MVIS

Business Context and Reporting Period

Company: Microvision, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Business Overview: Microvision designs and markets information display and image capture products, primarily utilizing scanned beam display technology. Key products include the Nomad wearable computer and the Flic laser bar code scanner. The company generates revenue through commercial product sales and development contracts with the U.S. government and commercial customers. Following the initial public offering of its former subsidiary, Lumera Corporation, in July 2004, Microvision accounts for its remaining 30% ownership in Lumera using the equity method.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue for the six months ended June 30, 2005, increased 62% to $8.7 million from $5.4 million in the prior year period. This was driven by a 72% increase in contract revenue ($7.1 million vs. $4.1 million) and a 30% increase in product revenue ($1.6 million vs. $1.3 million).
• Cost of Revenue: Cost of product revenue increased 158% to $3.4 million, largely due to $1.4 million in inventory write-downs attributed to product design changes and obsolescence. Cost of contract revenue increased 46% to $3.5 million due to higher direct labor and overhead allocation.
• Operating Expenses: Research and development (R&D) expenses decreased 51% to $3.9 million, primarily due to the shift from consolidating Lumera to equity accounting and the reclassification of manufacturing overhead. Sales, marketing, and general/administrative expenses decreased 7% to $9.1 million.
• Non-Operating Items: The company recorded a $1.6 million gain on the sale of Lumera equity method investment and a $1.1 million gain on the change in fair value of embedded derivative features of convertible notes. Conversely, interest expense increased significantly to $1.1 million due to the March 2005 issuance of convertible notes.
• Liquidity: Cash and cash equivalents increased to $2.3 million from $1.3 million at the end of 2004, supported by $10.7 million in proceeds from financing activities (convertible notes and warrants) and $2.3 million from the sale of Lumera stock.

Guidance, Outlook, and Risks

• Liquidity Outlook: Management states that current cash ($2.3 million) plus $5.0 million in proceeds from a subsequent August 2005 stock sale will fund operations through September 2005. The company explicitly states it will require additional financing to fund operations beyond that date.
• Financing Risks: There is no assurance that additional financing will be available on acceptable terms. Failure to secure funds could force substantial reductions in operations, capital expenditures, and staff.
• Debt Covenants: The Senior Secured Exchangeable Convertible Notes issued in March 2005 include limitations on incurring additional debt or liens, which may restrict future financing options. The notes are convertible into Microvision or Lumera stock (though an amendment in July 2005 removed the Lumera exchange feature).
• Market Acceptance: Future success depends on the market acceptance of scanned beam technology and the ability to lower production costs for Nomad and Flic products to competitive levels.
• Legal and Regulatory: Risks include potential patent infringement lawsuits, product liability claims related to eye-scanning technology, and the possibility that recent note issuances may not have been exempt from registration requirements, potentially leading to rescission claims.

Investor Verification Checklist

• Cash Runway: Verify the status of the August 2005 financing agreement and the company's ability to secure additional capital before September 2005.
• Inventory Valuation: Review the $1.4 million inventory write-downs and assess the risk of future obsolescence given the rapid technological changes in the display industry.
• Debt Structure: Analyze the terms of the convertible notes, specifically the conversion prices, redemption triggers, and the impact of the July 2005 amendment on dilution and liquidity.
• Lumera Investment: Monitor the market value of the Lumera investment (approx. $23.9 million total, with $15.5 million unpledged) as a potential source of liquidity or collateral.
• Contract Concentration: Note that a single commercial contract accounted for 64% of contract revenue in the first six months of 2005; assess the risk of concentration in government and commercial development contracts.