Forward-Looking Statements

The information set forth in this report in Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 3, "Quantitative and Qualitative Disclosure about Market Risk," includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is subject to the safe harbor created by that section. Such statements may include, but are not limited to, projections of revenues, income or loss, capital expenditures, plans for product development and cooperative arrangements, future operations, financing needs or plans of Microvision, as well as assumptions relating to the foregoing. The words "anticipate," "believe," "estimate," "expect," "goal," "may," "plan," "project," "will," and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Factors that could cause actual results to differ materially from those projected in our forward-looking statements include the following: our ability to obtain financing; market acceptance of our technologies and products; our financial and technical resources relative to those of our competitors; our ability to keep up with rapid technological change; government regulation of our technologies; our ability to enforce our intellectual property rights and protect our proprietary technologies; the ability to obtain additional contract awards and to develop partnership opportunities; the timing of commercial product launches; the ability to achieve key technical milestones in key products; and other risk factors identified in this report under the caption "Item 1A - Risk Factors."

We are developing high-resolution miniature display and imaging engines based upon our technology platform. Our technology platform utilizes our expertise in two dimensional Micro-Electrical Mechanical systems (MEMS), lasers, optics and electronics to create a high quality video or still image from a small form factor device with lower power needs than conventional display technologies.

Our strategy is to develop and supply a proprietary display engine called PicoP to potential OEM customers who will embed them into a variety of consumer and automotive products. The primary objective for consumer applications is to provide users of mobile devices with a large screen viewing experience produced by a small embedded projector. Mobile devices may include cell phones, PDA's, gaming consoles and other consumer electronics products. These potential products would allow users to watch movies, play videos, display images, and other data onto a variety of flat or curved surfaces.

We are currently developing a small accessory projector that would be the first commercial product based on the PicoP display engine. The accessory projector is expected to display images from a variety of video sources including cell phones, portable media players, PDAs, gaming consoles, laptop computers, digital cameras, and other consumer electronics products. We expect that the accessory product will be commercially available during 2009.

The PicoP with some modification could be embedded into a vehicle or integrated into a portable standalone aftermarket device to create a high-resolution head-up display (HUD) that could project point-by-point navigation, critical operational, safety and other information important to the driver or pilot. The PicoP could be further modified to be embedded into a pair of glasses to provide the mobile user with a see-through or occluded personal display to view movies, play games or access other content.

Results of Operations

Contract revenue.


                                                  % of                  % of
                                                contract              contract
(in thousands)                         2009      revenue     2008      revenue   $ change  % change
                                     ---------  ---------  ---------  ---------  --------- ---------
Three months ended March 31
Government revenue                  $     420       59.0  $     908       39.8  $    (488)    (53.7)
Commercial revenue                        292       41.0      1,373       60.2     (1,081)    (78.7)
                                     ---------             ---------             ---------
Total contract revenue              $     712             $   2,281             $  (1,569)    (68.8)
                                     =========             =========             =========

We earn contract revenue from performance on development contracts with the U.S. government and commercial customers and from the sale of prototype units and evaluation kits based on our PicoP display engine.

Our contract revenue from development contracts in a particular period is dependent upon when we enter into a contract, the value of the contracts we have entered into, and the availability of technical resources to perform work on the contracts.

We recognize contract revenue as work progresses on long-term, cost plus fixed fee and fixed price contracts using the percentage-of-completion method, which relies on estimates of total expected contract revenue and costs. Our revenue contracts generally include a statement of the work we are to complete and the total fee we will earn from the contract. When we begin work on the contract and at the end of each accounting period, we work with the members of our technical team to estimate the labor and material and other cost required to complete the statement of work compared to cost incurred to date. We use information provided by project mangers, vendors, outside consultants and others as we deem necessary to develop our cost estimates. Since our contracts generally require some level of technology development to complete, the actual cost required to complete a statement of work can vary from our estimated cost to complete. We have developed processes that allow us to make reasonable estimates of the cost to complete a contract. Historically, we have made only immaterial revisions in the estimates to complete the contract at each reporting period. Recognized revenues are subject to revisions as the contract progresses to completion and actual revenue and cost become certain. Revisions in revenue estimates are reflected in the period in which the facts that give rise to the revision become known. In the future, revisions in these estimates could significantly impact recognized revenue in any one reporting period. If the U.S. government cancels a contract, we would receive payment for work performed and costs committed to prior to the cancellation.

During the three months ended March 31, 2009, we began selling prototype units and evaluation kits based on our PicoP display engine. We recognize contract revenue on the sales of prototype units and evaluation kits upon acceptance of the deliverables by the customer or expiration of the contractual acceptance period. While we anticipate future sales of these units, revenue may vary substantially due to the timing of orders from customers and potential constraints on resources.

Contract revenue was substantially lower during the three months ended March 31, 2009 than the same period in 2008, due to reduced contract activity and lower beginning backlog in 2009 compared to the prior year. We expect that we will have fewer opportunities to enter into new development contracts as we move closer to the commercialization of products based on our PicoP display engine.

As long as most of our revenue is earned from performance on development contracts, we believe there may be a high degree of variability in revenue from quarter to quarter.

Our backlog of development contracts, including orders for prototype units, at March 31, 2009 was $479,000 compared to $1.5 million at March 31, 2008, all of which is scheduled for completion during the next twelve months.

Product revenue.

                                                  % of                  % of
                                                 product               product
(in thousands)                         2009      revenue     2008      revenue   $ change  % change
                                     ---------  ---------  ---------  ---------  --------- ---------
Three months ended March 31
Bar code revenue                    $     239      100.0  $     289      100.0  $     (50)    (17.3)

Our bar code sales generally include acceptance provisions. We recognize revenue for bar code shipments upon acceptance of the product by the customer or expiration of the contractual acceptance period. Our quarterly bar code revenue may vary substantially due to the timing of product orders from customers.

Bar code revenue was lower during the three months ended March 31, 2009 than the same period in 2008, due to decreased purchasing volume of small and mid-sized businesses as a result of the global economic conditions.

The backlog of bar code orders at March 31, 2009 was approximately $138,000, compared to $338,000 at March 31, 2008, all of which is scheduled for delivery during the next twelve months.

Cost of contract revenue.

                                                  % of                  % of
                                                contract              contract
(in thousands)                         2009      revenue     2008      revenue   $ change  % change
                                     ---------  ---------  ---------  ---------  --------- ---------
Three months ended March 31         $     383       53.8  $     762       33.4  $    (379)    (49.7)

Cost of contract revenue includes both the direct and allocated indirect costs of performing on development contracts. Direct costs include labor, materials and other costs incurred directly in performing on a contract. Indirect costs include labor and other costs associated with operating our research and development department and building our technical capabilities and capacity. Cost of contract revenue is determined both by the level of direct costs incurred on development contracts and by the level of indirect costs incurred in operating and building our technical capabilities and capacity. Both the direct and indirect costs can fluctuate substantially from period to period.

Cost of contract revenue was lower during the three months ended March 31, 2009 than March 31, 2008 as a result of the decreased activity on development contracts. The increase in cost of contract revenue as a percentage of contract revenue was the result of differences in the cost mix of the contracts during those periods. During the three months ended March 31, 2008, cost of contract revenue included contracts with more favorable cost structures and higher gross margins.

The cost of revenue as a percentage of revenue can fluctuate significantly from period to period, depending on the contract cost mix and the levels of direct and indirect costs incurred. However, over longer periods of time we expect modest fluctuations in the cost of contract revenue, as a percentage of contract revenue.

Cost of product revenue.

                                                  % of                  % of
                                                 product               product
(in thousands)                         2009      revenue     2008      revenue   $ change  % change
                                     ---------  ---------  ---------  ---------  --------- ---------
Three months ended March 31         $     241      100.8  $     339      117.3  $     (98)    (28.9)

Cost of product revenue includes both the direct and allocated indirect costs of manufacturing bar code scanners sold to customers. Direct costs include labor, materials and other costs incurred directly in the manufacture of bar code scanners. Indirect costs include labor and other costs associated with operating our manufacturing capabilities and capacity.

Our overhead, which includes the costs of procuring, inspecting and storing material, facility and depreciation costs, is allocated to inventory, cost of product revenue, cost of contract revenue, and research and development expense based on the proportion of direct material purchased for the respective activity. During the three months ending March 31, 2009 and 2008, we expensed approximately $73,000 and $47,000, respectively, of manufacturing overhead associated with production capacity in excess of production requirements.

The cost of product revenue as a percentage of product revenue can fluctuate significantly from period to period, depending on the product mix, the level of overhead expense and the volume of direct materials purchased.

Research and development expense.

(in thousands)                         2009       2008     $ change   % change
                                     ---------  ---------  ---------  ---------
Three months ended March 31         $   5,610  $   4,426  $   1,184       26.8

Research and development expense consists of:

º Compensation related costs of employees and contractors engaged in internal research and product development activities,
º Laboratory operations, outsourced development and processing work, and
º Other operating expenses.

We have increased spending in research and development as part of our strategy to accelerate the time to market for products based on the PicoP. The increase in cost is primarily attributable to increases in payroll costs and contracted services.

We believe that a substantial level of continuing research and development expense will be required to develop additional commercial products using the scanned beam display technology. Accordingly, we anticipate our level of research and development spending will continue to be substantial.

Sales, marketing, general and administrative expense.

(in thousands)                         2009       2008     $ change   % change
                                     ---------  ---------  ---------  ---------
Three months ended March 31         $   3,814  $   4,135  $    (321)      (7.8)

Sales, marketing, general and administrative expense includes compensation and support costs for marketing, sales, management and administrative staff, and for other general and administrative costs, including legal and accounting services, consultants and other operating expenses.

The decrease in sales, marketing, general and administrative expense for the three months ended March 31, 2009 compared to the same period in 2008 was primarily the result of decreased payroll due to reduction in staffing levels.

We continue to aggressively manage these costs as part of our strategy to accelerate the development of PicoP-based products while controlling our cash used in operations.

Interest income.

(in thousands)                         2009       2008     $ change   % change
                                     ---------  ---------  ---------  ---------
Three months ended March 31         $      64  $     412  $    (348)     (84.5)

The decrease in interest income for the three months ended March 31, 2009 compared to the same period in 2008 resulted primarily from lower average cash, investment securities balances, and interest rates.

Interest expense.

(in thousands)                         2009       2008     $ change   % change
                                     ---------  ---------  ---------  ---------
Three months ended March 31         $      11  $      13  $      (2)     (15.4)

Gain on derivative instruments, net.

(in thousands)                         2009       2008     $ change   % change
                                     ---------  ---------  ---------  ---------
Three months ended March 31         $     180  $   1,673  $  (1,493)     (89.2)

In March and December 2005, we issued convertible notes (the "Notes") with an aggregate principal amount of $20 million. The last payment on the Notes was made in March 2007. In connection with the issuance of the Notes we issued warrants to purchase 2,302,000 shares of common stock. The warrants met the definition of derivative instruments that must be accounted for as liabilities 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 we cannot engage in certain corporate transactions affecting the common stock unless we make a cash payment to the holders of the warrants. We record changes in the fair values of the warrants in the statement of operations each period. In July 2008, warrants to purchase 750,000 shares of common stock expired unexercised. We valued the remaining warrants to purchase 1,552,000 shares of common stock at March 31, 2009 using the Black-Scholes option-pricing model with the following assumptions: expected volatilities of 75%; expected dividend yields of 0%; risk free interest rates of from 0.6% to 0.7%; and contractual lives ranging from 1.0 year to 1.7 years. The change in value of the warrants of $180,000 for the three months ended March 31, 2009 was recorded as a non-operating gain and is included in "Gain on derivative instruments, net" in the consolidated statement of operations. We valued the warrants at March 31, 2008 using the Black-Scholes option-pricing model with the following assumptions: expected volatilities ranging from 65% to 67%; expected dividend yields of 0%; risk free interest rates ranging from 1.4% to 1.7%; and contractual lives ranging from 0.3 years to 2.7 years. The change in value of the warrants of $1,736,000 for the three months ended March 31, 2008 was recorded as a non-operating gain and is included in "Gain on derivative instruments, net" in the consolidated statement of operations.

Prior to December 9, 2008, we held warrants to purchase 170,500 shares of Lumera common stock. On December 9, 2008, Lumera merged with GigOptix, LLC and the combined company now conducts business as GigOptix, Inc. Our Lumera warrants were exchanged for warrants to purchase shares of the new company's common stock, after applying a 0.125 exchange ratio and exercise price escalation. As of December 31, 2008, the fair value of the warrants was determined to be zero. As of March 31, 2008, the warrants were valued using the Black-Scholes option-pricing model with the following assumptions: expected volatility of 83%; expected dividend yields of 0%; risk free interest rates of 1.78%; and contractual lives of 3.0 years. The change in value of $64,000 for the three months ended March 31, 2008 was recorded as a non-operating loss and is included in "Gain on derivative instruments, net" in the consolidated statement of operations.

Liquidity and Capital Resources

We have funded our operations to date primarily through the sale of equity and debt securities and, to a lesser extent, from development contract revenues and product sales. At March 31, 2009, we had $19.1 million in cash, cash equivalents and investment securities, available-for-sale. Our operating plan for 2009 includes the launch of the first accessory product, further development of our PicoP display engine for embedded applications and further development of automotive HUD and eyewear applications. In order to fully fund our product launch and our other development efforts, we will require additional capital in 2009. We plan to obtain additional cash through the issuance of equity or debt securities. There can be no assurance that additional cash will be available or that, if available, it will be available on terms acceptable to us on a timely basis. If adequate funds are not available in the next couple of months to fully implement our plan we will begin to reduce the scope of the business to extend our operations as we pursue other financing opportunities and business relationships. This reduction in scope could include delaying product launch and development projects resulting in reductions in staff, operating costs, capital expenditures and investment in research and development. With these adjustments to our operating plan, we believe we currently have sufficient cash, cash equivalents, and investment securities to fund operations through at least February 28, 2010.

Cash used in operating activities totaled $8.8 million during the three months ended March 31, 2009, compared to $5.3 million during the same period in 2008. During the three months ended March 31, 2009, the increase in cash used in operating activities was primarily driven by lower contract activity and higher research and development costs as we move closer to the commercialization of PicoP based products.

We had the following material gains and charges, and changes in assets during the three months ended March 31, 2009:

º "Gain on derivative instruments, net" In connection with the issuance of the Notes, we issued warrants to purchase 2,302,000 shares of common stock, of which 1,552,000 remain outstanding as of March 31, 2009. Due to changes in our stock price and declining terms to expiry on the warrants, we recognized a $180,000 non-operating gain during the three months ended March 31, 2009.
º "Accounts payable" During the three months ended March 31, 2009, accounts payable decreased by $1,049,000 due to payments made for inventory, research and development expenses, and general operating expenses that were billed to us in 2008.

Cash used in investing activities totaled $354,000 for the three months ended March 31, 2009 compared to cash provided by investing activities of $6.5 million during the three months ended March 31, 2008. During the three months ended March 31, 2009, we used cash of $354,000 for capital expenditures, compared to $137,000 during the same period in 2008. During the three months ended March 31, 2008, we had net sales of investment securities totaling $7.0 million.

Cash generated and used in financing activities during the three months ended March 31, 2009 and 2008 was not significant.