FY2005 10KA DOC

The following table sets forth the compensation awarded or paid to or earned by the person who served as Chief Executive Officer during 2005 and the next four most highly compensated persons who served as executive officers during 2005 (the "Named Executive Officers"):

(1) All Other Compensation amounts for 2005 include contributions of $1,500, $6,169, $6,300, $6,300 and $6,008 to the accounts of Messrs. Rutkowski, Willey, Raisig, Veeraraghavan and McIntyre, respectively, under the Company's qualified 401(k) Retirement Plan. The amounts also include forgiveness of $95,632, $22,181, and $37,749 of interest for Messrs. Rutkowski, Willey, Raisig, respectively, under one or both of the Company's Executive Option Exercise Note Plan and Executive Loan Plan. For a description of the two plans, see "Executive Loan Plans" below. No Options, Restricted Stock Awards or Long-Term Incentive Plan payments were made as of December 31, 2005.

(2) Bonus amounts for 2005 include Patent Incentive Program bonuses of $387 and $88 for Messrs. Willey and Veeraraghavan respectively.

(3) Richard F. Rutkowski, Richard A. Raisig and Vilakkudi Veeraraghavan are no longer employed by the Company.

The Company did not grant any options to acquire common stock to its named executive officers during 2005.

The following table provides information regarding the aggregate number of options exercised during the fiscal year ended December 31, 2005, by each of the Named Executive Officers and the number of shares subject to both exercisable and unexercisable stock options as of December 31, 2005.

(1) The value of unexercised in-the-money options is based on the difference between $3.60 (the fair market value of the Company's common stock as reflected by the closing price of the common stock on the Nasdaq National Market as of December 31, 2005) and the exercise price of such options multiplied by the number of shares issuable upon exercise thereof. As of December 31, 2005, the exercise price of all options held by named executive officers was greater than $3.60.

The Company previously adopted two loan plans under which Richard F. Rutkowski, Stephen Willey, and Richard Raisig were able to borrow funds from the Company. At the end of each year, the Company will forgive the interest that accrued under the loans if the executive remains employed by the Company. In 2005, the Company forgave $95,632, $22,181, and $37,749 of interest for Messrs. Rutkowski, Willey, and Raisig, respectively. No additional loans have been made under either the Executive Option Exercise Loan Plan or the Executive Loan Plan since July 2002, and the Company does not intend to make any additional loans under these plans. The Company also has no plans to forgive the principal balance outstanding of the lines of credit. On February 16, 2005, Stephen Willey transferred 28,844 shares of the Company's common stock in full repayment of an existing loan and accrued interest thereon, which had become due on December 31, 2004. For additional details regarding loan balances and terms, see Item 13.

As a result of Section 162(m) of the Internal Revenue Code of 1986, as amended, in the event that compensation paid by the Company to the Named Executive Officers in a year were to exceed an aggregate of $1,000,000, the Company's deduction for such compensation could be limited to $1,000,000.

Pursuant to the Independent Director Stock Option Plan (the "Director Plan"), each Independent Director is granted a nonstatutory option to purchase 15,000 shares of common stock on the date on which he or she is first elected or appointed to the Board of Directors. These options are fully vested and immediately exercisable upon the date of grant. Each Independent Director also receives, upon his or her initial appointment or election and upon each subsequent reelection to the Board of Directors, an option to purchase 15,000 shares that will vest in full on the earlier of (i) the day prior to the date of the Company's annual meeting of shareholders next following the date of grant, or (ii) one year from the date of grant, provided the Independent Director continues to serve as a director on the vesting date. If an Independent Director ceases to be a director for any reason other than death or disability before his or her term expires, then any outstanding unvested options issued under the Director Plan to such Independent Director will be forfeited. Options vested as of the date of termination for any reason other than death or disability are exercisable through the date of expiration. The exercise price for each option is equal to the closing price of the Company's common stock as reported on the Nasdaq National Market on the date of grant. The options generally expire on the tenth anniversary of the date of grant.

In addition, each Independent Director receives the following cash compensation for his or her service as a director:

All directors are reimbursed for reasonable travel and other out-of-pocket expenses incurred in attending meetings of the Board of Directors.

The Compensation Committee is composed entirely of the following Independent Directors: Slade Gorton, Richard Cowell and Mark Onetto. Dennis Reimer, who resigned from the Board of Directors on April 10, 2006, also served on the Compensation Committee during 2005.

The following table shows as of April 11, 2006, the number of shares of common stock held by all persons we know to beneficially own at least 5% of the Company's common stock, the Company's directors, the Named Executive Officers, and all directors and executive officers as a group.

(1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission (the "SEC") and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants that are currently exercisable or convertible or may be exercised or converted within sixty days are deemed to be outstanding and to be beneficially owned by the person holding these options or warrants for the purpose of computing the number of shares beneficially owned and the percentage of ownership of the person holding these securities, but are not outstanding for the purpose of computing the percentage ownership of any other person or entity. Subject to community property laws where applicable, the Company believes that each shareholder named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned thereby.

(2) Percentage of common stock is based on 25,243,026 shares of common stock outstanding as of April 11, 2006.

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.

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 Company has an existing executive loan plan under which Richard F. Rutkowski, Stephen R. Willey, and Richard A. Raisig have borrowed funds from the Company. No loans have been made under this executive loan plan since July 2002, and the Company does not intend to make any additional loans under this plan. The following table lists certain information describing each executive's loans as of December 31, 2005.

Under the Loan Plan, the advances must be repaid within one year of the executive's termination of employment or within 30 days of termination of the Loan Plan by the Board of Directors unless the executive elects to convert the outstanding balance to a one-year term note. Mr. Rutkowski and Raisig's employment terminated in January 2006.

The Company was billed the following fees for audit and other services from PricewaterhouseCoopers LLP, our independent registered accounting firm.

The aggregate fees for professional services rendered by PricewaterhouseCoopers LLP for the audit of the Company's annual financial statements and the reviews of the financial statements included in the Company's Quarterly Reports on Form 10-Q were $686,445 for the year ended December 31, 2005 and were $501,702 for the year ended December 31, 2004.

Fees for tax services, including tax compliance, tax advice, and tax planning, totaled $17,558 in 2005 and $15,700 in 2004.

Fees for all other services not described above totaled $200 in 2005 for tuition for a training conference provided by PricewaterhouseCoopers LLP and $0 in 2004.

The Company's Audit Committee has considered whether the provision of services under the heading "All Other Fees" is compatible with maintaining the accountants' independence and has determined that it is consistent with such independence.

The Board of Directors has selected PricewaterhouseCoopers LLP to serve as the Company's independent accountants for fiscal year 2006. Representatives of PricewaterhouseCoopers LLP are expected to be present at the Annual Meeting and will have an opportunity to make a statement and to respond to appropriate questions.

The Audit Committee pre-approves all audit services and all permitted non-audit services by the independent auditors. The Audit Committee has delegated the authority to take such action between meetings to the Audit Committee chairman, who reports the decisions made to the full Audit Committee at its next scheduled meeting.

The Audit Committee evaluates whether the Company's use of the independent auditors for permitted non-audit services is compatible with maintaining the independence of the independent auditors. The Audit Committee's policies prohibit the Company from engaging the independent auditors to provide any services relating to bookkeeping or other services related to accounting records or financial statements, financial information systems design and implementation, appraisal or valuation services, fairness opinions or contribution-in-kind reports, actuarial services, or internal audit outsourcing services unless it is reasonable to conclude that the results of these services will not be subject to audit procedures. The Audit Committee's policies completely prohibit the Company from engaging the independent auditors to provide any services relating to any management function, expert services not related to the audit, legal services, broker-dealer, investment adviser, or investment banking services or human resource consulting.

_______________

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

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

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

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

(5) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1999, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

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

(7) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, available at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 under the Company's Commission File Number, 0-21221.

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

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

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

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

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

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

(14) Incorporated by reference to the Company's Current Report on Form 8-K filed on September 10, 2004.

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

(16) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2004.

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

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

(19) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended June 30, 2005.

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

(21) Incorporated by reference to the Company's Current Report on Form 8-K filed on September 2, 2005.

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

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

+ Subject to confidential treatment.

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

LUMERA CORPORATION

INDEX TO FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm

Financial Statements

Balance Sheets

Statements of Operations

Statements of Changes in Mandatorily Redeemable Convertible Preferred Stock and Shareholder's Equity (Deficit)

Statements of Comprehensive Loss

Statements of Cash Flows

Notes to Financial Statements

Supplemental Schedule

Schedule II - Valuation and Qualifying Accounts and Reserves

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To Board of Directors

and Shareholders of

Lumera Corporation:

In our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Lumera Corporation at December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Prior to July 28, 2004, the Company was a subsidiary of Microvision, Inc. As discussed in Note 3, the Company had extensive transactions and relationships with that entity for each of the three years ended December 31, 2005

/s/ PRICEWATERHOUSECOOPERS LLP

Seattle, Washington

March 16, 2006

LUMERA CORPORATION

BALANCE SHEETS

	December 31,			December 31,
	2005			2004

*Assets*
Current Assets
Cash and cash equivalents	$	4,885,000		$	3,505,000
Investment securities, available-for-sale, current		16,871,000			15,460,000
Accounts receivable		—			32,000
Costs and estimated earnings in excess of billings on
uncompleted contracts		77,000			3,000
Other current assets		551,000			623,000
Total current assets		22,384,000			19,623,000

Investment securities, available-for-sale, long-term		—			11,216,000
Property and equipment, net		1,276,000			2,047,000
Other assets		46,000			—
TOTAL ASSETS	$	23,706,000		$	32,886,000

*LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)*

CURRENT LIABILITES
Accounts payable	$	493,000		$	416,000
Current portion of research liability		—			101,000
Accrued liabilities		1,059,000			976,000
Total current liabilities		1,552,000			1,493,000

Total liabilities		1,552,000			1,493,000

COMMITMENTS AND CONTINGENCIES (Note 10)		—			—

SHAREHOLDERS' EQUITY (DEFICIT)
Common stock, $0.001 par value, 120,000,000 shares authorized; 16,748,116 shares issued and outstanding at December 31, 2005, and 16,546,430 shares issued and outstanding at December 31, 2004		17,000			16,000
Additional Paid-in Capital		71,070,000			70,435,000
Deferred stock-based compensation		(215,000	)		(666,000	)
Accumulated other comprehensive gain (loss)		(18,000	)		(145,000	)
Accumulated deficit		(48,700,000	)		(38,247,000	)
Total shareholders' equity (deficit)		22,154,000			31,393,000
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)	$	23,706,000		$	32,886,000

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

LUMERA CORPORATION

STATEMENTS OF OPERATIONS

	Year ended December 31,
	2005			2004			2003


Revenue	$	1,509,000		$	989,000		$	1,725,000
Cost of revenue		922,000			651,000			1,014,000
GROSS PROFIT		587,000			338,000			711,000


Research and development expense		6,540,000			4,561,000			7,602,000
Marketing, general and administrative expense		5,155,000			4,588,000			1,270,000
Total operating expenses		11,695,000			9,149,000			8,872,000

Loss from operations		(11,108,000	)		(8,811,000	)		(8,161,000	)

Interest income		655,000			237,000			39,000
Interest expense					(349,000	)
Realized gain on sale of investment securities		-			-			39,000
Net loss		(10,453,000	)		(8,923,000	)		(8,083,000	)

Deemed dividend upon issuance of mandatorily redeemable convertible preferred stock		-			(500,000	)		-

NET LOSS AVAILABLE TO COMMON SHAREHOLDERS	$	(10,453,000	)	$	(9,423,000	)	$	(8,083,000	)

NET LOSS PER SHARE-BASIC AND DILUTED	$	(0.63	)	$	(0.89	)	$	(1.31	)

WEIGHTED-AVERAGE SHARES OUTSTANDING - BASIC AND DILUTED		16,607,653			10,613,606			6,172,400

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

LUMERA CORPORATION

STATEMENTS OF CHANGES IN MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS’ EQUITY (DEFICIT)

	Mandatorily Redeemable Convertible Preferred Stock						Common Stock				Paid-in Capital			Common Stock - A						Common Stock - B						Deferred Stock Compensation			Accumulated Other Comprehensive Income			Accumulated Deficit			Total Shareholders' Equity (Deficit)
Activity	Shares			$			Shares		$		$			Shares			$			Shares			$			$			$			$			$

Balance at December 31, 2002		2,400,000			24,603,000										802,414			3,325,000			5,370,000			105,000			(8,000	)		59,000			(21,241,000	)		(17,760,000	)

Issuance of mandatorily redeemable convertible preferred stock for cash, net of issuance costs of $67,000		1,335,000			2,603,000													—									—									—

Issuance of options for services																		36,000									(36,000	)								—

Amortization of deferred compensation																											13,000									13,000

Other comprehensive income																														(59,000	)					(59,000	)

Net Loss																																	(8,083,000	)		(8,083,000	)
Balance at December 31, 2003		3,735,000			27,206,000										802,414			3,361,000			5,370,000			105,000			(31,000	)		—			(29,324,000	)		(25,889,000	)

Issuance of mandatorily redeemable convertible preferred stock and related beneficial conversion feature		250,000																500,000																		500,000

Deemed dividend related to beneficial conversion feature					500,000													(500,000	)																	(500,000	)

Issuance of Common Stock, net of offering costs of $1,995,000								6,000,000	$	6,000	$	36,730,000																								36,736,000

Conversion of mandatorily redeemable convertible preferred stock and Common B to Common Stock		(3,985,000	)		(27,706,000	)		10,484,745		10,000		31,162,000			(802,414	)		(3,361,000	)		(5,370,000	)		(105,000	)											27,706,000

Deferred Compensation related to options issued												2,032,000															(2,032,000	)								—

Issuance of options for services												571,000																								571,000

Deemed dividend to Microvision related to options issued to Microvision employee												(272,000	)																							(272,000	)

Value of warrants issued in connction with convertible notes												301,000																								301,000

Reversal of deferred compensation expense for cancelled options												(112,000	)														112,000									0

Exercise of Warrants								38,935																												—

Exercises of options								22,750				23,000																								23,000

Amortization of deferred compensation																											1,285,000									1,285,000

Other comprehensive income																		—												(145,000	)					(145,000	)

Net Loss																																	(8,923,000	)		(8,923,000	)
Balance at December 31, 2004		0			0			16,546,430		16,000		70,435,000			—			—			—			—			(666,000	)		(145,000	)		(38,247,000	)		31,393,000

Issuance of options for services												236,000																								236,000

Reversal of deferred compensation expense for cancelled options												(37,000	)														37,000									0

Exercises of options								201,686		1,000		436,000																								437,000

Amortization of deferred compensation																											414,000									414,000

Other comprehensive income																		—												127,000						127,000

Net Loss																																	(10,453,000	)		(10,453,000	)
Balance at December 31, 2005		—		$	—			16,748,116	$	17,000	$	71,070,000			—		$	—			—		$	—		$	(215,000	)	$	(18,000	)	$	(48,700,000	)	$	22,154,000

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

LUMERA CORPORATION

STATEMENTS OF COMPREHENSIVE LOSS

	Year ended December 31,
	2005			2004			2003

Net loss	$	(10,453,000	)	$	(8,923,000	)	$	(8,083,000	)
Other comprehensive income (loss) -
Unrealized gain (loss) on investment
securities, available-for-sale:
Unrealized holding gains (losses)
arising during period		127,000			(145,000	)		(20,000	)
Less: Reclassification adjustment for
gains realized in net loss		—			—			(39,000	)
Net unrealized gain (loss)		127,000			(145,000	)		(59,000	)
Comprehensive loss	$	(10,326,000	)	$	(9,068,000	)	$	(8,142,000	)

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

LUMERA CORPORATION

STATEMENTS OF CASH FLOWS

	Year ended December 31,
	2005			2004			2003

Cash flows from operating activities
Net loss	$	(10,453,000	)	$	(8,923,000	)	$	(8,083,000	)
Adjustments to reconcile net loss to
net cash used in operations
Depreciation		1,297,000			1,198,000			1,185,000
Noncash expenses related to issuance of stock,
options and amortization of deferred compensation		469,000			1,985,000			1,041,000
Amortization on investments		254,000
Realized gain on sale of investment securities		—			—			(39,000	)
Interest on Notes Payable		—			301,000			(39,000	)
Change in
Accounts receivable		32,000			119,000			(68,000	)
Costs and estimated earnings in excess of billings
on uncompleted contracts		(74,000	)		163,000			(18,000	)
Other current assets		72,000			(568,000	)		57,000
Other assets		(46,000	)		100,000			100,000
Accounts payable		77,000			29,000			51,000
Payable to related party		—			(42,000	)		31,000
Accrued liabilities		264,000			142,000			136,000
Research liability		(101,000	)		(1,847,000	)		923,000
Net cash used in operating activities		(8,209,000	)		(7,343,000	)		(4,684,000	)

Cash flows from investing activities
Sales of investment securities		—			—			2,409,000
Purchases of investment securities		(16,122,000	)		(29,821,000	)		—
Maturities of investment securities		25,800,000			3,000,000
Purchases of property and equipment		(526,000	)		(378,000	)		(455,000	)
Net cash provided by (used in) investing activities		9,152,000			(27,199,000	)		1,954,000

Cash flows from financing activities:
Proceeds from issuance of convertible notes		—			2,300,000			—
Principal payments on convertible notes		—			(2,300,000	)		—
Net proceeds from issuance of common stock		—			36,964,000			—
Net proceeds from the exercise of stock options		437,000			23,000
redeemable convertible preferred stock		—			500,000			2,603,000
Net cash provided by financing activities		437,000			37,487,000			2,603,000

Net (decrease) increase in cash and cash equivalents		1,380,000			2,945,000			(127,000	)
Cash and cash equivalents at beginning of period		3,505,000			560,000			687,000

Cash and cash equivalents at end of period	$	4,885,000		$	3,505,000		$	560,000

Value assigned to warrants issued in connection with convertible note	$	—		$	301,000		$	—
Unrealized gain (loss) in investment securities, available-for-sale	$	127,000		$	(145,000	)	$	—
Accrued offering costs included in accounts payable	$	—		$	228,000		$	—
Accrued liability for non-cash stock compensation	$	84,000		$	266,000		$	—
Interest Paid	$	—		$	44,000		$	—
Deemed dividend upon issuance of options to Microvision Employee	$	—		$	272,000		$	—

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

LUMERA CORPORATION

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Lumera Corporation (the “Company” or “Lumera”) was incorporated in Washington State in early 2000 and reincorporated in Delaware in 2004, and was established to develop, manufacture and market devices using proprietary polymer materials. Until December 31, 2003, we were considered to be in the development stage. In early 2004, we commercialized the devices for potential wireless networking and optical networking applications and had largely completed financial planning, establishing sources of supply, acquiring plant and equipment and recruiting personnel. Therefore, we were considered to have exited the development stage in 2004. On July 28, 2004 when we completed its initial public offering (“IPO”) of 6.0 million shares of common stock at an offering price of $6.95 per share, raising proceeds of $38.7 million before expenses. We were a majority owned subsidiary of Microvision, Inc. (“Microvision”) until our IPO (see Note 3).

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. We have identified revenue recognition and accounting for research payments under the University of Washington agreements as areas where significant estimates and assumptions have been made in preparing the financial statements. We also evaluate the requirement for allowances for uncollectible receivables, and the valuation allowances for deferred income tax assets.

Cash and Cash Equivalents - We consider all highly liquid investment securities with remaining maturities, at the date of purchase, of three months or less to be cash equivalents. Management determines the appropriate classification of investment securities at the time of purchase and evaluates such designation as of each balance sheet date. We have classified its entire investment portfolio as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses included in shareholders equity (deficit) as a component of other comprehensive income (loss), unless the loss is deemed to be other-than-temporary, in which case it is recognized immediately as an expense. We estimate the fair value of our investment securities using readily available market information. Dividend and interest income are recognized when earned. Realized gains and losses are included in interest income or expense. The cost of securities is based on the specific identification method.

Concentration of Credit Risk - Financial instruments that potentially subject us to concentrations of credit risk are primarily cash and cash equivalents and investments. We have a cash investment policy that generally restricts investments to ensure preservation of principal and maintenance of liquidity. We typically do not require collateral from our customers. We make a provision for doubtful accounts when required. To date, we have not experienced any bad debts.

Revenue Recognition - Revenue has primarily been generated from research and development cost reimbursement contracts for the United States government. Revenue on such contracts is recorded using the percentage-of-completion method measured on a cost-incurred basis. 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.

Losses, if any, are recognized in full as soon as identified. Losses occur when the estimated direct and indirect costs to complete the contract exceed the unrecognized revenue on the contract. We evaluate the reserve for contract losses on a contract-by-contract basis. No losses have been incurred on any contracts to date.

The following table summarizes our contract revenue activity from our inception through December 31, 2005:

	Wideband polymer modulator				Polymer-based linear modulator				Electro-optic organic polymer				Polymer-based milimeter wave detection				Other
	Award		Revenue		Award		Revenue		Award		Revenue		Award		Revenue		Award		Revenue

2001	$	1,623,000	$	821,000
2002		1,031,000		885,000					$	149,000	$	61,000
2003		950,000		1,118,000	$	497,000	$	95,000		400,000		488,000					$	24,000	$	24,000
2004		1,114,000		780,000				192,000
2005		1,000,000		1,161,000				210,000					$	411,000	$	41,000		21,000		21,000
	$	5,718,000	$	4,765,000	$	497,000	$	497,000	$	549,000	$	549,000	$	411,000	$	41,000	$	45,000	$	45,000

All of our current and prior contracts with the government have been or are cost plus fixed fee type contracts. Under the terms of a cost plus fixed fee contract, the United States government pays us for actual direct and indirect costs incurred in performing the contracted services. We are under no obligation to spend more than the contract value to complete the contracted services. In addition, completion of the contracted services is generally on a best efforts basis. If the services are not completed, the government has the option to negotiate a follow-on contract to complete the services or to not pursue the services further with us. Contract deliveries consist of monthly financial reports, periodic technical reports and any devices if they have been successfully fabricated. There are no contractual provisions for repayments of any amounts disbursed to date under these contracts. The United States government accounted for 95% of revenues in 2005 and 99% of revenues in 2004 and 2003. Certain contracts awarded in one period may be partly performed in the next period.

Cost and estimated earnings in excess of billings on uncompleted contracts comprises amounts of revenue recognized on contracts that we have not yet billed to a customer because the amounts were not contractually billable at the balance sheet date. We were contractually able to bill 89% and 100% of the balance at December 31, 2005 and 2004, respectively, within 30 days of the respective year end.

Property and Equipment - Property and equipment is stated at cost. Depreciation is computed 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 initial lease term.

A summary of property and equipment at December 31 follows:

	2005			2004
Computer equipment	$	644,000		$	491,000
Furniture and office equipment		20,000			20,000
Lab equipment		3,513,000			3,244,000
Leasehold improvements		2,831,000			2,727,000
	$	7,008,000		$	6,482,000
Less: Accumulated depreciation		(5,732,000	)		(4,435,000	)
	$	1,276,000		$	2,047,000

Depreciation expense was $1,297,000, $1,198,000 and $1,185,000 for December 31, 2005, 2004 and 2003, respectively.

Valuation of Long-Lived Assets - We review the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Measurement of the impairment loss is based on the fair value of the asset, or group of assets. Generally, fair value will be determined using valuation techniques such as present value of expected future cash flows.

Research and Development - Research and development costs are expensed as incurred. As described in Note 10, we issued shares of common stock in connection with a research agreement. The value of these shares is amortized over the period of the research agreement.

Fair Value of Financial Instruments - Our financial instruments include cash and cash equivalents, investment securities, accounts receivable, accounts payable, and accrued liabilities. The carrying amounts of financial instruments approximate fair value due to their short maturities.

Income Taxes - We have filed a separate tax return since inception. We follow the liability method of accounting for income taxes. This liability method requires recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Stock Based Compensation - We have a stock-based employee compensation plan, which is described further in Note 7. We account for stock-based employee compensation arrangements on the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees and related amendments and interpretations. We comply with the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, which requires fair value recognition for employee stock-based compensation. We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) Issue No. 96-18.

Total non-cash stock option expense related to employee and director awards was $384,000, $1,285,000 and $6,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Had compensation cost for employee options been determined using the fair values at the grant dates, consistent with the methodology prescribed under SFAS No. 123, our net loss available to common shareholders and associated net loss per share would have increased to the pro forma amounts indicated below:

	For the year ended December 31,
	2005			2004			2003
Net loss available to common shareholders, as reported	$	(10,453,000	)	$	(9,423,000	)	$	(8,083,000	)
Deduct: Stock-based employee compensation expense included in net loss available to common shareholders, as reported	$	384,000		$	1,285,000		$	6,000
Add: Total stock-based employee compensation expense determined under fair value-based method for all awards	$	(2,141,541	)	$	(2,009,000	)	$	(245,000	)
Net loss available to common shareholders, pro forma	$	(12,210,541	)	$	(10,147,000	)	$	(8,322,000	)
Net loss per share, as reported (basic and diluted)	$	(0.63	)	$	(0.89	)	$	(1.31	)
Net loss per share, pro forma (basic and diluted)	$	(0.74	)	$	(0.96	)	$	(1.35	)

See Note 7 for the assumptions used in calculating the fair values of employee options.

Net Loss per Share - 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.

Basic and diluted net loss per share is the same because all potentially dilutive securities outstanding are anti-dilutive. Potentially dilutive securities not included in the calculation of diluted earnings per share include options and warrants to purchase common stock for all periods presented, and Series A and Series B convertible preferred stock for 2003 and 2002 and periods prior to the IPO in 2004. Total common stock options and common stock warrants not included in the calculation of diluted earnings per share were 3,160,502 for the twelve months ended December 31, 2005 and 2,664,176 and 1,069,180 for the twelve months ended December 31, 2004 and 2003, respectively.

Recent Accounting Pronouncements - Beginning in January 2006 we will be recording expenses associated with share-based awards under the provisions of SFAS 123(R) using the modified prospective method. Under this method, we will record not only the fair value associated with new share-based awards as compensation expense, but also the remaining fair value associated with previous awards which were unvested at the end of 2005. As of December 31, 2005 the fair value associated with unvested stock option grants given to employees in periods before 2006 was approximately $1,696,000 which will be expensed through 2009. We expect that the adoption of FAS123(R) on January 1, 2006 will impact 2006 earnings in the range of $2.5 million to $3.5 million.

2. INVESTMENT SECURITIES-AVAILABLE-FOR-SALE

Investment securities, which had maturities of less than one year, totaled $16,871,000 at December 31, 2005. Investment securities at December 31, 2004 with maturities of less than one year totaled $15,460,000 and maturities of greater than one year totaled $11,216,000. We estimate the fair value of our investment securities using readily available market information. All investment securities have been classified as available-for-sale and are carried at estimated fair value with unrealized gains and losses included as a component of accumulated other comprehensive income in stockholders’ equity. We had an unrealized gain on investment securities of $127,000 for the year ending December 31, 2005 and an unrealized loss on investment securities of $145,000 for the year ending December 31, 2004. We have concluded that these unrealized investment gains and losses are temporary due to our ability to hold these investments to maturity.

We had no net realized gains (losses) on investment securities for the year ending December 31, 2005 and 2004. Realized losses were $39,000 for the year ended December 31, 2003.

3. RELATED PARTY TRANSACTIONS

Since inception until July 2004 we were a majority owned subsidiary of Microvision, Inc. The following table describes Microvision’s ownership of Lumera at December 31 of each year:

	2005			2004			2003
Common Stock		27.60	%		32.84	%		—
Class B common stock		—			—			87.50	%
Series A convertible preferred stock		—			—			11.00	%
Series B convertible preferred stock		—			—			32.50	%

In July 2004, all outstanding shares of the our Series A convertible preferred stock, Series B convertible preferred stock and Class B common stock were automatically converted to common stock upon completion of our IPO in July 2004. Prior to the IPO, Microvision owned approximately 52% of our outstanding common stock on an as if converted basis. In January 2006 Microvision sold 2.55 million of its shares, or approximately 16% of our outstanding shares; most of Microvision’s remaining Lumera shares, which total approximately 12% of our outstanding shares as of March 1, 2006, are pledged as collateral under agreements which remain in effect until March 2007. Richard F. Rutkowski, until January 2006 the Chief Executive Officer of Microvision, is a current member of Microvision’s board of directors and also a director of Lumera.

In February 2004, we agreed to pay Mr. Rutkowski a $5,000 monthly retainer to supplement our management team during our public offering. During this retainer period, which ended in July 2004, Mr. Rutkowski also performed his role as Chief Executive Officer of Microvision. We also paid Mr. Rutkowski a one-time fee of $100,000 upon the successful completion of our convertible note financing in April 2004. We recognized $130,000 of administrative expense related to these fees in 2004. In addition, we paid Mr. Rutkowski a one-time fee of $100,000 upon the participation in and successful completion of our initial public offering, which was treated as a cost of raising capital. The boards of both Microvision and Lumera approved paying Mr. Rutkowski these fees.

During 2003 and 2004, we were allocated lease and utilities costs from Microvision under a month-to-month lease. In addition, we were charged a $5,000 per month fee to reimburse Microvision for certain other indirect charges.

In 2004, we entered into a sublease agreement with Microvision for its corporate facilities at a base rate of approximately $25,000 per month, plus common area charges, which is effective through April 6, 2006.

The following are a summary of charges we paid to Microvision for each year ended December 31:

	2005		2004		2003
Rent	$	323,000	$	320,000	$	317,000
Allocated Services		89,000		57,000		54,000
Management Fees		—		60,000		60,000
Total	$	412,000	$	437,000	$	431,000

4. ACCRUED LIABILITIES

Accrued liabilities consist of the following at December 31:

	2005		2004

Employee and benefit-related liabilities	$	372,000	$	363,000
Compensated absences		94,000		81,000
Professional fees		384,000		493,000
License and royalty fees		175,000		—
Other		34,000		39,000
	$	1,059,000	$	976,000

5. INCOME TAXES

No provision for income taxes has been recorded for any periods presented since we have incurred net losses from the date of our inception.

At December 31, 2005, we had $44.1 million of federal net operating loss carry forwards, which may be used to offset future taxable income. These carry forwards expire beginning in 2018 through 2024. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carry forwards that can be utilized if certain changes in our ownership occur.

At December 31, 2005 we had $1,055,000 of research and experimentation credits carry forwards which begin to expire in 2019 through 2024.

Deferred taxes consist of the following at December 31:

	2005			2004
Deferred income tax assets
Net operating loss carryforwards	$	14,997,000		$	11,673,000
R&D credit carryforwards	$	1,055,000		$	868,000
Other	$	1,412,000		$	1,194,000

Gross deferred tax assets		17,464,000			13,735,000
Less: valuation allowance		(17,464,000	)		(13,735,000	)

Net deferred tax asset	$	—		$	—

We recorded a valuation allowance for the full amount of its deferred tax assets at December 31, 2005 and 2004, as we believe it is more likely than not that the deferred tax assets will not be realized.

The valuation allowance and the research and experimentation credits account for substantially all of the difference between our effective income tax rate and the Federal statutory rate of 34%.

6. SHAREHOLDERS’ EQUITY (DEFICIT)

At December 31, 2005, our authorized capital consisted of 120 million shares of Common Stock, of which 1,299,956 shares are reserved for options granted under our 2000 Stock Option Plan and 2,500,000 shares are reserved for outstanding and future option grants under our 2004 Equity Incentive Plan. We also have 30,000,000 shares of authorized undesignated preferred stock, none of which have been issued.

In July 2004 we completed our initial public offering (the “IPO”), issuing 6 million shares of common stock at $6.95 per share. Upon completion of the IPO all outstanding shares of our Common A and B and Preferred A and B shares were automatically converted to common shares. At December 31, 2005 there were 16,748,116 shares of common stock outstanding.

Common Stock - In March 2000, we issued 4,700,000 shares of its Class B common stock to Microvision, Inc. and 670,000 shares of its Class B common stock to certain Microvision directors, executives, and other individuals (“individuals”). The shares issued to Microvision were valued at $94,000 and the proceeds were offset against the outstanding loan balance due. The shares issued to the individuals were valued at $12,000 and were issued subject to subscription loans, for which cash was received in November 2000.

In January 2001, we issued 802,414 shares of Class A common stock valued at $3,009,000 in connection with the research agreement described in Note 10.

Upon our initial public offering in July 2004 all shares of common A and B were automatically converted to Common Stock on a one-for-one basis.

Convertible Preferred Stock - In August through October 2003, we raised $2,670,000 (before issuance costs of $67,000) from the sale of 1,335,025 shares of Series B convertible preferred stock to private investors. In March 2004, we raised $500,000 from the sale of 250,000 shares of Series B convertible preferred stock to private investors issued in March 2004. The $2 per share conversion price of the Series B convertible preferred stock issued was less than the fair value of the Class A common stock on the issuance date. As a result, we recorded a $500,000 beneficial conversion feature upon issuance of the preferred stock. This amount was immediately recorded as a deemed dividend to preferred shareholders because the Series B convertible preferred stock had no stated term and was immediately convertible into Class A common stock.

Upon our initial public offering in July 2004 all shares of convertible preferred stock were automatically converted to Common Stock. Each Series A Preferred share was converted into 1.14 shares of common stock in accordance with anti-dilution provisions enacted upon the sale of the Preferred B shares resulting in 2,727,291 shares of common stock issued in exchange for 2,400,000 Series A Preferred shares. Each share of Series B Preferred was exchanged for common shares on a one-for-one basis, resulting in the issuance of 1,585,025 shares of common stock issued in exchange for the Series B Preferred shares.

Dividends - No dividends on convertible preferred stock or common stock have been declared from inception through December 31, 2005.

Arizona Microsystems, L.L.C. warrants exercised - In October 2002, we issued a warrant to purchase 164,000 shares of Class A common stock at an exercise price of $3.65 per share to Arizona Microsystems, L.L.C. for use of certain technology. These warrants were exercised in a cashless transaction for 38,935 shares of common stock in July 2004.

7. STOCK OPTIONS

Stock Option Plans In 2000, we adopted the 2000 Stock Option Plan (the “2000 Plan”). The 2000 Plan provided for the granting of stock options to our employees, consultants and non-employee directors. We reserved 3,000,000 shares of Class A Common Stock for issuance pursuant to the 2000 Plan. Following the adoption of the 2004 Equity Incentive Plan in July 2004, no more options will be issued under the 2000 Stock Option Plan. Grants, net of shares exercised and forfeited, under our 2000 Stock Option Plan totaled 1,299,956 shares at December 31, 2005.

In July 2004, we adopted the 2004 Equity Incentive Plan (the “2004 Plan”). Awards under the Plan, can be a combination of stock options, stock appreciation rights , restricted stock, unrestricted stock, stock units (including restricted stock units), performance awards, cash awards and other awards not described that are convertible into or otherwise based on the our stock. To date, only stock option awards have been granted under the Plan.

The 2004 Plan established an initial option pool of 2,000,000 shares plus an annual increase beginning in 2005, equal to the least of (i) 2,000,000 shares, (ii) 13.4% of the number of shares of Stock outstanding as of our immediately preceding fiscal year, or (iii) such lesser amount, if any, as the Board may determine. Our Board of Directors elected to limit the increase in the option share pool by 500,000 shares in both 2005 and 2006, bringing the shares in the pool to a total of 3,000,000.

Options under both the 2000 plan and the 2004 Plan may be granted for periods up to 10 years. Options granted under either plan may be either Incentive Stock Options (“ISO”’s) or non-qualified stock options. The exercise price of an ISO cannot be less than 100% of the estimated fair value of the common stock at the date of grant. To date, options granted to employees generally vest over four years.

The following table presents activity under the Plan:

				Weighted-		Weighted-
				Average		Average
				Exercise		Grant Date
Activity	Shares			Price		Fair Value
Outstanding at December 31, 2002		633,430		$	8.18
Granted
Exercise price greater than fair value		308,450		$	3.38	$	0.65
Forfeited		(36,700	)	$	10.00
Outstanding at December 31, 2003		905,180		$	6.47
Granted
Exercise price greater than fair value		5,000		$	2.00	$	0.65
Exercise price at fair value		257,550		$	6.12	$	4.16
Exercise price less than fair value		709,900		$	2.19	$	3.99
Forfeited		(76,250	)	$	4.01
Exercised		(22,750	)	$	1.01
Outstanding at December 31, 2004		1,778,630		$	4.88
Granted
Exercise price greater than fair value
Exercise price at fair value		733,950		$	5.05	$	3.56
Exercise price less than fair value
Forfeited		(35,938	)	$	5.95
Exercised		(201,686	)	$	2.16
Outstanding at December 31, 2005		2,274,956		$	5.16

Options Exerciseable at:
December 31, 2003		463,161		$	7.26
December 31, 2004		1,105,033		$	5.42
December 31, 2005		1,345,071		$	5.56

The following table presents outstanding and exercisable stock options at December 31, 2005:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
Exercise			Contractual		Exercise				Exercise
Price	Shares		Life (Years)		Price		Shares		Price
$0.50 - $2.50		680,551		7.50	$	1.91		512,973	$	1.88
$3.65 - $5.49		872,700		8.55	$	4.82		195,662	$	4.60
$5.50 - $10.00		721,705		6.19	$	8.62		636,436	$	8.82
		2,274,956		7.49	$	5.15		1,345,071	$	5.56

Non-Employee Options - Included in the option disclosures above are options granted to certain non-employees under our plan, as follows:

In August 2003, we 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. In April 2004, 61,500 of these shares were forfeited upon termination of one of the consulting agreements. The options have an exercise price of $3.65 per share and a 10-year life. In aggregate, 41,000 of the options were vested on the grant date. The remaining 61,500 shares vest one-third on each subsequent annual anniversary of the grant date and are subject to re-measurement at each balance sheet date during the vesting period. The aggregate value of the outstanding options was estimated at $136,000 at the grant date and December 31, 2003, $415,000 at December 31, 2004 and at $299,000 at December 31, 2005. The fair value of these options, net of forfeited options was recognized as compensation expense over the two-year period of service, which ended in August 2005. Total non-cash compensation expense related to these options was $4,000, $287,000 and $32,000 for the year ended December 31, 2005, 2004 and 2003, respectively. The fair values of the options were estimated at the grant date and December 31, 2005, 2004 and 2003, using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0%; expected volatility of 100%; risk-free interest rates of 4.3%, 4.62%, and 4.4%; and expected lives of 10 years, for each of the measurement dates, respectively.

In March 2004, we granted options under the 2000 Plan to purchase 65,000 shares of Class A common stock to a Microvision employee. These options have been accounted for as a dividend to Microvision and recorded at their fair value of $272,000, in accordance with the guidance in EITF Issue No. 00-23 Issue 21, Options Granted to Employees of Entities under Common Control.

Options issued at below market price - In March 2004 we granted options under the 2000 Plan to its CEO and each of our Directors to purchase an aggregate of 410,000 shares of common stock at a price below the then current market value. Our Directors were each awarded options to purchase 65,500 shares, of which 30,000 shares vested on the date of grant with 5,000 shares vesting quarterly thereafter until fully vested, have an exercise price of $2 per share and a 10-year life. Our CEO was awarded an option to purchase 150,000 shares, of which 50,000 vested September 1, 2004 and 50,000 annually thereafter until fully vested, with an exercise price of $2 per share and a 10-year life. The aggregate value of these options was estimated to be $1,230,000 and is being recognized as compensation expense over the vesting periods. We recognized $169,000 and $922,000 of compensation expense associated with these option grants during the years ended December 31, 2005 and 2004, respectively, net of forfeited options. As of December 31, 2005, $40,000 of deferred compensation remained to be amortized on these option grants.

In April 2004 we granted options under the 2000 Plan to its employees to purchase an aggregate of 156,650 shares of common stock at a price below the then current market value. The options have an exercise price of $2.00 per share and a 10-year life. One quarter of the options vested on July 1, 2004 with the remaining options vesting annually over the subsequent three years until fully vested. In July 2004, we issued options under the 2000 Plan to its employees to purchase an aggregate of 78,250 shares of common stock at a price below the then current market value. The options have a weighted average exercise price of $3.76 per share and a 10-year life. The aggregate value of these option grants was estimated at $801,000 and is being recognized as compensation expense over the vesting period. We recognized compensation expense associated with these option grants of $215,000 and $360,000, net of forfeited options, for the years ended December 31, 2005 and 2004, respectively. As of December 31, 2005, $162,000 of deferred compensation remained to be amortized.

A summary of stock compensation expense for each period is as follows:

	For the twelve months ended
	December 31,
	2005		2004		2003
Employees	$	343,000	$	644,000	$	6,000
Directors		41,000		641,000		-
Third Party		85,000		608,000		32,000
	$	469,000	$	1,893,000	$	38,000

Component of:
Research and development	$	95,000	$	573,000	$	35,000
Marketing, general and administrative		374,000		1,320,000		3,000
	$	469,000	$	1,893,000	$	38,000

Fair Value Disclosure - The fair values of the options granted to employees 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:

	December 31,
	2005			2004			2003
Risk Free Interest Rate		4.05	%		3.2	%		3.8	%
Expected Life (in years)		5.6			5.2			7.0
Dividend Yield		0.0	%		0.0	%		0.0	%
Volatility		83.0	%		83.0	%		83.0	%

8. WARRANTS

In October 2002, we issued a warrant to purchase 164,000 shares of Class A common stock at an exercise price of $3.65 per share to Arizona Microsystems, L.L.C. for use of certain technology. These warrants were exercised in a cashless transaction for 38,935 common shares in July 2004.

In April 2004 we issued warrants to purchasers of its convertible promissory notes for an aggregate of 115,000 shares of Common Stock at and exercise price of $7.20 per share. The value of the warrants granted, which are exercisable through April 21, 2009, was estimated to be approximately $344,000 using the Black Scholes option pricing model. The relative fair value of the warrants of $301,000 was treated as a debt issuance cost and amortized to interest expense over the one-year term of the debt.

In July 2004 we issued warrants to its Underwriters in connection with our initial public offering to purchase a total of 600,000 shares of our common stock at a purchase price of $8.34, or 120% of the price of the shares upon completion of our IPO. The warrants are exercisable through July 28, 2009. These warrants were treated as a cost of raising capital.

Microvision holds a warrant to purchase a total of 170,546 shares of Common Stock at an exercise price of $8.80 per share. The warrant, which was originally issued in 2001 for 150,000 Series A Preferred shares in lieu of interest payments due on a convertible note, and was exercisable at $10.00 per share, carried anti-dilution rights which, upon completion of our IPO, triggered an automatic adjustment to the number of shares and exercise price. The warrant, all of which was outstanding at December 31, 2005, expires in March 2011 and was valued by the amount of the interest forgiven or $719,000, as this was considered to be more readily determinable than the fair value of the warrant.

9. CONVERTIBLE NOTES PAYABLE

In April 2004, we received cash proceeds from the issuance of convertible promissory notes in the aggregate principal amount of $2.3 million. The notes accrued interest at a rate of 6.5% per annum and were payable on demand at the earlier of March 31, 2005 or upon the closing of an underwritten public offering of our common stock. The principal amount and any accrued but unpaid interest in respect of each note was convertible, at the option of the holder, into shares of our Class A common stock. The conversion price of the Notes was stated as the lesser of $6.00 per share of common stock or the price per share offered to the public in any underwritten IPO of our common stock.

In connection with the sale of these convertible notes, we also issued warrants to purchase an aggregate of 115,000 shares of common stock at a price of $7.20 per share. The warrants expire in April 2009. The value of the warrants granted was estimated to be approximately $344,000 at the date of grant using the Black-Scholes option pricing model. We allocated the proceeds to the convertible note and warrant based on their relative fair value. The relative fair value of the warrants of $301,000 was treated as a debt issuance cost and was amortized to interest expense over the one-year term of the debt.

Upon completion of our IPO in July 2004 the notes became due and payable. All of the note holders elected to receive cash payments, which resulted in principal and interest payments totaling $2,344,000 in August 2004. The unamortized debt issuance costs were recognized immediately as interest expense at that time. During 2004, we recognized a total of $345,000 of interest expense associated with the Notes.

10. COMMITMENTS AND CONTINGENCIES

Agreements with the University of Washington - In October 2000, we entered into a license agreement (the “License Agreement”) and a research agreement (the “Sponsored Research Agreement” or the “SRA”) with the University of Washington (the “UW”). The License Agreement grants us rights to certain intellectual property including technology being developed under the sponsored Research Agreement whereby hawse have a royalty-bearing license to make, sell or sublicense the licensed technology. Under the terms of the License Agreement, we issued 802,414 shares of our Class A common stock to the UW. The shares, although initially subject to a vesting schedule tied to performance under the Sponsored Research Agreement, were vested in full by mutual agreement between the UW and Lumera on January 8, 2001. The shares issued were valued by management at $3,009,000, based on a value of $3.75 per share on the date of issuance. We considered a number of factors, including an independent valuation, projected cash flows from our technology and expected future products, general market conditions and the risks inherent in achieving our business plan in determining the fair value of the common shares issued. The value of the shares issued was recorded as prepaid stock-based research expense and was fully amortized to expense as of March 31, 2004.

Under the terms of the License Agreement, we are also required to pay certain costs related to filing and processing of patents and copyrights related to the agreements. Additionally, we are required to pay certain ongoing royalty payments at a minimum of $75,000 per annum. We have not made any royalty payments to date in excess of these minimums. These payments have been expensed as incurred.

As part of the Sponsored Research Agreement, we agreed to pay an aggregate of $9,000,000 in quarterly payments over three years for research services. The first payment was made on February 26, 2001. We expensed the total expected payments on a straight-line basis because there was no more readily determinable pattern of the performance of the research services under the agreement.

In February 2002, Lumera and the UW amended the Sponsored Research Agreement to extend quarterly payments and performance through 2005. In March 2003, we entered into a second amendment to the SRA, which deferred certain 2003 payments until 2004. In November 2003, we entered into a third amendment to the SRA. Under the terms of the third amendment, our payment obligation to the UW was reduced to $125,000 per quarter from October 1, 2003 to September 30, 2004, and $300,000 for the quarter ending December 31, 2004. The amendment required us to make its unpaid payments of $2,000,000 by May 2005. In April 2004, we entered into a fourth amendment to the SRA that required payments of $125,000 for the quarters ending March 31, 2004 and September 30, 2004 and eliminated a contingent payment of $2,000,000 that had been due in April 2004. For each of the quarters ending September 30, 2004 and December 31, 2004, we were required to pay $250,000. Total payments under the Amended Sponsored Research Agreement, which terminated in June 2005, were $5,750,000 instead of the $9,000,000 under the terms of the original agreement.

Subsequent to each amendment noted above, we prospectively adjusted the amortization of the research payments to account for the extended period over which the payments would be made and services provided. As a result of these adjustments, we had cumulatively recognized expenses in excess of payments made of $1,948,000 at December 31, 2003. As a result of the fourth amendment and the elimination of the contingent $2 million payment in 2005, we recognized a credit to research and development expense of $2.4 million in 2004.

The following table summarizes payments made and expense recorded during the years ending December 31:

	2005		2004			2003

Payments made	$	1,018,000	$	800,000		$	1,300,000

Sponsored research	$	650,000	$	(1,223,000	)	$	1,924,000
Optical materials		166,000		50,000			300,000
Minimum royalty		75,000		75,000			75,000
Expenses recorded on payments	$	891,000	$	(1,098,000	)	$	2,299,000
Amortization of stock				159,000			1,003,000
Total expense recorded	$	891,000	$	(939,000	)	$	3,302,000

Helix Biopharma/Sensium - We have a licensing agreement with Sensium Technologies, Inc., a subsidiary of Helix BioPharma, which gives us an exclusive worldwide royalty bearing license in our field of business to a number of patents and the related technology for use in our NanoCapture™ Arrays. Under the terms of the agreement, we paid $250,000 in license fees, half of which we paid upon signing in January 2005 and half in February 2006. We also paid $125,000 in technology transfer fees during the first half of 2005. The Sensium licensing agreement contains minimum royalty provisions totaling $50,000 for the first year, $100,000 for the second year, $150,000 for the third year and $200,000 thereafter. Our license exclusivity is based upon achieving certain minimum revenues by the fourth royalty year.

Lease Commitments - We sublease our corporate facilities from Microvision at a base rate of approximately $25,000 per month, plus common area charges; the sublease is effective through April 6, 2006. We signed a five year lease to expand our current facilities which begins April 7, 2006. Once we complete our tenant improvements, which we believe will require cash expenditures in the range of $900,000 to $1.2 million, our facilities will occupy approximately 32,175 square feet of space located in the same building we currently occupy. The total of the minimum rental payments over the life of the initial lease term is approximately $2.5 million. We have an option to extend our new lease for one additional 5 year period. We had no other significant operating or capital leases at December 31, 2005.

Claims and Litigation - In our opinion, litigation, contingent liabilities and claims against us in the normal course of business are not expected to involve any judgments or settlements that would be material to our financial condition, results of operations or cash flows.

11. RETIREMENT SAVINGS PLAN

On August 31, 2004, we established its retirement savings plan (the “Plan”), which qualifies under the Internal Revenue Code Section 401(k) and covers all qualified employees. The Plan allows us to match 50% of an employee’s contribution to the Plan up to a maximum 6% of the employee’s base salary. During 2005 we contributed $57,000 to the Plan under the matching program and from September through December 31, 2004, we contributed $21,000 to the Plan under the matching program. Prior to August 31, 2004 our employees participated in the Microvision retirement savings plan. We contributed $33,000 and $43,000 in matching payments under the Microvision Plan in the first eight months of 2004, and in 2003, respectively.

12. QUARTERLY FINANICAL DATA (UNAUDITED)

The following table represents certain unaudited quarterly financial information for the eight quarters ended December 31, 2005. In our opinion, this information has been prepared on the same basis as the audited financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the unaudited quarterly results of operations set forth herein.

	First			Second			Third			Fourth			Fiscal
	Quarter			Quarter			Quarter			Quarter			Year
	(in thousands, except per share data)

Total Revenue
2005	$	240		$	348		$	681		$	240		$	1,509
2004	$	316		$	288		$	292		$	93		$	989
Gross Profit
2005		72			131			215			169			587
2004		122			100			128			(12	)		338
Net Loss Available to Common Shareholders
2005		(2,878	)		(2,926	)		(2,034	)		(2,615	)		(10,453	)
2004		(2,592	)		(732	)		(3,176	)		(2,923	)		(9,423	)

Basic and diluted net loss per share attributable to common stockholders
2005	$	(0.17	)	$	(0.18	)	$	(0.12	)	$	(0.16	)	$	(0.63	)
2004	$	(0.50	)	$	(0.04	)	$	(0.24	)	$	(0.18	)	$	(0.89	)

Quarterly and annual earnings per share are calculated independently, based on the weighted average number of shares outstanding during the periods.

Schedule II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES


	Balance at		Charges to		Charges				Balance at
	Beginning of		Costs		to				End of
	Fiscal		and		Other				Fiscal
	Year		Expenses		Accounts		Deductions		Period

Year ended December 31, 2003
Tax valuation allowance	$	7,426,000	$	3,170,000		—		—	$	10,596,000
Year ended December 31, 2004
Tax valuation allowance	$	10,596,000	$	3,139,000		—		—	$	13,735,000
Year ended December 31, 2005
Tax valuation allowance	$	13,735,000	$	3,728,000					$	17,463,000

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

MICROVISION, INC.

Date: May 2, 2006

/s/ Alexander Tokman
Alexander Tokman
President and Chief Executive Officer

EXHIBIT INDEX

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

3.1	Certificate of Incorporation of Microvision, Inc. ⁽²⁾
3.2		Bylaws of Microvision, Inc.⁽²⁾
3.3		Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock of Microvision, Inc.⁽¹⁴⁾
4.1		Form of Specimen Stock Certificate for Common Stock.⁽²⁾
4.2		Form of Indenture.⁽⁶⁾
4.3		Form of Warrant issued on July 22, 2002.⁽¹⁰⁾
4.4		Form of Warrant issued on March 5, 2003.⁽⁹⁾
4.5		Registration Rights Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC.⁽¹⁴⁾
4.6		Warrant No. 76 to Purchase Common Stock of Microvision, Inc. issued September 10, 2004 to Satellite Strategic Finance Associates, LLC.⁽¹⁴⁾
4.7		Form of Warrant issued under the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁵⁾
4.8		Registration Rights Agreement executed in connection with the Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁵⁾
4.9		Form of Amended and Restated Note issued as of March 11, 2005 under the Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁸⁾
4.10		Form of Warrant issued as of July 25, 2005 under the Master Amendment Agreement dated as of July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁸⁾
4.11		Registration Rights Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd..⁽²⁰⁾
4.12		Warrant No. 86 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Partners, Ltd.⁽²⁰⁾
4.13		Warrant No. 87 to Purchase Common Stock of Microvision, Inc. issued August 9, 2005 to Satellite Strategic Finance Associates, LLC.⁽²⁰⁾
4.14		Warrant No. 88 to Purchase Common Stock of Microvision, Inc. issued August 31, 2005 to Omicron Master Trust⁽²¹⁾
4.15		Form of Note issued as of December 1, 2005 under the Securities and Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽²²⁾
4.16		Form of Warrant issued under the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽²²⁾
4.17		Form of Amended and Restated Pledge and Security Agreement executed in connection with the Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽²²⁾
10.1		Assignment of License and Other Rights between The University of Washington and the Washington Technology Center and the H. Group, dated July 25, 1993.⁽¹⁾
10.2		Project II Research Agreement between The University of Washington and the Washington Technology Center and Microvision, Inc., dated October 28, 1993.⁽¹⁾+
10.3		Exclusive License Agreement between The University of Washington and Microvision, Inc., dated October 28, 1993.⁽¹⁾+
10.4		Exclusive License Agreement between the University of Washington and Microvision, Inc. dated March 3, 1994.⁽⁹⁾
10.5		1993 Stock Option Plan.^(1)*
10.6		1996 Stock Option Plan, as amended.^(8)*
10.7		Independent Director Stock Option Plan, as amended.^(8)*
10.8		Form of Executive Option Exercise Loan Plan.^(3)*
10.9		Lease Agreement between S/I Northcreek II, LLC and Microvision, Inc., dated October 27, 1998.⁽¹³⁾
10.9.1		Lease Amendment No 1 to Lease between S/I Northcreek II, LLC and Microvision, Inc. dated July 12, 1999.⁽⁵⁾
10.9.2		Lease Amendment No 2 to Lease between S/I Northcreek II, LLC and Microvision, Inc. dated February 14, 2000.⁽⁵⁾
10.10		Form of Consulting Agreement between Microvision, Inc. and Avram Miller and Jacqueline Brandwynne dated August 10, 2000.⁽⁴⁾
10.11		Form of Common Stock Purchase Warrant issued to Avram Miller and Jacqueline Brandwynne dated August 10, 2000.⁽⁴⁾
10.12		Executive Loan Plan and Related Form of Note.^(7)*
10.13		Form of Stock Purchase Agreement dated March 22, 2002.⁽¹¹⁾
10.14		Form of Stock Purchase Agreement dated July 22, 2002.⁽¹⁰⁾
10.15		Form of Securities Purchase Agreement dated as of March 3, 2003.⁽⁹⁾
10.16		Form of the Option Agreement for options granted outside of the Plans.⁽¹²⁾
10.17		Securities Purchase Agreement dated as of September 9, 2004 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC.⁽¹⁴⁾
10.18		License and Development Agreement dated as of December 30, 2004 by and between Microvision, Inc. and Ethicon Endo-Surgery, Inc. ⁽¹⁶⁾+
10.19		Securities Purchase Agreement dated as of March 11, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁵⁾
10.20		Employment Agreement between Microvision, Inc. and Alexander Y. Tokman dated July 18, 2005.⁽¹⁷⁾
10.21		Master Amendment Agreement dated July 25, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽¹⁸⁾
10.22		Lease Agreement between Carramerica Reality Operating Partnership, L.P. and Microvision, Inc., dated July 15, 2005.⁽¹⁹⁾
10.23		Securities Purchase Agreement dated as of August 8, 2005 by and between Microvision, Inc., Satellite Strategic Finance Associates, LLC and Satellite Strategic Finance Partners, Ltd.⁽²⁰⁾
10.24		Conversion and Modification Agreement dated as of August 8, 2005 by and between Microvision, Inc. and Satellite Strategic Finance Associates, LLC.⁽²⁰⁾
10.25		Securities Purchase Agreement dated as of August 31, 2005 by and between Microvision, Inc. and Omicron Master Trust.⁽²¹⁾
10.26		Securities Purchase Agreement dated as of December 1, 2005 by and among Microvision, Inc. and the investors listed on the Schedule of Buyers thereto.⁽²²⁾
23		Consent of Independent Registered Public Accounting Firm
23.1		Consent of Independent Registered Public Accounting Firm
31.1		Chief Executive Officer certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Principal Financial Officer certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Chief Executive Officer certification pursuant to Rule 13a-14(b) or Rule 15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
32.2		Principal Financial Officer certification pursuant to Rule 13a-14(b) or Rule 15d-14(b) and Section 1350, Chapter 63 of Title 18 United States Code (18 U.S.C. 1350), as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002.