MVIS

Business Context and Reporting Period

Company: Microvision, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2006
Business Overview: Microvision designs and markets scanned beam display and image capture products, including the Nomad wearable computer and Flic laser barcode scanners. The company is developing a modular integrated photonics module for automotive head-up displays, pico projectors, and color eyewear.

Key Financial Metrics

Operating Cash Flow: Net cash used in operating activities was $8.5 million for Q1 2006, compared to $4.8 million in Q1 2005.
Investing Cash Flow: Net cash provided by investing activities was $10.2 million, primarily driven by proceeds from the sale of Lumera securities.
Financing Cash Flow: Net cash used in financing activities was $1.5 million, largely due to principal payments on notes payable.

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 38% to $2.47 million, driven by a 47% drop in contract revenue ($1.78 million vs. $3.38 million) due to lower commercial contract backlog. Product revenue increased 15% to $0.69 million.
• Profitability Shift: The company reported a net income of $0.48 million, a significant turnaround from a net loss of $6.9 million in the prior year. This was primarily due to a one-time gain on sale of securities of equity subsidiary (Lumera) of approximately $7.3 million.
• Gross Margin Compression: Gross margin collapsed to $27,000 (1% margin) from $1.0 million (25% margin). This was caused by high cost of product revenue ($1.29 million) relative to low product sales volume, including $272,000 in expensed manufacturing overhead and $30,000 in inventory write-offs.
• Interest Expense Surge: Interest expense increased 854% to $1.82 million due to the amortization of discounts on convertible notes issued in 2005.
• Derivative Gains: The company recorded a $1.87 million gain on derivative instruments, offsetting some operating losses.

Guidance, Outlook, and Risks

• Liquidity Warning: Management states that current cash and investments ($8.3 million) will fund operations only through June 2006. Additional capital is required to continue operations beyond this date. There is no assurance that financing will be available on acceptable terms.
• Cost Reductions: In February 2006, the company terminated 16 employees (10% of the workforce), recording $493,000 in severance expenses. If funding is not secured, further reductions in staff and capital expenditures may be necessary.
• Product Development: The company is focusing on commercializing the Nomad system and developing prototypes for automotive head-up displays and pico projectors. It expects to define business cases for Nomad in the first half of 2006.
• Accounting Changes: The company adopted FAS 123(R) effective January 1, 2006, resulting in an additional $416,000 in share-based compensation expense for the quarter.
• Subsequent Events: On May 3, 2006, the company converted Series A Preferred Stock into common stock, issuing "Incentive Shares" which may result in a conversion inducement charge in Q2 2006.

Investor Verification Checklist

• Runway Confirmation: Verify the timeline and status of the planned capital raise required to fund operations beyond June 2006.
• Recurring Profitability: Assess the sustainability of operations excluding the $7.3 million one-time gain from the Lumera sale, as core operations remain loss-generating.
• Contract Backlog: Review the $1.3 million development contract backlog and the $92,000 product order backlog to gauge near-term revenue visibility.
• Debt Obligations: Monitor the $7.96 million current portion of notes payable and the associated high interest expense and derivative liabilities.
• Inventory Valuation: Review the $762,000 inventory balance and the history of write-offs ($30,000 in Q1 2006) for potential future impairments.