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 recently launched a small accessory projector that is the first commercial product based on the PicoP display engine. The accessory projector can 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 are currently shipping the accessory projector in limited quantity through our Asian based distributor. We plan to add distribution channels as the production capacity for our manufacturing partner, green laser suppliers and other component suppliers increases.

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
                                       2009      revenue     2008      revenue   $ change  % change
(in thousands)                       ---------  ---------  ---------  ---------  --------- ---------
Three months ended September 30
Government revenue                  $     370       45.3  $     376       78.3  $      (6)     (1.6)
Commercial revenue                        447       54.7        104       21.7        343     329.8
                                     ---------             ---------             ---------
Total contract revenue              $     817             $     480             $     337      70.2
                                     =========             =========             =========

Nine months ended September 30
Government revenue                  $   1,412       60.3  $   1,945       51.6  $    (533)    (27.4)
Commercial revenue                        930       39.7      1,822       48.4       (892)    (49.0)
                                     ---------             ---------             ---------
Total contract revenue              $   2,342             $   3,767             $  (1,425)    (37.8)
                                     =========             =========             =========

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 becomes 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.

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 higher during the three months ended September 30, 2009 than the same period in 2008 due to an increase in revenue from contracts for prototype units offsetting a decrease in development contract revenue. Contract revenue was lower during the nine months ended September 30, 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 commercialize 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.

In July 2009, Microvision entered into a 9 month $1.0 million subcontract with Lockheed Martin Corporation to supply two full-color, daylight readable, see-through display systems as part of the U.S. government's Urban Leader Tactical Response, Awareness & Visualization program. Lockheed Martin holds a prime contract with the U.S. government for development of the soldier worn display.

Our backlog of development contracts, including orders for prototype units, at September 30, 2009 was $103,000 compared to $336,000 at September 30, 2008, all of which is scheduled for completion during the next twelve months.

Product revenue.

                                                  % of                  % of
                                                 product               product
                                       2009      revenue     2008      revenue   $ change  % change
(in thousands)                       ---------  ---------  ---------  ---------  --------- ---------
Bar code revenue
Three months ended September 30     $     107      100.0  $     414      100.0  $    (307)    (74.2)
Nine months ended September 30            520      100.0      1,319      100.0  $    (799)    (60.6)

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 and six months ended September 30, 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. As a result of this downturn we have reduced our sales and marketing efforts on the bar code product. We do not expect to increase our investment in the bar code product in the future and we are currently evaluating opportunities to sell our existing bar code inventory, sell or license our bar code production capability and technology.

The backlog of product orders at September 30, 2009 was approximately $1,874,000, compared to $311,000 at September 30, 2008, all of which is scheduled for delivery during the next twelve months. The backlog at September 30, 2009 included $1,710,000 of orders for our recently introduced PicoP based accessory product.

Cost of contract revenue.

                                                  % of                  % of
                                                contract              contract
                                       2009      revenue     2008      revenue   $ change  % change

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, as a percentage of contract revenue, was lower during the three months ended September 30, 2009 than the same period in 2008 as a result of the cost mix of the contracts during those periods and the sale of prototype units that have been previously expensed to internally funded programs. Cost of contract revenue was lower during the nine months ended September 30, 2009 than September 30, 2008 as a result of the decreased activity on development contracts. The increase in cost of contract revenue as a percentage of contract revenue during the nine month periods ended September 30, 2009 compared to the same periods in 2008 was also the result of differences in the cost mix of the contracts during those periods.

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
                                       2009      revenue     2008      revenue   $ change  % change
(in thousands)                       ---------  ---------  ---------  ---------  --------- ---------
Three months ended September 30     $     720      672.9  $     356       86.0  $     364     102.2
Nine months ended September 30          1,504      289.2      1,224       92.8        280      22.9

Cost of product revenue includes both the direct and allocated indirect costs of manufacturing products sold to customers. Direct costs include labor, materials and other costs incurred directly in the manufacture of these products. 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 September 30, 2009 and 2008, we expensed approximately $33,000 and $40,000, respectively, of manufacturing overhead associated with production capacity in excess of production requirements. For the nine months ending September 30, 2009 and 2008, we expensed approximately $168,000 and $112,000, respectively, of manufacturing overhead associated with production capacity in excess of production requirements.

The Company has periodically entered into noncancelable purchase contracts in order to ensure the availability of materials to support bar code scanner production. Management periodically assesses the need to provide for the impairment on these purchase contracts and records a loss on purchase commitments when required. As a result of lower than planned ROV revenue, cost of product revenue for the three and nine month periods ending September 30, 2009 includes approximately $638,000 and $978,000 of inventory write-downs, respectively. In addition, cost of product revenue for the nine months ended September 30, 2009 included $19,000 for noncancelable purchase contracts that were in excess of estimated future proceeds from the sale of the ROV scanners.

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.

2009 2008 $ change % change (in thousands) --------- --------- --------- --------- Three months ended September 30 $ 5,839 $ 5,804 $ 35 0.6 Nine months ended September 30 17,165 16,111 1,054 6.5

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 during the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 is primarily attributable to increases in payroll costs and direct materials.

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.

2009 2008 $ change % change (in thousands) --------- --------- --------- --------- Three months ended September 30 $ 3,283 $ 3,456 $ (173) (5.0) Nine months ended September 30 10,764 11,694 (930) (8.0)

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 and nine months ended September 30, 2009 compared to the same periods in 2008 was primarily the result of decreased payroll costs due to reductions 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.

                                       2009       2008     $ change   % change
(in thousands)                       ---------  ---------  ---------  ---------
Three months ended September 30     $      45  $     271  $    (226)     (83.4)
Nine months ended September 30            188        962       (774)     (80.5)

The decrease in interest income for the three and nine months ended September 30, 2009 compared to the same period in 2008 resulted primarily from lower average cash, investment securities balances, and interest rates.

Interest expense.

                                       2009       2008     $ change   % change
(in thousands)                       ---------  ---------  ---------  ---------
Three months ended September 30     $      19  $      11  $       8       72.7
Nine months ended September 30             50         36         14       38.9

Gain (loss) on derivative instruments, net.

                                       2009       2008     $ change   % change
(in thousands)                       ---------  ---------  ---------  ---------
Three months ended September 30     $  (2,246) $     585  $  (2,831)    (483.9)
Nine months ended September 30         (3,048)     2,004     (5,052)    (252.1)

In March and December 2005, 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, (ASC 815) 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 statements 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 September 30, 2009 using the Black-Scholes option-pricing model with the following assumptions: expected volatilities of 78%; expected dividend yields of 0%; risk free interest rates of from 0.4% to 0.5%; and contractual lives ranging from 0.5 year to 1.2 years. The change in value of the warrants of $2,246,000 for the three months and $3,048,000 for the nine months ended September 30, 2009 was recorded as a non-operating loss and is included in "Gain
(loss) on derivative instruments, net" in the consolidated statements of operations. The realized losses were primarily due to changes in the Microvision stock price and decreasing terms to expiration. We valued the warrants at September 30, 2008 using the Black-Scholes option-pricing model with the following assumptions: expected volatilities of 69%; expected dividend yields of 0%; risk free interest rates ranging from 1.9% to 2.1%; and contractual lives ranging from 1.5 years to 2.2 years. The change in value of the warrants of $599,000 for the three months and $2,134,000 for the nine months ended September 30, 2008 were recorded as a non-operating gain and are included in "Gain (loss) on derivative instruments, net" in the consolidated statements 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 September 30, 2008, the warrants were valued using the Black-Scholes option-pricing model with the following assumptions: expected volatility of 127%; expected dividend yields of 0%; risk free interest rates of 2.13%; and contractual lives of 2.5 years. The change in value of $14,000 for the three months and $130,000 for the six months ended September 30, 2008 was recorded as a non-operating loss and is included in "Gain (loss) on derivative instruments, net" in the consolidated statements 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 September 30, 2009, we had $20.5 million in cash, cash equivalents and investment securities, available-for-sale. In October 2009, we raised $2,110,000 from the exercise of warrants to purchase 587,332 shares of common stock. Our operating plan for 2009 and 2010 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 operating plan for 2010, we will require additional capital. 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 by January 2010, we intend to consider reducing the scope of our business to extend our operations as we pursue other financing opportunities and business relationships. This reduction in scope could include delaying 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 that we currently have sufficient cash, cash equivalents, and investment securities to fund operations into June 2010.

Cash used in operating activities totaled $23.5 million during the nine months ended September 30, 2009, compared to $22.3 million during the same period in 2008. During the nine months ended September 30, 2009, the increase in cash used in operating activities was primarily driven by lower contract activity and higher research and development costs as we commercialize PicoP based products.

We had the following material gains and charges, and changes in assets and liabilities during the nine months ended September 30, 2009:

º "Gain on derivative instruments, net" In March and December 2005 we issued warrants to purchase 2,302,000 shares of common stock, of which 1,552,000 remain outstanding as of September 30, 2009. Due to changes in our stock price, we recognized a $3,048,000 non-operating loss during the nine months ended September 30, 2009.
º "Inventory write-downs" During the nine months ended September 30, 2009, we recorded $978,000 of inventory write-downs due to lower than planned ROV revenue.
º "Accounts payable" During the nine months ended September 30, 2009, accounts payable decreased by $286,000 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 $729,000 for the nine months ended September 30, 2009 compared to cash provided by investing activities of $15.5 million during the nine months ended September 30, 2008. During the nine months ended September 30, 2009, we used cash of $729,000 for capital expenditures, compared to $320,000 during the same period in 2008. During the nine months ended September 30, 2008, we had net sales of investment securities totaling $15.9 million.

Cash provided by financing activities totaled $16.4 million for the nine months ended September 30, 2009 compared to $24.4 million during the same period in 2008. In June 2009, we raised approximately $15.0 million, before issuance costs of approximately $217,000, from the sale of 8,076,239 shares of common stock and warrants to purchase 2,019,060 shares of our common stock. The warrants have an exercise price of $2.1850 per share, a three year term, and are exercisable on the date of issuance. We can call the warrants after six months and once the shares are registered if the average closing bid price of its stock is over $8.74 for any 20 consecutive trading days. In addition, in September 2009, we raised $1,475,000 from the exercise of warrants to purchase 451,795 shares of common stock.