canceled/expired                              (196,000)     18.41
                                             ------------
  Outstanding at December 31, 2004             1,718,000      12.14
  Granted:
  Exercise price greater than fair value       2,602,000       5.59
  Exercise price equal to fair value               7,000       5.32
  Exercised                                           --         --
  Canceled/expired                              (207,000)     25.14
                                             ------------
  Outstanding at December 31, 2005             4,120,000  $    6.99
                                             ============
  Exercisable at December 31, 2004             1,718,0002005             4,120,000  $    12.146.99
                                             ============
  
  

  The following table summarizes information about the weighted-average fair value of Microvision common stock warrants granted:

  
                                                                            Year Ended December 31,
                                                               -------------------------------------
                                                                  2005         2004         2003         2002
                                                               -----------  -----------  -----------
  Exercise price greater than fair value                      $      2.74  $      4.07  $      1.69
  $      1.29Exercise price equal to fair value                                 3.24
  Exercise price less than fair value                                  --                      4.10           --
  
  

  The following table summarizes information about Microvision common stock warrants outstanding and exercisable at December 31, 2004:2005:

  
                                        Warrants outstanding Warrantsand exercisable
                                       ---------------------------------
                                         ----------------------
                                         Number     Weighted
                                       Number
                                       outstanding   average   Weighted   excercisable   Weighted
                                           at       remaining   average
                                       at        average
                                       December 31, contractualexcercise  December 31, excercise
  Range of exercise prices                20042005        life       price       2004       price
  - -----------------------------------  -----------  ---------  ---------
  -----------  ---------
                                                  (years)                                    
  $4.80                                   234,000       2.56$3.94                                 1,090,000       4.92  $    4.80      234,000  3.94
  $4.80-$    4.80
  $6.50-5.32                             241,000       1.64       4.81
  $6.10-$6.29                           1,513,000       3.47       6.25
  $6.40-$6.56                           645,000       3.07       6.51      645,000       6.511,006,000       2.65       6.47
  $7.50-$8.16                             422,000       4.41       8.07      422,000       8.07
  $12.00-$19.20                           162,000       0.88      14.64      162,000      14.6412.00                             70,000       1.70       8.14
  $34.00                                  200,000       5.614.61      34.00
                                       200,000      -----------
  $3.94-$34.00                          $53.00-$61.13                            55,000       0.28      53.73       55,000      53.73
                                       -----------                        -----------
  $4.80-$61.13                          1,718,000                          1,718,000
                                       ===========4,120,000
                                       ===========
  
  

  The fair value of the Microvision common stock warrants granted was estimated on the date of grant using the Black-ScholesBlack Scholes option-pricing model with the following weighted-average assumptions used for grants in 2005, 2004 2003 and 2002,2003, respectively: dividend yield of zero percent for all years; expected volatility of 75%70%, 83%75% and 83%; risk-free interest rates of 3.4%4.2%, 2.1%3.4%, and 2.2%2.1% and expected lives of 4, 5 3 and 23 years, respectively.

  13. Options

  The Company has several stock option plans ("Option Plans") that provide for granting incentive stock options ("ISOs") and nonqualified stock options ("NSOs") to employees, directors, officers and certain non-employees of the Company as determined by the Board of Directors, or its designated committee ("Plan Administrator"). The Company deems the fair market value of its stock on any given trading day to be the closing price of its stock on the NASDAQ National Market on that date.

  In June 2005, shareholders approved an amendment to the Director Option Plan, increasing the number of shares reserved for the plan by 400,000, to 900,000 shares.

  In June 2004, the Company granted its independent directors options to purchase an aggregate of 90,000 shares of common stock at an exercise price of $8.35. The exercise price of the options was less than the fair market value of the shares at the date of grant. The Company recorded $81,000 of deferred compensation expense related to these options in June 2004. The deferred compensation iswas amortized to non cash compensation expense over the one-year vesting period of the grants. Deferred compensation expense of $35,000 and $46,000 was recorded in 2005 and 2004, and the remaining $35,000 is recorded as deferred compensation at December 31, 2004.respectively.

  In December 2003, the Board of Directors authorized extending the original expiration date for all outstanding employee options with original expiration terms of less than 10 years. Under terms of the offer, employees could extend the life of options that had original lives less than ten years by five years from the original expiration date. No other terms of the options were amended. All options were fully vested on the offer date. The extensions were voluntary and, in total, holders elected to extend 263,000 of the 264,000 eligible shares. At the time of the extensions the Company recorded $145,000 in non-cash compensation expense for the

  excess of the fair market value of the common stock over the relevant exercise prices of the options on the modification date.

  In November 2002, the Company offered to exchange most of its outstanding options to purchase common stock for new options scheduled to be granted on or after June 11, 2003. All eligible options that were properly submitted for exchange were accepted and cancelled effective December 10, 2002. Employees tendered options to purchase an aggregate of 2,521,714 shares of the Company's common stock. Under the terms of the exchange program, the Company granted new options to purchase an aggregate of 1,731,825 shares of the Company's common stock on June 13, 2003. The exercise price of the new options was $7.00 per share.

  In May 2002, shareholders approved an amendment to the 1996 Stock Option Plan, increasing the number of shares reserved for the Plan by 2,500,000 to 8,000,000. The shareholders also approved amendments to the

  Independent Director Stock Option Plan ("Director Option Plan") that increased the total shares reserved for the Plan by 350,000 to 500,000 shares; established a fully vested option grant to purchase 15,000 shares to each independent director upon initial election or appointment to the Board of Directors; increased the number of shares granted in the annual initial and reelection grants from 5,000 to 15,000; granted a one-time option to each independent director to purchase 10,000 shares; and, authorized the Board of Directors to make discretionary grants.

  For Option Plan grants, other than non-discretionary grants to directors, the date of grant, option price, vesting period and other terms specific to options granted are determined by the Plan Administrator. The specific terms of Mandatory Director Grants are specified by the plan document.

  Stock options issued under the Option Plans, other than the Director Option Plan, generally have vesting ranges from three years to four years; expirations of 10 years; and exercise prices greater than or equal to the fair market value of the Company's stock on the date of grant.

  The Director Option Plan provides for two types of Mandatory Grants: a fully vested option to purchase 15,000 shares of common stock to each independent director upon initial election or appointment to the Board of Directors, and an additional initial or annual reelection option to purchase 15,000 shares of common stock, which the earlier of one year or no later than the Company's subsequent regularly scheduled annual shareholders' meeting. For both types of Mandatory Grants, the exercise prices are set equal to the average closing price of the Company's common stock as reported on the NASDAQ National Market during the ten trading days prior toon the date of grant and have ten year terms. Upon leaving the Board, the director's grants remain exercisable until their expiration dates.

  The following table summarizes activity with respect to Microvision common stock options for the three years ended December 31, 2004:2005:

  
                                                           Weighted-
                                                            average
                                                           excercise
                                                Shares       price
                                             ------------  ---------
  Outstanding at December 31, 2001             5,057,000  $   21.52
  Granted:
    Exercise price greater than fair value       106,000      10.23
    Exercise price equal to fair value           694,000       9.71
  Exercised                                       (3,000)      7.40
  Cancelled under exchange program            (2,522,000)     24.63
  Forfeited                                     (256,000)     20.28
                                             ------------
  Outstanding at December 31, 2002             3,076,000  $   16.03
  
  Granted:
    Exercise price greater than fair value     1,935,000       7.15
    Exercise price equal to fair value           378,000       6.76
    Exercise price less than fair value          197,000       6.93
    Exercised                                    (82,000)      6.60
    Forfeited                                   (783,000)     10.06
                                             ------------
  Outstanding at December 31, 2003             4,721,000      12.43
  
  Granted:
    Exercise price greater than fair value       177,000       7.55
    Exercise price equal to fair value           487,000       6.76
    Exercise price less than fair value           90,000       8.35
    Exercised                                    (38,000)      6.25
    Forfeited                                   (319,000)     12.03
                                             ------------
  Outstanding at December 31, 2004             5,118,000      11.72
  
  Granted:
    Exercise price greater than fair value            --         --
    Exercise price equal to fair value           274,000       5.34
    Exercise price less than fair value          300,000       5.32
    Exercised                                     (5,000)      4.03
    Forfeited                                   (367,000)     10.99
                                             ------------
  Outstanding at December 31, 2005             5,320,000  $   11.09
                                             ============
  Exercisable at December 31, 2004             3,908,0002005             4,515,000  $   12.6611.90
                                             ============
  
  

  The following table summarizes information about the weighted-average fair value of Microvision common stock options granted:

  
                                                                      Year Ended December 31,
                                                               -------------------------------------
                                                                  2005         2004         2003         2002
                                                               -----------  -----------  -----------
  Exercise price greater than fair value                      $        3.19--  $      3.19  $      5.453.19
  Exercise price equal to fair value                                 3.21         3.33         4.26         6.58
  Exercise price less than fair value                                3.66         4.58         2.69           --
  
  

  The following table summarizes information about Microvision common stock options outstanding and exercisable at December 31, 2004:2005:

  
                                              Options outstanding          Options exercisable
                                       ---------------------------------  ----------------------
                                                    Weighted
                                         Number      average   Weighted     Number     Weighted
                                       outstanding aremaining   average   excercisable  average
                                       December 31, contractualexcercise  December 31, excercise
  Range of exercise prices                20042005        life       price       20042005        price
  - -----------------------------------  -----------  ---------  ---------  -----------  ---------
                                                  (years)                                    
  $3.25-$6.81                             603,000       8.365.32                             558,000       9.05  $    5.87      514,0005.09      133,000  $    6.04
  $7.00-$7.07                           1,657,000       8.444.89
  $5.33-6.99                              549,000       7.70       6.13      474,000       6.18
  $7.00-7.07                            1,582,000       7.46       7.00    1,219,0001,574,000       7.00
  $7.20-$10.47                            881,000       8.04       8.49      370,000       8.90
  $10.60-$14.94                           369,000       6.26      12.55      274,000      12.88
  $15.00-$15.16                           897,000       6.80$7.19-10.00                             561,000       7.14       7.82      354,000       7.91
  $10.20-14.94                            565,000       5.69      11.58      475,000      11.66
  $15.00-15.16                            874,000       5.81      15.00      897,000874,000      15.00
  $15.63-$20.00                           214,000       6.08      18.42      179,000      18.48
  $20.25-$33.50                           241,000       6.05      25.62      199,000      25.68
  $34.00-$60.75                           256,000       5.30      35.71      256,000      35.71$15.63-60.75                            631,000       4.72      27.99      631,000      27.99
                                       -----------                        -----------
  $3.25-$60.75                          5,118,000                          3,908,0005,320,000                          4,515,000
                                       ===========                        ===========
  
  

  Fair Value Disclosures

  The fair values of Microvision common stock options granted were estimated on the date of each grant using the Black Scholes option pricing model with the following weighted average assumptions used for grants in 2005, 2004 2003 and 2002,2003, respectively: dividend yield of zero percent for all years; expected volatility of 76%70%, 83%76% and 83%; risk free interest rates of 3.0%4.0%, 2.2%3.0%, and 4.2%2.2%; and expected lives of 3,5, 3 and 53 years. Actual forfeitures of 6.8%7.2%, 25.4%6.8% and 54.9%25.4% were used for the years ended December 31, 2005, 2004, 2003, and 20022003 respectively. Excluding shares cancelled under the voluntary extension for grants with terms less than ten years, the actual forfeiture rate for 2003 was 16.3%. Excluding shares cancelled under the November 1, 2002 voluntary stock option exchange offer, the actual forfeiture rate for 2002 was 5.0%.

  14. Commitments and contingencies

  Agreements with the University of Washington

  In October 1993, the Company entered into a Research Agreement and an exclusive license agreement ("License Agreement") with the UW. The License Agreement grants the Company the rights to certain intellectual property, including the technology being subsequently developed under the Microvision research agreement ("Research Agreement"), whereby the Company has an exclusive, royalty-bearing license to make, use and sell or sublicense the licensed technology. In consideration for the license, the Company agreed to pay a one-time nonrefundable license issue fee of $5,134,000. Payments under the Research Agreement were credited to the license fee. In addition to the nonrefundable fee, which has been paid in full, the Company is required to pay certain ongoing royalties. Beginning in 2001, the Company is required to pay the UW a nonrefundable license maintenance fee of $10,000 per quarter, to be credited against royalties due.

  Litigation

  The Company is subject to various claims and pending or threatened lawsuits in the normal course of business. The Company is not currently party to any legal proceedings that management believes the adverse

  outcome of which would have a material adverse effect on the Company's financial position, results of operations or cash flows.

  Lease commitments

  The Company leases its office space and certain equipment under noncancelable capital and operating leases with initial or remaining terms in excess of one year. The Company entered into a facility lease that commenced in April 1999, which includes extension and rent escalation provisions over the seven-year term of the lease. Rent expense is recognized on a straight-line basis over the lease term.

  The companyCompany entered into a 4290 month facility lease that commenced in 2002 for office space in San Mateo, California.February 2006. The Company has entered intolease includes extension and rent escalation provisions over the 90 month term of the lease. Rent expense will be recognized on a sublease agreement for this office space.straight-line basis over the lease term.

  Future minimum rental commitments under capital and operating leases for years ending December 31 are as follows:

  
                                                       Capital       Operating
                                                       leases         leases
                                                    -------------  -------------
  20052006                                             $      42,00041,000  $     1,985,000
  2006                                                     6,000        473,000741,000
  2007                                                    4,000         46,00039,000        850,000
  2008                                                    --             --33,000        834,000
  2009                                                    --             --27,000        837,000
  2010                                                    20,000        867,000
  Thereafter                                                  --      --2,400,000
                                                    -------------  -------------
  Total minimum lease payments                           52,000160,000  $   2,504,0006,529,000
                                                                   =============
  Less: Amount representing interest                     (4,000)(23,000)
                                                    -------------
  Present value of capital lease obligations             48,000137,000
  Less: Current portion                                  (39,000)(32,000)
                                                    -------------
  Long-term obligation at December 31, 20042005        $     9,000105,000
                                                    =============
  
  

  Operating lease commitments amounts do not include the impact of contractual sublease receipts of $474,000 and $79,000 for the yearsyear ended December 31, 2005 and 2006, respectively.2006.

  The capital leases are collateralized by the related assets financed and by security deposits held by the lessors under the lease agreements. The cost and accumulated depreciation of equipment under capital leases was $1,309,000, and $1,140,000, respectively at December 31, 2005 and $1,175,000 and $1,053,000, respectively, at December 31, 2004 and $1,160,000 and $928,000, respectively, at December 31, 2003.2004.

  Net rent expense was $1,435,000, $1,689,000, and $2,302,000 for 2005, 2004 and $1,639,000 for 2004, 2003, and 2002, respectively. Rent expense in 2003 includes $540,000 for the closure of the Company's facility in San Mateo, California. Sub- lease income of $575,000, $363,000 and $226,000 for 2005, 2004, and $77,000 for 2004, 2003 and 2002 respectively was included as a reduction in rent expense.

  Long-term debt

  During 1999, the Company entered into a loan agreement with the lessor of the Company's corporate headquarters to finance $420,000 in tenant improvements. The loan carries a fixed interest rate of 10% per annum, is repayable over the initial term of the lease, which expires in 2006, and is secured by a letter of credit. The balance of the loan was $99,000$22,000 and $169,000$99,000 at December 31, 20042005 and 20032004 respectively.

  15. Income taxes

  A provision for income taxes has not been recorded for 2005, 2004 2003 or 20022003 due to valuation allowances placed against the net operating losses and deferred tax assets arising during such periods. A valuation allowance has been recorded for all deferred tax assets because based on the Companies'Company's history of losses

  since inception, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets.

  At December 31, 2004,2005, Microvision has net operating loss carry forwards of approximately $168$191 million, for federal income tax reporting purposes. In addition, Microvision has research

  and development tax credits of $2,218,000.$2,559,000. The net operating loss carry forwards and research and development credits available to offset future taxable income, if any, will expire in varying amounts from 2008 to 20242025 if not previously utilized. In certain circumstances, as specified in the Internal Revenue Code, a 50% or more ownership change by certain combinations of the Company's stockholders during any three-year period would result in limitations on the Company's ability to utilize its net operating loss carry-forwards. The Company has determined that such a change occurred during 1995 and the annual utilization of loss carry-forwards generated through the period of that change will be limited to approximately $761,000. An additional change occurred in 1996; and the limitation for losses generated in 1996 is approximately $1,600,000.

  Deferred tax assets are summarized as follows:

  
                                                            December 31,
                                                    ----------------------------
                                                        2005           2004           2003
                                                    -------------  -------------
  Net operating loss carry forwards Microvision    $  57,112,00065,006,000  $  47,351,00057,112,000
  R&D credit carry forwards Microvision                2,559,000      2,218,000
  1,927,000
  Other                                                3,463,000      4,642,000      3,679,000
                                                    -------------  -------------
                                                      71,028,000     63,972,000     52,957,000
  Less: Valuation allowance                          (71,028,000)   (63,972,000)   (52,957,000)
                                                    -------------  -------------
  Deferred tax assets                              $          --  $          --
                                                    =============  =============
  
  

  The valuation allowance and the research and development credit carry forwards account for substantially all of the difference between the Company's effective income tax rate and the Federal statutory tax rate of 34%.

  Certain net operating losses arise from the deductibility for tax purposes of compensation under nonqualified stock options equal to the difference between the fair value of the stock on the date of exercise and the exercise price of the options. For financial reporting purposes, the tax effect of this deduction when recognized is accounted for as a credit to shareholders' equity.

  16. Retirement savings plan

  The Company has a retirement savings plan ("the Plan") that qualifies under Internal Revenue Code Section 401(k). The Plan covers all qualified employees. Contributions to the Plan by the Company are made at the discretion of the Board of Directors.

  In February 2000, the Board of Directors approved a plan amendment to match 50% of employee contributions to the Plan up to 6% of the employee's per pay period compensation, starting on April 1, 2000. During 2005, 2004 2003 and 2002,2003, the Company contributed $321,000, $337,000 $392,000 and $351,000$392,000 respectively, to the Plan under the matching program.

  17. Segment Information

  Prior to Lumera's initial public offering in July 2004, the Company was organized into two segments - Microvision, which is engaged in scanned beam displays and related technologies, and Lumera, which is engaged in optical systems components technology. The segments were determined based on how management views and evaluates the Company's operations.

  The accounting policies used to derive reportable segment results are described in Note 2, "Summary of Significant Accounting Policies."

  A portion of each segments' administration expenses arise from shared services and infrastructure that Microvision has provided to both segments in order to realize economies of scale and to efficiently use resources. These efficiencies include costs of certain legal, accounting, human resources and other Microvision corporate and infrastructure costs. These expenses are allocated to the segments and the allocation has been determined on a basis that the Company considered to be a reasonable reflection of the utilization of services provided to, or benefits received by, the segments.

  Since 2000, Microvision has held an investment in Lumera. From inception to July 2004, Lumera was a consolidated subsidiary and treated as a seperateseparate segment within Microvision. Subsequent to July 2004, Lumera became an equity method investment.: Since July 2004, Microvision has operated as one segment.

  At December 31, 2005 and 2004, Lumera iswas a significant unconsolidated equity investment of Microvision. For 2005 Lumera revenue was $1,509,000, Gross profit was $587,000, Loss from operations was $11,108,000 and Net loss was $10,453,000 For the period that Lumera iswas an unconsolidated investment in 2004 (July 2004 through December 31, 2004) Lumera revenue was $303,000, Gross profit was $85,000, Loss from operations was $5,205,000 and Net loss was $5,199,000. At December 31, 2005 Lumera had Current assets of $22,384,000, Noncurrent assets of $1,322,000, Current liabilities of $1,552,000 and Shareholders equity of $22,154,000 At December 31, 2004 Lumera had Current assets of $19,623,000, Noncurrent assets of $13,263,000, currentCurrent liabilities of $1,493,000 and Shareholders equity of $31,393,000.:

  The following tables reflect the results of the Company's reportable segments under the Company's management system. The performance of each segment is measured based on several metrics. These results are used, in part, by management, in evaluating the performance of, and in allocation of resources to, each of the segments (in thousands):

  
                                                                Year Ended December 31, 2004
                                                   --------------------------------------------------
                                                   Microvision    Lumera     Elimination     Total
                                                   -----------  -----------  -----------  -----------
  Contract Revenue                                $     8,135  $       686  $        --  $     8,821
  Product  Revenue                                      2,597           --           --        2,597
  Cost of Contract Revenue                              5,106          433           --        5,539
  Cost of Product Revenue                               3,868           --           --        3,868
  Research and development expense                     13,581        1,129                    14,710
  Marketing, general and administrative expense        17,795        1,433           --       19,228
  Non-cash compensation expense                           821        1,297           --        2,118
  Interest income                                         270            2           --          272
  Interest expense                                         31          120           --          151
  Segment loss                                         32,257        3,724       (2,438)      33,543
  Depreciation                                          1,711          695           --        2,406
  Expenditures for capital assets                         970           70           --        1,040
  Segment assets                                       25,538           --                    25,538
  
                                                                Year Ended December 31, 2003
                                                   --------------------------------------------------
                                                   Microvision    Lumera     Elimination     Total
                                                   -----------  -----------  -----------  -----------
  Contract Revenue                                $    11,792  $     1,725  $        --  $    13,517
  Product Revenue                                       1,135           --           --        1,135
  Cost of Contract Revenue                              5,015        1,014                     6,029
  Cost of Product Revenue                               1,017                                  1,017
  Research and development expense                     16,755        6,561           --       23,316
  Marketing, general and administrative expense        14,557        1,270           --       15,827
  Non-cash compensation expense                         1,115        1,041           --        2,156
  Interest income                                         342           39           --          381
  Interest expense                                         51           --           --           51
  Segment loss                                         25,205        8,083       (7,125)      26,163
  Depreciation                                          1,924        1,185           --        3,109
  Expenditures for capital assets                       1,094          455           --        1,549
  Segment assets                                       37,224        4,058       (7,364)      33,918
  
  
                                                                Year Ended December 31, 2002
                                                   --------------------------------------------------
                                                   Microvision    Lumera     Elimination     Total
                                                   -----------  -----------  -----------  -----------
  Contract Revenue                                $    14,443  $       946  $        --  $    15,389
  Product Revenue                                         528           --           --          528
  Cost of Contract Revenue                              6,139          330                     6,469
  Cost of Product Revenue                                 528                                    528
  Research and development expense                     18,362        7,157           --       25,519
  Marketing, general and administrative expense        15,577        1,221           --       16,798
  Non-cash compensation expense                           841        1,143           --        1,984
  Interest income                                         860          199           --        1,059
  Interest expense                                         59           --           --           59
  Segment loss                                         26,219        8,698       (7,741)      27,176
  Depreciation                                          1,894        1,049           --        2,943
  Expenditures for capital assets                         792          562           --        1,354
  Segment assets                                       30,144        8,589       (6,466)      32,267
  
  

  18. Quarterly Financial Information (Unaudited)

  The following table presents the Company's unaudited quarterly financial information for the years ending December 31, 20042005 and 2003:2004:

  
                                                         Year Ended December 31, 2005
                                          ----------------------------------------------------------
                                          December 31,   September 30,    June 30,       March 31,
                                          -------------  -------------  -------------  -------------
  Revenue                                $   2,709,000  $   3,330,000  $   4,725,000  $   3,982,000
  Gross Margin                              (1,756,000)      (434,000)       840,000      1,004,000
  Net loss available for common shareholde  (5,566,000)   (12,571,000)    (4,968,000)    (7,179,000)
  Net loss per share basic and diluted           (0.23)         (0.56)         (0.23)         (0.33)
  
                                                         Year Ended December 31, 2004
                                          ----------------------------------------------------------
                                          December 31,   September 30,    June 30,       March 31,
                                          -------------  -------------  -------------  -------------
  Revenue                                $   3,317,000  $   2,729,000  $   2,398,000  $   2,974,000
  Gross Margin                                  76,000        263,000        568,000      1,104,000
  Net loss                                  available for common shareholders    (8,247,000)   (10,094,000)    (8,512,000)    (6,690,000)
  Net loss per share basic and diluted           (0.38)         (0.47)         (0.40)         (0.31)
  
  
                                                             Year Ended December 31, 2003
                                              ----------------------------------------------------------
                                              December 31,   September 30,    June 30,       March 31,
                                              -------------  -------------  -------------  -------------
  Revenue                                    $   4,039,000  $   2,565,000  $   4,511,000  $   3,537,000
  Gross Margin                                   2,102,000      1,066,000      2,310,000      2,128,000
  Net loss                                      (5,210,000)    (6,865,000)    (6,692,000)    (7,396,000)
  Net loss per share basic and diluted               (0.26)         (0.39)         (0.38)         (0.46)
  
  

  19. Subsequent Event

  In March 2005, MicrovisionJanuary 2006, the Company raised $10,000,000 before issuance costs,$10,324,000 from the issuancesale of senior secured exchangeable convertible notes (the "Notes") and warrants to purchase an aggregate of 462,330 shares of Microvision common stock. The Notes are payable in six equal quarterly payments starting in December 2005. The Notes are convertible on demand by the holders into Microvision common stock at a conversion price of $6.84 per share of Microvision common stock and exchangeable on demand by the holders into Lumera common stock at an exchange price of $5.64 per share of Lumera common stock. The terms include a limit on the aggregate number of Lumera common shares that can be used to pay principal of 1,750,000 shares. The Notes are secured by the same 1,750,0002,550,000 shares of Lumera common stock. The initial conversion price is subject to adjustment in the event Microvision issues common stock or derivative securities atAs a price per share of common stock below the conversion priceresult of the Note. In addition, uponsale, the requestCompany will record a "gain on sale of equity subsidiary" of approximately $7.3 million. Subsequent to the sale, the Company owned 2,072,000 shares, or 12%, of the Note holders, Microvision is required to redeem the Notes for cash in certain circumstances, including in the eventoutstanding shares of a material breach of representations, warranties or covenants under the purchase agreement or a change in control.

  The Note terms include variable interest at a rate of LIBOR plus 3% within a range of 6% and 8%, payable quarterly.

  Each principal payment is payable in cash or registered common stock, at the election of the Company, subject to certain conditions. If the Company elects to pay principal in registered common stock, the Note holder can elect to receive payment in either Microvision or Lumera common stock. Interest is payableAfter January 31, 2006, due to the change in cash orownership percentage, Microvision common stock, subject to certain conditions. Some ofwill account for its investment in Lumera using the conditions which would precludecost method.

  In January 2006 the Company from paying in common stock are not withinChief Executive Officer's employment was terminated and the Company's immediate control.Chief Financial Officer resigned. The Company can electappointed Alexander Y. Tokman to convert the Note into Microvision common stock if the stock price exceeds $11.97 per share for any 20 out of any 30 consecutive days, subject to certain conditions. The warrants are immediately exercisable, have an exercise price of $6.84 per share and expireChief Executive Officer in March 2010. The initial exercise price is subject to adjustment in the event Microvision issues common stock or derivative securities at a price per share of common stock below or the exercise price of the warrant.January 2006.

  
  
  
  

  ---

  
  
  
  

  MICROVISION, INC.

  
  VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

  
  (in thousands)

  
                                                                                  Additions
                                                                         ------------------------
                                                            Balance at   Charges to   Charges to                  Balance at
                                                           beginning of   costs and      other                      end of
                        Description                        fiscal period  expenses     accounts     Deductions   fiscal period
  - -------------------------------------------------------  ------------  -----------  -----------  ------------  -------------
      Year Ended December 31, 20022003
          Allowance for receivables from related parties  $        --700  $       700200  $        --  $         --  $         700
          Tax valuation allowance                               39,971           --       12,088            --         52,059
  
      Year Ended December 31, 2003
          Allowance for receivables from related parties           700          200           --            --         900
          Tax valuation allowance                               52,059           --       11,454            --         63,513
  
      Year Ended December 31, 2004
          Allowance for receivables from related parties           900           --           --            --            900
          Tax valuation allowance                               63,513           --       11,015       (10,556)        63,972
  
      Year Ended December 31, 2005
          Allowance for receivables from related parties           900        1,031           --            --          1,931
          Tax valuation allowance                               63,972           --        7,056            --         71,028
  
  

  ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

  There have been no changes in or disagreements with accountants in accounting or financial disclosure matters during the Company's fiscal years ended December 31, 20042005 and 2003.2004.

  ITEM 9A. CONTROLS AND PROCEDURES
  
  (a) Evaluation of disclosure controls and procedures. The Chief Executive Officer and the ChiefPrincipal Financial Officer evaluated our disclosure controls and procedures (as defined in Rules 13a- 15(e)13a-15(e) and 15-d-15(e)15d-15(e) under the SecuritesSecurities and Exchange Act of 1934)1934 (the "Exchange Act") prior to the filing of this annual report. Based on that evaluation, they concluded that, as of the end of the period covered by this annual report, our disclosure controls and procedures were, in design and operation is effective and such information is accumulated and communicated to ensure that informationmanagement as appropriate to allow timely decisions regarding required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms.disclosure.

  (b)Management's Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control - Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under the framework inInternal Control - Integrated Framework,our management concluded that our internal control over financial reporting was effective as of December 31, 2004.

  2005.
  
  Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 20042005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included in Item 8 of this Annual Report on Form 10-K.

  (c)Changes in internal controls over financial reporting.reporting. There have not been any changes in the Company's internal control over financial reporting during the quarter ended December 31, 20042005 which have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
  

  ITEM 9B. OTHER INFORMATION

  None

  PART III

  ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

  The information under the headings "Election"Proposal One -Election of Directors," "Section 16(a) Beneficial Ownership Reporting Compliance," and "Audit Committee Report" in the Microvision, Inc., definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the next Annual Meeting of Shareholders to be held on

  June 30, 2005 (the15, 2006(the "Proxy Statement") is incorporated herein by reference. See Item 4A in Part 1I of this report for information regarding executive officers of the Company.

  ITEM 11. EXECUTIVE COMPENSATION

  The information required by this item is incorporated by reference to the Proxy Statement under the heading "Executive Compensation."Compensation and Other Matters" in our Proxy Statement is incorporated herein by reference.

  ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

  The following table shows the number of shares of common stock that could be issued upon exercise of outstanding options and warrants, the weighted average exercise price of the outstanding options and warrants and the remaining shares available for future issuance as of December 31, 2004.2005.

  
                                                                                 Equity Compensation Plan Information
                                                           ---------------------------------------------------------------------
                                                                Number of             Weighted-          Number of securities
                                                             securities to be     average excercise     remaining available for
                                                               issued upon             price of         further issuance under
                                                               excercise of          outstanding          equity compensation
                                                               outstanding        options, warrants        plans (excluding
                                                            options, warrants         and rights        securities reflected in
                                                                and rights                                    column (a))
  Plan Category                                                    (a)                   (b)                      (c)
  - -------------------------------------------------------  --------------------  --------------------  -------------------------
  Equity compensation plans approved by shareholders                 4,763,0004,982,000  $              11.44                  2,954,00010.79                  3,131,000
  Equity compensation plans not approved by shareholders               686,000                 23.20615,000                 20.53                         --
                                                           --------------------                        -------------------------
      Total                                                          5,449,0005,597,000  $              12.92                  2,954,00011.86                  3,131,000
                                                           ====================                        =========================
  
  

  As of December 31, 2004,2005, there were non-plan options to purchase a total of 355,000338,000 shares of Microvision common stock outstanding. 346,000329,000 of these were options approved by the Board of Directors and issued in October 2001, with an exercise priceprices in excess of the fair value of Microvision common stock on the date of grant. The October 2001 options have a $15.00 exercise price and vestvested 25% on the grant date and 25% at six-month intervals thereafter. The remaining 9,000 non-plan options were granted at fair valuevalues on the datedates of grant and vest 25% at each annual anniversary date of the grant.grants.

  All non-plan options are non-qualified options with 10 year terms granted to non-executive employees. The options are administered by the Compensation Committee of the Board of Directors or its authorized agents. Options surrendered, exchanged for another option, canceled or terminated without having been exercised in full will again be available for issuance by the Company. The options are not transferable other than by will or the laws of descent and distribution. Each option is exercisable during the lifetime of the optionee only by such optionee, upon its vest date and thereafter through the expiration date, subject to the termination of employment provisions. Following termination of employment by the Company other than for cause, resignation in lieu of dismissal, disability or death, an option holder may exercise options, vested as of the date of termination, within three months before the options will automatically expire, and any unvested options will automatically expire upon the termination date. The number and class of shares covered by the options and the exercise price per share shall be proportionately adjusted for any change in the number of issued shares of common stock of the Company resulting from a stock split, stock dividend or consolidation of shares or any like capital stock adjustment. In the event of a merger, consolidation or plan of exchange to which the Company is a party or a sale of all or substantially all of the Company's assets, the Board of Directors may elect to treat the options in one of the following ways: (i) outstanding options would remain in effect in accordance with their terms; (ii) outstanding options would be converted into options to purchase stock in the surviving or acquiring corporation in the transaction; or (iii) outstanding options would be exercised within a period determined by the Board of Directors prior to the consummation of the transaction, after which time the options automatically expire. The Board may accelerate the vesting of the options so they are exercisable in full.

  In August 2000, the Company issued two non-plan warrants to purchase an aggregate of 200,000 shares of Microvision common stock to two consultants in connection with entering into certain consulting agreements with the Company. Subsequently, one of the consultants was elected to the Board of Directors by shareholders. The warrants were fully outstanding as of December 31, 2003.2005. The warrants have an exercise price of $34.00 per share and are exercisable prior to their expiration in August 2010. As of the date of grant, all but 25,000 of the underlying shares of common stock issuable to each consultant upon exercise of the warrants were subject to lock-up restrictions that prevent the holder from transferring such shares. The number of shares subject to the lock-up restrictions is reduced by 25,000 for each consultant on each June 7 subsequent to the grant date. Rather than issue shares of common stock upon exercise of the warrants, the Company may elect to redeem the warrants if, in the opinion of the Board of Directors upon advice of counsel, it would be unlawful to issue the underlying securities. The warrants are transferable upon prior written approval of the Company. The Company cannot unreasonably withhold such approval with respect to transfers of warrants to purchase at least 10,000 shares that are not subject to the lock-up restrictions. If the Company terminates the consulting agreement due to the consultant's failure to provide consulting services during the first three years of the agreement, the consultant must return to the Company a pro-rata portion of the 75,000 warrants initially subject to the lock- uplock-up restrictions based on the number of calendar days remaining in the initial three year period. The number, class and price of securities for which the warrants may be exercised are subject to adjustment for certain changes in the Company's capital structure. The number of securities and exercise price per share will be proportionately adjusted if outstanding shares of the Company's common stock are divided into a greater number of shares or combined into a smaller number of shares, or a stock dividend is paid on the common stock. In the event of a change in the common stock from a merger, consolidation, reclassification, reorganization, partial or complete liquidation, or other change in the capital structure of the Company, the Company will, as a condition of the change in capital structure, make provision for the warrant holder to receive upon the exercise of the warrants the kind and amount of shares of stock, other securities or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of the warrants, and the exercise price will be proportionately adjusted.

  The Company has a warrant outstanding to purchase 50,000 shares of Microvision common stock that was issued in April 2000 in exchange for equity placement services by a non-employee. The warrant was issued fully vested, has an exercise price of $53.00 per share and is exercisable prior to its expiration in April 2005. Rather than issue shares of common stock upon exercise of the warrant, the Company may elect to redeem the warrant if, in the opinion of the Board of Directors upon advice of counsel, it would be unlawful to issue the underlying securities. The warrant is not transferable without prior written approval of the Company. The number, class and price of securities for which the warrant may be exercised are subject to adjustment for certain changes in the Company's capital structure. The number of securities and exercise price per share shall all be proportionately adjusted where outstanding shares of common stock are divided into a greater number of shares or combined into a smaller number of shares, or a stock dividend is paid on the common stock. In the event of a change in the common stock from a merger, consolidation, reclassification, reorganization, partial or complete liquidation, or other change in the capital structure of the Company, the Company will, as a condition of the change in capital structure, make provision for the warrant holder to receive upon the exercise of the warrants the kind and amount of shares of stock, other securities or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of the warrants, and the exercise price will be proportionately adjusted.

  The Company has a warrant outstanding to purchase 6,250 shares of Microvision common stock issued in exchange for equity placement services by a non-employee. The warrant was issued fully vested in June 2000 for 6,250 shares with an exercise price of $19.20 per share and is exercisable prior to its expiration in June 2005. Rather than issue shares of common stock upon exercise of the warrant, the Company may elect to redeem the warrant if, in the opinion of the Board of Directors upon advice of counsel, it would be unlawful to issue the underlying securities. The warrant is not transferable without prior written approval of the Company. The number, class and price of securities for which the warrants may be exercised are subject to adjustment for certain changes in the Company's capital structure. The number of securities and exercise price per share shall be proportionately adjusted where outstanding shares of common stock are divided into a greater number of shares or combined into a smaller number of shares, or a stock dividend is paid on the common stock. In the event of a change in the common stock from a merger, consolidation, reclassification, reorganization, partial or complete liquidation, or other change in the capital structure of the Company, the Company will, as a condition of the change in capital structure, make provision for the warrant holder to receive upon the exercise of the warrant the kind and amount of shares of stock, other securities or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of the warrant, and the exercise price will be proportionately adjusted.

  The Company has a warrant outstanding to purchase 4,907 shares of Microvision common stock that was issued in December 2000 in exchange for equity placement services by a non-employee. The warrant was issued fully vested, has an exercise price of $61.13 per share and is exercisable prior to its expiration in April 2005. Rather than issue shares of common stock upon exercise of the warrant, the Company may elect to redeem the warrant if, in the opinion of the Board of Directors upon advice of counsel, it would be unlawful to issue the underlying securities. The warrant is not transferable without prior written approval of the Company. The number, class and price of securities for which the warrant may be exercised are subject to adjustment for certain changes in the Company's capital structure. The number of securities and exercise price per share shall all be proportionately adjusted where outstanding shares of common stock are divided into a greater number of shares or combined into a smaller number of shares, or a stock dividend is paid on the common stock. In the event of a change in the common stock from a merger, consolidation, reclassification, reorganization, partial or complete liquidation, or other change in the capital structure of the Company, the Company will, as a condition of the change in capital structure, make provision for the warrant holder to receive upon the exercise of the warrants the kind and amount of securities or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of the warrants, and the exercise price will be proportionately adjusted.

  The Company has two warrants outstanding to purchase an aggregate of 70,000 shares of Microvision common stock that were issued in September 2003 to a third party for services. The first warrant for 60,000 shares has an exercise price of $7.50 per share and vests in three equal tranches. The first tranche vests on the issue date, the second and third tranches vest three and six months following the issue date, respectively. The second warrant for 10,000 shares has an exercise price of $12.00 per share and vests six months after the issue date. The Company may cancel unvested tranches or the second warrant prior to their respective vest dates if it determines in good faith, and notifies the holder, that it is not satisfied with the holder's performance under the agreement. Vested warrants are exercisable prior to their expiration in September 2007. The warrant holder may transfer any portion or all of the warrant shares by delivering the original warrant certificate and a form of assignment to the Company. The number and price of securities for which the warrant may be exercised are subject to adjustment for certain changes in the Company's capital structure. Where the outstanding shares of common stock are divided into a greater number of shares, combined into a smaller number of shares, or a stock dividend is paid on the common stock, the exercise price per share shall be proportionately adjusted by the ratio of common shares outstanding immediately before and after the transaction. In the event of a change in the common stock from a merger, consolidation, reclassification, tender offer or exchange offer, or partial or complete liquidation, the holder will be entitled to receive, upon the exercise of the warrants, the same amount and kind of securities, cash or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of warrants.

  In July 2005, Microvision issued a warrant to purchase 6,925 shares of common stock to a third party for services. The warrant is immediately exercisable, has an exercise price of $5.32 per share, and expires in July 2010. The number and price of securities for which the warrant may be exercised are subject to adjustment for certain changes in the Company's capital structure. Where the outstanding shares of common stock are divided into a greater number of shares, combined into a smaller number of shares, or a stock dividend is paid on the common stock, the exercise price per share shall be proportionately adjusted by the ratio of common shares outstanding immediately before and after the transaction. In the event of a change in the common stock from a reorganization, reclassification, consolidation, or merger, the holder will be entitled to receive, upon the exercise of the warrants, the same amount and kind of securities, cash or property to which the holder would have been entitled if, immediately prior to the change in capital structure, the warrant holder had held the number of shares of common stock obtainable upon the exercise of the warrants.

  The other information required by this item is incorporated by reference in the Proxy Statement under the heading "Information about Microvision Common Stock Ownership."

  ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  The information required by this item is incorporated by reference to the Proxy Statement under the heading "Certain Relationships and Related Transactions."Transactions" in our Proxy Statement is incorporated herein by reference.

  ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

  The information required by this Item is incorporated by reference to the Proxy Statement under the heading "Independent Accountants". in our Proxy Statement is incorporated herein by reference.

  PART IV

  ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

  a)(a) Documents filed as part of the report

  (1)1. Financial Statements

  Balance Sheets as of December 31, 20042005 and 20032004

  Statements of Operations for the years ended December 31, 2005, 2004 2003 and 20022003

  Statements of Shareholders' Equity for the years ended

  December 31, 2005, 2004 2003 and 20022003

  Statements of Comprehensive Loss for the years ended

  December 31, 2005, 2004 2003 and 20022003

  Statements of Cash Flows for the years ended December 31, 2005, 2004 2003 and 20022003

  Valuation and Qualified Accounts and Reserves for the years ended December 31, 2005, 2004 2003 and 20022003

  (2)2. None

  (3)(b) Exhibits

  3.1	Certificate of Incorporation of Microvision, Inc.,(2)
  3.2		Bylaws of Microvision, Inc. (2)
  3.3		Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock of Microvision, Inc.(24)(14)
  4.1		Form of Specimen Stock Certificate for Common StockStock.(2)
  4.2		Microvision, Inc. Series 2 Stock Purchase Warrant, dated April 1, 1999 issued to Capital Ventures International(5)
  4.3		Common Stock Purchase Warrant, dated asForm of April 1, 1999, issued to Josephthal & Co, Inc.Indenture.(6)
  4.4		Form of Indenture(14)
  4.5		Form of Warrant issued on October 9, 2001(15)
  4.64.3		Form of Warrant issued on July 22, 20022002.(19)(10)
  4.74.4		Form of Warrant issued on March 5, 20032003.(18)(9)
  4.84.5		Registration Rights Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (14)
  4.6		Warrant No. 76 to Purchase Common Stock of Microvision, Inc. issued September 10, 2004 to Satellite Strategic Finance Associates, LLC. (24)(14)
  4.9		Form of Note issued under the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.(25)
  4.104.7		Form of Warrant issued under the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(15)
  4.114.8		Company Registration Rights Agreement executed in connection with the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(15)
  4.124.9		Lumera Registration Rights Agreement executed in connection with the Securities Purchase Agreement datedForm of Amended and Restated Note issued as of March 11, 2005 under the Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(18)
  4.134.10		Form of Pledge and Security Agreement executed in connection withWarrant issued as of July 25, 2005 under the Securities PurchaseMaster Amendment Agreement dated as of March 11,July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(18)
  4.11		Registration Rights Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd.. (20)
  4.12		Warrant No. 86 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Partners, Ltd. (20)
  4.13		Warrant No. 87 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Associates, LLC. (20)
  4.14		Warrant No. 88 to Purchase Common Stock of Microvision, Inc. issued August 31, 2005 to Omicron Master Trust (21)
  4.15		Form of Note issued as of December 1, 2005 under the Securities and Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.(22)
  4.16		Form of Warrant issued under the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  4.17		Form of Amended and Restated Pledge and Security Agreement executed in connection with the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  10.1		Assignment of License and Other Rights between The University of Washington and the Washington Technology Center and the H. Group, dated July 25, 19931993.(1)
  10.2		Project II Research Agreement between The University of Washington and the Washington Technology Center and Microvision, Inc., dated October 28, 19931993.(1)+
  10.3		Exclusive License Agreement between The University of Washington and Microvision, Inc., dated October 28, 19931993.(1)+
  10.4		Exclusive License Agreement between the University of Washington and Microvision, Inc. dated March 3, 19941994.(18)(9)
  10.5		1993 Stock Option PlanPlan.(1)*
  10.6		1996 Stock Option Plan, as amended.(17)(8)*
  10.7		1996 Independent Director Stock Option Plan, as amended.(17)(8)*
  10.8		Form of Executive Option Exercise Loan PlanPlan.(3)*
  10.9		Lease Agreement between S/I Northcreek II, LLC and Microvision, Inc., dated October 27, 19981998.(23)(13)
  10.9.1		Lease Amendment No 1 to Lease between S/I Northcreek II, LLC and Microvision, Inc., dated July 12, 19991999.(9)(5)
  10.9.2		Lease Amendment No 122 to Lease between S/I Northcreek II, LLC and Microvision, Inc., dated February 14, 20012000.(9)(5)
  10.10		Form of Consulting Agreement between Microvision, Inc. and Avram Miller and Jacqueline Brandwynne dated August 10, 20002000.(8)(4)
  10.11		Form of Common Stock Purchase Warrant issued to Avram Miller and Jacqueline Brandwynne dated August 10, 20002000.(8)(4)
  10.12		Exclusive Licensing Agreement between the University of Washington and Lumera Corporation dated October 20, 2000(11). +
  10.13		Sponsored Research Agreement between the University of Washington and Lumera Corporation dated October 20, 2000(11).
  10.14		Independent Director Stock Option Plan, as amended(16)*
  10.15		Investors' Rights Agreement, dated as of March 14, 2001 by and between Lumera Corporation and certain investors(12)
  10.16		Executive Loan Plan and Related Form of NoteNote.(16)(7)*
  10.17		Microvision, Inc. Series 1 Stock Purchase Warrant, dated April 1, 1999, issued to Capital Ventures International (18)
  10.1810.13		Form of Stock Purchase Agreement dated March 22, 20022002.(20)(11)
  10.1910.14		Form of Stock Purchase Agreement dated July 22, 20022002.(19)(10)
  10.2010.15		Form of Securities Purchase Agreement dated as of March 3, 20032003.(18)(9)
  10.2110.16		Form of the Option Agreement for options granted outside of the PlansPlans.(21)(12)
  10.22		Common Stock Purchase Warrant, dated as of January 14, 1999, issued to Stan Berk(22)
  10.23		Common Stock Purchase Warrant, dated as of July 13, 1999, issued to Stan Berk(22)
  10.24		Common Stock Purchase Warrant, dated as of April 13, 2000, issued to Burt S. Davis(22)
  10.25		Common Stock Purchase Warrant, dated as of June 21, 2000, issued to Stan Berk(22)
  10.26		Common Stock Purchase Warrant, dated as of October 15, 2001, issued to Ladenburg Thalmann & Co. Inc. (22)
  10.27		Registration Rights Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (24)
  10.2810.17		Securities Purchase Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (24)(14)
  10.2910.18		License and Development Agreement dated as of December 30, 2004 by and between Microvision, Inc. and Ethicon Endo-Surgery, Inc.(16)+
  10.3010.19		Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (15)
  10.20		Employment Agreement between Microvision, Inc. and Alexander Y. Tokman dated July 18, 2005.(17)
  10.21		Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (18)
  10.22		Lease Agreement between Carramerica Reality Operating Partnership, L.P. and Microvision, Inc., dated July 15, 2005.(19)
  10.23		Securities Purchase Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd. (20)
  10.24		Conversion and Modification Agreement dated as of August 8, 2005 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (20)
  10.25		Securities Purchase Agreement dated as of August 31, 2005 by and between Microvision, Inc. and Omicron Master Trust. (21)
  10.26		Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  23		Consent of Independent Registered Public Accounting FirmFirm.
  24		Power of Attorney pursuant to which this report may be filed.
  31.1		Chief Executive Officer certification pursuant to Rule 13a-14(a)13a- 14(a)/15d-14a15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2		ChiefPrincipal Financial Officer certification pursuant to Rule 13a-14(a)13a- 14(a)/15d-14a15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1		Chief Executive Officer certification pursuant to Rule 13a-14(b) or Rule 13d-14(b)15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
  32.2		ChiefPrincipal Financial Officer certification pursuant to Rule 13a-14(b)13a- 14(b) or Rule 15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

  _______________

  __________

  (1) Incorporated by reference to the Company's Form SB-2 Registration Statement, Registration No. 333-05276-LA.

  (2) Incorporated by reference to the Company's Post-Effective Amendment to Form S-3 Registration Statement, Registration No. 333-102244.

  (3) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended

  June 30, 1998.1998, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (4) Incorporated by reference to the Company's Annual Report on Form 10-K10-Q for the yearquarterly period ended December 31, 1997.September 30, 2000, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1998.1999, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (6) Incorporated by reference to the Registration Statement on Form S-3, Registration No. 333- 33612.333-69652.

  (7) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2000.

  (8) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended September 30, 2000.

  (9) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999.

  (10) Incorporated by reference to Registration Statement on Form S-3, Registration No. 333- 33612.

  (11) Incorporated by reference to2001, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Annual Report on Form 10-K for the year ended December 31, 2000.Commission File Number, 0-21221.

  (12) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended March 31, 2001.

  (13)(8) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2001.2002.

  (9) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 5, 2003.

  (10) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 23, 2002.

  (11) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 26, 2002.

  (12) Incorporated by reference to the Company's Schedule TO file on November 1, 2002.

  (13) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended September 30, 1998, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (14) Incorporated by reference to the Registration StatementCompany's Current Report on Form S-3, Registration No. 333-69652.8-K filed on September 10, 2004.

  (15) Incorporated by reference to the Company's Current Report on Form 8-K filed on October 9, 2001.March 14, 2005.

  (16) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001.2004.

  (17) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 7, 2005.

  (18) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 29, 2005.

  (19) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2002.

  (18) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 5, 2003.

  (19) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 23, 2002.2005.

  (20) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 26, 2002.August 10, 2005.

  (21) Incorporated by reference to the Company's Schedule TO file on November 1, 2002.

  (22) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

  (23) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended September 30, 1998.

  (24) Incorporated by reference to the Company's Current Report on Form 8-K filed on September 10, 2004.2, 2005.

  (25)(22) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 14,December 1, 2005.

  (23) Incorporated by reference to the Company's Current Report on Form 8-K\A filed on December 2, 2005.

  + Subject to confidential treatment.

  * Management contracts and compensatory plans and arrangements required to be filed as exhibits pursuant to Item 15(c)15(b) of this Report.

  
  
  
  

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  SIGNATURES

  Pursuant to the requirements of Section 13 or 15(d) 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.

  MICROVISION, INC.

  Date: March 16, 20052006

  By

  Richard F. Rutkowski Richard F. Rutkowski Alexander Tokman Alexander Tokman President and Chief Executive Officer

  Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the following capacities on March 16, 2005.2006.

  Signature	Title
  /s/ Richard F. Rutkowski Richard F. RutkowskiAlexander Tokman Alexander Tokman	Chief Executive Officer and Director (Principal Executive Officer)
  /s/ Stephen R. Willey Stephen R. Willey	President and Director
  /s/ Richard A. Raisig Richard A. Raisig	Chief Financial Officer and Vice President, Operations (Principal Financial Officer)
  /s/ Jeff Wilson Jeff Wilson	Chief AccountingPrincipal Financial Officer (Principal Accounting Officer)
  * Jacqueline Brandwynne	Director
  /s/ Richard A. Cowell Richard A. Cowell	Director
  * Slade Gorton	Director
  * Walter J. Lack Marc Onetto	Director
  /s/ Robert A. Ratliffe Robert A. Ratliffe Richard F. Rutkowski	Director
  * /s/ Dennis J. Reimer Dennis J. Reimer	Director

  *By: /s/ Jeff Wilson
  Jeff Wilson
  Attorney-in Fact

  
  
  
  

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  EXHIBIT INDEX

  The following documents are filed herewith or have been included as exhibits to previous filings with the Securities and Exchange Commission and are incorporated by reference as indicated below.

  3.1	Certificate of Incorporation of Microvision, Inc.,(2)
  3.2		Bylaws of Microvision, Inc. (2)
  3.3		Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock of Microvision, Inc.(24)(14)
  4.1		Form of Specimen Stock Certificate for Common StockStock.(2)
  4.2		Microvision, Inc. Series 2 Stock Purchase Warrant, dated April 1, 1999 issued to Capital Ventures International(5)
  4.3		Common Stock Purchase Warrant, dated asForm of April 1, 1999, issued to Josephthal & Co, Inc.Indenture.(6)
  4.4		Form of Indenture(14)
  4.5		Form of Warrant issued on October 9, 2001(15)
  4.64.3		Form of Warrant issued on July 22, 20022002.(19)(10)
  4.74.4		Form of Warrant issued on March 5, 20032003.(18)(9)
  4.84.5		Registration Rights Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (14)
  4.6		Warrant No. 76 to Purchase Common Stock of Microvision, Inc. issued September 10, 2004 to Satellite Strategic Finance Associates, LLC. (24)(14)
  4.9		Form of Note issued under the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.(25)
  4.104.7		Form of Warrant issued under the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(15)
  4.114.8		Company Registration Rights Agreement executed in connection with the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(15)
  4.124.9		Lumera Registration Rights Agreement executed in connection with the Securities Purchase Agreement datedForm of Amended and Restated Note issued as of March 11, 2005 under the Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(18)
  4.134.10		Form of Pledge and Security Agreement executed in connection withWarrant issued as of July 25, 2005 under the Securities PurchaseMaster Amendment Agreement dated as of March 11,July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(18)
  4.11		Registration Rights Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd.. (20)
  4.12		Warrant No. 86 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Partners, Ltd. (20)
  4.13		Warrant No. 87 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Associates, LLC. (20)
  4.14		Warrant No. 88 to Purchase Common Stock of Microvision, Inc. issued August 31, 2005 to Omicron Master Trust (21)
  4.15		Form of Note issued as of December 1, 2005 under the Securities and Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.(22)
  4.16		Form of Warrant issued under the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  4.17		Form of Amended and Restated Pledge and Security Agreement executed in connection with the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  10.1		Assignment of License and Other Rights between The University of Washington and the Washington Technology Center and the H. Group, dated July 25, 19931993.(1)
  10.2		Project II Research Agreement between The University of Washington and the Washington Technology Center and Microvision, Inc., dated October 28, 19931993.(1)+
  10.3		Exclusive License Agreement between The University of Washington and Microvision, Inc., dated October 28, 19931993.(1)+
  10.4		Exclusive License Agreement between the University of Washington and Microvision, Inc. dated March 3, 19941994.(18)(9)
  10.5		1993 Stock Option PlanPlan.(1)*
  10.6		1996 Stock Option Plan, as amended.(17)(8)*
  10.7		1996 Independent Director Stock Option Plan, as amended.(17)(8)*
  10.8		Form of Executive Option Exercise Loan PlanPlan.(3)*
  10.9		Lease Agreement between S/I Northcreek II, LLC and Microvision, Inc., dated October 27, 19981998.(23)(13)
  10.9.1		Lease Amendment No 1 to Lease between S/I Northcreek II, LLC and Microvision, Inc., dated July 12, 19991999.(9)(5)
  10.9.2		Lease Amendment No 122 to Lease between S/I Northcreek II, LLC and Microvision, Inc., dated February 14, 20012000.(9)(5)
  10.10		Form of Consulting Agreement between Microvision, Inc. and Avram Miller and Jacqueline Brandwynne dated August 10, 20002000.(8)(4)
  10.11		Form of Common Stock Purchase Warrant issued to Avram Miller and Jacqueline Brandwynne dated August 10, 20002000.(8)(4)
  10.12		Exclusive Licensing Agreement between the University of Washington and Lumera Corporation dated October 20, 2000(11). +
  10.13		Sponsored Research Agreement between the University of Washington and Lumera Corporation dated October 20, 2000(11).
  10.14		Independent Director Stock Option Plan, as amended(16)*
  10.15		Investors' Rights Agreement, dated as of March 14, 2001 by and between Lumera Corporation and certain investors(12)
  10.16		Executive Loan Plan and Related Form of NoteNote.(16)(7)*
  10.17		Microvision, Inc. Series 1 Stock Purchase Warrant, dated April 1, 1999, issued to Capital Ventures International (18)
  10.1810.13		Form of Stock Purchase Agreement dated March 22, 20022002.(20)(11)
  10.1910.14		Form of Stock Purchase Agreement dated July 22, 20022002.(19)(10)
  10.2010.15		Form of Securities Purchase Agreement dated as of March 3, 20032003.(18)(9)
  10.2110.16		Form of the Option Agreement for options granted outside of the PlansPlans.(21)(12)
  10.22		Common Stock Purchase Warrant, dated as of January 14, 1999, issued to Stan Berk(22)
  10.23		Common Stock Purchase Warrant, dated as of July 13, 1999, issued to Stan Berk(22)
  10.24		Common Stock Purchase Warrant, dated as of April 13, 2000, issued to Burt S. Davis(22)
  10.25		Common Stock Purchase Warrant, dated as of June 21, 2000, issued to Stan Berk(22)
  10.26		Common Stock Purchase Warrant, dated as of October 15, 2001, issued to Ladenburg Thalmann & Co. Inc. (22)
  10.27		Registration Rights Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (24)
  10.2810.17		Securities Purchase Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (24)(14)
  10.2910.18		License and Development Agreement dated as of December 30, 2004 by and between Microvision, Inc. and Ethicon Endo-Surgery, Inc.(16)+
  10.3010.19		Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (25)(15)
  10.20		Employment Agreement between Microvision, Inc. and Alexander Y. Tokman dated July 18, 2005.(17)
  10.21		Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (18)
  10.22		Lease Agreement between Carramerica Reality Operating Partnership, L.P. and Microvision, Inc., dated July 15, 2005.(19)
  10.23		Securities Purchase Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd. (20)
  10.24		Conversion and Modification Agreement dated as of August 8, 2005 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC. (20)
  10.25		Securities Purchase Agreement dated as of August 31, 2005 by and between Microvision, Inc. and Omicron Master Trust. (21)
  10.26		Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto. (22)
  23		Consent of Independent Registered Public Accounting FirmFirm.
  24		Power of Attorney pursuant to which this report may be filed.
  31.1		Chief Executive Officer certification pursuant to Rule 13a-14(a)13a- 14(a)/15d-14a15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2		ChiefPrincipal Financial Officer certification pursuant to Rule 13a-14(a)13a- 14(a)/15d-14a15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1		Chief Executive Officer certification pursuant to Rule 13a-14(b) or Rule 13d-14(b)15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
  32.2		ChiefPrincipal Financial Officer certification pursuant to Rule 13a-14(b)13a- 14(b) or Rule 15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

  _______________

  __________

  (1) Incorporated by reference to the Company's Form SB-2 Registration Statement, Registration No. 333-05276-LA.

  (2) Incorporated by reference to the Company's Post-Effective Amendment to Form S-3 Registration Statement, Registration No. 333-102244.

  (3) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended

  June 30, 1998.1998, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (4) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended September 30, 2000, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.

  (5) Incorporated by reference to1999, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Annual Report on Form 10-K for the year ended

  December 31, 1998.Commission File Number, 0-21221.

  (6) Incorporated by reference to the Registration Statement on Form S-3, Registration No. 333-33612.333-69652.

  (7) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30,

  2000.

  (8) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended September

  30, 2000.

  (9) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999.

  (10) Incorporated by reference to Registration Statement on Form S-3, Registration No. 333-33612.

  (11) Incorporated by reference to2001, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Annual Report on Form 10-K for the year endedCommission File Number, 0-21221.

  December 31, 2000.

  (12) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended March 31,

  2001.

  (13)(8) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2001.2002.

  (9) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 5, 2003.

  (10) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 23, 2002.

  (11) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 26, 2002.

  (12) Incorporated by reference to the Company's Schedule TO file on November 1, 2002.

  (13) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended September 30, 1998, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

  (14) Incorporated by reference to the Registration StatementCompany's Current Report on Form S-3, Registration No. 333-69652.8-K filed on September 10, 2004.

  (15) Incorporated by reference to the Company's Current Report on Form 8-K filed on October 9, 2001.March 14, 2005.

  (16) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001.2004.

  (17) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 7, 2005.

  (18) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 29, 2005.

  (19) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2002.

  (18) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 5, 2003.

  (19) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 23, 2002.2005.

  (20) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 26, 2002.August 10, 2005.

  (21) Incorporated by reference to the Company's Schedule TO file on November 1, 2002.

  (22) Incorporated by reference to the Company's Annual Report on Form 10K for the year ended December 31, 2002.

  (23) Incorporated by reference to the Company's Form 10-QSB for the quarterly period ended September 30, 1998.

  (24) Incorporated by reference to the Company's Current Report on Form 8-K filed on September 10, 2004.2, 2005.

  (25)(22) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 14,December 1, 2005.

  (23) Incorporated by reference to the Company's Current Report on Form 8-K\A filed on December 2, 2005.

  + Subject to confidential treatment.

  * Management contracts and compensatory plans and arrangements required to be filed as exhibits pursuant to Item 15(c)15(b) of this Report.

  
  
  
  

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