Shareholders' Equity
                                                           Mandatorily     -----------------------------------------------------------------------------------------------------------------------
                                                           redeemable
                                                          convertible                                                       Subscriptions  Receivables   Accumulated
                                                         preferred stock       Common Stock      Additional                  receivable       from          other
                                                       ------------------- -------------------     paid-in      Deferred    from related     related    comprehensive  Accumulated   Shareholders'
                                                        Shares   Par Value  Shares   Par Value     capital     Compensation    parties       parties    (loss) income    defecit        Equity
                                                       --------  --------- --------  ---------  -------------  -----------  -------------  -----------  -------------  ------------  -------------
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  $   4,166   25,138  $      25  $     212,993  $       (85) $          --  $      (792) $          --  $   (215,650) $      (3,509)
                                                       ========  ========= ========  =========  =============  ===========  =============  ===========  =============  ============  =============

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

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

See accompanying notes to consolidated financial statements.

Microvision, Inc.

Consolidated Statement of Cash Flows
(in thousands)

                                                                                              Years Ended December 31,
                                                                                         -------------------------------
                                                                                           2005       2004       2003
                                                                                         ---------  ---------  ---------
Cash flows from operating activities                                                                                    
  Net loss                                                                              $ (28,183) $ (33,197) $ (26,163)
  Adjustments to reconcile net loss to net cash used in operations
    Depreciation                                                                            1,602      2,406      3,113
    Loss (gain) on disposal of fixed assets                                                    --          1        (36)
    Non-cash expenses related to issuance of stock, warrants, and options,
     and amortization of deferred compensation                                                429      2,118      2,156
    Non-cash interest expense, net                                                          2,730         --         --
    Derivative features of notes payable                                                   (2,659)
    Inventory write-downs                                                                   3,732      2,084        500
    Allowance for receivables from related parties                                          1,031         --        200
    Realized gain on sale of investment securities                                             --         --        (39)
    Minority interests in loss of consolidated subsidiary                                      --     (2,438)    (7,125)
    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)
    Interest on notes payable                                                                  --        125         --
    Allowance for estimated contract losses                                                   (53)        53         --
  Change in
    Accounts receivable                                                                     3,847     (3,420)      (581)
    Intercompany receivable                                                                    --         38         --
    Costs and estimated earnings in excess of billings on uncompleted contracts              (607)        35        409
    Inventory                                                                              (1,324)    (4,920)       (84)
    Other current assets                                                                       61       (427)       (93)
    Other assets                                                                              340         87         40
    Accounts payable                                                                       (1,050)     2,631        (68)
    Accrued liabilities                                                                      (190)       865        705
    Billings in excess of costs and estimated earnings on uncompleted contracts            (3,267)     3,265       (177)
    Notes payable                                                                              --         --
    Research liability, current and long-term                                                  --     (1,762)       923
                                                                                         ---------  ---------  ---------
      Net cash used in operating activities                                               (19,727)   (30,831)   (26,405)
                                                                                         ---------  ---------  ---------
Cash flows from investing activities                                                                                    
  Sales of investment securities                                                            1,248     12,053      3,249
  Purchases of investment securities                                                       (1,248)    (1,000)    (9,080)
  Sales of restricted investment securities                                                 1,238      1,269      1,356
  Purchases of restricted investment securities                                            (2,101)    (1,238)    (1,269)
  Increase in restricted cash                                                                (755)        --
  Collections of receivables from related parties                                              --         --         20
  Sale of long term investment - Lumera                                                     3,893         --         --
  Purchases of property and equipment                                                      (1,239)    (1,040)    (1,549)
                                                                                         ---------  ---------  ---------
      Net cash provided by used in investing activities                                     1,036     10,044     (7,273)
                                                                                         ---------  ---------  ---------
Cash flows from financing activities                                                                                    
  Principal payments under capital leases                                                     (46)       (63)       (90)
  Proceeds from issuance of short term notes                                                   --      2,300         --
  Principal payments under long-term debt                                                     (77)       (70)       (63)
  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)        --
  Net proceeds from inssuance of common stock                                               9,939        360         --
  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
                                                                                         ---------  ---------  ---------
Net increase (decrease) in cash and cash equivalents                                        5,592     (7,982)       828
Cash and cash equivalents at beginning of period                                            1,268     10,700      9,872
Change in cash due to Lumera deconsolidation                                                   --     (1,450)        --
                                                                                         ---------  ---------  ---------
Cash and cash equivalents at end of period                                              $   6,860  $   1,268     10,700
                                                                                         =========  =========  =========
                                                                                                                        
Supplemental disclosure of cash flow information                                                                        
Cash paid for interest                                                                  $     348  $     151  $      51
                                                                                         =========  =========  =========
                                                                                                                        
Supplemental schedule of non-cash investing and financing activities                                                    
Property and equipment acquired under capital leases                                    $     135  $      15  $       8
                                                                                         =========  =========  =========
Other non-cash additions to property and equipment                                      $     812  $      18  $      66
                                                                                         =========  =========  =========
Conversion of preferred stock into common stock                                         $   4,117  $      --  $      --
                                                                                         =========  =========  =========
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
                                                                                         =========  =========  =========

The accompanying notes are an integral part of these 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 and was consolidated into Microvision. In July 2004, Lumera completed an initial public offering of its common 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-linear electro-optical chromophore materials. Lumera is working to commercialize the devices for potential wireless networking and optical networking applications.

The accompanying consolidated financial statements have been prepared assuming that the 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 before July 2006 through the sale of 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.

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

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.

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.

The Company considers all investments that mature within 90 days of the date of purchase to be cash equivalents. At December 31, 2005, all short-term investment securities held by the Company were classified as cash equivalents.

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.

As of December 31, 2005, restricted cash and investments includes:

• $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 in Bothell, WA. The balance is required to be maintained for the remaining term of the lease, which expires in April 2006.
• $1.0 million, 1,750,000 shares of Lumera common stock pledged as collateral for the Company's Notes.

Property and equipment is stated at cost and depreciated over the estimated useful lives of the assets (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 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. Provisions are made for warranties at the time revenue is recorded. Warranty expense was not material for any periods presented.

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 35%, 42%, and 49% of total revenue during 2005, 2004 and 2003, respectively. Contracts with three commercial customers represented 38%, 25%, and 35% of total revenues during 2005, 2004, and 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 41% and 21% of the accounts receivable balance at December 31, 2005 and 2004, respectively. In 2005, 61% of consolidated revenue was earned from development contracts with two customers. In 2004, 11% of consolidated revenue was earned from a development contract with one customer.

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.

Basic net loss per share is calculated on the basis of the weighted- 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 and 2003 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, and 6,295,000, at December 31, 2005, 2004 and 2003, respectively.

Research and development costs are expensed as incurred.

The Company's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and long-term debt.  The carrying amount of long-term debt at December 31, 2005 and 2004 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.

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.

The Company and Lumera each have stock-based employee compensation plans, which are more fully described in Note 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, and $271,000 for the years ended December 31, 2005, 2004 and 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
                                                                     ---------  ---------  ---------
Net loss available for common shareholders, as reported             $ (30,284) $ (33,543) $ (26,163)
Add: Stock-based employee compensation expense included in net loss
 available for common shareholders, as reported                            94        339        266
Deduct: Total stock-based employee compensation expense determined
 under fair value based method for all awards                          (1,931)    (5,886)    (8,915)
                                                                     ---------  ---------  ---------
Net loss available for common shareholders, pro forma               $ (32,121) $ (39,090) $ (34,812)
                                                                     =========  =========  =========
Net loss per share As reported                                      $   (1.35) $   (1.56) $   (1.46)
                                                                     =========  =========  =========
  Basic and diluted pro forma                                       $   (1.43) $   (1.82) $   (1.94)
                                                                     =========  =========  =========

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 its financial statements.

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, 2005 and 2004. The following table summarizes when the Company will be contractually able to bill the balance as of December 31, 2005 and 2004.

                                                                        Year Ended December 31,
                                                                      --------------------------
                                                                          2005          2004
                                                                      ------------  ------------
Billable within 30 days                                              $    686,000  $    577,000
Billable between 31 and 90 days                                             3,000         2,000
Billable after 90 days                                                    515,000        18,000
                                                                      ------------  ------------
                                                                     $  1,204,000  $    597,000
                                                                      ============  ============

"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, 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.

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.

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

                                                                      December 31,  December 31,
                                                                          2005          2004
                                                                      ------------  ------------
Costs and estimated earnings incurred on uncompleted contracts       $ 17,325,000  $  6,410,000
Billings on uncompleted contracts                                     (16,172,000)   (9,131,000)
                                                                      ------------  ------------
                                                                     $  1,153,000  $ (2,721,000)
                                                                      ============  ============
Included in accompanying balance sheets under the following captions:                           

Costs and estimated earnings in excess of billings on uncompleted
 contracts                                                           $  1,204,000  $    597,000
Billings in excess of costs and estimated earnings on uncompleted
 contracts                                                                (51,000)   (3,318,000)
                                                                      ------------  ------------
                                                                     $  1,153,000  $ (2,721,000)
                                                                      ============  ============

Inventory consists of the following:

                                                       December 31, December 31,
                                                          2005          2004
                                                       -----------  ------------
Raw materials                                         $   267,000  $  1,607,000
Work in process                                           141,000        77,000
Finished goods                                            351,000     1,483,000
                                                       -----------  ------------
                                                      $   759,000  $  3,167,000
                                                       ===========  ============

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.

Accrued liabilities consist of the following:

                                                               December 31,
                                                       -------------------------
                                                          2005          2004
                                                       -----------  ------------
Bonuses                                               $ 1,000,000  $  1,600,000
Payroll and payroll taxes                                 732,000       763,000
Compensated absences                                      497,000       475,000
Taxes other than income taxes                              12,000        43,000
Facility closing cost                                          --       253,000
Professional Fees                                         558,000       371,000
Relocation                                                166,000        90,000
Consultants                                               525,000
Other                                                   1,023,000       943,000
                                                       -----------  ------------
                                                      $ 4,513,000  $  4,538,000
                                                       ===========  ============

Property and equipment consists of the following:

                                                               December 31,
                                                       ---------------------------
                                                           2005           2004
                                                       -------------  ------------
Lab and production equipment                          $   2,126,000  $  4,455,000
Leasehold improvements                                    3,990,000     2,165,000
Computer hardware and software                            6,495,000     3,873,000
Office furniture and equipment                            1,124,000     1,057,000
                                                       -------------  ------------
                                                         13,735,000    11,550,000
Less: Accumulated depreciation                          (10,833,000)   (9,232,000)
                                                       -------------  ------------
                                                      $   2,902,000  $  2,318,000
                                                       =============  ============

Depreciation expense was $1,602,000, $2,406,000 and $3,113,000 in 2005, 2004 and 2003 respectively.

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, 2005 and 2004, a total of $2,723,000 and $2,723,000, respectively, was outstanding under the lines of credit.

In 2005, the Company determined that certain of its senior officers may have insufficient net worth and short-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 $1,931,000 and $900,000 at December 31, 2005 and 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 December 31, 2005 and 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 2005, 2004 and 2003, respectively, for interest forgiven.

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 University 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 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. 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. The fair values of the options were estimated at the grant date and December 31, 2003, using the Black 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, 2005, Microvision owned 4,622,000 shares or 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, 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 $14,138,000 during the third quarter as a result of the change to the equity method. The net change in interest gain for 2004 was $13,727,000. 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.

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, 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, 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                    $   5,766
                                                              =========

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.

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)
                                                              =========  =========  ==========  ==========  ===============

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.

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.

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 362,000 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 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 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 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

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 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 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 Scholes option-pricing model with the following weighted-average assumptions: expected volatilities of 83%, risk- free interest rates of 2.7% and dividend yields of zero percent. The contractual 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 were estimated at $5,476,000.

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, and $595,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The fair values of the warrants were estimated at June 7, 2003 and December 31, 2002 using the Black Scholes option-pricing model with the following weighted- 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.

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

                                           Warrants to   Weighted-
                                             purchase     average
                                              common     excercise
                                              Shares       price
                                           ------------  ---------
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, 2005             4,120,000  $    6.99
                                           ============

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

                                                                          Year Ended December 31,
                                                             -------------------------------------
                                                                2005         2004         2003
                                                             -----------  -----------  -----------
Exercise price greater than fair value                      $      2.74  $      4.07  $      1.69
Exercise 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, 2005:

                                      Warrants outstanding and exercisable
                                     ---------------------------------
                                       Number     Weighted
                                     outstanding   average   Weighted
                                         at       remaining   average
                                     December 31, contractualexcercise
Range of exercise prices                2005        life       price
- -----------------------------------  -----------  ---------  ---------
                                                (years)                                    
$3.94                                 1,090,000       4.92  $    3.94
$4.80-$5.32                             241,000       1.64       4.81
$6.10-$6.29                           1,513,000       3.47       6.25
$6.40-$6.56                           1,006,000       2.65       6.47
$7.50-$12.00                             70,000       1.70       8.14
$34.00                                  200,000       4.61      34.00
                                     -----------
$3.94-$34.00                          4,120,000
                                     ===========

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

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 was 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, 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 closing price of the Company's common stock as reported on the NASDAQ National Market on 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, 2005:

                                                         Weighted-
                                                          average
                                                         excercise
                                              Shares       price
                                           ------------  ---------
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, 2005             4,515,000  $   11.90
                                           ============

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

                                                                    Year Ended December 31,
                                                             -------------------------------------
                                                                2005         2004         2003
                                                             -----------  -----------  -----------
Exercise price greater than fair value                      $        --  $      3.19  $      3.19
Exercise price equal to fair value                                 3.21         3.33         4.26
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, 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                2005        life       price       2005        price
- -----------------------------------  -----------  ---------  ---------  -----------  ---------
                                                (years)                                    
$3.25-$5.32                             558,000       9.05  $    5.09      133,000  $    4.89
$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    1,574,000       7.00
$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      874,000      15.00
$15.63-60.75                            631,000       4.72      27.99      631,000      27.99
                                     -----------                        -----------
$3.25-$60.75                          5,320,000                          4,515,000
                                     ===========                        ===========

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 and 2003, respectively: dividend yield of zero percent for all years; expected volatility of 70%, 76% and 83%; risk free interest rates of 4.0%, 3.0%, and 2.2%; and expected lives of 5, 3 and 3 years. Actual forfeitures of 7.2%, 6.8% and 25.4% were used for the years ended December 31, 2005, 2004, and 2003 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%.

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.

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 Company entered into a 90 month facility lease that commenced in February 2006. The lease includes extension and rent escalation provisions over the 90 month term of the lease. Rent expense will be recognized on a 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
                                                  -------------  -------------
2006                                             $      41,000  $     741,000
2007                                                    39,000        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                           160,000  $   6,529,000
                                                                 =============
Less: Amount representing interest                     (23,000)
                                                  -------------
Present value of capital lease obligations             137,000
Less: Current portion                                  (32,000)
                                                  -------------
Long-term obligation at December 31, 2005        $     105,000
                                                  =============

Operating lease commitments amounts do not include the impact of contractual sublease receipts of $79,000 for the year ended December 31, 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.

Net rent expense was $1,435,000, $1,689,000, and $2,302,000 for 2005, 2004 and 2003, 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 2003 respectively was included as a reduction in rent expense.

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 $22,000 and $99,000 at December 31, 2005 and 2004 respectively.

A provision for income taxes has not been recorded for 2005, 2004 or 2003 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 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, 2005, Microvision has net operating loss carry forwards of approximately $191 million, for federal income tax reporting purposes. In addition, Microvision has research and development tax credits of $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 2025 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
                                                  -------------  -------------
Net operating loss carry forwards Microvision    $  65,006,000  $  57,112,000
R&D credit carry forwards Microvision                2,559,000      2,218,000
Other                                                3,463,000      4,642,000
                                                  -------------  -------------
                                                    71,028,000     63,972,000
Less: Valuation allowance                          (71,028,000)   (63,972,000)
                                                  -------------  -------------
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.

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 and 2003, the Company contributed $321,000, $337,000 and $392,000 respectively, to the Plan under the matching program.

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 separate 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 was 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 was 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, Current 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

The following table presents the Company's unaudited quarterly financial information for the years ending December 31, 2005 and 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                                  (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)

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 cost method.

In January 2006 the Chief Executive Officer's employment was terminated and the Chief Financial Officer resigned. The Company appointed Alexander Y. Tokman to Chief Executive Officer in 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, 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

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, 2005 and 2004.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. The Chief Executive Officer and the Principal Financial Officer evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 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 management as appropriate to allow timely decisions regarding required 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 in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2005.

Our management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 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. There have not been any changes in the Company's internal control over financial reporting during the quarter ended December 31, 2005 which have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

None

The information under the headings "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 15, 2006(the "Proxy Statement") is incorporated herein by reference. See Item 4A in Part I of this report for information regarding executive officers of the Company.

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

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, 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                 4,982,000  $              10.79                  3,131,000
Equity compensation plans not approved by shareholders               615,000                 20.53                         --
                                                         --------------------                        -------------------------
    Total                                                          5,597,000  $              11.86                  3,131,000
                                                         ====================                        =========================

As of December 31, 2005, there were non-plan options to purchase a total of 338,000 shares of Microvision common stock outstanding. 329,000 of these were options approved by the Board of Directors and issued in October 2001, with exercise prices 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 vested 25% on the grant date and 25% at six-month intervals thereafter. The remaining 9,000 non-plan options were granted at fair values on the dates of grant and vest 25% at each annual anniversary date of the 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, 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-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 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."

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

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

(a) Documents filed as part of the report

2. None

(b) Exhibits