June 30, 2002

Forward-Looking Statements

The information set forth in this report in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 3, “Quantitative and Qualitative Disclosure about Market Risk,” includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and is subject to the safe harbor created by that section.  Such statements may include, but are not limited to, projections of revenues, income or loss, capital expenditures, plans for product development and cooperative arrangements, future operations, financing needs or plans of the Company, as well as assumptions relating to the foregoing.  The words “believe,” “expect,” “anticipate,” “estimate,” “project,” and similar expressions identify forward-looking statements, which speak only as of the date the statement was made. Certain factors that realistically could cause results to differ materially from those projected in the forward-looking statements are set forth below under the caption “Risk Factors Relating to the Company’s Business.”

Overview

Microvision, Inc. (“Microvision” or the “Company”) develops information display and capture devices and related technologies.  The Company is developing and seeks to commercialize technologies and products in three business platforms relating to the delivery of images and information:

•                   Retinal Scanning Displays - Uses the retinal scanning display technology to display information on the retina of the viewers eye.

•                   Image Capture Devices - Uses proprietary scanning technology to capture images and information in applications such as bar code readers or cameras.

•                   Electro-Optical Materials Technology - Uses a new class of organic non-linear materials technology that interact with, and can be used to change the properties of, light waves to transmit information.

Retinal Scanning Displays

The Company has developed prototype retinal scanning display technology devices, including head-worn, portable color versions as well as head-worn monochrome and color see-through versions, and is currently refining and developing its retinal scanning display technology for defense, medical, industrial and consumer applications.  The Company is commercializing its technology through the development of products and also plans to supply personal display technology to original equipment manufacturers.  The Company believes the retinal scanning display technology will be useful in a variety of applications, such as portable communications and visual simulation applications that will require images to be superimposed onto the user’s field of vision.  The Company expects that its retinal scanning display technology will allow for

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the production of highly miniaturized, lightweight, battery-operated displays that can be held or worn comfortably.

The Company’s retinal scanning display technology includes proprietary technology developed by the Company, technology licensed from other companies and technology licensed from the University of Washington.

Image Capture Devices

The Company is also developing products that capture images using the Company’s proprietary scanning technologies.  The Company believes that the basic scanning components of the retinal scanning display system can be used to develop products, such as bar code readers and miniature high-resolution cameras, that have higher performance and lower cost than those currently available.   The Company has developed proprietary scanner technology, which it plans to use in a low cost hand held bar code scanner targeted at industrial applications.  The laser-based hand held bar code device would allow the user to record information in a way that is both easy and fast.  The Company plans to continue to refine the design of the hand held scanner and introduce the product in September 2002.

Electro-Optical Materials and Devices

During 2000, the Company formed a subsidiary company, Lumera Corporation (“Lumera”), to develop and commercialize a new class of non-linear organic electro-optical chromophores (“Optical Materials”) and devices that use the optical properties of these proprietary materials.  Non-linear organic electro-optical materials interact with and can be used to change the properties of light waves to transmit information.  The formation of Lumera was an outgrowth of the Company’s prior work in photonics.  In October 2000, Lumera entered into an exclusive license agreement with the University of Washington for certain Optical Materials technology.  Lumera expects that these materials and devices made from the Optical Materials will improve the performance and reduce the cost of electro-optic components used for fiber-optic telecommunications and data communications systems, phased-array antennas, optical computing and other photonics applications.

Plan of Operation

The Company introduced Nomad™, a production version of a retinal scanning display, in December 2001.   The Company plans to sell Nomad to customers in general aviation, industrial, medical and defense sectors.  The Company plans to distribute Nomad directly to end-users and through value added resellers who will develop applications using Nomad.  As of June 30, 2002 the Company had entered into agreements with 21 value added resellers to distribute Nomad.

The Company plans to introduce “Flic™”, a hand held bar code scanner, in September 2002.  Flic will be produced by a contract manufacturer.  The Company plans to distribute Flic through the

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same channels as existing bar code products including value added resellers and original equipment manufacturers.

The Company also intends to continue entering into strategic relationships with systems integrators and original equipment manufacturers to pursue the development of commercial products incorporating the retinal scanning display technology.

In addition, the Company plans to continue to pursue, obtain and perform on development contracts.  The Company expects that such contracts will further the development of the retinal scanning display and Optical Materials technologies and lead to additional commercial applications of its technologies.  The Company also plans to invest funds for ongoing innovation and improvements to the retinal scanning display and Optical Materials technologies.  These innovations and improvements include developing component technology, building additional prototypes, and designing components and products for manufacturability.  The Company intends to continue hiring qualified sales, technical and other personnel and to continue investing in laboratory facilities and equipment to achieve development and production objectives.

Lumera plans to develop optical components that offer increased speed, reduced size and cost, greater reliability, and more efficient operation than existing electro-optic component technologies.  Moreover, Lumera believes that its Optical Materials technology is well suited to the manufacture of highly complex, highly integrated optical systems.  The first product planned for introduction is a high-speed electro-optical (“EO”) modulator that will provide a direct replacement for currently available lithium niobate modulators.  The function of an EO modulator is to encode data onto laser beams that carry and deliver data throughout optical fiber networks.  Lumera’s Optical Materials and devices can be designed to optimize performance for a specific application.  In addition, the Optical Materials technology has potential applications in a broad range of optical networking components.

Lumera’s Optical Materials technology may ultimately be sold in a variety of forms, including coated wafers, non-packaged discrete devices, non-packaged integrated devices, packaged discrete components, packaged integrated components, and intellectual property in the form of licenses, integrated cells and other forms.  Lumera’s target customers include strategic technology partners, sub-system manufacturers, private label component vendors, component distributors and systems manufacturers in the telecommunications industry.

Results of Operations

THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO

THREE MONTHS ENDED JUNE 30, 2001

Revenue .  The Company earns revenue from performance on development contracts, sales of demonstration products, and sales of Nomad.  Revenue in the three months ended June 30, 2002 increased by $2.9 million, or 167%, to $4.7 million from $1.8 million in the same period in 2001. For the three months ended June 30, 2002, 78% of revenue was derived from performance on development contracts with the United States government, 18% from performance on development contracts with commercial customers, and

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the remainder from the sales of Nomad units.

In May 2002, the Company entered a $3.3 million contract modification with the U.S. Army’s Aviation Applied Technology Directorate to continue work on an advanced helmet mounted display and imaging system to be used in the virtual cockpit optimization program.

In June 2002, the Company entered a $1.9 million development contract with NASA Langley Research Center to deliver a prototype cockpit helmet display system.

The backlog of development contracts and product sales at June 30, 2002 was $5.7 million of development contract work and product orders, all of which are scheduled for completion during the next twelve months.  The backlog is comprised of development contracts, including amendments thereto, and purchase orders that were entered into through June 30, 2002.

Cost of Revenue .  Cost of revenue includes both the direct and allocated indirect costs of performing on development contracts and producing Nomad. Indirect costs include staff and related support costs associated with building the Company’s technical capabilities and capacity to perform on development contracts the Company expects to enter into in the future.

Cost of revenue for the three months ended June 30, 2002 increased by $1.1 million, or 103%, to $2.2 million from $1.1 million in the same period in 2001.  Total direct costs for the three months ended June 30, 2002 increased by approximately 90% over the same period in 2001.  The direct labor costs portion of direct cost for the three months ended June 30, 2002 increased by 200% over the same period in 2001.  The increase in direct cost was principally a result of the higher volume of contract work that the Company performed during the three months ended June 30, 2002 compared to the same period in 2001.  Research and development overhead is allocated to both cost of revenue and research and development expense based on the proportion of direct labor cost incurred in cost of revenue and research and development, respectively.  As a result of the higher direct labor cost in cost of revenue for the three months ended June 30, 2002 approximately 60% more overhead was allocated to cost of revenue than in the same period in 2001.

The Company is in the early phase of Nomad production and has not achieved production volumes to support commercial production as described in SFAS No. 2 “Accounting for Research and Development Cost.”  The Company’s costs to produce Nomad units during the three months ended June 30, 2002 were substantially higher than product revenue.  The Company has classified production cost in excess of product revenue as research and development expense.  When the Company reaches normal Nomad production levels all manufacturing costs will be included in cost of revenue.

The Company expects that cost of revenue on an absolute dollar basis will increase in the future.  This increase will likely result from anticipated sales of commercial products, additional development contract work that the Company expects to perform and commensurate growth in the Company’s personnel and technical capacity required for performance on such contracts and product sales.  The cost of revenue as a

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percentage of revenue can fluctuate significantly from period to period, depending on the contract mix, the cost of future products and the level of direct and indirect cost incurred.

                                                Research and Development Expense.   Research and development expense consists of:

•                   Compensation related costs of employees and contractors engaged in internal research and product development activities,

•                   Related operating expenses.

Included in research and development expenses are costs incurred in acquiring and maintaining licenses of technology from other companies.  The Company has charged all research and development costs to cost of revenue or research and development expense.

Research and development expense in the three months ended June 30, 2002 decreased by $2.0 million, or 26%, to $6.0 million from $8.0 million in the same period in 2001.  During the three month period ended June 30, 2001 the Company recorded $1.4 million in direct expense relating to light source research performed for the Company by CREE, Inc.  The Company’s development agreement with CREE ended in April 2002, resulting in a $1.4 million cost reduction in the three-month period ended June 30, 2002.

Due to the higher volume of work performed on revenue contracts during the three months ended June 30, 2002, more indirect research and development costs were allocated to cost of revenue than in the same period in 2001.

The Company believes that a substantial level of continuing research and development expense will be required to develop additional commercial products using the retinal scanning display technology and the Optical Materials technology.  Accordingly, the Company anticipates that a high level of research and development spending will continue.  These expenses will be incurred as a result of:

•                   Hiring additional technical and support personnel.

The Company expects that the amount of spending on research and product development will grow as the Company:

•                   Continues development of the Company’s retinal scanning display technology,

•       Develops and commercializes the Optical Materials technology,

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•                   Prepares for the planned introduction of the Company’s first bar code product in September 2002,

•       Accelerates development of microdisplays to meet emerging market opportunities, and

•                   Pursues other potential business opportunities.

Marketing, General and Administrative Expense.   Marketing, general and administrative expenses include compensation and support costs for sales, marketing, management and administrative staff, and for other general and administrative costs, including legal and accounting services, consultants and other operating expenses.

The Company’s marketing activities include corporate awareness campaigns, such as web site development and participation at trade shows; corporate communications initiatives; and working with potential customers and joint venture partners to identify and evaluate product applications in which the Company’s technology could be integrated or otherwise used.

Marketing, general and administrative expenses in the three months ended June 30, 2002 increased by $1.1 million, or 32%, to $4.4 million from $3.3 million in the same period in 2001.  The increase includes increases in compensation expenses and support costs for employees and contractors.  The Company expects marketing, general and administrative expenses to increase substantially in future periods as the Company:

•                         Increases the level of corporate and administrative activity.

During the three months ended June 30, 2002 the Company determined that one of its senior officers may have insufficient net worth and short-term earnings potential to repay loans outstanding under the Company’s executive loan program.  The Company recorded an allowance for doubtful accounts for receivables from related parties of $500,000 in the three months ended June 30, 2002.

Non-Cash Compensation Expense .  Non-cash compensation expense in the three months ended June 30, 2002 decreased 48% or $366,000 to $398,000 from $764,000 in the same period in 2001.

The following table shows the major components of non-cash compensation expense for the three months ended June 30, 2002 and 2001, respectively.

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Interest Income and Expense.  Interest income in the three months ended June 30, 2002 decreased by $442,000, or 61%, to $281,000 from $723,000 in the same period in 2001.  This decrease resulted primarily from lower average cash and investment securities balances in the three months ended June 30, 2002 than the average cash and investment securities balances in the same period of the prior year.

Interest expense in the three months ended June 30, 2002 was consistent with the same period in 2001 as the Company’s borrowings remained relatively constant.

Loss in Long-Term Investment .  In December 1999, the Company invested $624,000 in Gemfire Corporation (“Gemfire”), a privately held corporation.  Gemfire is a developer of laser components for display and telecommunication applications.  The Company accounts for the investment using the cost method.

In June 2002, Gemfire announced a recapitalization plan that would reduce the value of the Company’s investment.  In June 2002, the Company recorded an expense for a loss of the entire value of its investment in Gemfire.

SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO

SIX MONTHS ENDED JUNE 30, 2001

Revenue .  The Company earns revenue from performance on development contracts, sales of demonstration products, and sales of Nomad.  Revenue in the six months ended June 30, 2002 increased by $4.4 million, or 108%, to $8.5 million from $4.1 million in the same period in 2001. For the six months ended June 30, 2002, 85% of revenue was derived from performance on development contracts with the United States government, 11% from performance on development contracts with commercial customers and the remainder from the sales of Nomad units.

Cost of Revenue.   Cost of revenue for the six months ended June 30, 2002 increased by $1.4 million, or 52%, to $4.0 million from $2.6 million in the same period in 2001.  Total direct costs for the six months ended June 30, 2002 increased approximately 30% from the same period in 2001.  The direct labor costs portion of direct cost for the six months ended June 30, 2002 increased by approximately 175% over the same period in 2001.  The increase in direct labor cost was a result of the higher volume of contract work that the Company was performing and increased product costs during the six months ended June 30,

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2002 compared to the same period in 2001.  Research and development overhead is allocated to both cost of revenue and research and development expense based on the proportion of direct labor cost incurred in cost of revenue and research and development, respectively.  As a result of the higher direct labor cost in cost of revenue for the six months ended June 30, 2002 approximately 40% more overhead was allocated to cost of revenue than in the same period in 2001.

The Company is in the early phase of Nomad production and has not achieved production volumes to support commercial production as described in SFAS No. 2 “Accounting for Research and Development Costs.”  The Company’s costs to produce Nomad units during the six months ended June 30, 2002 were substantially higher than product revenue.  The Company has classified production cost in excess of product revenue as research and development expense.  When the Company reaches normal Nomad production levels all manufacturing costs will be included in cost of revenue.

Research and Development Expense.   Research and development expense in the six months ended June 30, 2002 decreased by $2.7 million, or 17%, to $13.3 million from $16.0 million in the same period in 2001.  The decrease is partially a result of a license fee paid to the University of Washington in February 2001 for the HALO Technology.  The HALO technology involves the projection of data and images onto the inside of a dome that is placed over the viewer’s head.  The Company issued 37,000 shares of Common Stock valued at $1.0 million and paid $100,000 to the University of Washington as final payment for the license.

In addition, during the six month period ended June 30, 2001 the Company recorded $2.3 million in expense relating to light source research performed for the Company by CREE Inc.  The Company’s research agreement with Cree ended in April 2002, resulting in a $900,000 cost reduction in the six-month period ended June 30, 2002.

The decrease in the HALO license fee and CREE research expense was offset by increases in other costs, which reflect the continued implementation of the Company’s operating plan, which calls for building technical staff and supporting activities, establishing and equipping in-house laboratories, and developing and maintaining intellectual property.

As discussed above, due to the higher volume of work performed on revenue contracts, more indirect research and development costs were allocated to cost of revenue during the three months ended June 30 than in the comparable period in 2001.

Marketing, General and Administrative Expense.   Marketing, general and administrative expenses in the six months ended June 30, 2002 increased by $1.9 million, or 27%, to $8.9 million from $7.0 million in the same period in 2001.  The increase includes increases in compensation expenses and support costs for employees and contractors.  The Company expects marketing, general and administrative expenses to increase substantially in future periods as the Company:

•                         Adds to its sales and marketing staff,

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•                         Increases the level of corporate and administrative activity.

Non-Cash Compensation Expense .  Non-cash compensation expense in the six months ended June 30, 2002 decreased 31% or $406,000 to $913,000 from $1,319,000 for the same period in 2001.

The following table shows the major components of non-cash compensation expense for the six months ended June 30, 2002 and 2001, respectively.

Interest Income and Expense.  Interest income in the six months ended June 30, 2002 decreased by $810,000, or 57%, to $619,000 from $1.4 million in the same period in 2001.  This decrease resulted primarily from lower average cash and investment securities balances in the six months ended June 30, 2002 than the average cash and investment securities balances in the same period of the prior year.

Interest expense in the six months ended June 30, 2002 was consistent with the same period in 2001, as our borrowings remained relatively constant.

Loss in Long-Term Investment .  In December 1999, the Company invested $624,000 in Gemfire Corporation (“Gemfire”), a privately held corporation.  Gemfire is a developer of diode laser components for display and telecommunication applications.  The Company accounts for the investment using the cost method.

In June 2002, Gemfire announced a recapitalization plan that would reduce the value of the Company’s investment.  In June 2002, the Company recorded an impairment for the entire value of its investment in Gemfire.

Liquidity and Capital Resources

The Company has funded operations to date primarily through the sale of common stock, convertible preferred stock and, to a lesser extent, revenues from development contracts and product sales. At June 30, 2002, the Company had $23.2 million in cash, cash equivalents and investment securities.

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Cash used in operating activities totaled $15.1 million during the six months ended June 30, 2002, compared to $18.2 million during the same period in 2001.  Cash used in operating activities for each period resulted primarily from the net loss for the period.

In July 2002 the Company reduced its workforce by approximately 7% as part of the Company’s plan to reduce operating costs.  The reduction was a result of eliminating and consolidating certain positions.  The Company will pay approximately $200,000 in involuntary termination benefits during the third quarter of 2002.  The liability for the involuntary termination benefits did not meet the criteria for accrual established in Emerging Issues Task Force 94-3, and therefore the related expense will be recognized in the third quarter of 2002.  The Company expects that its work force will grow as it continues to hire qualified sales, technical and other personnel to meet its operating plan.

Cash provided by investing activities totaled $4.8 million during the six months ended June 30, 2002, compared to cash used in investing activities of $2.4 million during the same period of 2001.  During the six months ended June 30, 2002 the Company had net sales of investment securities of $5.8 million compared to net purchases of investment securities of $392,000 during the same period in 2001.  The proceeds from the sales of investment securities were used to fund the Company’s operations.

The Company used $650,000 for capital expenditures during the six months ended June 30, 2002, compared to $2.6 million during the same period in 2001.  Historically, capital expenditures have been used to make leasehold improvements to leased office space and to purchase computer hardware and software, laboratory equipment and furniture and fixtures to support growth.

Cash provided by financing activities totaled $5.8 million during the six months ended June 30, 2002, compared to $22.2 million during the same period in 2001.  In March 2002, the Company raised $6.0 million, before issuance costs, from the sale of 524,000 shares of its common stock at a price of $11.50 per share.  During the six months ended June 30, 2001, Lumera raised $21.4 million, before issuance costs, from the issuance of 2,136,000 shares of manditorily redeemable convertible preferred stock.

Future operating expenditures and capital requirements will depend on numerous factors, including the following:

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In order to maintain exclusive rights under its license agreements with the University of Washington, the Company is obligated to make royalty payments to the University of Washington.  If the Company is successful in establishing OEM co-development and joint venture arrangements, the Company expects that its partners will fund a portion of non-recurring engineering costs for product development.

Microvision and Lumera maintain separate cash and investment accounts.  Each company’s cash and investments are generally used to fund its separate business activities.

At June 30, 2002, the Company had combined cash, cash equivalents and investment securities balances of $23.2 million.  Based on its current operating plan, these funds along with the additional $3.0 million, before issuance costs raised in July 2002, will meet the Company’s cash requirements through the end of the first quarter of 2003.  In order to implement its operating plan thereafter, the Company will be required to raise additional financing.

Actual expenses may be greater than estimated and the Company may require additional capital earlier than anticipated to:

•                   Accelerate the development of retinal scanning display technology and the Optical Materials technology,

•                   Respond to competitive pressures, or

•                   Meet unanticipated development difficulties.

In addition, the Company’s operating plan calls for the addition of technical and business staff and the purchase of additional computer and laboratory equipment and leasehold improvements.  The operating plan also provides for the development of strategic relationships with systems and equipment manufacturers.  The Company’s capital requirements will depend on many factors, including, but not limited to, the rate at which the Company can, directly or through arrangements with OEMs, introduce products incorporating the retinal scanning display technology and the market acceptance and competitive position of such products.

There can be no assurance that additional financing will be available to the Company or that, if available, it will be available on acceptable terms on a timely basis.  If adequate funds are not available to satisfy either short-term or long-term capital requirements, the Company may be required to reduce operations significantly.

New Accounting Pronouncements

In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.”  The Company adopted this statement during the first quarter of 2002.  As the Company has no recorded goodwill or intangible assets, there was no initial effect from adoption of this standard.

In July 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  Adoption of this statement is required no later than January 1, 2003.  The Company is currently

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assessing the impact of this statement on its results of operations, financial position and cash flows.

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  FAS 144 retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and for measurement of long-lived assets to be disposed of by sale.  This statement applies to all long-lived assets, including discounted operations, and replaces the provisions of APB Opinion No. 30, “Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business”, for the disposal of segments of a business.  This statement requires that those long-lived assets be measured at the lower of carrying amount or fair value.  Microvision adopted this statement during the first quarter of 2002 and there was no material impact on the Company’s results of operations, financial position or cash flows.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The Company will be required to adopt this statement for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 will not have a significant impact on its financial position, results of operations and cash flows.

Subsequent Event

In July 2002, the Company raised $3.0 million, before issuance costs, from the sale of 937,500 shares of common stock at $3.20 per share and fully vested five-year warrants to purchase 234,375 shares of common stock at a price of $4.80 per share to two investors.

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Risk Factors Relating to the Company’s Business

We have a history of operating losses and expect to incur significant losses in the future.

We have had substantial losses since our inception and we anticipate an operating loss during the year ending December 31, 2002.  We cannot assure you that we will ever become or remain profitable.

•       As of June 30, 2002, we had an accumulated deficit of $115.8 million.

•                   We incurred net losses of $39.5 million from inception through 1999, $26.6 million in 2000, $34.8 million in 2001 and $14.9 million during the six months ended June 30, 2002.

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 the retinal scanning display technology 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 customer orders for products incorporating the retinal scanning display technology.  In light of these factors, we expect to continue to incur substantial losses and negative cash flow at least through 2003 and likely thereafter.  We cannot be certain that we will become profitable or achieve positive cash flow at any time in the future.

We will require additional capital to continue implementing our business plan.  This may lessen the value of current stockholders’ shares.

We will need additional funds in order to, among other requirements:

•                   further develop the retinal scanning display and optical materials technologies,

•                   fund long-term business development opportunities.

We cannot be certain that we will be able to obtain financing when needed or on satisfactory terms, if at all.  If additional funds are raised through the issuance of equity, convertible debt or similar securities, current shareholders will experience dilution and the securities issued to the new investors may have rights or preferences senior to those of the holders of our common stock.  If adequate funds were not available to satisfy our short–term or long–term financial needs, we would be required to limit our operations significantly.

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We cannot be certain that the retinal scanning display technology or products incorporating this technology will achieve market acceptance.  If the retinal scanning display technology does not achieve market acceptance, our revenues may not grow.

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

It may become more difficult to sell our stock in the public market.

Our common stock is listed for quotation on the Nasdaq National Market.  To keep our listing on this market, we must meet Nasdaq’s listing maintenance standards.  If the bid price of our common stock falls below $1.00 for an extended period, or we are unable to continue to meet Nasdaq’s listing maintenance standards for any other reason, our common stock could be delisted from the Nasdaq National Market.  If our common stock were delisted, we likely would seek to list the common stock on the Nasdaq SmallCap 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 SmallCap 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 National 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 National 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 National Market.  While the penny stock rules should not affect the quotation of our common stock on the Nasdaq National 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.  During the third quarter of 2002 the market price of our stock has traded below $5.00 per share.

Our lack of the financial and technical resources relative to our competitors may reduce our revenues, potential profits and overall market share.

The retinal scanning display and products that may incorporate this technology will compete with established manufacturers of miniaturized cathode ray tube and flat panel display devices, many of which have substantially greater financial, technical and other resources than us and many of

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which are also developing miniature displays.  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.

We may not be able to keep up with rapid technological change and our financial results may suffer.

•                   lack of funds to invest in development.

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

Our products may be subject to future health and safety regulations that could increase our development and production costs.

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

If we experience delays or failures in developing and producing commercially viable products, we may have lower revenues.

We began production of Nomad, our first commercial product, in December 2001.  Through June 2002, we have not built Nomads in the volumes necessary for profitable production.  We must improve our manufacturing processes and efficiency to build Nomads profitably.

In addition, we have developed demonstration units incorporating the retinal scanning technology, and demonstration units have been built using the optical materials technology.  However, we must undertake additional research, development and testing before we are able to produce additional products for commercial sale.  Product development delays or the inability to enter into relationships with potential product development partners may delay or prevent us from introducing products for commercial sale.

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If we are unable to adequately protect our proprietary technology with patents and other intellectual property rights, we may be unable to compete with other companies.

Our 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 retinal scanning display and related technologies.  We also rely on proprietary optical materials technology licensed from the University of Washington.  Although our licensors have patented and applied for patents on various aspects of the retinal scanning display technology and applied for patents on various aspects of the optical materials technology, and although we have patented and continue to file our own patent applications covering retinal scanning display features, optical materials technology and related technologies, we cannot be certain as to the degree of protection offered by these patents or as to the likelihood that patents will be issued from the pending patent applications.  Moreover, these patents may have limited commercial value or may lack sufficient breadth to protect adequately the aspects of our technology to which the patents relate.  We cannot be certain that our competitors, many of which have substantially greater resources than us and have made substantial investments in competing technologies, will not apply for and obtain patents that will prevent, limit or interfere with our ability to make and sell products incorporating our technologies.

We also rely on unpatented proprietary technology.  Third parties could develop the same or similar technology or otherwise obtain access to our proprietary technology.  We cannot be certain that we will be able to adequately protect our trade secrets, know–how or other proprietary information or prevent the unauthorized use, misappropriation or disclosure of such trade secrets, know–how or other proprietary information.

We could face lawsuits related to our use of the retinal scanning display technology.  These suits could be costly, time consuming and reduce our revenues.

We are aware of several patents held by third parties that relate to certain aspects of retinal scanning displays.  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 the retinal scanning display technology 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 the retinal scanning display 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 retinal scanning display technology, to cease licensing the retinal scanning display technology, or to require disputed rights to be licensed from third parties.  Such licenses would

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increase our cost or may not be available at all.  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.

Our revenues are highly sensitive to developments in the defense and aerospace industries.

Our revenues to date have been derived principally from product development research relating to defense applications of the retinal scanning display technology.  We believe that development programs and sales of potential products in this market will represent a significant portion of our future revenues.  Developments that adversely affect the defense sector, including delays in government funding and a general economic downturn, could cause our revenues to decline substantially.

If we cannot supply products in commercial quantities, we will not achieve commercial success.

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.

If we cannot manufacture products at competitive prices, our financial results will be adversely affected.

To date, we have produced limited quantities of Nomad, and demonstration units for research, development and demonstration purposes.  The cost per unit for these units 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.

If we lose the exclusive use of the virtual retinal display technology or the optical materials technology, our business operations and prospects would be adversely affected.

We acquired the exclusive rights to the virtual retinal display technology and the optical materials technology under exclusive license agreements with the University of Washington. If the University of Washington were to violate the terms of the license agreements by providing the technology to another company, our business, operations and prospects would be adversely affected.  In addition, we could lose the exclusivity under the license agreement if we fail to challenge, within the designated time limits, claims that other companies are using the virtual retinal display technology in violation of our rights under the license agreement.

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We need to collaborate with third parties to be able to successfully develop products for commercial sale.

Our strategy for developing, testing, manufacturing and commercializing the retinal scanning display technology and products incorporating the retinal scanning display technology includes entering into cooperative development, 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 retinal scanning display technology or find that the development, manufacture or sale of products incorporating the retinal scanning display technology 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 efforts of third parties.  We cannot be certain that any such arrangements will be successful.

Loss of any of our key personnel could have a negative effect on the operation of our business.

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.

A substantial number of our shares may be sold into the market in the near future, which could cause the market price of our common stock to drop significantly.

•                   warrants to purchase 837,363 shares of common stock.

Sales in the public market of common stock issuable upon exercises of stock options or warrants could depress prevailing market prices for our common stock.  Even the perception that such sales could occur may adversely impact the market price for our stock.  A decrease in market price would decrease the value of an investment in our common stock.

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Our quarterly performance may vary substantially and this variance may decrease our stock price.

Our revenues to date have been generated 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; or

•                   the status of particular development programs and the timing of performance under specific development agreements.

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.

If we fail to manage expansion effectively, our revenue and expenses could be adversely affected.

Our ability to successfully offer products and implement our business plan in a rapidly evolving market requires an effective planning and management process. We have significantly expanded the scope of our operations. 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.

It may be difficult for a third party to acquire us and this could depress our stock price.

Certain provisions of Washington law and our amended and restated articles of incorporation and bylaws contain provisions that create burdens and delays if a third party were to attempt to purchase us.  As a result, these provisions could limit the price that investors are willing to pay for our stock.  These provisions:

•                   authorize our board of directors, without further shareholder approval, to issue preferred stock that has rights superior to those of the common stock.  Potential purchasers may pay less for us because the preferred stockholders may use their rights to take value from us; and

•                   provide that written demand of at least 30% of the outstanding capital stock is required to call a special meeting of the shareholders, which may be needed to approve our sale.  The delay that this creates could deter a potential purchaser.

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Additional risks associated with the Lumera business.

We cannot be certain that our optical materials will achieve market acceptance.

Lumera’s success will depend in part on the commercial acceptance of the optical materials technology.  The optical switching industry is currently fragmented with many competitors developing different technologies.  We expect that only a few of these technologies ultimately will gain market acceptance.  The optical materials may not be accepted by original equipment manufacturers and systems integrators of optical switching networks.  To be accepted, the optical material must meet the technical and performance requirements of our potential customers in the telecommunications industry.  If our optical materials technology fails to achieve market acceptance, we may not be able to continue to develop the technology.

Our lack of the financial and technical resources relative to our competitors may affect our ability to commercialize the optical materials.

The optical switching market is a highly competitive market.  Other companies, that have substantially greater financial, technical and other resources than us, are working on competing technologies.  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 technology could cause our optical materials technology not to become commercially viable, which could reduce the value of our business.

Lumera’s revenues are highly sensitive to developments in the telecommunications industry.

Lumera’s expected revenues will be derived from product sales to original equipment manufacturers and system integrators in the telecommunications industry.  We believe that sales of potential products in this market could represent a significant portion of our future revenues.  Developments that adversely affect the telecommunications sector, including delays in traffic growth, government regulation or a general economic downturn, could slow or halt our revenue growth.

We expect the current downturn in the telecommunications sector will have the following effects on Lumera:

•                   Reduced capital spending and technology investment by telecommunication companies may make it more difficult for our potential products to gain market acceptance.  Customers may be less willing to purchase new technology such as ours or invest in new technology development when they have limited cash.

•                   Potential customers for our future products are very focused on reducing cost.  This has reduced profit margins for telecommunications equipment suppliers.  Therefore, our future products must compete with products that are less expensive than before the telecommunications downturn.

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•                   The building of a high-speed telecommunications infrastructure has slowed.  Currently companies are building networks using 10-gigabyte modulators, which has delayed the need for 40-gigabyte modulators.  We believe that our potential products will compete more effectively with existing technologies at higher modulating speeds.

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