This report contains 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 those sections. 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," "could," "believe," "estimate," "expect," "goal," "may," "plan," "project," "will," and similar expressions identify forward-looking statements. 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 below in Item 1A.

We are developing miniature display and imaging engines based upon our integrated photonics module technology platform. Our technology platform combines two dimensional Micro-Electrical Mechanical system (MEMS) light scanning technologies, lasers, optics, electronics, and our system controls expertise into compact display or imaging solutions that we anticipate will lead to new applications and high-volume products in the consumer and automotive markets. Historically, we have entered into development agreements with commercial and U.S. government customers to develop advanced prototype and demonstration units based on our light scanning technologies.

In 2006, we announced our strategy to develop and supply a proprietary display engine called PicoP™. The PicoP display engine enables an ultra-miniature video projector capable of producing color rich, high resolution, large images, but is small and low power enough to be embedded directly into mobile devices, such as cell phones. PicoP-based miniature display engines are being marketed to potential original equipment manufacturer (OEM) customers who would embed them into a variety of consumer and automotive products. The primary objective for consumer applications is to provide mobile device users with a large screen viewing experience produced by a small embedded projector. Mobile devices may include cell phones, portable media players, PDAs, gaming consoles, laptop computers, digital cameras, and other consumer electronics products. These potential products would allow users to watch movies, play videos, and display images and other data onto a variety of surfaces. The PicoP display engine, with some modification, could be embedded into a vehicle or integrated into a portable standalone aftermarket device to create a head-up display (HUD) that could project point-by-point navigation, critical operational, safety and other information important to the vehicle operator. The PicoP display engine could also be 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.

The development and procurement of intellectual property rights relating to our technologies is a key aspect of our business strategy. We generate intellectual property as a result of our ongoing performance on development contracts and our internal research and development activities. We also have acquired under license agreements exclusive rights to various technologies.

Our bi-directional MEMS scanning mirror is the key component of our integrated technology platform and is one of our core competencies. Our MEMS design is a silicon device at the center of which is a tiny mirror. This mirror is connected to small flexures which allow it to oscillate. The 2D MEMS scanner oscillates vertically and horizontally to capture (imaging) or reproduce (display) an image pixel-by-pixel. 2D MEMS scanners are used in our PicoP display engine that powers Pico Projector Displays, Vehicle Displays, and Wearable Displays. A 1D MEMS scanner used in our ROV Bar Code Scanner oscillates along one axis only and is used to capture a bar code image.

Our PicoP display engine technology platform includes a MEMS Scanner, laser light sources, electronics, and optics combined using Microvision's proprietary system control expertise, gained through years of internal research and development. Our unique display and imaging engines use a single beam of laser light and a single small scanning mirror to create a brilliant, full color, high contrast, uniform display over the entire field of view, from a small and thin package.

We believe that our proprietary light scanning technology offers significant advantages over traditional display and imaging systems. Depending on the specific product application, these advantages may include:

• Small and thin package size
• Higher brightness and contrast
• Higher resolution
• Clear text readability
• Reduced power requirements
• Simpler optical design that does not require a focusing lens
• Lower price at volume

Our business strategy is to promote our technology in the form of integrated and embedded components to leading OEMs for widespread use in display and imaging product applications, as well as leverage our technology expertise into our own end-user products. Presently we are focused on the following steps to implement our business strategy:

• Target leading OEMs to integrate our PicoP display engines into their products. We have also worked with original design manufacturers and Tier 1 suppliers to produce advanced prototypes and demonstration units to be used to market to our partners' OEM customers directly by us or by our partners.
• Expand and solidify the supply chain architecture to support high volume manufacturing of the PicoP display engine, its subsystems and its components.
• Continue to promote awareness of our technology platform to all members of the value chain. We have been continually in contact with OEMs, original design manufacturers and mobile content providers to understand the features our PicoP display engines must have in order to provide desired benefits to all members of the value chain. We have and will continue to consider this information in connection with the design and development of our technology platform.
• Continue rapid advancement of our technology platform and roadmap.

We are working with partners to develop small projector displays as stand alone systems or embedded into mobile products. The display industry is calling this new class of projectors "pico projectors." We believe our PicoP display engine can meet the size, power and performance requirements to be embedded into portable hand-held devices including mobile phones or function as a stand alone accessory device that connects to a mobile video source such as a personal media player, cell phone or laptop computer. We plan to enter into agreements with OEMs that will result in production and a distribution of the PicoP-based products.

In January 2009, we demonstrated our pre-production pico projector named SHOW WX™ at both Macworld in San Francisco and at the Consumer Electronics Show in Las Vegas. At 118mm long by 60mm wide by 14mm thick, it is about 25% smaller than the SHOW™ prototype that we unveiled at the 2008 Consumer Electronics Show. The SHOW WX is a battery operated plug-and-play projector that can project a full color, WVGA (848 X 480 pixels), DVD quality image with vivid colors and exceptional contrast. We plan to provide a number of these pre-production pico projectors to select OEM and carrier partners for evaluation in the first half of 2009. Initial commercial production is expected to begin in mid 2009, followed by larger commercial quantities in the second half of the year. We have entered into an agreement with a high volume manufacturer that we plan to have build the PicoP display engine and integrate it into finished products. We are evaluating multiple distribution channels to bring the first PicoP-based accessory projector to market.

We believe an automotive head-up display (HUD) improves driver safety by reducing the distraction of looking away from the road to read information such as GPS mapping images, audio controls and other automobile instrumentation. Working independently and with Tier 1 suppliers, we have produced prototypes that demonstrate our PicoP's ability to project a high-resolution readable image during day or night onto the windshield of an automobile to provide the driver with a variety of information related to the car's operation. We believe that an automotive HUD based on the PicoP display engine offers three distinct advantages over competing head-up displays:

• Size - Our prototype display is less than half the size of current competitive offerings. This smaller form factor can accommodate a wider variety of vehicle configurations.

• Contrast Ratio - Our prototype has a contrast ratio an order of magnitude higher than current competitive offerings. The high contrast ratio allows the driver to see the display clearly in any ambient lighting conditions.

• Installation Cost - Our prototype can be electronically customized to match the unique curvature of a particular automobile's windshield, thereby reducing installation time and cost. The current competitive offerings must be manually adjusted to match the curvature of a windshield.

We have worked with various Tier 1 automotive suppliers to develop PicoP enabled HUD prototypes and market them to their OEM customers. We have also developed a portable full color head-up display demonstrator powered by the PicoP display engine to showcase the capabilities of the PicoP display engine for potential use in automobiles, specialty vehicles, trucks, buses and motor coaches. We expect that our PicoP display engine subsystem could be integrated by a Tier 1 supplier into their HUD product package for sale to automobile manufacturers or by a product integrator into an aftermarket product for direct sale to their customers.

We believe the PicoP display engine can be modified and integrated with a light-weight optical design to create a full color near-eye wearable display platform. This wearable display platform could be in the form of ruggedized helmet mounted display systems or lightweight fashionable eyewear displays. Wearable displays could be used to provide personal viewing of information that originates from a mobile device and arrives at the display through a wired or wireless connection. We believe that wearable displays based on the PicoP display engine could provide the following advantages over competing wearable display technologies:

• See-through performance - See-through eyewear displays enable the wearer to interact with the real world and their personal mobile services at the same time. Unlike competing wearable displays, a see-through display does not obstruct the wearer's vision or reduce their awareness of what is happening around them.

• Daylight readability - The high-brightness capability of color eyewear based on the PicoP display engine enables images to be clearly visible in brightly lit ambient environments, including direct sunlight. Current LCD-based head worn displays are difficult to see in bright light environments.

• Fashion and ergonomics - We are developing thin and lightweight optics that can be integrated with the PicoP display engine so that our OEM partners can design wearable displays that match conventional eyewear frames in size and weight and provide significantly improved ergonomics compared to competing wearable displays.

We are working with the US military and commercial customers to further develop the optical design and integration of the PicoP display engine for military applications such as helmet mounted displays and full color see-through eyewear. We plan to work with OEMs and system integrators to incorporate the PicoP display engine into integrated solutions for potential military and commercial customers. In 2008, we entered into contracts with commercial and government customers to develop high definition (720p) eyewear displays.

We currently market our line of ROV hand held bar code scanners and bar code scanner enabled enterprise solutions. The ROV Scanner incorporates our proprietary MEMS technology and is designed to accommodate mobile workers who need simple and affordable data collection solutions on the mobile platforms of their choosing. The ROV Scanner has lower power consumption and total operating cost than many competing laser bar code scanners. ROV Scanners are manufactured for us by a contract manufacturer located in Malaysia. We distribute ROV Scanners directly to end users through value added resellers, original equipment manufacturers and phone and internet orders.

We are evaluating opportunities to widely market our products using a variety of distribution channels such as establishing partnerships with OEMs and distributors and establishing infrastructure to support direct marketing through web-based, retail or other outlets. Our products may carry the Microvision brand or be branded and distributed by our OEM or distribution partners.

Certain potential applications using the PicoP display engines, such as an automotive HUD or pico projector for mobile phones, could require integration of our technology with other related technologies. In markets requiring high volume production of the PicoP display engine components or subsystems that are to be integrated with other components, we may provide designs for components, subsystems and systems to OEMs under licensing agreements.

We expect that some customers will require unique designs for their products. We expect that such relationships will generally involve a period of co-development during which engineering, manufacturing and marketing professionals from potential customers and OEMs would work with our technical staff to modify the PicoP display engine for their targeted market and application. We may charge fees to our customers or OEMs to fund the costs of the engineering effort incurred on such development projects. The nature of the relationships with such customers or OEMs may vary from partner to partner depending on the proposed specifications for the PicoP display engine, the product to be developed, and the customers' or OEMs' design, manufacturing and distribution capabilities. We believe that by limiting our own direct manufacturing investment for products, we will reduce our capital requirements and risks inherent in taking the PicoP display engine to the consumer market.

As part of our research and development activities, we conduct ongoing research on safety factors that must be addressed by products incorporating our technology, including such issues as the maximum permissible laser exposure limits established by International Electrotechnical Commission ("IEC") and others. Independent experts have concluded that laser exposure to the eye resulting from use of the light scanning displays under normal operating conditions would be below the calculated maximum permissible exposure level set by IEC.

In addition, Microvision works with and commissions outside independent experts in the field of laser safety to assist in meeting safety specifications as requested by our customers.

The information display industry is highly competitive. Our potential display products will compete with established manufacturers of mature display technologies such as miniaturized cathode ray tube and flat panel display devices, as well as companies developing new display technologies. Our competitors include companies such as Texas Instruments Incorporated, 3M, and Light Blue Optics Ltd. in the pico projection display segment and Siemens VDO and Nippon Seiki in the vehicle displays segment, most of which have much greater financial, technical and other resources than we do. Many of our competitors are developing alternative miniature display technologies. Our competitors may succeed in developing information display technologies and products that could render our technology or our proposed products commercially infeasible or technologically obsolete.

Pico projectors are an emerging class of miniature projectors that are generally handheld, battery operated, mobile projectors. Most of the competing projectors currently on the market or planned for introduction in the next 6-12 months are primarily based on either liquid crystal on silicon (LCOS) panel solutions or Texas Instruments' DLP™ display technology. Each of these solutions can create images from a small form factor of varying resolution, brightness, image quality, battery life, and ease of use.

The information display industry has been characterized by rapid and significant technological advances. Our technology and potential products may not remain competitive with such advances, and we may not have sufficient funds to invest in new technologies, products or processes. Although we believe our technology platform and proposed display products could deliver images of a substantially better quality and resolution from a smaller form factor device than those of commercially available miniaturized liquid crystal displays and cathode ray tube based display products, manufacturers of liquid crystal displays and cathode ray tubes may develop further improvements of screen display technology that could reduce or eliminate the anticipated advantages of our proposed products.

We compete with other companies in the display industry and other technologies for government funding. In general, our government customers plan to integrate our technology into larger systems. Ongoing contracts are awarded based on our past performance on government contracts, the customer's progress in integrating our technology into the customer's overall program objectives, and the status of the customer's overall program.

The image capture industry is also highly competitive. Our current and planned bar code products will compete with existing laser and wand-type scanners produced by established bar code companies. Our current products compete on the basis of price and performance.

We generate intellectual property as a result of our ongoing performance on development contracts and our internal research and development activities. The inventions covered by our patent applications generally relate to component miniaturization, specific implementation of various system components and design elements to facilitate mass production. We consider protection of these key enabling technologies and components to be a fundamental aspect of our strategy to penetrate diverse markets with unique products. As such, we intend to continue to develop our portfolio of proprietary and patented technologies at the system, component and process levels.

Since our inception in 1993, we have acquired under license agreements exclusive rights to various technologies, including, among others, rights related to the ability to superimpose images on the user's field of view and with a retinal display, and rights related to the design and fabrication of micro miniature devices using semiconductor fabrication techniques. In some cases, the licensors have retained limited, non-commercial rights with respect to the technology, including the right to use the technology for non-commercial research and for instructional purposes. Some licensors have the right to consent to our sublicensing arrangements and to the prosecution and settlement by us of our of infringement disputes.

Our ability to compete effectively in the display and image capture market will depend, in part, on our ability and the ability of the licensors to maintain the proprietary nature of these technologies.

We also rely on unpatented proprietary technology. To protect our rights in these areas, we require all employees and, where appropriate, contractors, consultants, advisors and collaborators, to enter into confidentiality and non-compete agreements. There can be no assurance, however, that these agreements will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.

Among the marks we have registered are "MicroHud" and the "tri-curve" logo with the United States Patent and Trademark Office. We have filed for registration of various other marks including "PicoP" and "ROV" with the United States Patent and Trademark Office.

We perform research and development to design and develop our technology platform and modifications to the PicoP display engine that will be required for specific applications. Research and development expense for the fiscal years ended December 31, 2008, 2007 and 2006 was $22.6 million, $14.9 million, and $10.7 million, respectively. Substantially all of our revenue has been generated from development contracts to develop the light scanning technology to meet customer specifications. Our customers have included both the United States government and commercial enterprises. In 2008, 34% of revenue was derived from performance on development contracts with the United States government, 40% from performance on development contracts with commercial customers and the remainder from sales of ROV and Flic units. Two commercial customers accounted for 15% and 11%, respectively, of total revenue in 2008. In 2007, 61% of revenue was derived from performance on development contracts with the United States government, 25% from performance on development contracts with commercial customers and the remainder from sales of ROV, Flic and Nomad units. One commercial customer accounted for approximately 15% of total revenue during 2007. In 2006, 51% of revenue was derived from performance on development contracts with the United States government, 24% from performance on development contracts with commercial customers and the remainder from sales of Flic and Nomad units. One commercial customer accounted for approximately 11% of total revenue during 2006. Our contracts with the United States government can be terminated for convenience by the United States government at any time. See Management's Discussion and Analysis of Financial Condition and Results of Operations.

We had a backlog of $1.2 million at December 31, 2008 compared to a backlog of $4.1 million at December 31, 2007. The backlog at December 31, 2008, is composed of $714,000 in government development contracts and $228,000 in commercial development contracts entered into through December 31, 2008 and $276,000 in orders for ROV. Microvision plans to complete all of the backlog contracts by the end of 2009.

As of February 17, 2009, we had 165 employees.

Microvision was founded in 1993 as a Washington corporation and reincorporated in 2003 under the laws of the State of Delaware. Our principal office is located at 6222 185^th Avenue NE, Redmond WA 98052 and our telephone number is 425-936-6847.

Our Internet address is www.microvision.com. We make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Investors can access this material by visiting our website, clicking on "Investors" and then on "SEC Filings."

We have had substantial losses since our inception. We cannot assure you that we will ever become or remain profitable.

• As of December 31, 2008, we had an accumulated deficit of $292.0 million.
• We incurred consolidated net losses of $215.6 million from inception through 2005, $24.0 million in 2006, $19.8 million in 2007, and $32.6 million in 2008.

The likelihood of our success must be considered in light of the expenses, difficulties and delays frequently encountered by companies formed to develop and market new technologies. In particular, our operations to date have focused primarily on research and development of our technology platform and development of demonstration units. We are unable to accurately estimate future revenues and operating expenses based upon historical performance.

We cannot be certain that we will succeed in obtaining additional development contracts or that we will be able to obtain substantial customer orders for our products. In light of these factors, we expect to continue to incur substantial losses and negative cash flow at least through 2009 and likely thereafter. We cannot be certain that we will achieve positive cash flow at any time in the future.

Our operating plan for 2009 includes the launch of our first accessory product, further development of the 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. We will require additional capital in the future to fund our operations, including to:

• Further develop the technology platform and PicoP display engine,
• Develop and protect our intellectual property rights, and
• Fund long-term marketing and business development opportunities.

Our capital requirements will depend on many factors, including, but not limited to, the rate at which we can, directly or through arrangements with original equipment manufacturers, introduce products incorporating the PicoP display engine and image capture technologies and the market acceptance and competitive position of such products. If revenues are less than we anticipate, if the level and mix of revenues vary from anticipated amounts and allocations or if expenses exceed the amounts budgeted, we may require additional capital earlier than expected to further the development of our technologies, for expenses associated with product development, and to respond to competitive pressures or to meet unanticipated development difficulties. In addition, our operating plan provides for the development of strategic relationships with systems and equipment manufacturers that may require additional investments by us.

Additional capital may not be available to us, or if available, on terms acceptable to us or on a timely basis. Raising additional capital may involve issuing securities with rights and preferences that are senior to our common stock and may dilute the value of current shareholders' shares. If adequate funds are not available in the next several months to fully implement our plan we will begin to reduce 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 product launch and projects resulting in reductions in staff and operating costs as well as reductions in 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.

We are currently negotiating component pricing with suppliers for our future products. The cost per unit for PicoP based accessory projectors currently exceeds the level at which we could expect to profitably sell these products. If we cannot lower our cost of production, we may face increased demands on our financial resources, possibly requiring additional equity and/or debt financing to sustain our business operations.

Our success will depend in part on customer acceptance of the PicoP display engine. The PicoP display engine may not be accepted by manufacturers who use display technologies in their products, by systems integrators who incorporate our products into their products or by end users of these products. To be accepted, the PicoP display engine must meet the expectations of our potential customers in the consumer, defense, industrial, and medical markets. If our technology fails to achieve market acceptance, we may not be able to continue to develop our technology platform.

We rely on and will continue to rely on technologies, such as light sources, MEMS and optical components that are developed and produced by other companies. The commercial success of certain of our planned future products will depend in part on advances in these and other technologies by other companies. We may, from time to time, contract with and support companies developing key technologies in order to accelerate the development of them for our specific uses. There are no guarantees that such activities will result in useful technologies or components for us.

Our common stock is listed for quotation on The NASDAQ Global Market. To keep our listing on this market, we must meet NASDAQ's listing maintenance standards. If we are unable to continue to meet NASDAQ's listing maintenance standards, our common stock could be delisted from The NASDAQ Global Market. If our common stock were delisted, we likely would seek to list the common stock on the NASDAQ Capital Market, the American Stock Exchange or on a regional stock exchange. Listing on such other market or exchange could reduce the liquidity for our common stock. If our common stock were not listed on the Capital Market or an exchange, trading of our common stock would be conducted in the over-the- counter market on an electronic bulletin board established for unlisted securities or directly through market makers in our common stock. If our common stock were to trade in the over-the-counter market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the common stock. A delisting from The NASDAQ Global Market and failure to obtain listing on such other market or exchange would subject our securities to so-called penny stock rules that impose additional sales practice and market-making requirements on broker-dealers who sell or make a market in such securities. Consequently, removal from The NASDAQ Global Market and failure to obtain listing on another market or exchange could affect the ability or willingness of broker-dealers to sell or make a market in our common stock and the ability of purchasers of our common stock to sell their securities in the secondary market. In addition, when the market price of our common stock is less than $5.00 per share, we become subject to penny stock rules even if our common stock is still listed on The NASDAQ Global Market. While the penny stock rules should not affect the quotation of our common stock on The NASDAQ Global Market, these rules may further limit the market liquidity of our common stock and the ability of investors to sell our common stock in the secondary market. The market price of our stock has mostly traded below $5.00 per share during 2008, 2007, and 2006. On February 17, 2009, the closing price of our stock was $1.34.

Our current products and potential future products will compete with established manufacturers of existing products and companies developing new technologies. Many of our competitors have substantially greater financial, technical and other resources than we have. Because of their greater resources, our competitors may develop products or technologies that are superior to our own. The introduction of superior competing products or technologies could result in reduced revenues, lower margins or loss of market share, any of which could reduce the value of our business.

The information display industry has been characterized by rapidly changing technology, accelerated product obsolescence and continuously evolving industry standards. Our success will depend upon our ability to further develop our technology platform and to cost effectively introduce new products and features in a timely manner to meet evolving customer requirements and compete with competitors' product advances.

We may not succeed in these efforts because of:

• delays in product development,
• lack of market acceptance for our products, or
• lack of funds to invest in product development and marketing.

The occurrence of any of the above factors could result in decreased revenues, market share and value.

We are aware of several patents held by third parties that relate to certain aspects of light scanning displays and image capture products. These patents could be used as a basis to challenge the validity, limit the scope or limit our ability to obtain additional or broader patent rights of our patents or patents we have licensed. A successful challenge to the validity of our patents or patents we have licensed could limit our ability to commercialize our technology and the PicoP display engine and, consequently, materially reduce our revenues. Moreover, we cannot be certain that patent holders or other third parties will not claim infringement by us with respect to current and future technology. Because U.S. patent applications are held and examined in secrecy, it is also possible that presently pending U.S. applications will eventually be issued with claims that will be infringed by our products or our technology. The defense and prosecution of a patent suit would be costly and time consuming, even if the outcome were ultimately favorable to us. An adverse outcome in the defense of a patent suit could subject us to significant cost, to require others and us to cease selling products that incorporate the PicoP display engine, to cease licensing our technology or to require disputed rights to be licensed from third parties. Such licenses, if available, would increase our operating expenses. Moreover, if claims of infringement are asserted against our future co-development partners or customers, those partners or customers may seek indemnification from us for damages or expenses they incur.

Products incorporating the PicoP display engine could become subject to new health and safety regulations that would reduce our ability to commercialize the PicoP display engine. Compliance with any such new regulations would likely increase our cost to develop and produce products using the PicoP display engine and adversely affect our financial results.

Currently, the majority of our distributor relationships for the ROV Scanner and its accessories involve the distributor taking inventory positions and reselling to multiple customers. With these distributor relationships, we do not recognize revenue until the distributors sell the product through to their end user customers. Our distributor relationships reduce our ability to forecast sales and increases risks to our business. Since our distributors act as intermediaries between us and the end user customers, we must rely on our distributors to accurately report inventory levels and production forecasts. This requires us to manage a more complex supply chain and monitor the financial condition and credit worthiness of our distributors and the end user customers. Our failure to manage one or more of these risks could result in excess inventory or shortages that could adversely impact our operating results and financial condition.

Our ROV sales are made on the basis of purchase orders rather than long-term commitments. Our customers may cancel or defer purchases at any time. This requires us to forecast demand based upon assumptions that may not be correct. If our customers or we overestimate demand, we may create inventory that we may not be able to sell or use, resulting in excess inventory, which could become obsolete or negatively affect our operating results. Conversely, if our customers or we underestimate demand, or if sufficient manufacturing capacity is not available, we may lose revenue opportunities, damage customer relationships and we may not achieve expected revenues.

Our success depends, in part, on our ability to gain acceptance of our current and future products by a large number of customers. Achieving market acceptance for our products will require marketing efforts and the expenditure of financial and other resources to create product awareness and demand by potential customers. We may be unable to offer products consistently, or at all, that compete effectively with products of others on the basis of price or performance. Failure to achieve broad acceptance of our products by potential customers and to effectively compete would have a material adverse effect on our operating results.

We currently use a contract manufacturer in Asia to manufacture our ROV product, and we plan to use foreign manufacturers to manufacture future products, where appropriate. These international operations are subject to inherent risks, which may adversely affect us, including:

• political and economic instability;
• high levels of inflation, historically the case in a number of countries in Asia;
• burdens and costs of compliance with a variety of foreign laws;
• foreign taxes;
• changes in tariff rates or other trade and monetary policies; and
• changes or volatility in currency exchange rates.

We rely on single suppliers to manufacture our ROV Scanner product and our MEMS chips in wafer form. The lead time required to establish a relationship with a new contract manufacturer or foundry is long, and it takes time to adapt a product's design to a particular manufacturer's processes. Accordingly, there is no readily available alternative source of supply for these products and components in high volumes. This could cause significant delays in shipping products if we have to change our source of supply and manufacture quickly, which may result in lost revenues and damaged customer relationships.

We have developed demonstration units incorporating the PicoP display engine. However, we must undertake additional research, development and testing before we are able to develop additional products for commercial sale. Product development delays by us or our potential product development partners, or the inability to enter into relationships with these partners, may delay or prevent us from introducing products for commercial sale. We intend to rely on third party developments or to contract with other companies to continue development of green laser devices we will need for our products.

We are developing our capability to manufacture products in commercial quantities. Our success depends, in part, on our ability to provide our components and future products in commercial quantities at competitive prices. Accordingly, we will be required to obtain access, through business partners or contract manufacturers, to manufacturing capacity and processes for the commercial production of our expected future products. We cannot be certain that we will successfully obtain access to sufficient manufacturing resources. Future manufacturing limitations of our suppliers could result in a limitation on the number of products incorporating our technology that we are able to produce.

Intellectual property protection for our products is important and uncertain. If we do not obtain effective intellectual property protection for our products, processes and technology, we may be subject to increased competition. Our commercial success will depend in part on our ability and the ability of the University of Washington and our other licensors to maintain the proprietary nature of the PicoP display and other key technologies by securing valid and enforceable patents and effectively maintaining unpatented technology as trade secrets. We try to protect our proprietary technology by seeking to obtain United States and foreign patents in our name, or licenses to third-party patents, related to proprietary technology, inventions, and improvements that may be important to the development of our business. However, our patent position and the patent position of the University of Washington and other licensors involve complex legal and factual questions. The standards that the United States Patent and Trademark Office and its foreign counterparts use to grant patents are not always applied predictably or uniformly and can change. Additionally, the scope of patents are subject to interpretation by courts and their validity can be subject to challenges and defenses, including challenges and defenses based on the existence of prior art. Consequently, we cannot be certain as to the extent to which we will be able to obtain patents for our new products and technology or the extent to which the patents that we already own or license from others protect our products and technology. Reduction in scope of protection or invalidation of our licensed or owned patents, or our inability to obtain new patents, may enable other companies to develop products that compete with ours on the basis of the same or similar technology.

We also rely on the law of trade secrets to protect unpatented know-how and technology to maintain our competitive position. We try to protect this know-how and technology by limiting access to the trade secrets to those of our employees, contractors and partners with a need to know such information and by entering into confidentiality agreements with parties that have access to it, such as our employees, consultants and business partners. Any of these parties could breach the agreements and disclose our trade secrets or confidential information, or our competitors might learn of the information in some other way. If any trade secret not protected by a patent were to be disclosed to or independently developed by a competitor, our competitive position could be materially harmed.

We may be subject to product liability claims if any of our product applications are alleged to be defective or cause harmful effects. For example, because some of our PicoP displays are designed to scan a low power beam of colored light into the user's eye, the testing, manufacture, marketing and sale of these products involve an inherent risk that product liability claims will be asserted against us. Product liability claims or other claims related to our products, regardless of their outcome, could require us to spend significant time and money in litigation, divert management time and attention, require us to pay significant damages, harm our reputation or hinder acceptance of our products. Any successful product liability claim may prevent us from obtaining adequate product liability insurance in the future on commercially desirable or reasonable terms. An inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of our products.

During the full years 2008, 2007, and 2006, 34%, 61%, and 51% respectively, of our revenue was derived from performance on a limited number of development contracts with the U.S. government. Therefore, any significant disruption or deterioration of our relationship with the U.S. government would significantly reduce our revenues. Our government programs must compete with programs managed by other contractors for limited amounts and uncertain levels of funding. The total amount and levels of funding are susceptible to significant fluctuations on a year-to-year basis. Our competitors continuously engage in efforts to expand their business relationships with the government and are likely to continue these efforts in the future. Our contracts with the government are subject to immediate termination by the government for convenience at any time. The government may choose to use contractors with competing display technologies or it may decide to discontinue any of our programs altogether. In addition, those development contracts that we do obtain require ongoing compliance with applicable government regulations. Termination of our development contracts, a shift in government spending to other programs in which we are not involved, a reduction in government spending generally, or our failure to meet applicable government regulations could have severe consequences for our results of operations.

Our development agreements have lengthy sales cycles that involve numerous steps including determination of a product application, exploring the technical feasibility of a proposed product, evaluating the costs of manufacturing a product and manufacturing or contracting out the manufacturing of the product. Our long sales cycle, which can last several years, makes it difficult to predict the quarter in which contract signing and revenue recognition will occur. Delays in entering into development agreements could cause significant variability in our revenues and operating results for any particular quarterly period.

Our development contracts, including without limitation those discussed in this document are exploratory in nature and are intended to develop new types of products for new applications. These efforts may prove unsuccessful and these relationships may not result in the development of products that will be profitable.

Our revenues to date have been derived principally from product development research relating to defense applications of our technology. We believe that development programs and sales of potential products in this market will represent a significant portion of our future revenues, until such time when we can derive a higher percentage of our revenues from the sale of our commercial products. Developments that adversely affect the defense sector, including delays in government funding and a general economic downturn, could cause our revenues to decline substantially.

Our business depends in part on technology rights licensed from third parties. We could lose our exclusivity or other rights to use the technology under our licenses if we fail to comply with the terms and performance requirements of the licenses. In addition, certain licensors may terminate a license upon our breach and have the right to consent to sublicense arrangements. If we were to lose our rights under any of these licenses, or if we were unable to obtain required consents to future sublicenses, we would lose a competitive advantage in the market, and may even lose the ability to commercialize our products completely. Either of these results could substantially decrease our revenues.

Our strategy for commercializing our technology and products incorporating the PicoP display engine includes entering into cooperative development, manufacturing, sales and marketing arrangements with corporate partners, original equipment manufacturers and other third parties. We cannot be certain that we will be able to negotiate arrangements on acceptable terms, if at all, or that these arrangements will be successful in yielding commercially viable products. If we cannot establish these arrangements, we would require additional capital to undertake such activities on our own and would require extensive manufacturing, sales and marketing expertise that we do not currently possess and that may be difficult to obtain. In addition, we could encounter significant delays in introducing the PicoP display engine or find that the development, manufacture or sale of products incorporating the PicoP display engine would not be feasible. To the extent that we enter into cooperative development, sales and marketing or other joint venture arrangements, our revenues will depend upon the performance of third parties. We cannot be certain that any such arrangements will be successful.

Our success depends on our executive officers and other key personnel and on the ability to attract and retain qualified new personnel. Achievement of our business objectives will require substantial additional expertise in the areas of sales and marketing, research and product development and manufacturing. Competition for qualified personnel in these fields is intense, and the inability to attract and retain additional highly skilled personnel, or the loss of key personnel, could reduce our revenues and adversely affect our business.

Our revenues to date have been generated primarily from a limited number of development contracts with U.S. government entities and commercial partners. Our quarterly operating results may vary significantly based on:

• reductions or delays in funding of development programs involving new information display technologies by the U.S. government or our current or prospective commercial partners;
• changes in evaluations and recommendations by any securities analysts following our stock or our industry generally;
• announcements by other companies in our industry;
• changes in business or regulatory conditions;
• announcements or implementation by our competitors of technological innovations or new products;
• the status of particular development programs and the timing of performance under specific development agreements;
• economic and stock market conditions; or
• other factors unrelated to our company or industry.

In one or more future quarters, our results of operations may fall below the expectations of securities analysts and investors and the trading price of our common stock may decline as a consequence. In addition, following periods of volatility in the market price of a company's securities, shareholders often have instituted securities class action litigation against that company. If we become involved in a class action suit, it could divert the attention of management, and, if adversely determined, could require us to pay substantial damages.

Our ability to successfully offer products and implement our business plan in a rapidly evolving market requires an effective planning and management process. The growth in business and relationships with customers and other third parties has placed, and will continue to place, a significant strain on our management systems and resources. We will need to continue to improve our financial and managerial controls, reporting systems and procedures and will need to continue to train and manage our work force.

None

We currently lease approximately 67,000 square feet of combined use office, laboratory and manufacturing space at our headquarters facility in Redmond, Washington. The 90 month lease expires in 2013.

We have sued our former CEO and President Richard Rutkowski and his spouse to collect $1,733,000 in outstanding loans from the Company that were due in January 2007 and remain unpaid. Counterclaims were filed by Mr. Rutkowski and his spouse, seeking to recover damages in an amount in excess of $15,000,000. We believe these claims are without merit and intend to defend them vigorously. However, an adverse outcome could have a material adverse affect on our financial condition.

We are subject to various other claims and pending or threatened lawsuits in the normal course of business. We are not currently party to any other legal proceedings that we believe would have a material adverse effect on our financial position, results of operations or cash flows.

There were no matters submitted to a vote of shareholders during the fourth quarter of the year ending December 31, 2008.

Executive officers are appointed by our Board of Directors and hold office until their successors are elected and duly qualified. Mr. Tokman also serves as a director of Microvision. The following persons serve as executive officers of Microvision:

Alexander Tokman, age 47, has served as President, Chief Executive Officer and a director of Microvision since January 2006. Mr. Tokman served as Microvision's President and Chief Operating Officer from July 2005 to January 2006. Mr. Tokman, a former GE executive, joined Microvision after a 10-year tenure at GE Healthcare, a subsidiary of General Electric, where he led several global businesses, most recently as General Manager of its Global Molecular Imaging and Radiopharmacy multi-technology business unit from 2003 to 2005. Prior to that, between 1995 and 2003, Mr. Tokman served in various cross-functional and cross-business leadership roles at GE where he led the definition and commercialization of several medical modalities product segments including PET/CT, which added over $500 million of revenue growth to the company within the first three years of its commercial introduction. Mr. Tokman is a certified Six Sigma and Design for Six Sigma (DFSS) Black Belt and Master Black Belt and as one of GE's Six Sigma pioneers, he drove the quality culture change across GE Healthcare in the late 1990s. From November 1989 to March 1995 Mr. Tokman served as technical programs lead and a head of I&RD at Tracor Applied Sciences a subsidiary of then Tracor, Inc. Mr. Tokman has both an M.S. and B.S. in Electrical Engineering from the University of Massachusetts, Dartmouth.

Ian D. Brown, age 46, has served as Vice President, Sales and Marketing of Microvision since February 2006. Prior to joining Microvision, from March 1994 to February 2006, Mr. Brown served in various Sales and Marketing positions with General Electric Healthcare, Americas. Most recently, from April 2004 to February 2006, Mr. Brown served as the Sales and Marketing Manager--Nuclear Medicine. From April 1989 to March 1994 Mr. Brown served as Technical Author--Nuclear Medicine Operator Documentation with IGE Medical Systems, Radlett, UK. Mr. Brown holds Ordinary & Higher National Certificates in Medical Physics & Physiological Measurements from Paddington College, London, Post Graduate Diploma in Management studies, University of Hertfordshire. He also holds a Six Sigma Black Belt.

Sid Madhavan, age 42, joined Microvision in April 2006 as Vice President of Research and Product Development. Madhavan, who worked for GE Healthcare from 1998 to 2006 where he held various management positions and most recently served as an Engineering Subsystem Manager for a $2.1 billion Molecular Imaging and Computer Tomography business, is a certified Six Sigma Black Belt and brings over fifteen years of engineering product development and global management experience. Mr. Madhavan received his B.S. degree in Electronics and Communications from Madurai Kamaraj University in India and his M.S. in Electrical Engineering from Texas A&M.

Thomas M. Walker, age 44, joined Microvision in May 2002 and serves as Vice President, General Counsel and Secretary. Prior to joining Microvision, Mr. Walker served as Senior Vice President, General Counsel and Secretary of Advanced Radio Telecom Corp., a publicly held technology and services company where he managed domestic and international legal affairs from April 1996 to April 2002. Prior to that, Mr. Walker advised publicly and privately held businesses while practicing in the Los Angeles offices of the law firms of Pillsbury Winthrop and Buchalter, Nemer Fields and Younger. Mr. Walker holds a B.A. from Claremont McKenna College and a J.D. from the University of Oregon.

Jeff T. Wilson, age 48, has served as Chief Financial Officer since April 2006, Principal Financial Officer since January 2006 and Principal Accounting Officer of Microvision since August 1999. Mr. Wilson served as Vice President, Accounting of Microvision from April 2002 to April 2006 and as Director of Accounting of Microvision from August 1999 to March 2002. Prior to joining Microvision, from 1991 to 1999, Mr. Wilson served in various accounting positions for Siemens Medical Systems, Inc., a developer and manufacturer of medical imaging equipment. Prior to 1991, Mr. Wilson served as a manager with the accounting firm PricewaterhouseCoopers LLP. Mr. Wilson is a Certified Public Accountant. Mr. Wilson holds a B.S. in Accounting from Oklahoma State University.

Our common stock trades on The NASDAQ Global Market under the symbol "MVIS." As of February 17, 2009, there were approximately 375 holders of record of 68,080,000 shares of common stock outstanding. We have never declared or paid cash dividends on our common stock. We currently anticipate that we will retain all future earnings to fund the operations of our business and do not anticipate paying dividends on the common stock in the foreseeable future.

Our common stock began trading publicly on August 27, 1996. The quarterly high and low sales prices of the Company's common stock for each full quarterly period in the last two fiscal years and the year to date as reported by The NASDAQ Global Market are as follows:

                                                            Common Stock
                                                       --------------------
Quarter Ended                                            HIGH        LOW
                                                       ---------  ---------

2007                                                                       
March 31, 2007                                        $    4.08  $    2.98
June 30, 2007                                              5.90       3.62
September 30, 2007                                         6.08       4.40
December 31, 2007                                          4.75       3.83

2008                                                                       
March 31, 2008                                        $    4.65  $    1.82
June 30, 2008                                              4.05       2.35
September 30, 2008                                         3.16       1.85
December 31, 2008                                          2.20       1.06

2009                                                                       
January 1, 2009 to February 17, 2009                  $    2.20  $    1.33

A summary of selected financial data as of and for the five years ended December 31, 2008 is set forth below. It should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Form 10-K.

                                                                                         Years Ended December 31,
                                                                 ----------------------------------------------------------
                                                                    2008        2007        2006        2005        2004
                                                                 ----------  ----------  ----------  ----------  ----------
                                                                              (in thousands, except per share data)        
Statement of Operations Data:                                                                                              
Revenue                                                         $    6,611  $   10,484  $    7,043  $   14,746  $   11,418
Net loss available for common shareholders                         (32,620)    (19,787)    (27,257)    (30,284)    (33,543)
Basic and diluted net loss per share                                 (0.53)      (0.40)      (0.81)      (1.35)      (1.56)
Weighted average shares outstanding basic and diluted               61,643      49,963      33,572      22,498      21,493 
Balance Sheet Data:                                                                                                        
Cash and cash equivalents                                       $   25,533  $   13,399  $   14,552  $    6,860  $    1,268
Investments available-for-sale                                       2,705      22,411          --          --          --
Working capital                                                     24,347      30,043      19,160      (4,723)        903
Total assets                                                        36,964      45,298      35,325      23,363      25,538
Long-term liabilities                                                1,776       2,201       2,616       4,412          52
Mandatorily redeemable preferred stock                                  --          --          --       4,166       7,647
Total shareholders' equity (deficit)                                27,651      33,061      21,864      (3,509)      7,190

Statement of Operations data for 2004 includes financial information for our previously consolidated subsidiary Lumera. Lumera was deconsolidated in July 2004.

We are developing 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.

In 2006, we announced our strategy to develop and supply a proprietary display engine called PicoP to potential original equipment manufacturing (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 surfaces. The PicoP with some modification could be embedded into the dashboard of an automobile or an airplane or integrated into a portable aftermarket device to create a 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.

We have incurred substantial losses since inception and expect to incur a substantial loss during the fiscal year ending December 31, 2009.

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, contract losses, bad debts, investments and contingencies and litigation. We base our estimates on historical experience, terms of existing contracts, our evaluation of trends in the display and image capture industries, information provided by our current and prospective customers and strategic partners, information available from other outside sources, and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following key accounting policies require more significant judgments and estimates used in the preparation of its consolidated financial statements:

Revenue Recognition. 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.

Our product sales generally include acceptance provisions. We recognize revenue for product shipments upon acceptance of the product by the customer or expiration of the contractual acceptance period.

Losses on Uncompleted Contracts. We establish an allowance for estimated losses if a contract has an estimated cost to complete that is in excess of the remaining contract value. The entire estimated loss is recorded in the period in which the loss is first determined. We determine the estimated cost to complete a contract through a detailed review of the work to be completed, the resources available to complete the work and the technical difficulty of the remaining work. If the revised estimated cost to complete the contract is higher than the total contract revenue, the entire contract loss is recognized. The actual cost to complete a contract can vary significantly from the estimated cost, due to a variety of factors including availability of technical staff, availability of materials and technical difficulties that arise during a project. Most of our development contracts are cost plus fixed fee type contracts. Under these types of contracts, we are not required to spend more than the contract value to complete the contracted work.

Allowance for uncollectible receivables. We maintain allowances for uncollectible receivables, including accounts receivable, cost and estimated earnings in excess of billings on uncompleted contracts and receivables from related parties. We review several factors in determining the allowances including the customer's and related party's past payment history and financial condition. If the financial condition of our customers or the related parties with whom we have receivables were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.

Inventory. We value inventory at the lower of cost or market with cost determined on a weighted average cost basis. We review several factors in determining the market value of our inventory including evaluating the replacement cost of the raw materials and the net realizable value of the finished goods. If we do not achieve our targeted sales prices, if market conditions for our components or products were to decline or if we do not achieve our sales forecast, additional reductions in the carrying value of the inventory would be required.

Investments Available-For-Sale and Fair Value Measurements. We account for investment securities in accordance with the provisions of Statement of Financial Accounting Standards ("FAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities ("FAS 115") and FAS No. 157, Fair Value Measurements ("FAS 157"). FAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for investments in debt securities. FAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Adopting FAS 157 on January 1, 2008 for financial assets and liabilities did not have a material impact on our consolidated financial position, results of operations or cash flows.

FAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in its principal or most advantageous market in an orderly transaction between market participants on the measurement date. FAS 157 establishes a three level fair value inputs hierarchy, and requires an entity to maximize the use of observable valuation inputs and minimize the use of unobservable inputs. We utilize market data, assumptions and risks we believe market participants would use in measuring the fair value of the asset or liability, including the risks inherent in the inputs and the valuation techniques. The hierarchy is summarized below.

• Level 1 - Observable inputs such as quoted prices in active markets for identical assets or liabilities
• Level 2 - Observable inputs such as quoted prices for similar assets or liabilities in markets that are not sufficiently active to qualify as level 1 or, other observable inputs
• Level 3 - Unobservable inputs for which there is little or no market data, which requires us to develop our own assumptions, which are significant to the measurement of the fair values

Estimating valuation inputs and selecting and applying valuation methods may require significant judgments by management. Changes in the estimated inputs and valuation methods could result in materially different values, credits and charges presented in the consolidated financial statements.

The investments are stated at fair value and classified as cash and cash equivalents or current investment securities available-for-sale on the consolidated balance sheets with unrealized gains and losses included in the consolidated statements of comprehensive loss. We classify investment securities available-for-sale purchased with 90 days or less remaining until contractual maturity as cash equivalents on the balance sheet in "Cash and cash equivalents." Interest income, realized gains and losses, and other- than-temporary impairments are recognized in the period earned or incurred, and presented separately in the consolidated statements of operations. Changes in the fair values of derivatives are realized in the period of remeasurement and recorded in "Gain (loss) on derivative instruments, net" in the consolidated statements of operations. The cost of securities sold is based on the specific identification method.

Employee Share-Based Compensation. We issue share-based compensation to employees in the form of options exercisable into our common stock and restricted or unrestricted shares of our common stock. We account for employee share-based compensation under the guidance provided by Financial Accounting Standards Board ("FASB") Statement No. 123(R), Share-Based Payment ("FAS123(R)"). The value of equity shares is determined using the fair value method, which is based on the number of shares granted and the closing price of our common stock on the NASDAQ Global Market on the date of grant. The value of options is determined using the Black-Scholes option pricing model with estimates of option lives, stock price volatilities and interest rates, then expensed over the periods of service allowing for pre-vest forfeitures. This widely accepted method results in reasonable option values and interperiod expense allocation, and comparability across companies. Changes in the estimated inputs or using other option valuation methods could result in materially different option values and share-based compensation expense.

The key accounting policies described above are not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for us to apply judgment or make estimates. There are also areas in which our judgment in selecting any available alternative would not produce a materially different result to our consolidated financial statements. Additional information about our accounting policies, and other disclosures required by generally accepted accounting principles, are set forth in the notes to our consolidated financial statements.

Inflation has not had a material impact on our revenues, or income from continuing operations over the three most recent fiscal years.

YEAR ENDED DECEMBER 31, 2008 COMPARED TO YEAR ENDED DECEMBER 31, 2007

                                                              % of                  % of
                                                            contract              contract
                                                   2008      revenue     2007      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Government revenue                              $   2,237       45.9  $   6,430       71.4  $  (4,193)     (65.2)
Commercial revenue                                  2,637       54.1      2,580       28.6         57        2.2
                                                 ---------             ---------             ---------
Total contract revenue                          $   4,874             $   9,010             $  (4,136)     (45.9)
                                                 =========             =========             =========

We earn contract revenue from performance on development contracts with the United States government and commercial customers. Our contract revenue 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.

Contract revenue from government contracts was substantially lower during 2008 than in 2007 due to reduced contract activity and lower beginning backlog in 2008 compared to the previous 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 one period to another.

In December 2007, we entered into a $1 million contract with a commercial customer to develop prototype units based on our PicoP technology, for evaluation of future consumer electronics product applications. The development work under this contract was initiated and fully completed in 2008.

Our backlog of development contracts at December 31, 2008 was $714,000 in government contracts and $228,000 in commercial contracts compared to $2.0 million in government contracts and $1.8 million in commercial contracts at December 31, 2007. The decrease in backlog from 2007 is primarily attributed to completion of government and commercial development contracts in 2007 and early 2008. We plan to complete the entire contract backlog during 2009.

                                                              % of                  % of
                                                             product               product
                                                   2008      revenue     2007      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Bar code revenue                                $   1,737      100.0  $   1,393       94.5  $     344       24.7
Nomad revenue                                           0        0.0         81        5.5        (81)    (100.0)
                                                 ---------             ---------             ---------
Total product revenue                           $   1,737             $   1,474             $     263       17.8
                                                 =========             =========             =========

Bar code revenue includes the sales of ROV and our discontinued Flic bar code scanners. The increase in bar code revenue for the year ended December 31, 2008 compared to the same period in 2007 was due to the increased sales of our ROV product line.

Our quarterly revenue may vary substantially due to the timing of product orders from customers, production constraints and raw material availability.

The backlog of product orders at December 31, 2008 was approximately $276,000, compared to $245,000 at December 31, 2007, all of which is scheduled for delivery during 2009.

Cost of Contract Revenue.

                                                              % of                  % of
                                                            contract              contract
                                                   2008      revenue     2007      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Cost of contract revenue                        $   1,708       35.0  $   4,916       54.6  $  (3,208)     (65.3)

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.

The cost of contract revenue as a percentage of revenue was lower in 2008 than in 2007 as a result of negotiating better terms on contracts and from the sale of prototype units that have been previously expensed to internally funded programs.

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.

                                                              % of                  % of
                                                             product               product
                                                   2008      revenue     2007      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Cost of product revenue                         $   2,143      123.4  $   1,690      114.7  $     453       26.8

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 2008 and 2007, we expensed approximately $143,000 and $289,000, respectively, of manufacturing overhead associated with production capacity in excess of production requirements.

The increase in cost of product revenue for 2008 compared to 2007 was a result of increased revenue from the sales of ROV and the increase in inventory write-downs during the respective periods. In 2008, cost of product revenue included $475,000 of inventory write-downs compared to $84,000 for the same period in 2007.

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.

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Research and development                        $  22,575  $  14,944  $   7,631       51.1

Research and development expense consists of:

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

In addition, we allocate our research and development resources based on the business opportunity of the available projects, the skill mix of the resources available and the contractual commitments we have made to customers. In order to accelerate our time to market and because contract revenue was lower for the year ended December 31, 2008 compared to the same period in 2007, we directed more of our research and development work to internally funded projects compared to the same period last year. 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 light scanning technology. Accordingly, we anticipate our level of research and development spending will continue to be substantial.

Sales, Marketing, General and Administrative Expense.

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Sales, marketing, general and administrative    $  15,730  $  15,779  $     (49)      (0.3)

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.

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 and Expense.

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Interest income                                 $   1,130  $   1,358  $    (228)     (16.8)

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Interest expense                                $      48  $     513  $    (465)     (90.6)

The decrease in interest income in 2008 from 2007 results primarily from lower interest rates on our investment securities compared to 2007.

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, resulting in a decrease in interest expense for the year ended December 31, 2008 compared to the same period in 2007.

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Impairment of investments, available-for-sale   $    (300) $       0  $    (300)          n/a

At December 31, 2008, our marketable securities portfolio included $3.0 million par value AAA rated student loan auction-rate securities ("SLARS"). Based on the length of the historical duration of failed SLARS auctions and significant uncertainty of the prospective duration of inactivity and lack of liquidity in the SLARS market, we determined that the estimated fair values of the SLARS were less than par value and the impairments were other-than- temporary. We used a discounted cash flow model, with rates adjusted for liquidity, to determine the estimated fair values of the SLARS as of December 31, 2008. We recorded an "impairment of investment securities, available-for- sale" of $300,000 for the period ended December 31, 2008.

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Gain (loss) on derivative instruments, net      $   2,196  $    (483) $   2,679     (554.7)

We issued warrants to purchase 2,302,000 shares of common stock in connection with the issuance of the Notes. The warrants met the definition of derivative instruments that must be accounted for as liabilities under the provisions of Emerging Issues Task Force ("EITF") Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock ("EITF 00-19"), because we cannot engage in certain corporate transactions affecting the common stock unless we made a cash payment to the holders of the warrants. In July 2008, warrants to purchase 750,000 shares of common stock expired unexercised. We record changes in the fair values of the warrants in the statement of operations each period. We valued the remaining warrants to purchase 1,552,000 shares of common stock at December 31, 2008 using the Black-Scholes option pricing model with the following assumptions: expected volatility of 72%; expected dividend yield of 0%; risk free interest rates ranging from 0.6% to 0.8%; and contractual lives ranging from 1.2 years to 1.9 years. The change in value of the warrants of $2.3 million in 2008 was recorded as a non-operating gain and is included in "Gain (loss) 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 will conduct 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 and the change in value of $130,000 in 2008 was recorded as a loss to "Gain (loss) on derivative instruments, net."

Gain on sale of securities of equity investment:

                                                   2008       2007     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Gain on sale of investment in Lumera            $       0  $   6,606  $  (6,606)    (100.0)

During 2007, we sold 1,714,000 shares of Lumera common stock for gross proceeds of $8.7 million and we recorded a gain of $6.6 million.

As result of the merger discussed above, the 36,000 shares of Lumera common stock we held were exchanged for 5,000 shares of GigOptix common stock.

No provision for income taxes has been recorded because we have experienced net losses from inception through December 31, 2008. At December 31, 2008, we had net operating loss carry-forwards of approximately $217.6 million for federal income tax reporting purposes. In addition, we have research and development tax credits of $4.3 million. The net operating loss carry forwards and research and development credits available to offset future taxable income, if any, will expire in varying amounts from 2009 to 2027 if not previously utilized. In certain circumstances, as specified in the Internal Revenue Code, a 50% or more ownership change by certain combinations of our shareholders during any three-year period would result in a limitation on our ability to utilize a portion of our net operating loss carry-forwards. We have determined that such a change of ownership occurred during 1995 and that the annual utilization of loss carry-forwards generated through the period of that change will be limited to approximately $761,000. An additional change of ownership occurred in 1996 and the annual limitation for losses generated in 1996 is approximately $1.6 million.

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. We did not have any unrecognized tax benefits which would require an adjustment to the January 1, 2007 beginning balance of retained earnings. We did not have any unrecognized tax benefits at December 31, 2007 or at December 31, 2008.

We recognize interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years ended December 31, 2008 and 2007, we recognized no interest and penalties.

YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006

                                                              % of                  % of
                                                            contract              contract
                                                   2007      revenue     2006      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Government revenue                              $   6,430       71.4  $   3,586       68.0  $   2,844       79.3
Commercial revenue                                  2,580       28.6      1,689       32.0        891       52.8
                                                 ---------             ---------             ---------
Total contract revenue                          $   9,010             $   5,275             $   3,735       70.8
                                                 =========             =========             =========

Contract revenue was higher during 2007 than in 2006, due to higher beginning government contract backlog and an increased level of activity on commercial contracts compared to the prior year.

In May 2007, we announced that we had entered into a $3.2 million contract with the U.S. Air Force to provide a lightweight, see-through, full-color eyewear display prototype to the government. The contract, which continued a development activity with the Air Force, specified the development, design, verification, testing, and delivery of a lightweight, see-through full-color wearable display for evaluation by several DOD project offices.

Our backlog of development contracts at December 31, 2007 was $$2.0 million in government contracts and $1.8 million in commercial contracts compared to $5.2 million in government contracts and $1.6 million in commercial contracts at December 31, 2006.

                                                              % of                  % of
                                                             product               product
                                                   2007      revenue     2006      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Bar code revenue                                $   1,393       94.5  $   1,589       89.9  $    (196)     (12.3)
Nomad revenue                                          81        5.5        179       10.1        (98)     (54.7)
                                                 ---------             ---------             ---------
Total product revenue                           $   1,474             $   1,768             $    (294)     (16.6)
                                                 =========             =========             =========

In May 2007, we announced the launch of ROV, our new bar code scanner product. We had planned to begin commercial shipments of ROV during the third quarter of 2007. During our Beta evaluation, we determined that ROV did not meet our quality standards and we delayed the launch of ROV production until we could correct the deficiencies. Commercial shipments of ROV began during the fourth quarter of 2007.

The decrease in bar code revenue in 2007 compared to 2006 was the result of the timing of the release of ROV. We believe that many of our customers were waiting for the availability of ROV before placing orders for our bar code scanning products.

The decrease in Nomad revenue was the result of our decision in June 2006 to no longer promote the Nomad product. The Nomad had not gained the commercial acceptance we had planned when it was introduced.

The backlog of product orders at December 31, 2007 was approximately $245,000, compared to $353,000 at December 31, 2006.

Cost of Contract Revenue.

                                                              % of                  % of
                                                            contract              contract
                                                   2007      revenue     2006      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Cost of contract revenue                        $   4,916       54.6  $   3,398       64.4  $   1,518       44.7

The cost of contract revenue as a percentage of revenue was lower in 2007 than in 2006 as a result of negotiating better terms on contracts entered into in late 2006 and early 2007. We target a gross margin for each contract of at least 40%; however, the gross margin can vary based on the technical challenges encountered in completing the contract.

                                                              % of                  % of
                                                             product               product
                                                   2007      revenue     2006      revenue   $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------  ---------  ---------
Cost of product revenue                         $   1,690      114.7  $   4,768      269.7  $  (3,078)     (64.6)

During 2007 and 2006, we expensed approximately $289,000 and $1,224,000, respectively, of manufacturing overhead associated with production capacity in excess of production requirements.

The decline in cost of product revenue as a percentage of product revenue for 2007 compared to 2006 is attributable to the following factors:

• The decision in June 2006 to no longer support the Nomad product line. During 2006, we recorded expenses of $1.2 million associated with the Nomad product line that were not repeated in 2007.

• Reduced direct cost and overhead on the Flic product line resulting in a savings of approximately 108% for the year ended December 31, 2007 compared to the same period in 2006.

• The absence of losses associated with noncancelable purchase contracts. In 2006, we recorded a loss of $310,000 to cost of product revenue as a result of commitments to purchase materials for the Flic scanner that were in excess of our estimated future proceeds from the sale of the Flic scanners.

Research and Development Expense.

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Research and development                        $  14,944  $  10,715  $   4,229       39.5

The increase in research and development expense in 2007 compared to 2006 was the result of our increased spending as part of our strategy to accelerate the time to market for products based on the PicoP. The increase in cost was primarily attributable to increases in payroll costs and contracted services.

Sales, Marketing, General and Administrative Expense.

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Sales, marketing, general and administrative    $  15,779  $  17,362  $  (1,583)      (9.1)

In early 2006, we announced our plan to reduce spending in sales, marketing, general and administrative expenses. The decrease in sales, marketing, general and administrative expense in 2007 compared to 2006 is the result of the cost reduction efforts.

Interest Income and Expense.

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Interest income                                 $   1,358  $     719  $     639       88.9

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Interest expense                                $     513  $   5,753  $  (5,240)     (91.1)

The increase in interest income in 2007 from 2006 results from higher average cash and investment securities balances.

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, resulting in a decrease in interest expense for the year ended December 31, 2007 compared to the same period in 2006.

The following table shows the gain on derivative instruments, net:

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Gain (loss) on derivative instruments, net      $    (483) $   1,627  $  (2,110)    (129.7)

In connection with the issuance of the Notes in 2005, we concluded that the note holders' right to convert all or a portion of the Notes into our common stock is an embedded derivative instrument as defined by FAS 133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133"). We determine the value of the derivative features at each balance sheet date using the Black-Scholes option pricing model. We retired the Notes in March 2007 and decreased the value of the derivative feature to zero. The change in value of $68,000 from December 31, 2006 to the date of retirement of the Notes was recorded as a non-operating gain and is included in "Gain (loss) on derivative instruments, net" in the consolidated statement of operations.

We issued warrants to purchase 2,302,000 shares of common stock in connection with the issuance of the Notes. The warrants met the definition of derivative instruments that must be accounted for as liabilities under the provisions of EITF 00-19, because we cannot engage in certain corporate transactions affecting the common stock unless we made 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. We valued the warrants at December 31, 2007 using the Black-Scholes option pricing model with the following assumptions: expected volatility of 67%, expected dividend yield of 0%, risk free interest rates ranging from 3.05% to 3.07%, and contractual lives ranging from 0.6 years to 2.9 years. The change in value of the warrants of $85,000 in 2007 was recorded as a non-operating loss and is included in "Gain (loss) on derivative instruments, net" in the consolidated statement of operations.

At December 31, 2007, we held warrants to purchase 170,500 shares of Lumera common stock. Changes in the fair value of the warrants are recorded in the statement of operations each period. As of December 31, 2007, the warrants were valued using the Black-Scholes option pricing model with the following assumptions: expected volatility of 83%, expected dividend yield of 0%, risk free interest rate of 3.11%, and contractual life of 3.2 years. As of December 31, 2007, the fair value of the warrants decreased to $130,000 and the change in value of $465,000 in 2007 was recorded as a loss to "Gain (loss) on derivative instruments, net."

Equity in losses of Lumera:

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Equity in losses of Lumera                      $       0  $    (290) $     290     (100.0)

Gain on sale of securities of equity investment:

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Gain on sale of investment in Lumera            $   6,606  $   8,738  $  (2,132)     (24.4)

In 2006, we sold 2.9 million shares of our Lumera common stock for $12.2 million. We recorded a "Gain on sale of investment in Lumera" of approximately $8.7 million. In January 2006, we recorded a charge of $290,000 for our proportion of Lumera net loss for the period preceding the change in accounting method which resulted from the reduction of our ownership in Lumera.

During 2007, we sold 1,714,000 shares of Lumera common stock for gross proceeds of $8.7 million and we recorded a gain of $6.6 million. As of December 31, 2007, we owned 36,000 shares of Lumera common stock.

Income Taxes.

At December 31, 2007, we had net operating loss carry-forwards of approximately $200.0 million for federal income tax reporting purposes. In addition, we had research and development tax credits of $3.6 million.

Inducement for Conversion of Preferred Stock.

                                                   2007       2006     $ change   % change
(in thousands)                                   ---------  ---------  ---------  ---------                      
Inducement for conversion of preferred stock    $       0  $  (3,076) $   3,076     (100.0)

In September 2004, we raised $10.0 million before issuance costs of $90,000 from the sale of 10,000 shares of Series A Convertible Preferred Stock and a warrant to purchase 362,000 shares of common stock. The preferred stock terms included a dividend of 3.5% per annum, payable quarterly in cash or registered common stock, at our election, subject to certain conditions.

The net cash proceeds of $9,910,000 were allocated to the preferred stock and the warrant based on the relative fair values of the securities. The warrants were valued using the Black-Scholes option pricing model with the following assumptions: expected volatility of 75%, expected dividend yield of 0%, risk free interest rate of 3.4%, and contractual life of five years. Proceeds of $1.3 million were allocated to the warrant and recorded as an increase to additional paid-in capital.

Subsequent to the relative fair value allocation, the effective conversion price of the convertible preferred stock was less than the closing price of our common stock on the date of commitment to purchase the preferred stock, resulting in the recognition of a beneficial conversion feature in accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments. This beneficial conversion feature was measured at $1.2 million, which represents the difference between the fair value of the common stock and the effective conversion price. The beneficial conversion feature was recorded as additional paid-in capital and a deemed dividend to preferred stockholders. It was amortized using the effective interest method over the three year stated life of the preferred stock. During 2005, we recorded $280,000 in dividends on the preferred stock and $303,000 in amortization of the beneficial conversion feature of the preferred stock.

In May 2006, we entered into a Conversion Agreement with the holders of our preferred stock. As consideration for converting 5,000 preferred shares, we issued a total of 1,353,066 shares of our common stock, $.001 par value, of which 565,000 shares were issued as an inducement to convert ("Incentive Shares"). The value of the Incentive Shares of $2.0 million together with unamortized discounts of $0.6 million and fees of $0.1 million were recorded as "Inducement for conversion of preferred stock" in the consolidated statement of operations.

In connection with the conversion, we agreed to register the Incentive Shares and to a 45-trading-day price protection provision. We determined that the price protection feature of the Incentive Shares included an embedded derivative feature as defined by FAS 133. We estimated the initial value of the derivative feature at conversion to be $401,000 using the Black-Scholes option pricing model with the following assumptions: expected volatility of 65%, dividend yield of 0%, risk free interest rate of 4.9%, and contractual life 0.3 years and recorded it as a non-operating expense included in "Inducement for conversion of preferred stock" in the consolidated statement of operations. The value of the price protection feature fluctuated with the value of our common stock and, to a lesser extent, with changes in valuation variables. In August 2006, the Company determined and recorded the final value and paid the liability of $1,074,000. The change in estimated fair value of the derivative feature of $673,000 was included as a non-operating expense in "Gain (loss) on Derivative instruments, net".

We have incurred significant losses since inception. We have funded operations to date primarily through the sale of common stock, convertible preferred stock, warrants, the issuance of convertible debt and, to a lesser extent, from development contract revenues and product sales. In July 2008, we received $26.0 million, before issuance costs, from the issuance of 11,172,000 shares of our common stock and warrants exercisable for 6,703,000 shares of our common stock at $3.60 per share. At December 31, 2008, we had $28.2 million in cash, cash equivalents, and investment securities, available-for-sale. Our cash, cash equivalents, and investment securities available-for-sale balance includes $2.7 million in auction rate securities ("ARS"). There is currently no established market for these ARS and if we were required to sell them in a short period of time we may receive less than our book value for them.

Our operating plan for 2009 includes the launch of our first accessory product, further development of the 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 several months to fully implement our plan we will begin to reduce 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 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 $31.2 million during 2008, compared to $21.3 million during 2007. During 2008, the increased cash outlay was primarily driven by the acceleration of research and development activities on our PicoP and related technologies for planned PicoP and other product applications. The balance of the change was largely due to lower contract revenue in 2008 than in 2007.

We had the following material gains and charges, and changes in assets and liabilities during the year ended December 31, 2008.

• "(Gain) loss on derivative instruments" In connection with the issuances of our Notes in 2005, we issued warrants to purchase 2,302,000 shares of our common stock, which are accounted for as derivative security liabilities according to guidance in EITF 00-19. The value of the warrants fluctuates with our common stock price and the decreasing lives of the warrants as they approach expiration. The net decrease in our stock price during 2008 combined with decreasing terms to expiration resulted in a $2.3 million non-cash non-operating gain recorded in "(Gain) loss on derivative instruments, net" on the consolidated statements of operations and a non- cash adjustment in operating cash flows recorded to "(Gain) loss on derivative instruments" on the consolidated statements of cash flows. We record the fair values of the warrants in "Liability associated with common stock warrants" on the consolidated balance sheets. The valuation assumptions and method are detailed in the Results of Operations section above.

• "Accounts receivable, net" Our accounts receivable decreased by approximately $1.3 million from the end of 2007 due to lower contract revenue near the end of 2008.

• "Billings in excess of costs and estimated earnings on uncompleted contracts" We ended 2008 with $908,000 less than 2007. This was mostly a result of receiving a $500,000 advance cash payment from a customer in December 2007 for contract revenue work performed in January 2008. The balance of the decrease is associated with completing contracts in the third quarter of 2008 and lower contract revenue near the end of 2008.

• "Inventory" Ending inventory increased by $764,000 over 2007 as a result of the timing of our production schedule for ROV and lower than expected sales volumes. We value inventory at the lower of cost or market with cost determined on a weighted average cost basis. The following table shows the composition of the inventory at December 31, 2008 and 2007:

                                                       December 31,   December 31,
                                                           2008           2007
                                                       -------------  ------------
Raw materials                                         $      45,000  $    122,000
Work in process                                                  --        10,000
Finished goods                                            1,480,000       629,000
                                                       -------------  ------------
                                                      $   1,525,000  $    761,000
                                                       =============  ============

Cash provided by investing activities totaled $19.0 million in 2008 compared to cash used in investing activities of $14.2 million in 2007. We invested the proceeds from our July 2008 issuance of common stock and warrants of $26.0 million, before issuance fees, into money market accounts and short term investments. As a result, the purchases and sales of these investments appear in cash and cash equivalents changes instead of in investing activities on the consolidated statements of cash flows. Cash provided by investing activities in 2008 was generated from the net sales of investment securities to fund continuing operations which were purchased in 2007. The 2007 net purchases in investing activities of $22.3 million were made with proceeds from the call of our publicly traded warrants and sale of Lumera common stock.

Cash provided by financing activities totaled $24.3 million in 2008, compared to $34.4 million in 2007, largely as a result of the relative sizes of our financing transactions completed in 2008 and 2007, coupled with cash payments totaling $1.4 million in 2007 to retire our Notes. The following is a list of our securities issuances during 2008, 2007 and 2006.

• In July 2008, we raised an aggregate of $26.0 million before issuance costs of approximately $2.0 million through a registered direct public offering of 11.2 million shares of our common stock and warrants to purchase 6.7 million shares of our common stock. The warrants have an exercise price of $3.60 per share, a five year term, and are not exercisable for one year from the date of issuance. The warrants are callable after one year from the date of issuance if the average closing bid price of our stock is over $7.20 for any 20 consecutive trading days. The warrants are listed on the NASDAQ Global Market under the ticker "MVISW."

• In June 2007, we called our publicly traded warrants issued as part of a 2006 mid-year financing transaction. The warrant holders had until July 6, 2007 to exercise their warrants or the warrants would expire. We received $34.1 million from the exercise of 12,855,000 warrants.

• In November 2006, we raised $7.9 million before issuance costs of $779,000 through an underwritten public offering of 3,318,000 shares of our common stock.

• In June and July 2006, we raised an aggregate of $27.1 million before issuance costs of $2.2 million through an underwritten public offering of 11.6 million shares of our common stock and warrants to purchase 12.4 million shares of our common stock. In connection with the offering, we also issued the underwriter a warrant to acquire 537,500 warrants, identical to those sold in the offering, at an exercise price of $0.16 per warrant. The underwriter exercised the warrants for warrants in connection with the call in June 2007.

The following is a list of scheduled payments we made in connection with our Notes during 2007 and 2006.

• During 2007:

•   cash payments of $1.4 million in principal and $28,000 in interest, and
•   issued 459,000 shares of our common stock in payment of $1.4 million in principal and $21,000 in interest.

                                                                      Payments Due By Period
                                               ------------------------------------------------------------------
                                               Less than 1 year    1-3 years        3-5 years     More than 5 years  Total
                                               ---------------  ---------------  ---------------  ---------------  ---------
Contractual Obligations:                                                                                                    
Open purchase obligations *                   $         3,991  $           104  $            74  $            --  $   4,169
Minimum payments under capital leases                      47               48               --               --         95
Minimum payments under operating leases                   844            1,774            1,502               --      4,120
Minimum payments under long-term debt                     103              206              172               --        481
Minimum payments under research, royalty
 and licensing agreements                                 735            1,733            1,733               --  +   4,201
                                               ---------------  ---------------  ---------------  ---------------  ---------
    Total                                     $         5,720  $         3,865  $         3,481  $            --  $  13,066
                                               ===============  ===============  ===============  ===============  =========

                                             Amount      Percent
                                          ------------  ---------  
Cash and cash equivalents                $ 16,173,000       57.3 %
Less than one year                          9,365,000       33.1
One to two years                                   --         --
Greater than five years                     2,700,000        9.6
                                          ------------  ---------
                                         $ 28,238,000      100.0 %
                                          ============  =========

                                                                                            December 31,
                                                                                       ----------------------
                                                                                          2008        2007
                                                                                       ----------  ----------
Assets                                                                                                       
Current assets
  Cash and cash equivalents                                                           $   25,533  $   13,399
  Investment securities, available-for-sale                                                2,705      22,411
  Accounts receivable, net of allowances of $57 and $123                                     537       1,885
  Costs and estimated earnings in excess of billings on uncompleted contracts                695         443
  Inventory                                                                                1,525         761
  Other current assets                                                                       889       1,180
                                                                                       ----------  ----------
    Total current assets                                                                  31,884      40,079

  Property and equipment, net                                                              3,701       4,047
  Restricted investments                                                                   1,332       1,125
  Other assets                                                                                47          47
                                                                                       ----------  ----------
      Total assets                                                                    $   36,964  $   45,298
                                                                                       ==========  ==========

Liabilities and Shareholders' Equity                                                                         
Current liabilities
  Accounts payable                                                                    $    3,487  $    2,146
  Accrued liabilities                                                                      3,545       4,154
  Billings in excess of costs and estimated earnings on uncompleted contracts                 62         970
  Liability associated with common stock warrants                                            331       2,657
  Current portion of capital lease obligations                                                41          44
  Current portion of long-term debt                                                           71          65
                                                                                       ----------  ----------
    Total current liabilities                                                              7,537      10,036

  Capital lease obligations, net of current portion                                           45          88
  Long-term debt, net of current portion                                                     322         393
  Deferred rent, net of current portion                                                    1,409       1,720
                                                                                       ----------  ----------
    Total liabilities                                                                      9,313      12,237
                                                                                       ----------  ----------

Commitments and contingencies                                                                 --          --

Shareholders' Equity
  Common stock, par value $.001; 125,000 shares authorized; 68,080 and
  56,730 shares issued and outstanding                                                        68          57
  Additonal paid-in capital                                                              319,662     292,374
  Accumulated other comprehensive income (loss)                                              (38)         51

  Accumulated deficit                                                                   (292,041)   (259,421)
                                                                                       ----------  ----------
    Total shareholders' equity                                                            27,651      33,061
                                                                                       ----------  ----------
      Total liabilities and shareholders' equity                                          36,964      45,298
                                                                                       ==========  ==========

                                                                                               Years Ended December 31,
                                                                                         ----------------------------------
                                                                                            2008        2007        2006
                                                                                         ----------  ----------  ----------
Contract revenue                                                                        $    4,874  $    9,010  $    5,275
Product revenue                                                                              1,737       1,474       1,768
                                                                                         ----------  ----------  ----------
Total revenue                                                                                6,611      10,484       7,043
                                                                                         ----------  ----------  ----------

Cost of contract revenue                                                                     1,708       4,916       3,398
Cost of product revenue                                                                      2,143       1,690       4,768
                                                                                         ----------  ----------  ----------
Total cost of revenue                                                                        3,851       6,606       8,166
                                                                                         ----------  ----------  ----------
    Gross margin                                                                             2,760       3,878      (1,123)
                                                                                         ----------  ----------  ----------


Research and development expense                                                            22,575      14,944      10,715
Sales, marketing, general and administrative expense                                        15,730      15,779      17,362
Gain on disposal of fixed assets                                                                (5)       (117)       (198)
                                                                                         ----------  ----------  ----------
Total operating expenses                                                                    38,300      30,606      27,879
                                                                                         ----------  ----------  ----------
Loss from operations                                                                       (35,540)    (26,728)    (29,002)

Interest income                                                                              1,130       1,358         719
Interest expense                                                                               (48)       (513)     (5,753)
Impairment of investment securities, available-for-sale                                       (300)         --          --
Gain (loss) on derivative instruments, net                                                   2,196        (483)      1,627
Other expense                                                                                  (58)        (27)        (23)
                                                                                         ----------  ----------  ----------
Net loss before Lumera transactions                                                        (32,620)    (26,393)    (32,432)

Equity in losses of Lumera                                                                      --          --        (290)
Gain on sale of investment in Lumera                                                            --       6,606       8,738
                                                                                         ----------  ----------  ----------
Net loss                                                                                   (32,620)    (19,787)    (23,984)

Stated dividend on mandatorily redeemable convertible preferred stock                           --          --         (59)
Accretion to par value of preferred stock                                                       --          --        (138)
Inducement for conversion of preferred stock                                                    --          --      (3,076)
                                                                                         ----------  ----------  ----------
Net loss available for common shareholders                                              $  (32,620) $  (19,787) $  (27,257)
                                                                                         ==========  ==========  ==========
Net loss per share basic and diluted                                                    $    (0.53) $    (0.40) $    (0.81)
                                                                                         ==========  ==========  ==========

Weighted-average shares outstanding basic and diluted                                       61,643      49,963      33,572
                                                                                         ==========  ==========  ==========

                                                                                                               Shareholders' Equity (Deficit)
                                                           Mandatorily     -----------------------------------------------------------------------------------------------------------
                                                           redeemable     |
                                                          convertible     |                                                 Receivables   Accumulated
                                                         preferred stock  |    Common Stock      Additional                    from          other                         Total
                                                       -------------------|-------------------     paid-in      Deferred      related    comprehensive  Accumulated    Shareholders'
                                                        Shares    Amount  | Shares   Par Value     capital     Compensation   parties       income        deficit     Equity (Deficit)
                                                       --------  ---------|--------  ---------  -------------  -----------  -----------  -------------  ------------  ----------------
Balance at December 31, 2005                                 5  $   4,166 | 25,138  $      25  $     212,993  $       (85) $      (792) $          --  $   (215,650) $         (3,509)
Amortization of share-based compensation                                  |                            1,740           85                                                       1,825
Exercise of warrants and options                                          |     16                        44                                                                       44
Sales of common stock and warrants                                        |
 (net of issuance costs of $3.0 million)                                  | 14,867         15         32,015           --                                                      32,030
Conversion of preferred stock                               (5)    (5,000)|    786          1          4,999                                                                    5,000
Inducement to preferred shareholders                                      |                           (2,379)                                                                  (2,379)
Unamortized discount and offering costs                                   |
 on preferred stock                                                   419 |                             (419)                                                                    (419)
Issuance of common stock and change in                                    |
  warrant value to preferred shareholders                                 |    565          1          1,978                                                                    1,979
Beneficial conversion feature of                                          |
 mandatorily redeemable convertible preferred stock                   278 |                             (278)                                                                    (278)
Non-cash accretion on mandatorily redeemable convertible                  |
 preferred stock                                                      137 |                             (137)                                                                    (137)
Issuance of common stock for payment on senior                            |
 secured exchangeable convertible notes                                   |  1,466          1          1,966                                                                    1,967
Issuance of common stock for payment of interest on senior                |
 secured exchangeable convertible notes                                   |     67                        88                                                                       88
Issuance of common stock on preferred dividend                            |     16                        59                                                                       59
Dividend on preferred stock                                               |                              (59)                                                                     (59)
Warrants to purchase Lumera common stock                                  |                              476                                                                      476
Allowance for doubtful accounts on receivables from                       |
  related parties                                                         |                                                        542                                            542
Other comprehensive income                                                |                                                                     8,619                           8,619
Net loss                                                                  |                                                                                 (23,984)          (23,984)
                                                       --------  ---------|--------  ---------  -------------  -----------  -----------  -------------  ------------  ----------------
Balance at December 31, 2006                                --         -- | 42,921         43        253,086           --         (250)         8,619      (239,634)           21,864
Amortization of share-based compensation                                  |                            1,886                                                                    1,886
Exercise of warrants and options                                          | 13,350         13         35,883                                                                   35,896
Sales of common stock and warrants                                        |                              130           --                                                         130
Issuance of common stock for payment on senior                            |
 secured exchangeable convertible notes                                   |    452          1          1,367                                                                    1,368
Issuance of common stock for payment of interest on senior                |
 secured exchangeable convertible notes                                   |      7                        22                                                                       22
Sale of Lumera stock held as collateral on receivables                    |
  from related parties                                                    |                                                        227                                            227
Allowance for doubtful accounts on receivables from                       |
  related parties                                                         |                                                         23                                             23
Other comprehensive income                                                |                                                                    (8,568)                         (8,568)
Net loss                                                                  |                                                                                 (19,787)          (19,787)
                                                       --------  ---------|--------  ---------  -------------  -----------  -----------  -------------  ------------  ----------------
Balance at December 31, 2007                                --         -- | 56,730         57        292,374           --           --             51      (259,421)           33,061
Amortization of share-based compensation                                  |     35                     2,857                                                                    2,857
Exercise of warrants and options                                          |    143         --            388                                                                      388
Sales of common stock and warrants                                        | 11,172         11         24,043                                                                   24,054
Other comprehensive income                                                |                                                                       (89)                            (89)
Net loss                                                                  |                                                                                 (32,620)          (32,620)
                                                       --------  ---------|--------  ---------  -------------  -----------  -----------  -------------  ------------  ----------------
Balance at December 31, 2008                                --  $      -- | 68,080  $      68  $     319,662  $        --  $        --  $         (38) $   (292,041) $         27,651
                                                       ========  ========= ========  =========  =============  ===========  ===========  =============  ============  ================

                                                                                               Years Ended December 31,
                                                                                         ----------------------------------
                                                                                            2008        2007        2006
                                                                                         ----------  ----------  ----------
Net loss                                                                                $  (32,620) $  (19,787) $  (23,984)
                                                                                         ----------  ----------  ----------
Other comprehensive gain (loss)
    Unrealized gain (loss) on investment securities, available-for-sale:
        Unrealized holding gain (loss) arising during period                                   (89)     (1,962)     17,357
        Less: reclassification adjustment for gains realized in net loss                        --      (6,606)     (8,738)
                                                                                         ----------  ----------  ----------
        Net unrealized gain (loss)                                                             (89)     (8,568)      8,619
                                                                                         ----------  ----------  ----------
Comprehensive loss                                                                      $  (32,709) $  (28,355) $  (15,365)
                                                                                         ==========  ==========  ==========

                                                                                              Years Ended December 31,
                                                                                         -------------------------------
                                                                                           2008       2007       2006
                                                                                         ---------  ---------  ---------
Cash flows from operating activities                                                                                    
  Net loss                                                                              $ (32,620) $ (19,787) $ (23,984)
  Adjustments to reconcile net loss to net cash used in operations:
    Depreciation                                                                              989        953      1,218
    Gain on disposal of fixed assets                                                           (5)      (117)      (198)
    Non-cash expenses related to issuance of stock, warrants, and options,
     and amortization of deferred compensation                                              2,831      1,897      1,825
    Non-cash interest expense, net                                                             --        371      4,753
    Loss (gain) on derivative instruments                                                  (2,196)       482     (1,627)
    Impairment of short-term investment securities                                            300         --         --
    Inventory write-downs                                                                     475         84      1,181
    Allowance for receivables from related parties                                           (241)        23        542
    Equity in losses of Lumera                                                                 --         --        290
    Gain on sale of investment in Lumera                                                       --     (6,606)    (8,738)
    Net accretion of discount on short-term investments                                       (97)       (80)        --
    Increase in deferred rent                                                                  --         --      1,042
    Non-cash deferred rent                                                                   (275)      (277)      (231)
  Change in:
    Accounts receivable                                                                     1,348       (719)       214
    Costs and estimated earnings in excess of billings on uncompleted contracts              (252)       122        639
    Inventory                                                                              (1,239)       198     (1,465)
    Other current assets                                                                      184        408        121
    Other assets                                                                               --         (6)        83
    Accounts payable                                                                        1,188        461       (689)
    Accrued liabilities                                                                      (642)       515     (1,139)
    Billings in excess of costs and estimated earnings on uncompleted contracts              (908)       770        149
                                                                                         ---------  ---------  ---------
      Net cash used in operating activities                                               (31,160)   (21,308)   (26,014)
                                                                                         ---------  ---------  ---------
Cash flows from investing activities                                                                                    
  Sales of investment securities                                                           20,400      7,200         --
  Purchases of investment securities                                                         (986)   (29,504)        --
  Sales of restricted investment securities                                                    --      2,329      1,100
  Purchases of restricted investment securities                                              (350)    (2,329)      (268)
  Decrease in restricted investment                                                           143        143         --
  Decrease in restricted cash                                                                  --         --        755
  Collections of receivables from related parties                                             241        227         --
  Sale of long-term investment - Lumera                                                        --      8,637     12,142
  Proceeds on sale of property and equipment                                                    5        117        200
  Purchases of property and equipment                                                        (495)    (1,058)    (2,152)
                                                                                         ---------  ---------  ---------
      Net cash provided by (used in) investing activities                                  18,958    (14,238)    11,777
                                                                                         ---------  ---------  ---------
Cash flows from financing activities                                                                                    
  Principal payments under capital leases                                                     (41)       (45)       (40)
  Principal payments under long-term debt                                                     (65)       (58)       (55)
  Increase in long-term debt                                                                   --         --        536
  Payments on notes payable                                                                    --     (1,400)    (9,600)
  Payment of embedded derivative feature of preferred stock conversion                         --         --     (1,074)
  Payment of preferred dividend                                                                --         --        (43)
  Net proceeds from issuance of common stock and warrants                                  24,442     35,896     32,205
                                                                                         ---------  ---------  ---------
      Net cash provided by financing activities                                            24,336     34,393     21,929
                                                                                         ---------  ---------  ---------
Net increase (decrease) in cash and cash equivalents                                       12,134     (1,153)     7,692
Cash and cash equivalents at beginning of period                                           13,399     14,552      6,860
                                                                                         ---------  ---------  ---------
Cash and cash equivalents at end of period                                              $  25,533  $  13,399     14,552
                                                                                         =========  =========  =========
                                                                                                                        
Supplemental disclosure of cash flow information                                                                        
Cash paid for interest                                                                  $      48  $      92  $     786
                                                                                         =========  =========  =========
                                                                                                                        
Supplemental schedule of non-cash investing and financing activities                                                    
Property and equipment acquired under capital leases                                    $      --  $      --  $      80
                                                                                         =========  =========  =========
Other non-cash additions to property and equipment                                      $     199  $      46  $     115
                                                                                         =========  =========  =========
Conversion of preferred stock into common stock                                         $      --  $      --  $   4,417
                                                                                         =========  =========  =========
Issuance of common stock for payment of principal and interest on senior
   secured exchangeable convertible notes                                               $      --  $   1,388  $   1,755
                                                                                         =========  =========  =========
Conversion of convertible debt into common stock                                        $      --  $      --  $     344
                                                                                         =========  =========  =========
Inducement for conversion of preferred stock                                            $      --  $      --  $   3,076
                                                                                         =========  =========  =========

                                                                                December 31,
                                                                   ------------------------------------
                                                                      2008         2007         2006
                                                                   -----------  -----------  ----------             
Publicly traded warrants                                            6,703,000           --   12,362,000
Options and private warrants                                        9,804,000    9,518,000   10,906,000
Notes payable                                                              --           --      620,000
                                                                   -----------  -----------  ----------
                                                                   16,507,000    9,518,000   23,888,000
                                                                   ===========  ===========  ==========

                                                                       Year Ended December 31,
                                                                   ------------------------------------
                                                                      2008         2007         2006
                                                                   -----------  -----------  ----------             
Cost of contract revenue                                          $    85,000  $   138,000  $   80,000
Cost of product revenue                                                25,000       20,000      70,000
Research and development expense                                      824,000      365,000     246,000
Sales, marketing, general and administrative expense                1,873,000    1,274,000   1,429,000
                                                                   -----------  -----------  ----------
                                                                  $ 2,807,000  $ 1,797,000  $1,825,000
                                                                   ===========  ===========  ==========

                                                                        Year Ended December 31,
                                                                      --------------------------
                                                                          2008          2007
                                                                      ------------  ------------
Billable within 30 days                                              $    688,000  $    434,000
Billable between 31 and 90 days                                                --            --
Billable after 90 days                                                      7,000         9,000
                                                                      ------------  ------------
                                                                     $    695,000  $    443,000
                                                                      ============  ============

                                                                      December 31,  December 31,
                                                                          2008          2007
                                                                      ------------  ------------
Costs and estimated earnings incurred on uncompleted contracts       $ 14,166,000  $  9,357,000
Billings on uncompleted contracts                                     (13,533,000)   (9,884,000)
                                                                      ------------  ------------
                                                                     $    633,000  $   (527,000)
                                                                      ============  ============
Included in accompanying balance sheets under the following captions:                           

Costs and estimated earnings in excess of billings on uncompleted
 contracts                                                           $    695,000  $    443,000
Billings in excess of costs and estimated earnings on uncompleted
 contracts                                                                (62,000)     (970,000)
                                                                      ------------  ------------
                                                                     $    633,000  $   (527,000)
                                                                      ============  ============

Balance, December 31, 2007                                                    $        --
Transfer into Level 3, September 30, 2008                                       3,000,000
Recognized loss included in earnings                                             (300,000)
                                                                               -----------
Balance, December 31, 2008                                                    $ 2,700,000
                                                                               ===========

                                            Level 1     Level 2     Level 3       Total
                                          -----------  ----------  ----------  ----------- 
Assets
    Corporate debt securities            $        --  $4,984,000  $       --  $ 4,984,000
    Auction rate securities                       --          --   2,700,000    2,700,000
                                          -----------  ----------  ----------  -----------
                                         $        --  $4,984,000  $2,700,000  $ 7,684,000
                                          ===========  ==========  ==========  ===========
Liabilities
    Liability associated with
        common stock warrants                         $  331,000              $   331,000
                                                       ==========              ===========

                                                                                            Classification on Balance Sheet
                                                                                            ---------------------------------------------------
                                                                                                                                   Liability
                                                                                                                                  Associated
                                                                                                         Investment                  With
                                             Cost/       Gross       Gross                               Securities,    Other       Common
                                           Amortized   Unrealized  Unrealized   Estimated      Cash      Available-    Current       Stock
                                             Cost        Gains       Losses    Fair Value   Equivalents   For-Sale      Assets     Warrants
                                          -----------  ----------  ----------  -----------  -----------  -----------  ----------  -----------
As of December 31, 2008:
  Assets
    Corporate debt securities            $ 5,022,000  $       --  $  (38,000) $ 4,984,000  $ 4,979,000  $     5,000  $       --
    Auction-rate securities                2,700,000          --          --    2,700,000           --    2,700,000          --
                                          -----------  ----------  ----------  -----------  -----------  -----------  ----------
                                         $ 7,722,000  $       --  $  (38,000) $ 7,684,000  $ 4,979,000  $ 2,705,000  $       --
                                          ===========  ==========  ==========  ===========  ===========  ===========  ==========
  Liabilities
    Liability associated with
       common stock warrants                                                  $   331,000                                        $   331,000
                                                                               ===========                                        ===========


                                                                                            Classification on Balance Sheet
                                                                                            --------------------------------------------------
                                                                                                                                   Liability
                                                                                                                                  Associated
                                                                                                         Investment                  With
                                             Cost/       Gross       Gross                               Securities,    Other       Common
                                           Amortized   Unrealized  Unrealized   Estimated      Cash      Available-    Current       Stock
                                             Cost        Gains       Losses    Fair Value   Equivalents   For-Sale      Assets     Warrants
                                          -----------  ----------  ----------  -----------  -----------  -----------  ----------  -----------
As of December 31, 2007:
  Assets
    Corporate debt securities            $ 9,074,000  $   54,000  $   (5,000) $ 9,123,000  $        --  $ 9,123,000  $       --
    U.S. government and agency securities  4,486,000       3,000      (1,000)   4,488,000           --    4,488,000          --
    Auction-rate securities                8,800,000          --          --    8,800,000           --    8,800,000          --
    Warrants                                      --          --          --      130,000                               130,000
                                          -----------  ----------  ----------  -----------  -----------  -----------  ----------
                                         $22,360,000  $   57,000  $   (6,000) $22,541,000  $        --  $22,411,000  $  130,000
                                          ===========  ==========  ==========  ===========  ===========  ===========  ==========
  Liabilities
    Liability associated with
        common stock warrants                                                 $ 2,657,000                                        $ 2,657,000
                                                                               ===========                                        ===========

                                                            Gross        Gross
                                             Amortized   Unrealized   Unrealized    Estimated
                                               Cost         Gains       Losses      Fair Value
                                            -----------  -----------  -----------  ------------
Maturity date:
    Less than one year                     $ 5,022,000           --      (38,000) $  4,984,000
    Due in 1-3 years                                --                                      --
    Greater than five years                  2,700,000                               2,700,000
                                            -----------                            ------------
                                           $ 7,722,000                            $  7,684,000
                                            ===========                            ============

                                                       December 31,   December 31,
                                                           2008           2007
                                                       -------------  ------------
Raw materials                                         $      45,000  $    122,000
Work in process                                                  --        10,000
Finished goods                                            1,480,000       629,000
                                                       -------------  ------------
                                                      $   1,525,000  $    761,000
                                                       =============  ============

                                                               December 31,
                                                       ---------------------------
                                                           2008           2007
                                                       -------------  ------------
Bonuses                                               $     500,000  $  1,500,000
Payroll and payroll taxes                                   809,000       656,000
Compensated absences                                        623,000       458,000
Deferred rent credit                                        311,000       306,000
Adverse purchase commitments                                119,000            --
Professional fees                                           343,000       447,000
Other                                                       840,000       787,000
                                                       -------------  ------------
                                                      $   3,545,000  $  4,154,000
                                                       =============  ============

                                                               December 31,
                                                       ---------------------------
                                                           2008           2007
                                                       -------------  ------------
Production equipment                                  $   3,124,000  $  2,815,000
Leasehold improvements                                    3,310,000     3,304,000
Computer hardware and software/lab equipment              7,192,000     6,879,000
Office furniture and equipment                            1,496,000     1,490,000
                                                       -------------  ------------
                                                         15,122,000    14,488,000
Less: Accumulated depreciation                          (11,421,000)  (10,441,000)
                                                       -------------  ------------
                                                      $   3,701,000  $  4,047,000
                                                       =============  ============

                                           Warrants to   Weighted-
                                             purchase     average
                                              common     excercise
                                              Shares       price
                                           ------------  ---------
Outstanding at December 31, 2005             4,120,000  $    6.99
Granted:
Exercise price greater than intrinsic value 12,900,000       2.66
Exercise price equal to intrinsic value        537,000       2.81
Exercised                                           --         --
Canceled/expired                                    --         --
                                           ------------
Outstanding at December 31, 2006            17,557,000       3.50
Granted:
Exercise price greater than intrinsic value    537,000       2.65
Exercise price equal to intrinsic value         25,000       3.42
Exercised                                  (13,803,000)      2.59
Canceled/expired                              (252,000)      6.30
                                           ------------
Outstanding at December 31, 2007             4,064,000       6.19
Granted:
Exercise price greater than intrinsic value  6,703,000       3.60
Exercise price equal to intrinsic value             --         --
Exercised                                           --         --
Canceled/expired                            (1,257,000)      6.11
                                           ------------
Outstanding at December 31, 2008             9,510,000  $    4.32
                                           ============
Exercisable at December 31, 2008             2,807,000  $    6.04
                                           ============

                                                                     Year Ended December 31,
                                                             -------------------------------------
                                                                2008         2007         2006
                                                             -----------  -----------  -----------
Exercise price greater than fair value                      $      1.59  $        --  $      1.81
Exercise price equal to fair value                                   --         2.08           --
Exercise price less than fair value                                  --         0.47         2.00

                                           Warrants outstanding            Warrants exercisable
                                     ---------------------------------  ------------------------
                                                  Weighted
                                       Number      average      Weighted      Number      Weighted
                                   outstanding at  remaining   average   exercisable at   average
                                     December 31, contractual   excercise  December 31,   excercise
Range of exercise prices                2008      life (years)  price        2008         price
-----------------------------------  -----------  ---------  ---------  -------------  ---------
                                                                                             
$2.76-$3.51                             472,000       2.24  $    2.93        472,000    $  2.93
$3.60-$3.61                           7,065,000       4.36       3.60        362,000       3.61
$3.77-$3.94                           1,304,000       1.87       3.91      1,304,000       3.91
$5.03-$5.32                             469,000       1.19       5.03        469,000       5.03
$34.00                                  200,000       1.61      34.00        200,000      34.00
                                     -----------                        -------------
$2.76-$34.00                          9,510,000                            2,807,000
                                     ===========                        =============

                                                                       Year Ended December 31,
                                                                   ------------------------------------
                                                                      2008         2007         2006
                                                                   -----------  -----------  ----------             
Share-based employee compensation expense charged against loss    $     2,807  $     1,797  $    1,825
                                                                   ===========  ===========  ==========

                                                                      Pre-         Post-
                                                                   modification modification
                                                                   -----------  -----------                         
Weighted average:
   Exercise price                                                 $      8.84  $      2.77
   Volatility                                                              73%          65%
   Expected term (years)                                                  6.9          4.2
   Risk free rate                                                         5.0%         5.0%
   Pre-vest forfeiture rate                                               5.0%         5.0%

                                                                       Year Ended December 31,
                                                                   ------------------------------------
                                                                      2008         2007         2006
                                                                   -----------  -----------  ----------             
Assumptions (weighted average)
Volatility                                                                 65%          68%         72%
Expected term (in years)                                                  5.1          6.2         6.1
Risk-free rate                                                            3.0%         5.0%        5.0%
Expected dividends                                                         --           --          --
Pre-vest forfeiture rate                                                  5.0%         5.0%        5.0%
Grant date fair value of options granted                          $      1.32  $      2.67  $     2.26

                                                                                              Weighted
                                                                                              Average
                                                                                 Weighted    Remaining
                                                                                  Average    Contractual  Aggregate
                                                                                 Exercise       Term      Intrinsic
Options                                                              Shares        Price      (years)       Value
-----------------------------------------------------------------  -----------  -----------  ----------  -----------
Outstanding at December 31, 2005                                    5,320,000  $     11.09         6.8  $     3,000
Granted  *                                                          4,280,000         2.99
Exercised                                                             (16,000)        2.77
Forfeited or expired  *                                            (3,873,000)        9.62
                                                                   -----------
Outstanding as of December 31, 2006                                 5,711,000         6.04         6.9    1,384,000
Granted                                                             1,617,000         4.08
Exercised                                                             (84,000)        2.78
Forfeited or expired                                               (1,790,000)        9.05
                                                                   -----------
Outstanding as of December 31, 2007                                 5,454,000         4.52         6.9    3,320,000
Granted                                                             2,276,000         2.33
Exercised                                                            (143,000)        2.72
Forfeited or expired                                                 (590,000)        2.93
                                                                   -----------
Outstanding as of December 31, 2008                                 6,997,000  $      3.98         7.2  $    63,000
                                                                   ===========  ===========  ==========  ===========

Vested and expected to vest as of December 31, 2008                 6,745,000  $      4.02         7.1  $    59,000
                                                                   ===========  ===========  ==========  ===========

Exercisable as of December 31, 2008                                 3,163,000  $      5.12         6.1  $    27,000
                                                                   ===========  ===========  ==========  ===========

                                                     Capital       Operating
                                                     leases         leases
                                                  -------------  -------------
2009                                             $      47,000  $     844,000
2010                                                    40,000        870,000
2011                                                     8,000        904,000
2012                                                        --        938,000
2013                                                        --        564,000
Thereafter                                                  --             --
                                                  -------------  -------------
Total minimum lease payments                            95,000  $   4,120,000
                                                                 =============
Less: Amount representing interest                      (9,000)
                                                  -------------
Present value of capital lease obligations              86,000
Less: Current portion                                  (41,000)
                                                  -------------
Long-term obligation at December 31, 2008        $      45,000
                                                  =============

                                                          December 31,
                                                  ----------------------------
                                                      2008           2007
                                                  -------------  -------------
Deferred tax assets, current
   Reserves                                      $   1,990,000  $   2,460,000
   Other                                               996,000        712,000
                                                  -------------  -------------
Total gross deferred tax assets, current             2,986,000      3,172,000
                                                  -------------  -------------
Deferred tax assets, noncurrent
   Net operating loss carryforwards                 74,605,000     68,658,000
   R&D credit carryforwards                          4,258,000      3,601,000
   Depreciation/amortization deferred               15,665,000     10,848,000
   Other                                             3,520,000      2,581,000
                                                  -------------  -------------
Total gross deferred tax assets, noncurrent         98,048,000     85,688,000
                                                  -------------  -------------
Deferred tax liabilities, noncurrent
   Convertible debt                                 (1,828,000)    (1,209,000)
                                                  -------------  -------------
Total gross deferred tax liabilities, noncurrent    (1,828,000)    (1,209,000)
                                                  -------------  -------------
Net deferred taxes before valuation allowance       99,206,000     87,651,000
Less: Valuation allowance                          (99,206,000)   (87,651,000)
                                                  -------------  -------------
Deferred tax assets                              $          --  $          --
                                                  =============  =============

                                                       Year Ended December 31, 2008
                                        ----------------------------------------------------------
                                        December 31,   September 30,    June 30,       March 31,
                                        -------------  -------------  -------------  -------------
Revenue                                $   1,525,000  $     894,000  $   1,622,000  $   2,570,000
Gross Margin                                 287,000        285,000        719,000      1,469,000
Net loss available for common shareholde  (9,873,000)    (8,443,000)    (9,266,000)    (5,038,000)
Net loss per share basic and diluted           (0.15)         (0.13)         (0.16)         (0.09)

                                                       Year Ended December 31, 2007
                                        ----------------------------------------------------------
                                        December 31,   September 30,    June 30,       March 31,
                                        -------------  -------------  -------------  -------------
Revenue                                $   2,988,000  $   2,599,000  $   2,662,000  $   2,235,000
Gross Margin                               1,092,000        846,000        999,000        941,000
Net loss available for common shareholde  (6,022,000)    (4,718,000)    (2,155,000)    (6,892,000)
Net loss per share basic and diluted           (0.11)         (0.08)         (0.05)         (0.16)

                                                                             Additions
                                                                       ------------------------
                                                          Balance at   Charges to   Charges to                  Balance at
                                                         beginning of   costs and      other                      end of
                      Description                        fiscal period  expenses     accounts     Deductions   fiscal period
-------------------------------------------------------  ------------  -----------  -----------  ------------  -------------
    Year Ended December 31, 2006
        Allowance for receivables from related parties         1,931          542           --            --          2,473
        Tax valuation allowance                               71,028           --        5,537            --         76,565

    Year Ended December 31, 2007
        Allowance for receivables from related parties         2,473           23           --            --          2,496
        Tax valuation allowance                               76,565           --       11,086            --         87,651

    Year Ended December 31, 2008
        Allowance for receivables from related parties         2,496           --           --          (645)         1,851
        Tax valuation allowance                               87,651           --       11,555            --         99,206

                                                                               Equity Compensation Plan Information
                                                         ---------------------------------------------------------------------
                                                              Number of             Weighted-          Number of securities
                                                           securities to be     average excercise     remaining available for
                                                             issued upon             price of         further issuance under
                                                             excercise of          outstanding          equity compensation
                                                             outstanding        options, warrants        plans (excluding
                                                          options, warrants         and rights        securities reflected in
                                                              and rights                                    column (a))
Plan Category                                                    (a)                   (b)                      (c)
-------------------------------------------------------  --------------------  --------------------  -------------------------
Equity compensation plans approved by shareholders                 6,996,000  $               3.97                  4,089,000
Equity compensation plans not approved by shareholders               233,000                 29.79                         --
                                                         --------------------                        -------------------------
    Total                                                          7,229,000  $               4.80                  4,089,000
                                                         ====================                        =========================