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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 0-21221
MICROVISION, INC.
(Exact name of registrant as specified in its charter)
Washington 91-1600822
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
19910 North Creek Parkway
Bothell, Washington 98011
(425) 415-6847
(Address and telephone number of principal executive offices)
Securities registered under Section 12(b) of the Exchange Act:
--------------------------------------------------------------
None
Securities registered under Section 12(g) of the Exchange Act:
--------------------------------------------------------------
Common Stock, no par value
(Title of Class)
Common Stock Purchase Warrants
(Title of Class)
Check whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-K contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _____
The aggregate market value of the common stock held by non-affiliates of the
registrant as of March 31, 1999 was approximately $96,756,700 (based on the
closing price for the registrant's Common Stock on the Nasdaq National Market of
$16.625 per share).
The number of shares of the registrant's Common Stock outstanding as of March
31, 1999 was 6,159,399.
Documents Incorporated by Reference: Portions of the Proxy Statement to be
delivered to shareholders in connection with the Registrant's Annual Meeting of
Shareholders to be held on June 10, 1999 are incorporated by reference into Part
III of this report.
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
INDEX
Page
PART I
Item 1 - Description of Business........................................ 1
Item 2 - Description of Property........................................17
Item 3 - Legal Proceedings..............................................17
Item 4 - Submission of Matters to a Vote of Security Holders............18
PART II
Item 5 - Market for the Registrant's Common Stock and Related
Shareholder Matters............................................19
Item 6 - Selected Financial Data........................................20
Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations..................21
Item 7A - Quantitative and Qualitative Disclosures About Market Risk.....33
Item 8 - Financial Statements...........................................34
Item 9 - Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................54
PART III
Items 10 - 13 Directors and Executive Officers of the Registrant.............55
PART IV
Item 14 - Exhibits, Financial Statement Schedules and Reports
on Form 8-K....................................................56
SIGNATURES ...............................................................58
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PART I
Preliminary Note Regarding Forward-Looking Statements
The information set forth in this report in Item 1 "Description of
Business" and in Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" 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. With respect to the
discussion below under "Year 2000 Compliance," factors that could affect the
actual results include the possibility that remediation programs will not
operate as intended, the Company's failure to timely or completely identify all
software or hardware applications requiring remediation, unexpected costs, and
the uncertainty associated with the impact of year 2000 issues on the Company's
customers, vendors and others with whom it does business. 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
in Item 1 "Description of Business - Considerations Related to the Company's
Business."
ITEM 1. DESCRIPTION OF BUSINESS
Overview
Microvision, Inc. ("Microvision" or the "Company"), incorporated in 1993,
develops information display technologies that allow electronically generated
images and information to be projected to the retina of the viewer's eye. The
Company has developed prototype Virtual Retinal Display(TM) ("VRD(TM)") devices,
including portable color and monochrome versions and is currently refining and
developing its VRD technology for commercial applications. The Company expects
to commercialize its technology through the development of products and as a
supplier of personal display technology to original equipment manufacturers
("OEMs"). The Company believes the VRD technology will be useful in a variety of
applications, including portable communications and visual simulation for
defense, medical, industrial and entertainment that may include superimposing
images on the user's field of vision. The Company expects that its technology
will allow for the production of highly miniaturized, lightweight,
battery-operated displays that can be held or worn comfortably. The Company's
scanning technology may also be applied to the capturing of images, in such
possible applications as a digital camera or a bar code reader. The Company may
expend funds in evaluating and developing solutions for possible future products
involving this application.
Information displays are the primary medium through which text and images
generated by computers and other electronic systems are delivered to end-users.
For decades, the cathode
1
ray tube ("CRT") and, more recently, flat panel displays have been the dominant
display devices. In recent years, as the computer and electronics industries
have made substantial advances in miniaturization, manufacturers have sought
lightweight, low power, cost effective displays to develop more portable
products.
The Company's VRD technology is fundamentally different from previously
commercialized display technologies. By scanning a low power beam of colored
light to "paint" rows of pixels on the retina of the viewer's eye, the VRD
creates a high resolution, full motion image. In certain applications, the image
appears in the viewer's field of vision as if the viewer were only an arm's
length away from a high quality video screen. The VRD also can superimpose an
image on the viewer's field of vision, enabling the viewer to see data or other
information projected by the device in the context of his or her natural
surroundings. In each case, a high resolution, bright image is created.
The Company's objective is to be a leading provider of scanned display
products and image capture products in a broad range of professional and
consumer applications. The Company intends to achieve this objective and to
generate revenues through a combination of the following activities: the
licensing of technology to OEMs of consumer electronics products; the provision
of engineering services associated with cooperative development arrangements and
research contracts; and the manufacture and sale of high-performance personal
display products to professional users, directly or through joint ventures.
The Company is in discussions with systems and equipment manufacturers in
the defense and aerospace, health care, wireless communications, medical and
industrial, and consumer electronics industries to develop or co-develop
products that the Company believes to be the most commercially viable. Although
the Company is engaged in development and co-development projects, it does not
expect commercial sales of products until at least 2000, and commercial sales
may not occur until substantially later, if at all.
The Company's existing prototypes have demonstrated the technical
feasibility of the VRD technology and the Company's ability to miniaturize
certain of its key components. The Company has completed the development of a
mechanical resonant scanner ("MRS"), which the Company believes represents a
breakthrough in the miniaturization of scanning devices. The Company believes
that the MRS will permit the development of high quality displays using smaller
components produced at lower cost than is possible with current alternative
technologies. Additional work is in progress to achieve full color capability in
miniaturized VRD devices, to expand the "exit pupil" of the VRD system (which
defines the range within which the viewer's eye can move and continue to see the
image) and to design products for specific applications.
Fundamental to the Company's technology development strategy is the
development of standardized modules for each of the key components of a VRD
system. These standardized modules can then be used in unique combinations to
create a small number of technology platforms. Each platform is a complete VRD
system that can be extended to meet the individual features for an entire family
of products for a wide array of applications for various markets.
2
Considerations Relating to the Company's Business
The following factors should be considered in evaluating the Company's
business and operations:
Market Acceptance of New Technology. The Company's success will depend on
successful development and commercial acceptance of the VRD technology. To
achieve commercial success, this technology and products incorporating this
technology must be accepted by OEMs and end-users, and must meet the
expectations of the Company's potential customer base. There can be no assurance
that the VRD technology will achieve market acceptance. See " - Strategy," "-
Applications Markets and Products."
Early Stage of Product Development. Although the Company has developed
prototype VRD displays, further research, development and testing are necessary
before any products will be available for commercial sale. There can be no
assurance that the Company will be successful in further refining the VRD
technology to produce marketable products. In addition, delays in the
development of products, or the inability of the Company to procure partners for
the development of products, may delay the introduction of, or prevent the
Company from introducing, products to the marketplace and adversely affect the
Company's competitive position, results of operations and financial condition.
See "- Applications, Markets and Products."
Expectation of Losses; Negative Cash Flows. The Company's revenues to date
have been generated from development contracts. The Company does not expect to
generate significant revenues from product sales in the near future. As of
December 31, 1998, the Company had an accumulated deficit since inception of
$22,836,000, and the Company expects to continue to incur substantial losses and
negative cash flow at least through 2000 and possibly thereafter. There can be
no assurance that the Company will become profitable or cash flow positive at
any time in the future. The likelihood of the success of the Company must be
considered in light of the expenses, difficulties, and delays frequently
encountered by businesses formed to pursue development of new technologies. In
particular, the Company's operations to date have focused primarily on research
and development of the VRD technology and prototypes, and the Company has only
during the past year developed marketing capabilities. It is not possible to
estimate future operating expenses and revenues based upon historical
performance. Operating results will depend, in part, on matters over which the
Company has no control, including, without limitation, general economic
conditions, technological and other developments in the electronics, computing,
information display and imaging industries, and competition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Patents and Protection of Proprietary Technology. The Company's ability to
compete effectively in the information display market will depend, in part, on
the ability of the Company, the University of Washington and the Company's other
licensors to maintain the proprietary nature of the VRD and related
technologies. Although the Company's licensors
3
have patented various aspects of the VRD technology, and the Company continues
to file its own patent applications, there can be no assurance 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 the Company's technology to which the patents relate.
There can be no assurance that competitors in the United States and in
foreign countries, many of which have substantially greater resources than the
Company and have made substantial investments in competing technologies, will
not apply for and obtain patents that will prevent, limit or interfere with the
Company's ability to make and sell its products. In addition, the Company is
aware of several patents held by third parties that relate to certain aspects of
retinal scanning devices. There is no assurance that these patents would not be
used as a basis to challenge the validity of the University of Washington's
patent rights, to limit the scope of the University's patent rights or to limit
the University's ability to obtain additional or broader patent rights. A
successful challenge to the validity of the University's patents may adversely
affect the Company's competitive position and could limit the Company's ability
to commercialize the VRD technology. Moreover, there can be no assurance that
such patent holders or other third parties will not claim infringement by the
Company or by the University 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 issue with
claims that will be infringed by the Company's products or the VRD technology.
The defense and prosecution of patent suits is costly and time-consuming, even
if the outcome is ultimately favorable to the Company. This is particularly true
in foreign countries where the expenses associated with such proceedings can be
prohibitive. An adverse outcome in the defense of a patent suit could subject
the Company to significant liabilities to third parties, require the Company and
others to cease selling products that incorporate VRD technology or cease
licensing the VRD technology, or require disputed rights to be licensed from
third parties. Such licenses may not be available on satisfactory terms, or at
all. Moreover, if claims of infringement are asserted against future
co-development partners or customers of the Company, those partners or customers
may seek indemnification from the Company for damages or expenses they incur.
The Company also relies on unpatented proprietary technology. Third parties
could develop the same or similar technology or otherwise obtain access to the
Company's proprietary technology. There can be no assurance that the Company
will be able to meaningfully protect its trade secrets, know-how or other
proprietary information or to prevent the unauthorized use, misappropriation or
disclosure of such trade secrets, know-how or other proprietary information. See
"- Intellectual Property and Proprietary Rights."
Dependence on Future Collaborations; Dependence on Third Parties. The
Company's strategy for the development, testing, manufacture and
commercialization of the VRD technology and products incorporating the VRD
technology includes entering into cooperative development, joint venture or
licensing arrangements with corporate partners, OEMs and other third parties.
There can be no assurance that the Company will be able to negotiate such
4
arrangements on acceptable terms, if at all, or that such arrangements will be
successful in yielding commercially viable products. If the Company is not able
to establish such arrangements, it would require additional working capital to
undertake such activities at its own expense and would require extensive sales,
marketing and manufacturing expertise that it does not currently possess. In
addition, the Company could encounter significant delays in introducing the VRD
technology into certain markets or find that the development, manufacture or
sale of products incorporating the VRD technology in such markets would not be
feasible without, or would be adversely affected by the absence of, such
agreements. To the extent the Company enters into cooperative development or
other joint venture or licensing arrangements, the revenues received by the
Company will depend upon the efforts of third parties, and there can be no
assurance that such parties will put forth such efforts or that such efforts
will be successful. See "- Strategy" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
Loss of Exclusive License. The Company's success depends on technology that
it has licensed from the University of Washington. In 1993, the Company acquired
the exclusive rights to the VRD technology under a license agreement with the
University of Washington (the "UW License Agreement"). The Company relies on the
University of Washington to prepare, file and prosecute patent applications
relating to the VRD technology. If the University of Washington were to violate
the terms of the UW License Agreement, the Company's operations and business
prospects could be materially and adversely affected. In addition, the Company
could lose the exclusivity under the UW License Agreement if it fails to respond
timely to claims of infringement with respect to the VRD technology. The loss of
exclusivity under the UW License Agreement could have a material adverse effect
on the Company's business, operating results, and financial condition. See
"Business- UW License Agreement."
Competition and Technological Advances. The information display industry is
highly competitive. The Company's products and the VRD technology will compete
with established manufacturers of miniaturized CRT and flat panel display
devices, including companies such as Sony Corporation and Texas Instruments
Incorporated, most of which have substantially greater financial, technical and
other resources than the Company and many of which are developing alternative
miniature display technologies. The Company also will compete with other
developers of miniaturized display devices. There can be no assurance that the
Company's competitors will not succeed in developing information display
technologies and products that would render the VRD technology or the Company's
proposed products commercially infeasible or technologically obsolete. Rapid and
significant technological advances have characterized the electronic information
display industry. There can be no assurance that the VRD technology or the
Company's proposed products will remain competitive with such advances or that
the Company will have sufficient funds to invest in new technologies or
processes. See "- Competition."
Year 2000 Compliance. The effect on the Company of an internal Y2K failure,
a third party Y2K failure or a combination of internal and external Y2K failures
could range from a minor disruption in the Company purchases to an extended
interruption in the information technology ("IT") and non-IT systems of third
parties whose operations materially impact the Company's operations. Such an
interruption could result in a material adverse effect on the
5
Company's business, operating results and financial position. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Year
2000 Compliance Strategy."
Lack of Manufacturing Experience. The Company's success depends in part on
its ability to manufacture its products and components to meet high quality
standards in commercial quantities at competitive prices. The Company currently
has no capability to manufacture products in commercial quantities. The Company
has only produced prototypes for research, development and demonstration
purposes. Accordingly, the Company must obtain access through partners or
contract manufacturers to manufacturing capacity and processes for the
production of its future products, if any, in commercial quantities, which will
require extensive lead time. There can be no assurance that the Company will
successfully obtain access to these resources or, if it does, that these
resources will meet quality standards. See "- Strategy."
Capital Requirements. The Company believes that its current cash balances
will satisfy its budgeted capital and operating requirements for at least the
next 12 months, based on the Company's current operating plan. Actual expenses,
however, may exceed the amount budgeted therefor and the Company may require
additional capital to fund long-term operations and business development. The
Company's capital requirements will depend on many factors, including, but not
limited to, the rate at which the Company can develop the VRD technology, its
ability to attract partners for product development and licensing arrangements,
and the market acceptance and competitive position of products that incorporate
the VRD technology. There can be no assurance that the Company will be able to
obtain financing, or that, if it is able to obtain financing, it will be able to
do so on satisfactory terms or on a timely basis. If additional funds are raised
through the issuance of equity, convertible debt or similar securities,
shareholders may experience additional dilution and such securities may have
rights or preferences senior to those of the Common Stock. Moreover, if adequate
funds were not available to satisfy the Company's short-term or long-term
capital requirements, the Company would be required to limit its operations
significantly. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources."
Dependence on Key Personnel. The Company's success is dependent on its
officers and other key personnel and on the ability to attract and retain
qualified new personnel. Achievement of the Company's business objectives will
require substantial additional expertise in the areas of sales and marketing,
technology 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 have a
material adverse effect on the Company's business and results of operations. See
"- Employees."
Possibility of Future Regulation. The Company is not aware of any health or
safety regulations applicable to VRD products, other than regulations related to
labeling of devices that emit electro-magnetic radiation. There can be no
assurance, however, that new health and safety regulations will not be
promulgated that might materially and adversely affect the Company's ability to
commercialize the VRD technology. See "Human Factors and Safety."
6
Shares Eligible for Future Sale. The sale of a substantial number of shares
of the Company's Common Stock or Public Warrants in the public market or the
prospect of such sales could materially and adversely affect the market price of
the Common Stock and the Public Warrants. As of December 31, 1998, the Company
had outstanding 6,064,626 shares of Common Stock; 2,273,926 Public Warrants to
purchase 2,273,926 shares of Common Stock; and private warrants to purchase an
aggregate of 69,526 shares of Common Stock. As of that date, the Company had
grants outstanding under its stock option plans options to purchase an aggregate
of 2,365,151 shares of Common Stock. Almost all of the Company's outstanding
shares of Common Stock may be sold without substantial restriction. All shares
issued upon exercise of options granted under the Company's stock option plans
are available for sale in the public market, subject in some cases to volume and
other limitations. The Company also had granted Paulson Investment Company, Inc.
and marion bass securities corporation, investment banking firms, the right to
purchase 178,075 shares of Common Stock and 178,075 warrants exercisable for
178,075 shares of Common Stock (the "Representatives' Warrants"). The remaining
286,150 shares of Common Stock that are issuable upon exercise of the
Representatives' Warrants (including exercise of the warrants included therein)
will be eligible for resale without restriction under the Securities Act.
Potential Effect of Anti-Takeover Provisions. The Company's Restated
Articles of Incorporation (the "Articles of Incorporation") give the Company's
Board of Directors the authority to issue, and to fix the rights and preferences
of, shares of the Company's Preferred Stock, which may have the effect of
delaying, deterring or preventing a change in control of the Company without
action by the Company's shareholders. Furthermore, the Articles of Incorporation
provide that the written demand of at least 25% of the outstanding shares is
required to call a special meeting of the shareholders. In addition, certain
provisions of Washington law could have the effect of delaying, deterring or
preventing a change in control of the Company.
Industry Background
The popularity of personal computing, electronic communication, television
and video products has created a worldwide market for display technologies.
Information displays are the primary medium through which text and images
generated by computer and other electronic systems are delivered to end-users.
While early computer systems were designed and used for tasks that involved
little interaction between the user and the computer, today's graphical and
multimedia information and computing environments require systems that devote
most of their resources to generating and updating visual displays. The market
for display technologies also has been stimulated by the increasing popularity
of portable pagers and cellular phones; interest in simulated environments and
augmented vision systems; and the recognition that improved means of connecting
people and machines can increase productivity and enhance the enjoyment of
electronic entertainment and learning experiences.
For decades, the CRT has been the dominant display device. A CRT creates an
image by scanning a beam of electrons across a phosphor-coated screen, causing
the phosphors to emit visible light. The beam is generated by an electron gun
and is passed through a deflection
7
system that scans the beam rapidly left to right and top to bottom. A magnetic
lens focuses the beam into a small glowing dot on the phosphor screen. It is
these rapidly moving spots of light ("pixels") that "paint" the image on the
surface of the viewing screen. The next generation of imaging technology, flat
panel displays, is now in widespread use in portable computers, calculators, and
other personal display devices. The most prevalent flat panel technology is the
liquid crystal display ("LCD"), which can consist of hundreds of thousands of
pixels, each of which is formed by a single transistor acting on a crystalline
material.
In recent years, as the computer and electronics industries have made
substantial advances in miniaturization, manufacturers have sought lightweight,
low power, cost effective displays to enable the development of more portable
products. Flat panel technologies have made meaningful advances in these areas,
and liquid crystal flat panel displays are now commonly used for laptop
computers and other electronic products. Both CRT and flat panel technologies,
however, pose difficult engineering and fabrication problems for more highly
miniaturized products, because of inherent constraints in size, weight and power
consumption. In addition, CRT and flat panel displays often become dim and
difficult to see in outdoor or other settings where the ambient light is
stronger than the light emitted from the screen. The Company believes that as
display technologies attempt to keep pace with miniaturization and other
advances in information delivery systems, conventional CRT and flat panel
technologies will no longer provide the full range of performance
characteristics, including high resolution, high level of brightness and low
power consumption required for state-of-the-art information systems.
Microvision's Retinal Display Technology
The Company's VRD technology is fundamentally different from previously
commercialized display technologies. VRD systems create an image on the retina
like a miniaturized video projector focused on the "projection screen" at the
back of the viewer's eye. By continuously scanning a low power beam of colored
light to "direct" rows of pixels to the retina of the viewer's eye, the VRD
technology creates a high resolution, full motion image. The light source acts
on the retina in much the same way as other natural light sources.
The drive electronics of the VRD technology acquire and process signals
from the image or data source to control and synchronize the color mix,
"gray-level" and placement of pixels. Color pixels are generated by a modulated
light source, which varies the intensity of each of the red, green and blue
lights to generate a complete palette of colors and shades. The pixels are then
arranged on the retina by a horizontal scanner that rapidly sweeps the light
beam to place the pixels into a row, and a vertical scanner, which moves the
light beam downward where another row of pixels is drawn. This process is
continued until an entire field of "rows" has been placed and a full image
appears to the user. Optical elements direct the beam of light through the pupil
of the viewer's eye to create an image on the retina.
8
Strategy
The Company's objective is to be a leading provider of scanned display and
image capture products in a broad range of professional and consumer
applications. Key elements of the Company's strategy to achieve this objective
are:
Custom design, manufacture and sale of high performance products. The
Company anticipates providing high performance products to professional
end-users in markets with lower product volume requirements. The Company expects
that end-users in this category will include professionals in the defense, law
enforcement, industrial process control and health care industries. The Company
believes that, because the unit volume requirements for such end-users are
generally lower, demand for such products may be more predictable and the risks
associated with production and inventory more easily managed. Depending upon the
circumstances, the Company may manufacture these products using standard
component suppliers and contract manufacturers as required, or may seek to form
one or more joint ventures to manufacture the products.
Licensing of proprietary technology to OEMs for volume manufacture of
products. The Company believes that in consumer markets the ability to compete
effectively is largely driven by the ability to price aggressively for maximum
market penetration. Significant economies of scale in purchasing, volume
manufacturing and distribution are important factors in driving costs downward
to achieve pricing objectives and profitability. The Company's strategy will be
to seek both initial license fees from such arrangements as well as ongoing per
unit royalties.
Additionally, certain potential applications of the VRD technology, such as
pagers or cellular phones, could require integration of the VRD technology with
other unrelated technologies. In markets requiring volume production of personal
display components or subsystems that can be integrated with non-display
components, the Company may provide components, subsystems or systems design
technology to OEMs under licensing agreements.
The Company expects that such relationships generally will involve a period
of co-development during which engineering and marketing professionals from OEMs
would work with the Company's technical staff to specify, design and develop a
product appropriate to the targeted market and application. The Company would
charge fees to such OEMs to compensate for the costs of the engineering effort
allocated to such development projects. The nature of the relationships with
such OEMs may vary from partner to partner depending on the proposed application
for the VRD, the product to be developed, and the OEM's design, manufacturing
and distribution capabilities. The Company believes that by limiting its own
direct manufacturing obligations for consumer products it will reduce the
capital requirements and risks inherent in bringing the VRD technology to the
consumer market.
Development of an Intellectual Property Portfolio. The Company believes
that it can enhance its competitive position by reducing the cost and improving
the performance of its VRD technology and by expanding its portfolio of
intellectual property rights. A key part of
9
the Company's technology development strategy includes developing and protecting
(i) concepts relating to the function, design and application of the VRD system;
(ii) component technologies and integration techniques essential to the
commercialization of the VRD technology and which are expected to reduce the
cost and improve the performance of the system; and (iii) component technologies
and integration techniques that reduce technical requirements and accelerate the
pace of commercial development. The Company is continuing to develop a portfolio
of patented technologies and proprietary processes and techniques that relate
directly to the functionality and to the commercial viability of the VRD
technology. See "-Technology Development" and " - Intellectual Property and
Proprietary Rights."
Applications, Markets and Products
The Company has identified a variety of potential applications for its VRD
technology, including the following:
Hand-held Communications Devices. Manufacturers of wireless and cellular
communications devices have identified a need for products that incorporate
personal display units for viewing electronic mail, fax and graphic images on
highly miniaturized devices. Existing display technologies have had difficulty
satisfying this demand fully because of the requirements that such devices be
highly miniaturized, full format, relatively low cost, and offer high resolution
and brightness without requiring high levels of power supply. The Company
expects that the range of potential products in this category may include
cellular phones, pagers, or personal digital assistants that project into view
electronic mail messages, faxes, or other information as a bright, sharp image.
Visualization for Defense, Healthcare, Commercial, Industrial and Consumer
Applications. Manufacturers of interactive media products have recognized that
the visual experience offered by simulation is enhanced by high resolution,
three-dimensional displays projected over a wide field of vision. Although
simulated environments traditionally have been used as a training tool for
professional use, they are increasingly popular as a means of entertainment,
particularly in computer games.
Augmented vision applications superimpose high contrast, monochromatic or
color images and information on the user's view of the surrounding environment
as a means of enhancing the safety, precision or speed of the user's performance
of tasks. For example, a head-mounted display could superimpose critical patient
information such as vital signs, EKG traces, reference materials, X-rays or MRI
images in a surgeon's field of vision. For military applications, troops could
be equipped with eyeglasses that display high definition imagery that could be
viewed without blocking normal vision and could assist in threat detection,
reconnaissance and other activities.
The Company has targeted various market segments for these potential
applications, including defense and public safety, healthcare, business,
industrial and consumer electronics. The following table identifies product
development opportunities within each of these markets.
10
MARKETS
- -----------------------------------------------------------------------------------------------------------------------------
..........................Defense & Public
..........................Safety Healthcare Business Industrial Consumer
- -----------------------------------------------------------------------------------------------------------------------------
Hand-held o Command and o Patient status o Fax viewing o Maintenance o E-mail viewing
Communication control monitoring o E-mail viewing and field o Internet
Devices o Tactical o Internet access service access
information
systems
o Portable
maintenance
o Public safety
o Law
A enforcement
P -----------------------------------------------------------------------------------------------------------------------
P Simulation and o Battlefield o Surgical o Architecture o Training o Gaming
L Entertainment simulation training and interior o On-line
I Displays o Aircraft o Endoscopic design shopping
C simulation surgeries o Industrial o Virtual
A design reality
T simulation
I -----------------------------------------------------------------------------------------------------------------------
O Augmented o Pilot o Overlay o Multiple o Maintenance o Private
N Vision information of patient screen viewing o Inventory viewing
S systems data during for securities control laptop
o Mine surgeries traders o Factory systems
detection o "Head-down" process
o Tactical viewing of control
warfare data patient vitals o Sales
o Personnel automation
status
monitor
o GENII
soldier
system
- -----------------------------------------------------------------------------------------------------------------------------
The Company believes certain market segments will be early adopters of the
VRD technology, particularly those applications for which VRD technology, even
at an earlier stage of development, can offer significant productivity or
performance gains and associated cost savings. The Company believes that
military and industrial users will value the ability of personal VRD based
displays to superimpose high contrast images on the user's natural field of
vision. Similarly, users of wireless devices who have a need to receive critical
or timely data through electronic mail, Internet or facsimile transmission are
expected to value the performance characteristics that VRD systems are expected
to deliver.
Prototypes
The Company has developed several prototypes to demonstrate the feasibility
of the VRD technology. These prototypes are not incorporated into specific
commercial products or applications, but rather are demonstration models of the
technology. The first prototype developed was a table-top model that received
output from a personal computer and generated a full color image. The second and
third prototypes are portable hand-held devices. For
11
demonstration purposes, they also connect to a personal computer. The projection
optics of the portable prototypes are packaged together with the vertical and
horizontal scanners. One demonstrator is monochromatic and fits in an attache
case that also houses the electronics that receive and condition the signal. The
second demonstrator is a full color model with the electronics that receive and
condition the signal being housed in a separate case that is the size of an
airline carry-on bag. In 1998, the Company continued to develop prototypes, for
Company use and for customers, that demonstrated higher resolution, greater
brightness, smaller size and lower power consumption. The following four
prototypes were developed: an SVGA (480,000 pixels) color helmet-mounted VRD; a
high luminance, SXGA (approximately 1,300,000 pixels) green monochrome
helmet-mounted VRD; a high-luminance, SXGA full color head-mounted VRD; and a
battery powered, head-mounted red monochrome VRD. Currently under development is
a "very high resolution" green monochrome system. During this same period, a
color portable SVGA display was specifically developed for use by the Company
for marketing purposes.
Technology Development
The Company's existing prototypes have demonstrated the technological
feasibility of the VRD system and the Company's ability to miniaturize certain
of its key components. Additional work is in progress to continue
miniaturization advances necessary for large scale application, to achieve full
color capability in highly miniaturized versions and to design new architectures
for specific applications. Research and development expenses for the fiscal
years ended December 31, 1998, 1997 and 1996 were $3,305,600, $2,593,900 and
$1,586,700, respectively. All of the Company's contract revenue to date has been
derived from performance on development contracts. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Drive Electronics. The Company has identified three areas where additional
development of the drive electronics is necessary. The first involves further
miniaturization using integrated circuits and advanced packaging techniques. To
date, the Company has identified no technological barriers to the further
miniaturization of the drive electronics. The second area involves refining the
timing and nature of the signals driving the photon source and scanners to
improve display quality. The third area of development relates to achieving and
improving compatibility of the drive electronics with existing and emerging
video standards. The Company's existing prototypes are compatible with current
video format standards and the output from most personal computers. In 1998, two
electronics architectures were developed, namely a very high resolution
subsystem and a low-power subsystem. Both were incorporated into prototypes that
were sold to customers. In 1999, the Company intends to develop the VRD
technology to conform to a broader range of interface standards, including
existing higher resolution standards and emerging standards such as high
definition television. For interfaces with emerging video standards, additional
development of the drive electronics technology will likely be required.
Photon Sources. The photon generator is the source of the light beam that
creates the image on the retina. In a full color VRD system, red, green and blue
photon generators will be used and modulated to generate a mix yielding the
desired color and brightness. Low power solid state lasers, laser diodes and
light-emitting diodes ("LEDs") are suitable photon
12
generators for the VRD system. Red and green solid state lasers are currently
available, but are useful only for VRD applications where cost and size are not
critical. Miniaturized visible laser diodes are currently available only in red,
although a number of companies are developing blue laser diodes in anticipation
of large data storage markets. Miniaturized LEDs are less expensive than laser
diodes. The Company expects these LEDs will provide sufficient brightness for
certain applications, however, the Company still expects to use laser diodes for
augmented vision applications that require maximum brightness. The Company
intends to rely on others to complete development of the materials and processes
necessary to produce commercial blue and green LEDs and laser diodes. This
development is not expected prior to the introduction of the Company's proposed
initial products, and as a result the Company's proposed initial full color VRD
products may use conventional lasers. However, an important milestone was
achieved in 1998 when the Company demonstrated custom green and blue LEDs as
potential light sources for certain low power, low cost applications.
Scanning. A pair of scanners, one horizontal and one vertical, is used to
direct the light beam that creates the image on the retina. In laser printers
and bar code readers, a spinning or oscillating mirror is used to scan a light
beam, but these mechanical scanners are typically too large and too slow for use
in miniaturized display settings. To solve this problem, the Company developed a
mechanical resonance scanner ("MRS") to create the horizontal scan. In
operation, the MRS resembles a very small tuning fork with a mirrored surface.
It is tuned to resonate at the exact scanning frequency needed to generate the
display, so that very little power is needed to keep it oscillating. Directing
the light beam at the vibrating mirror causes the light beam to scan rapidly
back and forth horizontally. A second vibrating mirror is used to direct the
horizontal beam vertically. The Company believes that its MRS and its vertical
scanner counterpart may have significant commercial value independent of VRD
applications.
Continued development of the scanning subsystem of the VRD will be required
in order to allow scanning capability for current standard video formats,
including high definition television, as well as new digital video standards.
Existing designs for scanner and scanner electronics may prove ineffective at
higher resolutions and may need to be replaced with alternative scanning
methods. In 1998 the Company demonstrated smaller "micro-electro-mechanical
system" (MEMS) versions of both horizontal and vertical scanners. With the
availability of both MRS and MEMS scanning systems, the Company achieved
important flexibility from the standpoint of developing optimal architectures
for potential products.
Optics. For applications where the VRD device is to be worn, it is
desirable to have an exit pupil (the range within which the viewer's eye can
move and continue to see the image) of 10 to 15 millimeters. The Company has
recently developed an expanded exit pupil of approximately 15 millimeters, which
was demonstrated in a full color system. Continued design and engineering of
this expanded exit pupil is required to develop commercial applications. In
1998, Company engineers developed optics designs for both monocular (one-eye)
and biocular (two-eye) prototypes. A full "binocular" system was also developed
and shipped to a customer. This system offered viewing of 3-dimensional imagery.
The Company's ongoing optics development is directed at the creation of optical
systems that are lightweight, high performance and cost-effective to
manufacture.
13
Intellectual Property and Proprietary Rights
In 1993, the Company acquired the exclusive rights to the VRD technology
under the UW License Agreement. Additional development of the VRD technology
took place at the University's Human Interface Technology Lab (the "HIT Lab")
pursuant to a research agreement between the Company and the University (the
"Research Agreement"). See " - University of Washington License Agreement." The
University has received seven patents on the VRD technology and the MRS and has
an additional seventeen U.S. patent applications pending in the United States
and in certain foreign countries, all of the rights to which have been
exclusively licensed to the Company.
The Company's ability to compete effectively in the information display
market will depend, in part, on the ability of the Company, the University of
Washington and other licensors to maintain the proprietary nature of the VRD
technology or other technologies, including claims related to the ability to
superimpose images on the user's field of view; a VRD using optical fiber; an
expanded exit pupil; and the MRS.
During 1998, the Company entered into a license agreement with a third
party whereby the Company acquired an exclusive license to certain intellectual
property related to the design and fabrication of a microminiature scanner using
semiconductor fabrication techniques. The licensor has received four patents and
has 11 patent applications pending pertaining to the intellectual property
licensed by the Company.
The Company also generates intellectual property as a result of its ongoing
performance on development contracts and as a result of the Company's internal
research and development activities, and has filed seven patent applications in
its own name resulting from these activities. The inventions covered by such
applications generally address and accommodate component miniaturization,
specific implementation of various system components and design elements to
facilitate mass production.
The Company considers protection of these key enabling technologies and
components to be a fundamental aspect of its strategy to penetrate diverse
markets with unique products. As such, it intends to continue to develop its
portfolio of proprietary and patented technologies at the system, component, and
process levels.
The Company also relies on unpatented proprietary technology. To protect
its rights in these areas, the Company requires all employees and where
appropriate, contractors, consultants, advisors and collaborators to enter into
confidentiality and noncompetition agreements. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's 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. In addition, the University of
Washington retains the right to publish information regarding the VRD technology
for academic purposes.
14
The Company filed for registration of the marks "Virtual Retinal Display"
and "VRD" in the United States Patent and Trademark Office. The marks were
examined and entered into the opposition phase, where an opposition was filed.
The Company believes the opposition filing is without merit and that the Company
should prevail in the proceedings. Regardless of the outcome, the Company
believes that it will be entitled to continue to use the terms "Virtual Retinal
Display" and "VRD."
University of Washington License Agreement
The VRD technology was originally developed at the University of
Washington's HIT Lab by a team of technicians and engineers under the direction
of Dr. Thomas A. Furness, III. In 1993, the Company secured the exclusive rights
to the VRD technology and associated intellectual property from the University
of Washington pursuant to the UW License Agreement. The scope of the license
covers all possible commercial uses of the VRD technology worldwide, including
the right to grant sublicenses. The license expires upon the expiration of the
last of the University's patents that relate to the VRD, unless sooner
terminated by the Company or the University. In granting the license, the
University retained limited non-commercial rights with respect to the VRD
technology, including the right to use the technology for non-commercial
research and for instructional purposes and the right to comply with applicable
laws regarding the non-exclusive use of the technology by the United States
government. The University also has the right to consent to the Company 's
sublicensing arrangements and to the prosecution and settlement by the Company
of infringement disputes.
The Company could lose the exclusivity under the UW License Agreement if
the Company fails to respond to any infringement action relating to the VRD
technology within 90 days of learning of such claim. In the event of the
termination of the Company's exclusivity, the Company would lose its rights to
grant sublicenses and would no longer have the first right to take action
against any alleged infringement. In addition, each of the Company and the
University of Washington has the right to terminate the License Agreement in the
event that the other party fails to cure a material breach of the Agreement
within 30 days of written notice of the breach. The Company may terminate the
License Agreement at any time by serving 90 days prior written notice on the
University of Washington. In the event of any termination of the License
Agreement, the license granted to the Company would terminate.
Under the terms of the UW License Agreement, Microvision agreed to pay a
non-refundable fee of $5,133,500 (the "License Fee") and to issue to the
University and to the inventors of the VRD technology, including Dr. Furness,
shares of the Company's Common Stock. In addition, the University of Washington
is entitled to receive certain ongoing royalties. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." In August 1997, the Company made the final payment due under
the Research Agreement, which resulted in the Company having paid in full the
$5,133,500 license fee due under the UW License Agreement. In the event the
Company defaults on its obligations, including the royalty obligation, the
University of Washington may terminate the License Agreement.
15
At the same time it entered into the UW License Agreement, Microvision
contracted with the HIT Lab and the Washington Technology Center to fund further
research and development of the VRD technology pursuant to the Research
Agreement. The Research Agreement called for the Company to pay $5,133,500 to
the University of Washington over a four year term. Payments made pursuant to
the Research Agreement were credited against the License Fee. Any intellectual
property developed by the HIT Lab pursuant to the Research Agreement is included
in the exclusive license granted to Microvision under the UW License Agreement.
In October 1997, the Company and the University of Washington agreed to extend
the term of the Research Agreement from October 31, 1997 through March 31, 1998,
at no additional cost to the Company, in order to enable the University of
Washington to complete performance of certain research activities under the
Research Agreement. In August 1997, the Company made the final payment due under
the Research Agreement. In March 1998, the Company and the University of
Washington again agreed to extend the terms of the Research Agreement from April
1, 1998 through December 31, 1998, at no additional cost to the Company, in
order to enable the University of Washington to complete performance of certain
research activities under the Research Agreement. The Research Agreement
terminated on December 31, 1998. See Note 7 of Notes to the Financial
Statements.
Human Factors and Safety
As part of its research and development activities, the Company conducts
ongoing research as to the cognitive, physiological and ergonomic factors that
must be addressed by products incorporating VRD technologies and the safety of
VRD technology, including such issues as the maximum permissible laser exposure
limits established by American National Standards Institute ("ANSI").
Researchers from the HIT Lab have concluded that laser exposure to the retina
under normal operating conditions would be below the calculated maximum
permissible exposure level set by ANSI.
Competition
The information display industry is highly competitive. The Company's
products and the VRD technology will compete with established manufacturers of
miniaturized CRT and flat panel display devices, including companies such as
Sony Corporation and Texas Instruments Incorporated, most of which have
substantially greater financial, technical and other resources than the Company
and many of which are developing alternative miniature display technologies. The
Company also will compete with other developers of miniaturized display devices.
There can be no assurance that the Company's competitors will not succeed in
developing information display technologies and products that would render the
VRD technology or the Company's proposed products commercially infeasible or
technologically obsolete.
The electronic information display industry has been characterized by rapid
and significant technological advances. There can be no assurance that the VRD
technology or the Company's proposed products will remain competitive with such
advances or that the Company
16
will have sufficient funds to invest in new technologies or products or
processes. Although the Company believes that its VRD technology and proposed
display products could deliver images of a quality and resolution substantially
better than that of commercially available miniaturized LCD and CRT-based
display products, there is no assurance that manufacturers of LCDs and CRTs will
not develop further improvements of screen display technology that would
eliminate or diminish the anticipated advantages of the Company's proposed
products.
Other Technology Investment
The Company intends to pursue the acquisition and development of other
imaging and display technologies as opportunities to do so arise.
In March 1994, the Company entered into a second exclusive license
agreement with the University of Washington to commercialize imaging technology
unrelated to the VRD technology. This technology involves the projection of data
and information onto the inside of a dome that is placed over the viewer's head.
This imaging technology is referred to as HALO. The HALO license agreement
requires the Company to pay $175,000 to the University, and to issue 93,750
shares of Common Stock to the University and the inventors of the technology,
$75,000 and 31,250 shares of Common Stock upon filing of the first patent and
$100,000 and 62,500 shares of Common Stock upon issuance of the first patent.
See Note 7 of Notes to the Financial Statements.
Employees
As of March 31, 1999, Microvision had 95 employees and seven contractors.
The Company's employees are not subject to any collective bargaining agreements
and management regards its relations with employees to be good.
ITEM 2. DESCRIPTION OF PROPERTY
On April 12, 1999, the Company completed its move to its new headquarters
located at 19910 North Creek Parkway, Bothell, Washington, where the Company
initially leases approximately 67,500 square feet of combined use office and
laboratory space. The Company also has a commitment to lease between 25,000 and
34,000 additional square feet during the fourth year of the seven year lease.
See "--Liquidity and Capital Resources."
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is its property subject to, any material
pending legal proceeding.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of the shareholders of the Company was held on October
15, 1998.
Richard F. Rutkowski, Stephen R. Willey, Richard A. Raisig, Jacob Brouwer,
Robert A. Ratliffe, Richard Cowell, and Walter J. Lack were elected as directors
for one year terms expiring at the next annual meeting of shareholders.
The amendment of the Company's 1996 Stock Option Plan to increase the
number of shares of Common Stock reserved for issuance upon exercise of options
granted under the Plan from 750,000 to 3,000,000 shares was approved.
The appointment of PricewaterhouseCoopers LLP as independent auditors of
the Company for the year ending December31, 1998 was approved.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND WARRANTS; RELATED
SHAREHOLDER MATTERS.
The Company's Common Stock and Public Warrants are traded on the Nasdaq
National Market under the symbols "MVIS" and "MVISW," respectively. As of March
25, 1999, there were 149 holders of record of 6,159,399 shares of Common Stock
and ten holders of record of 2,273,926 Public Warrants. The Company has never
declared or paid cash dividends on the Common Stock. The Company currently
anticipates that it will retain all future earnings to fund the operation of its
business and does not anticipate paying dividends on the Common Stock in the
foreseeable future.
The Company's Common Stock and Public Warrants began trading publicly on
August 27, 1996. The quarterly high and low sales prices of the Company's Common
Stock and Public Warrants for each full quarterly period in the last two fiscal
years and the year to date as reported by the Nasdaq National Market are as
follows:
Common Stock Public Warrants
-------------------- --------------------
Quarter Ended High Low High Low
- ------------- -------- -------- -------- --------
March 31, 1997 7 11/16 3 1/2 2 11/16 15/16
June 30, 1997 6 7/8 5 3/16 2 7/8 1 1/2
September 30, 1997 18 3/4 5 1/4 8 3/8 1 1/2
December 31, 1997 19 1/4 11 3/8 9 5/8 5 3/8
March 31, 1998 16 3/8 12 1/2 7 7/8 5 1/4
June 30, 1998 14 7/8 8 5/8 7 13/16 3 1/8
September 30, 1998 11 15/16 6 4 17/32 1 1/2
December 31, 1998 13 1/2 4 9/16 3 1/4 1 3/4
March 31, 1999 16 3/4 11 3/8 8 3/8 4 11/16
On March 31, 1999, the closing sale price for the Common Stock was $16.625
and the closing sale price for the Public Warrants was $7.750.
19
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data set forth below with respect to the years
ended December 31, 1998, 1997 and 1996, and the balance sheet data at December
31, 1998 and December 31, 1997 are derived from, and are qualified by reference
to, the audited financial statements included elsewhere in this report and
should be read in conjunction with those financial statements and notes thereto.
The statement of operations data for the years ended December 31, 1995 and 1994
and the balance sheet data at December 31, 1996, 1995 and 1994 are derived from
audited financial statements not included herein.
Selected Financial Data
(in thousands, except per share data)
Years Ended December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Statement of Operations Data
Contract revenue $ 7,074 $ 1,713 $ 102 $ 29 $ --
Net loss (7,328) (4,945) (3,457) (2,944) (2,812)
Net loss per share (1.22) (.85) (.90) (.63) --
Weighted average shares
outstanding 5,994 5,806 3,832 4,677
Balance Sheet Data
Cash, cash equivalents and $ 2,269 $ 8,841 $14,266 $ 99 $ 68
investments held for
resale
Working capital 1,358 8,441 13,321 (376) (30)
Total assets 6,362 10,741 14,565 179 138
Capital lease obligations 418 92 -- -- --
Total shareholders' equity
(deficit) 2,589 9,164 13,509 (365) (10)
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
The Company commenced operations in May 1993 to develop and commercialize
technology for displaying images and information onto the retina of the eye. In
1993, the Company acquired an exclusive license to the Virtual Retinal Display
from the University of Washington and entered into a research agreement with the
University of Washington to further develop the VRD technology. The Company was
in the development stage through the period ended December 31, 1996. In
connection with its development activities, the Company incurred costs to
incorporate and establish its business activities as well as to develop and
market the VRD technology. Since the completion of its initial public offering
in August 1996, the Company also has established and equipped its own in-house
laboratory for the continuing development of the VRD technology and has
transferred the research and development work from the HIT Lab to the Company.
The Company has incurred substantial losses since its inception and expects to
continue to incur significant operating losses over the next several years.
The Company currently has several prototype versions of the VRD including
monochromatic and color portable units and a full color table-top model. The
Company expects to continue funding prototype and demonstration versions of
products incorporating the VRD technology throughout 1999. Future revenues,
profits and cash flow and the Company's ability to achieve its strategic
objectives as described herein will depend on a number of factors including
acceptance of the VRD technology by various industries and OEMs, market
acceptance of products incorporating the VRD technology and the technical
performance of such products. See "Description of Business - Considerations
Related to the Company's Business."
Plan of Operation
The Company intends to continue entering into strategic co-development
relationships with systems and equipment manufacturers to pursue the development
of commercial products incorporating the VRD technology. In 1997, the Company
hired a Vice President, Sales with experience in technical product sales to
pursue development contracts as well as strategic relationships with systems
integrators and equipment manufacturers for the joint development of commercial
products incorporating the VRD technology. In March 1999, the Company hired a
Vice President, Marketing to identify and assess the various market and product
opportunities available to the Company for the commercialization of the VRD
technology and to identify and evaluate potential co-development partners. The
Company plans to continue to expand its sales and marketing staff in support of
its objective of commercializing the VRD technology.
The Company plans to continue to pursue, obtain and perform on development
contracts, with the expectation that such contracts will lead to products
incorporating the
21
Company's VRD technology as well as to further the development of the VRD
technology. The Company also plans to continue investing in ongoing innovation
and improvements to the VRD technology, including the development of component
technology and additional prototypes, as well as design of subsystems and
potential products. In March 1999, the Company hired a Vice President, Research
& Development with experience in product development and technology
commercialization to lead the Company's research and product development
efforts, manage the performance of revenue contracts, and direct the Company's
internal research and product development activities. The Company has
established, staffed, and equipped in-house laboratories to support its
performance on development contracts as well as VRD technology development. The
Company intends to continue hiring qualified technical personnel to achieve the
Company's technology development objectives.
Results of Operations
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED
DECEMBER 31, 1997.
Contract Revenue. Contract revenue increased by $5,361,400 to $7,074,100 in
1998 from $1,712,700 in 1997. The increase resulted from a higher level of
development contract business in 1998 over that performed in 1997 on contracts
entered into in both 1998 and 1997. The Company's customers include both the
United States Government and various commercial enterprises, representing
approximately 83% and 17%, respectively, of total revenue during 1998, and 37%
and 63%, respectively, of total revenue during 1997. The Company expects its
sources of revenue to fluctuate from year to year. See Note 2 of Notes to the
Financial Statements.
During 1998, the Company entered into several development contracts with
both commercial and government entities for further development of the VRD
technology directed toward meeting specific customer applications.
In the commercial segment in 1998, the Company announced that it had
entered into a contract with the Wallace-Kettering Neuroscience Institute to
collaborate on the design and manufacture of an advanced head-wearable display
for use in neurosurgery. The display, which will provide "see-through"
readability using the Company's VRD technology, is designed to allow surgeons to
conveniently view anatomical images and other information during surgery. Also
during 1998, the Company and Saab AB, in collaboration with Ericsson Saab
Avionics AB, agreed to extend and broaden the company's commercial development
program to develop the next generation high-resolution, helmet-mounted display
technology for use in advanced aircraft display systems. During the year, the
Company delivered its second helmet-mounted display to Saab AB and Ericsson Saab
Avionics AB. The full-color, high-resolution system was designed to deliver
unprecedented image fidelity for fighter pilots.
In the defense segment in 1998, the Company entered into a $1 million
contract with the U.S. Army's Battle Command Battle Lab to build a head-worn
display with the objective of replacing the desktop monitor at a workstation
within its tactical operations center. The
22
prototype will be a light weight, dual eye (biocular) head-worn device with full
color and high resolution. During the year, the Company received a Phase II
Small Business Innovation Research (SBIR) contract for the development of a high
fidelity head-mounted display for use in flight simulators for training military
pilots. The $1.1 million contract combines contributions from the Department of
Defense, and Saab Ericsson Avionics, the Company's commercial partner, in the
project. In June, the Company received a $583,000 Phase II SBIR from the U.S.
Air Force to develop a wide field of view head-mounted display system using the
Company's VRD technology. The display is designed to allow Command, Control,
Communications, Computers and Intelligence personnel to view large amounts of
mission and situation critical data through a lightweight eyewear display
system, resembling glasses. Also in 1998, the Company announced that it had
entered into a contract to develop a lightweight, head wearable display for the
U.S. Navy. The VRD enabled display, which features daylight "see-through"
readability, will be used on Navy vessels to provide enhanced user interface to
complex on-board information systems. The demonstrator was delivered to the U.S.
Navy in December 1998.
Cost of Revenue. Cost of revenue includes both the direct and indirect
costs of performing on revenue contracts as well as the additional staff and
related support costs associated with building the Company's technical
capabilities in preparation for performing additional contracts expected to be
entered into by the Company in 1999 and thereafter. Cost of revenue also
includes amounts invested by the Company in research and development activities
undertaken in conjunction with work performed in fulfillment of development
contracts.
Cost of revenue increased by $4,596,700 to $6,416,900 in 1998 from
$1,820,200 in 1997. The increase includes increases in both the direct and
indirect costs incurred in the performance of development contracts resulting
from a higher level of development contract business as well as a higher level
of expenses incurred for staff, and related support costs associated with
building the Company's technical capabilities and capacity to perform on
expected future development contracts. The higher level of expense in 1998 over
1997 also reflects a higher level of investment made by the Company in
developing its technology through work performed on development contracts, in
addition to costs incurred on its own internal research and development
projects. See "--Research and Development Expense."
The Company expects that the cost of revenue on a dollar basis will
increase in the future. This increase likely will result from additional
development contact work that the Company will be performing and the
commensurate growth in the Company's personnel and technical capacity. The cost
of facilities is also expected to increase as a result of the Company's
relocation of its headquarters to larger facilities in April 1999. See
"--Liquidity and Capital Resources." As a percentage of contract revenue, the
Company expects that the cost of revenue will decline over time as the Company
realizes economies of scale associated with a higher level of development
contract business and as the Company's expenditures incurred to increase its
technical capabilities and capacity become less as a percentage of a higher
level of revenues.
23
Research and Development Expense. Research and development expense consists
of compensation and related support costs of employees and contractors engaged
in internal research and development activities; payments made for lab
operations, outside development and processing work; payments made under the
Research Agreement in 1997 and prior years; fees and expenses related to patent
applications and patent prosecution; and other expenses incurred in support of
the Company's on-going internal research and development activities. Included in
research and development expenses are costs incurred in acquiring and
maintaining licenses of technology from other companies, options or other rights
to acquire or use intellectual property, either related to the Company's VRD
technology or otherwise. To date, the Company has expensed all research and
development costs. See Note 2 of Notes to the Financial Statements.
Research and development expenses increased by $711,700 to $3,305,600 in
1998 from $2,593,900 in 1997. In 1997 the Company made payments totaling
$962,500 to the University of Washington pursuant to the Research Agreement.
With the final payment on the Research Agreement having been made in 1997, no
such payments to the University of Washington were required or made in 1998. The
balance of the expenses of $3,305,600 and $1,631,400 in 1998 and 1997
respectively, were incurred directly by the Company to further develop the VRD
technology and to build the Company's research and product development
capabilities through the addition of staff and equipment and related supporting
costs. In addition, during 1998, the Company acquired an exclusive license on
patents and other intellectual property related to the design and manufacture of
a microminiature silicon scanner using microelectromechanical technology. The
costs and expenses related to this acquisition are included in research and
development expense in 1998.
The increase in research and development expenses of $711,700 in 1998 over
1997 reflects continued implementation of the Company's operating plan, which
calls for building its technical staff and supporting activities to further
develop the Company's technology; establishing and equipping its own
laboratories; and developing or acquiring intellectual property related to the
Company's business.
The Company believes that a substantial level of continuing research and
development expense will be required to further commercialize the VRD technology
and to develop products incorporating the VRD technology. Accordingly, the
Company anticipates that it will continue to commit substantial resources to
research and development, including hiring additional technical and support
personnel, and that these costs will continue to increase in future periods.
Marketing, General and Administrative Expense. Marketing, general and
administrative expenses include compensation and support costs for the Company's
sales, marketing, management and administrative staff and their related
activities, and for other general and administrative costs, including legal and
accounting costs, costs of consultants and professionals and other expenses.
Marketing, general and administrative expenses increased by $1,827,100 to
$4,904,600 in 1998 from $3,077,500 in 1997. The increase includes increased
aggregate compensation and
24
associated support costs for employees and contractors, including those employed
at December 31, 1997 and those hired subsequent to that date, in sales and
marketing and in management and administrative areas. The Company expects
marketing, general and administrative expenses to increase substantially in
future periods as the Company adds to its sales and marketing staff, makes
additional investments in sales and marketing activities to support
commercialization of its VRD technology and development of anticipated products
and as it increases the level of corporate and administrative activity.
Other Income. Other income of $222,500 in 1997 resulted from the reduction
of an accrued liability for litigation upon settlement of the matter at a lesser
amount than the established reserve.
Interest Income and Expense. Interest income decreased by $307,700 to
$307,100 in 1998 from $614,800 in 1997. This decrease resulted from lower
average cash and investment balances in 1998, representing the remaining net
proceeds received by the Company from its initial public offering in August
1996.
Interest expense increased by $78,200 to $81,600 in 1998 from $3,400 in
1997. This increase resulted from interest related to assignments of certain
accounts receivable under the Company's accounts receivables assignment facility
and increased interest expense related to capital lease obligations entered into
in 1998 and 1997.
Income Taxes. At December 31, 1998 the Company has net operating loss
carry-forwards of approximately $17,866,500 for federal income tax reporting
purposes. The net operating losses will expire beginning in 2005 if not
previously utilized. In certain circumstances, as specified in the Internal
Revenue Code, a 50% or more ownership change by certain combinations of the
Company's shareholders during any three-year period would result in limitations
on the Company's ability to utilize its net operating loss carry-forwards. The
Company has determined that such a change occurred during 1995 and the annual
utilization of loss carry-forwards generated through the period of that change
will be limited to approximately $761,000. An additional change occurred in
1996; however, the actual amount of the annual limitation is not significant.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Contract Revenue. Contract revenue increased by $1,610,500 to $1,712,700 in
1997 from $102,200 in 1996. The increase resulted from the Company recognizing
revenue from various contracts entered into in 1997, which exceeded the
recognition of contract revenue in 1996. See Note 2 of Notes to the Financial
Statements.
During 1997, the Company entered into several development contracts with
both commercial and defense entities for further development of the VRD
technology directed toward meeting specific customer applications.
25
In the commercial segment, the Company entered into a contract with Saab
AB, in collaboration with Ericsson Saab Avionics AB to explore the possibilities
of advanced visual display systems incorporating the VRD technology. The Company
was also contracted by The Boeing Company to build a technology demonstration
system incorporating the VRD technology. The Company delivered the demonstrator
to the Boeing Company in August 1997, which was the Company's first full color
VRD system to be delivered to any customer. Also during 1997, the Company
entered into a third commercial development contract to incorporate its VRD
technology into advanced helmet-mounted display systems for fixed wing military
aircraft.
In the defense segment, the Company was awarded a multi-million dollar
contract to build a helmet-mounted display system based on the VRD technology
for the Army's ACIS Comanche Compatible Common Helmet Program. The phase one
contract, exceeding $4 million, calls for the Company to provide the U.S. Army
with a prototype display system that incorporates a higher performance
alternative to commercial helmet-mounted display technologies currently in use.
The defense segment also included two Small Business Innovation Research
(SBIR) contracts with the United States Air Force. One SBIR is to initiate the
development of a full color, high definition, head-mounted display for pilot
training applications. The second SBIR is to explore the development of very
wide field of view, immersive display systems for command, control,
communications, and computer information systems. The Company was awarded its
third SBIR from the United States Army to initiate the development of a
high-definition, head-mounted display to present visual imagery to helicopter
pilots in an operation flight simulator.
Cost of Revenue. Cost of revenue includes both the direct and indirect
costs of performing on revenue contracts as well as the additional staff and
related support costs associated with building the Company's technical and
managerial capabilities in preparation for performing on additional contracts
expected to be entered into by the Company in 1999 and thereafter. Cost of
revenue also includes amounts invested by the Company in research and
development activities undertaken in conjunction with work performed in
fulfillment of development contracts.
Cost of revenue increased by $1,618,400 to $1,820,200 in 1997 from $201,800
in 1996. The increase includes increases in both the direct and indirect costs
incurred in the performance of development contracts resulting from a higher
level of development contract business as well as a higher level of expenses
incurred in staff and related support costs associated with building the
Company's technical capabilities and capacity to perform on expected future
development contracts. The higher level of expense in 1997 over 1996 also
reflects a higher level of investment made by the Company in developing its
technology through work performed on development contracts in addition to that
performed on its own internal research and development projects. See "--Research
and Development Expense."
26
Research and Development Expense. Research and development expense consists
of compensation and related support costs of employees and contractors engaged
in internal research and product development activities; costs incurred for lab
materials, outside development and processing work; payments made under the
Research Agreement; fees and expenses related to patent applications and patent
prosecution; and other expenses incurred in support of the Company's on-going
internal research and development activities. To date, the Company has expensed
all such costs. See Note 2 of Notes to the Financial Statements.
Research and development expenses increased by $1,007,200 to $2,593,900 in
1997 from $1,586,700 in 1996. The Company made payments totaling $962,500 and
$1,283,400 in 1997 and 1996 respectively to the University of Washington
pursuant to the Research Agreement. The balance of the expenses of $1,631,400
and $303,300 in 1997 and 1996 respectively, were incurred directly by the
Company to further develop the VRD technology and to build the Company's
research and product development capabilities through the addition of staff and
equipment and related supporting costs.
The increase in research and development expense of $1,007,200 in 1997 over
1996 reflects implementation of the Company's operating plan, which calls for
building its technical staff and supporting activities to further develop the
Company's technology, independent of work performed at the University of
Washington pursuant to the Research Agreement.
Marketing, General and Administrative Expense. Marketing, general and
administrative expenses include compensation and support costs for the Company's
sales, marketing, management and administrative staff and their related
activities and for other general and administrative costs, including legal and
accounting costs, costs of consultants and professionals and other expenses.
Marketing, general and administrative expenses increased by $1,227,700 to
$3,077,500 in 1997 from $1,849,800 in 1996. The increase includes increased
aggregate compensation and associated support costs for employees and
contractors, including those employed at December 31, 1996 and those hired
subsequent to that date, in sales and marketing and in management and
administration.
Other Income. Other income of $222,500 in 1997 resulted from the reduction
of an accrued liability for litigation upon settlement of the matter at a lesser
amount than the established reserve.
Interest Income and Expense. Interest income increased by $334,800 to
$614,800 in 1997 from $280,000 in 1996. This increase resulted from higher
average cash and investment balances in 1997, representing the remaining net
proceeds received by the Company from its initial public offering in August
1996.
Interest expense decreased by $197,100 to $3,400 in 1997 from $200,500 in
1996. This decrease resulted from the repayment in November and December 1996 of
the Company's 7% Convertible Subordinated Notes and related interest.
27
Liquidity and Capital Resources
From inception through July 1996, the Company financed its operations
primarily through private offerings of common stock and convertible preferred
stock and convertible subordinated notes. In August 1996, the Company completed
an initial public offering of 2,250,000 units, each unit consisting of one share
of Common Stock and one five-year redeemable Public Warrant to purchase one
share of Common Stock at $12.00 per share. The Company received net proceeds
from the offering of approximately $15,500,000 after deducting underwriting
discounts and offering expenses.
In July 1996, the Company raised net proceeds of $707,500 in a private
placement of $750,000 in principal amount of its 7% Convertible Subordinated
Notes due 1997 (the "7% Notes"). From November 25, 1996, through March 15, 1997,
the 7% Notes were redeemable at the option of the noteholder at par (plus
accrued and unpaid interest) plus 6,000 shares of Common Stock for every
$100,000 principal so redeemed. In November and December 1996, the 7% Notes were
redeemed in full (plus accrued interest) and 45,000 shares of Common Stock were
issued to the noteholders. See Note 6 of Notes to the Financial Statements.
Through December 31, 1998, the Company had incurred an accumulated deficit
of $22,836,000, of which $5,133,500 represented payments made to the University
of Washington to fund the research and development of its VRD technology
pursuant to the terms of the Research Agreement, and $2,357,300 represented
non-cash expenses for compensation and services associated with the issuances of
stock, warrants and options.
In 1998, the Company established a non-recourse receivables assignment
facility (the "Facility") with a financial institution. The Facility allows the
Company to assign accounts receivable to the financial institution on a
non-recourse basis for cash. The maximum amount of assigned but uncollected
receivables at any one time is $2,500,000. The Facility, which carries an
administrative fee and an interest discount, expires on September 24, 1999. As
of December 31, 1998, approximately $696,800 of receivables were assigned under
this Facility and were recorded by the Company as a reduction of trade accounts
receivable. See Note 5 to Notes to the Financial Statements.
In January 1999, the Company raised $5,000,000 from the sale of convertible
preferred stock to a private investor in a private placement. Unless converted
sooner at the election of the investor, the convertible preferred stock will
automatically convert into 400,000 shares of common stock at the end of its
five-year term. The convertible preferred stock carries a cumulative dividend of
4% per annum, payable in cash or additional convertible preferred stock at the
election of the Company. The investor also acquired two options to purchase
additional convertible preferred stock, one with a six-month maturity and one
with a nine-month maturity from the closing date of the transaction. Terms of
the transaction include certain rights for the investor to have the common stock
issuable upon conversion of the preferred stock registered under the Securities
Act of 1933 (the "Securities Act") for resale by the holders thereof. See Note
11 of Notes to the Financial Statements.
28
In April 1999, the Company raised $6,000,000 from the sale of 440,893
shares of common stock to a private investment fund in a private placement. The
investor also acquired two warrants to purchase additional common stock, one
with a five-year term and the other with a one-year term. Under the terms of the
agreement, the Company will register the shares issued in the initial sale and
underlying the two warrants for resale by the holders thereof in accord with the
Securities Act. Terms of the transaction include a provision that could result
in a one-time issuance of additional shares, up to a fixed maximum, if the
market price, as defined in the purchase agreement, of the Company's common
stock on the date of effectiveness of the registration statement is less than
the market price of the common stock on the closing date of the initial sale.
See Note 11 of Notes to the Financial Statements.
In October 1998, the Company entered into a lease for office space to house
the Company's operations over the longer term by providing space to accommodate
planned growth in staff, lab and production space requirements. Under the terms
of the lease, the Company will lease between 92,000 square feet and 101,000
square feet over the first four years of the seven-year term of the lease. Based
on the initial commitment of approximately 67,500 square feet, the base rent
expense during the first year of occupancy is approximately $951,500, increasing
to approximately $1,002,300 in the second year. The lease is a triple net lease,
which requires the Company to pay operating expenses in addition to the base
rent. The lease terms include an option for the Company to extend the initial
lease term for one period of five years, a second option to extend for an
additional period of two years, and other options to acquire additional space
during the initial seven-year term should the need arise. The terms of the lease
require the Company to provide the landlord with a lease bond in the amount of
$1,150,000 as credit enhancement for the lease. As of December 31, 1998,
$400,000 of the required lease bond had been issued, with the remaining $750,000
being issued in January 1999. The Company was required to secure one-half of the
lease bond with a letter of credit. The Company was further required to secure
the full amount of the letter of credit with cash. The requirement to maintain
the lease bond can be terminated when the Company meets certain financial
criteria as described in the lease. In January 1999, the Company exercised its
option to finance $420,000 of tenant improvements through the landlord and
provided a letter of credit to support the borrowing. The Company was required
to secure the entire amount of the letter of credit with cash. The amount of the
letter of credit required is reduced over the term of the borrowing based on
repayments made. Repayment of the borrowing will be included in the Company's
rent. The Company completed its relocation into this facility in April 1999.
The Company's future expenditures and capital requirements will depend on
numerous factors, including the progress of its research and development
program, the progress in commercialization activities and arrangements, the cost
of filing, prosecuting, defending and enforcing any patent claims and other
intellectual property rights, competing technological and market developments
and the ability of the Company to establish cooperative development, joint
venture and licensing arrangements. In order to maintain its exclusive rights
under the UW License Agreement, the Company is obligated to make payments with
respect to royalties on the VRD. See "Description of Business- University of
Washington License Agreement." If the Company is successful in establishing OEM
co-development and joint venture arrangements, it is expected that the Company's
partners would fund certain non-recurring
29
engineering costs for product development. Nevertheless, the Company expects its
cash requirements to increase significantly each year as it expands its
activities and operations.
At December 31, 1998, the Company's total cash, cash equivalents and
short-term investment securities balance was $2,269,000. The Company believes
that this balance, together with the $5,000,000 of proceeds received in January
1999 from the sale of convertible preferred stock and the $6,000,000 of proceeds
received in April 1999 from the sale of common stock, will satisfy its budgeted
cash requirements for at least the next 12 months, based on the Company's
current operating plan. Actual expenses, however, may exceed the amounts
budgeted therefor and the Company may require additional capital earlier to
develop its products, to respond to competitive pressures or to meet
unanticipated development difficulties. The Company's operating plan calls for
the purchase and installation of certain laboratory equipment and facilities and
the addition of technical and business staff. The operating plan also provides
for the development of strategic relationships with systems and equipment
manufacturers. See "Description of Business." There can be no assurance that
additional financing will be available to the Company or that, if available, it
will be available on terms acceptable to the Company 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 limit its operations
significantly. 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 VRD
technology and the market acceptance and competitive position of such products.
See "Description of Business - Considerations Related to the Company's Business
- - Capital Requirements."
Year 2000 Compliance Strategy
The Company has developed and is implementing a comprehensive strategy for
updating its information technology ("IT") and non-IT systems for Year 2000
("Y2K") compliance. These systems include PC-based hardware, embedded systems,
enterprise software (available Company-wide) and individual software (available
on a user-by-user basis). The Company's strategy for achieving Y2K compliance
includes evaluating its current systems and software for Y2K compliance,
purchasing new systems and software where necessary and developing contingency
plans for those systems that the Company cannot control.
Essentially all of the Company's IT systems have been purchased within the
last three years. During that period, Y2K compliance has been a consideration in
the purchase of all of the Company's primary IT and non-IT systems. The Company
believes that it has currently reached the following levels of compliance:
30
Current Level
Technology of Compliance
---------- -------------
PC-based hardware 90%
Embedded systems 25%
Enterprise software 70%
Individual software 50%
In April 1999, the Company moved its headquarters and commenced a new lease
with a different lessor. See "-- Liquidity and Capital Resources." Pursuant to
the terms of the lease, the lessor is responsible for making the systems serving
the facility "Year 2000 Compliant."
The Company's strategy includes identifying third parties whose failure to
be Y2K compliant could have a material adverse impact on the Company's
operations or financial condition. This process includes examining the Company's
interaction with other IT systems including those of vendors and parties with
which it communicates via e-mail and other information systems. The Company
plans to request a statement from all significant vendors and third parties
reporting their Y2K compliance status. If such vendors or other third parties
raise Y2K compliance concerns, the Company plans to utilize backup vendors that
are Y2K compliant. In addition, the Company is requesting a statement from all
of its customers regarding their levels of Y2K compliance.
The Company presently expects its overall Y2K assessment to be completed
the second quarter of 1999. There is no assurance, however, that taking the
steps described within the proposed timeframe will ensure complete Y2K
compliance.
To date, the cost of the Company's Y2K compliance strategy has been
immaterial. The Company will have a budget of potential expenditures relating to
its Y2K compliance strategy upon completion of its assessment in the second
quarter of 1999.
The effect on the Company of an internal Y2K failure, a third party Y2K
failure or a combination of internal and external Y2K failures could range from
a minor disruption in the Company purchases to an extended interruption in the
IT and non-IT systems of third-parties whose operations materially impact the
Company's operations. Such an interruption could result in a material adverse
effect on the Company's operating results and financial position. In addition,
if the Company has a production product by the year 2000, the potential for a
material adverse effect on the Company would increase. There can be no assurance
that such a scenario, or part of such a scenario, will not occur.
The Company's contingency plans for a Y2K disruption of its operations
include making additional purchase from vendors for a reasonable period
following January 1, 2000 in order to ensure the availability of materials
needed for the Company to perform on its contractual obligations. The Company is
also in the process of developing backup plans that will enable it to continue
operations with the least amount of downtime and expense. There is
31
no assurance, however, that such backup plans will enable the Company to avoid a
materially adverse impact on its results of operations in the event of a Y2K
disruption.
32
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
33
ITEM 8. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.............................................35
Balance Sheet as of December 31, 1998 and December 31, 1997...................36
Statement of Operations for the years ended December 31, 1998,
December 31, 1997 and December 31, 1996.......................................37
Statement of Shareholders' Equity for the years ended
December 31, 1998, December 31, 1997 and December 31, 1996....................38
Statement of Comprehensive Loss for the years ended December 31, 1998,
December 31, 1997 and December 31, 1996.......................................40
Statement of Cash Flows for the years ended December 31, 1998,
December 31, 1997 and December 31, 1996.......................................41
Notes to Financial Statements ...............................................42
34
Report of Independent Accountants
April 1, 1999
To the Board of Directors
and Shareholders of
Microvision, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of shareholders' equity, of comprehensive loss and of cash flows
present fairly, in all material respects, the financial position of Microvision,
Inc. at December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
35
Microvision, Inc.
Balance Sheet
- ----------------------------------------------------------------------------------------------
December 31,
1998 1997
Assets
Current assets
Cash and cash equivalents $ 2,269,000 $ 5,049,200
Investment securities available-for-sale 3,792,000
Accounts receivable, net of allowance of $24,000 and $0 1,538,800 150,000
Costs and estimated earnings in excess of billings on
uncompleted contracts 758,500 843,800
Other current assets 282,800 113,100
------------ ------------
Total current assets 4,849,100 9,948,100
Property and equipment, net 1,394,100 772,700
Other assets 119,000 20,000
------------ ------------
Total assets $ 6,362,200 $ 10,740,800
============ ============
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 1,327,700 $ 768,200
Accrued liabilities 1,028,100 715,900
Allowance for estimated contract losses 228,000
Billings in excess of costs and estimated
earnings on uncompleted contracts 771,500
Current portion of capital lease obligations 136,100 22,700
------------ ------------
Total current liabilities 3,491,400 1,506,800
------------ ------------
Capital lease obligations, net of current portion 281,800 69,600
------------ ------------
Commitments and contingencies (Notes 7 and 8)
Shareholders' equity
Preferred stock, no par value, 31,250,000 shares
authorized, none issued and outstanding
Common stock, no par value, 31,250,000 shares
authorized, 6,064,626 and 5,920,264 shares issued
and outstanding 25,742,600 25,375,300
Deferred compensation (238,700) (701,200)
Subscriptions receivable from related parties (78,900)
Unrealized holding loss on investment securities (1,200)
Accumulated deficit (22,836,000) (15,508,500)
------------ ------------
Total shareholders' equity 2,589,000 9,164,400
------------ ------------
Total liabilities and shareholders' equity $ 6,362,200 $ 10,740,800
============ ============
The accompaning notes are an integral part of these financial statements.
36
Microvision, Inc.
Statement of Operations
- -------------------------------------------------------------------------------------------------------
Year ended December 31,
1998 1997 1996
Contract revenue $ 7,074,100 $ 1,712,700 $ 102,200
Cost of revenue 6,416,900 1,820,200 201,800
----------- ----------- -----------
Gross margin 657,200 (107,500) (99,600)
----------- ----------- -----------
Research and development expense 3,305,600 2,593,900 1,586,700
Marketing, general and administrative expense 4,904,600 3,077,500 1,849,800
----------- ----------- -----------
Total operating expenses 8,210,200 5,671,400 3,436,500
----------- ----------- -----------
Loss from operations (7,553,000) (5,778,900) (3,536,100)
Other income 222,500
Interest income 307,100 614,800 280,000
Interest expense (81,600) (3,400) (200,500)
----------- ----------- -----------
Net loss $(7,327,500) $(4,945,000) $(3,456,600)
=========== =========== ===========
Net loss per share $ (1.22) $ (.85) $ (.90)
=========== =========== ===========
Weighted-average shares outstanding 5,993,500 5,806,200 3,832,000
=========== =========== ===========
Net loss per share assuming dilution $ (1.22) $ (.85) $ (.90)
=========== =========== ===========
Weighted-average shares outstanding assuming dilution 5,993,500 5,806,200 3,832,000
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
37
Microvision, Inc.
Statement of Shareholders' Equity
- -------------------------------------------------------------------------------------------------------
page 1, part 1 of 2
Preferred stock Common stock Deferred
Shares Amount Shares Amount compensation
Balance at December 31, 1995 499,478 $2,038,900 3,098,828 $ 4,745,900 $ (42,800)
Issuance of stock to board
members for services 22,250 110,000 (65,500)
Issuance of warrants and
options for common stock 23,400
Issuance of preferred stock
for cash, net of costs 360,298 1,493,900
Issuance of common stock and
warrants for services 10,605 71,000
Exercise of warrants
for common stock 50,000 40,000
Cashless exercise of warrants
for common stock 296,875
Cancellation of founder's
common stock (859,375) (66,000)
Amortization of deferred
compensation, net 64,700
Sale of common stock and
warrants in IPO 2,250,000 15,482,900
Conversion of convertible
preferred stock (859,776) (3,532,800) 859,776 3,532,800
Collection of
subscription receivable
Issuance of stock relating
to retirement of 7%
subordinated notes 45,000 176,200
Other 4,817
Net loss
-------- ---------- ---------- ----------- ----------
Balance at December 31, 1996 - - 5,778,776 24,116,200 (43,600)
The accompanying notes are an integral part of these financial statements.
38a
page 1, part 2 of 2
Unrealized
Subscriptions holding (loss)
receivable gain on
from related investment Accumulated Shareholders'
parties securities deficit equity
Balance at December 31, 1995 $ - $ - $(7,106,900) $ (364,900)
Issuance of stock to board
members for services 44,500
Issuance of warrants and
options for common stock 23,400
Issuance of preferred stock
for cash, net of costs 1,493,900
Issuance of common stock and
warrants for services 71,000
Exercise of warrants
for common stock (10,000) 30,000
Cashless exercise of warrants
for common stock -
Cancellation of founder's
common stock (66,000)
Amortization of deferred
compensation, net 64,700
Sale of common stock and
warrants in IPO 15,482,900
Conversion of convertible
preferred stock -
Collection of
subscription receivable 10,000 10,000
Issuance of stock relating
to retirement of 7%
subordinated notes 176,200
Other -
Net loss (3,456,600) (3,456,600)
------------- ------------- ------------ ------------
Balance at December 31, 1996 - - (10,563,500) 13,509,100
The accompanying notes are an integral part of these financial statements.
38b
Microvision, Inc.
Statement of Shareholders' Equity (continued)
- --------------------------------------------------------------------------------------------------
page 2, part 1 of 2
Preferred stock Common stock Deferred
Shares Amount Shares Amount compensation
Issuance of stock to board
members for services 9,600 78,600 $ (78,600)
Exercise of warrants and
options for common stock 56,420 348,500
Cashless exercise of
warrants for common stock 75,468
Issuance of options
for services 37,200
Issuance of options
for common stock 785,000 (785,000)
Amortization of
deferred compensation 206,000
Unrealized holding loss on
investment securities
Other 9,800
Net loss
-------- ---------- ---------- ----------- ----------
Balance at December 31, 1997 - - 5,920,264 25,375,300 (701,200)
Issuance of stock to board
members for services 24,000 120,000 (120,000)
Exercise of warrants and
options for common stock 85,178 344,600
Cashless exercise of
warrants for common stock 31,684
Issuance of stock and
options for services 3,500 34,700
Issuance of options
for common stock 5,300 (5,300)
Forfeitures of options
for common stock (137,300) 137,300
Amortization of
deferred compensation 450,500
Unrealized holding gain on
investment securities
Net loss
-------- ---------- ---------- ----------- ----------
Balance at December 31, 1998 - $ - 6,064,626 $25,742,600 $ (238,700)
======== ========== ========== =========== ==========
The accompanying notes are an integral part of these financial statements.
39a
page 2, part 2 of 2
Unrealized
Subscriptions holding (loss)
receivable gain on
from related investment Accumulated Shareholders'
parties securities deficit equity
Issuance of stock to board
members for services -
Exercise of warrants and
options for common stock 348,500
Cashless exercise of
warrants for common stock
Issuance of options
for services 37,200
Issuance of options
for common stock
Amortization of
deferred compensation 206,000
Unrealized holding loss on
investment securities (1,200) (1,200)
Other 9,800
Net loss (4,945,000) (4,945,000)
------------- ------------- ------------ ------------
Balance at December 31, 1997 - (1,200) (15,508,500) 9,164,400
Issuance of stock to board
members for services -
Exercise of warrants and
options for common stock (78,900) 265,700
Cashless exercise of
warrants for common stock -
Issuance of stock and
options for services 34,700
Issuance of options
for common stock -
Forfeitures of options
for common stock -
Amortization of
deferred compensation 450,500
Unrealized holding gain on
investment securities 1,200 1,200
Net loss (7,327,500) (7,327,500)
------------- ------------- ------------ ------------
Balance at December 31, 1998 $ (78,900) $ - $(22,836,000) $ 2,589,000
============= ============= ============ ============
The accompanying notes are an integral part of these financial statements.
39b
Microvision, Inc.
Statement of Comprehensive Loss
- ------------------------------------------------------------------------------------------------------------
Year ended December 31,
1998 1997 1996
Net loss $ (7,327,500) $ (4,945,000) $ (3,456,600)
Other comprehensive income - unrealized gain (loss)
on investment securities available-for-sale 1,200 (1,200)
------------ ------------ ------------
Comprehensive loss $ (7,326,300) $ (4,946,200) $ (3,456,600)
============ ============ ============
The accompanying notes are an integral part of these financial statements.
40
Microvision, Inc.
Statement of Cash Flows
- ------------------------------------------------------------------------------------------------------------
Year ended December 31,
1998 1997 1996
Cash flows from operating activities
Net loss $ (7,327,500) $(4,945,000) $ (3,456,600)
Adjustments to reconcile net loss to net cash used
in operations
Depreciation and loss on disposal of equipment 468,900 146,200 44,000
Noncash expenses related to issuance of stock,
warrants and options and amortization of
deferred compensation 485,200 243,200 313,800
Allowance for estimated contract losses 228,000
Change in:
Accounts receivable (1,388,800) (125,000) (25,000)
Costs and estimated earnings in excess of
billings on uncompleted contracts 85,300 (843,800)
Other current assets (169,700) (26,600) (86,500)
Other assets (99,000) 10,200 41,200
Accounts payable 559,500 379,600 181,100
Accrued liabilities 312,200 48,300 331,200
Billings in excess of costs and expenses 771,500
------------ ------------ ------------
Net cash used in operating activities (6,074,400) (5,112,900) (2,656,800)
------------ ------------ ------------
Cash flows from investing activities
Sales of investment securities 7,695,100
Purchases of investment securities (3,901,900) (3,793,200)
Purchases of property and equipment (696,300) (666,600) (192,700)
------------ ------------ ------------
Net cash provided by (used in)
investing activities 3,096,900 (4,459,800) (192,700)
------------ ------------ ------------
Cash flows from financing activities
Principal payments under capital leases (68,400) (2,200)
Proceeds from 7% convertible subordinated notes 750,000
Repayment of 7% convertible subordinated notes (750,000)
Net proceeds from issuance of common stock 265,700 358,300 15,522,900
Net proceeds from issuance of preferred stock 1,493,900
------------ ------------ ------------
Net cash provided by financing activities 197,300 356,100 17,016,800
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (2,780,200) (9,216,600) 14,167,300
Cash and cash equivalents at beginning of year 5,049,200 14,265,800 98,500
------------ ------------ ------------
Cash and cash equivalents at end of year $ 2,269,000 $ 5,049,200 $ 14,265,800
============ ============ ============
Supplemental disclosure of cash flow information
Cash paid for interest $ 81,600 $ 3,400 $ 21,700
============ ============ ============
Supplemental schedule of noncash investing and financing activities
Property and equipment acquired under capital leases $ 394,000 $ 94,500 $ -
============ ============ ============
The accompanying notes are an integral part of these financial statements.
41
1. The Company
Microvision, Inc. (the Company), a Washington corporation, was established
to develop, manufacture and market Virtual Retinal Display (VRD)
technology, which projects images onto the eye's retina. The Company is
working to commercialize the VRD technology for potential defense,
healthcare, business, industrial and consumer applications.
2. Summary of significant accounting policies
Cash, cash equivalents and investment securities
The Company considers all investments with original maturities of three
months or less to be cash equivalents.
Short-term investment securities are primarily debt securities. The Company
has classified its entire investment portfolio as available-for-sale.
Available-for-sale securities are stated at fair value with unrealized
gains and losses included in shareholders' equity. Dividend and interest
income are recognized when earned. Realized gains and losses are included
in other income. The cost of securities sold is based on the specific
identification method.
Property and equipment
Property and equipment is stated at cost and depreciated over the estimated
useful lives of the assets (three to five years) using the straight-line
method. Leasehold improvements are depreciated over the shorter of their
estimated useful life or the lease term.
Revenue recognition
Revenue has primarily been generated from contracts for further development
of the VRD technology and to produce prototypes for commercial enterprises
and for the United States Government. Revenue on such contracts is recorded
using the percentage-of-completion method measured on a cost incurred basis
to the extent nonrefundable.
Losses, if any, are recognized in full as soon as identified. Changes in
contract performance, contract conditions and estimated profitability,
including those arising from contract penalty provisions, and final
contract settlements may result in revisions to costs and income and are
recognized in the period in which the revisions are determined. Profit
incentives are included in revenues when their realization is assured.
Concentration of credit risk and sales to major customers
Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily accounts receivable and cash
equivalents. The Company typically requires no collateral from its
customers. The Company has a cash investment policy which generally
restricts investments to ensure preservation of principal and maintenance
of liquidity.
The Company's customers include the United States Government and commercial
enterprises, representing approximately 83% and 17%, respectively, of total
revenue during 1998. These customers represented 37% and 63%, respectively,
of total revenue during 1997. All revenues in 1996 were attributed to two
commercial customers. Three commercial enterprises represent 17% and 63% of
total revenues during 1998 and 1997, respectively.
Income taxes
The Company provides for income taxes under the principles of Statement of
Financial Accounting Standards No. 109 (SFAS 109) which requires that
provision be made for taxes currently due and for the expected future tax
effects of temporary differences between book and tax bases of assets and
liabilities.
42
Net loss per share
Statement of Financial Accounting Standards No. 128 (SFAS 128) was issued
in February 1997. This pronouncement modifies the calculation and
disclosure of net loss per share and was adopted by the Company during
1997. Under the provisions of SFAS 128, net loss per share is calculated on
the basis of the weighted-average number of common shares outstanding
during the periods. Net loss per share assuming dilution is calculated on
the basis of the weighted-average number of common shares outstanding and
the dilutive effect of all common stock equivalents and convertible
securities. Net loss per share assuming dilution for the years ended
December 31, 1998, 1997 and 1996 is equal to net loss per share since the
effect of common stock equivalents outstanding during the periods,
including options and warrants computed using the treasury stock method, is
anti-dilutive. All net loss per share amounts from prior periods have been
restated to reflect the adoption of SFAS 128.
Research and development
Research and development costs are expensed as incurred. Research and
development costs will be expensed until the net realizable value of a
related product or technology is assured.
Fair value of financial instruments
The Company's financial instruments include cash and cash equivalents,
investment securities, accounts receivable, accounts payable, accrued
liabilities and capital lease obligations. Except for the capital leases,
the carrying amounts of financial instruments approximates fair value due
to their short maturities. The carrying amount of capital leases at
December 31, 1998 and 1997 was not materially different from the fair value
based on rates available for similar types of arrangements.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Stock-based compensation
The Company's stock-based compensation plans are subject to provisions of
Financial Accounting Standards Board issued Statement No. 123, "Accounting
for Stock-Based Compensation" (SFAS 123). Under the provisions of this
statement, employee stock-based compensation expense is measured using
either the intrinsic-value method as prescribed by Accounting Principles
Board Opinion No. 25 (APB 25) or the fair value method described in SFAS
123. Companies choosing the intrinsic-value method are required to disclose
the pro forma impact of the fair value method on net income and earnings
per share. The Company decided to implement SFAS 123 using the
intrinsic-value method for its employee stock-based compensation plans. The
Company is required to implement SFAS 123 for stock-based awards to other
than employees. Accordingly, during 1998, 1997 and 1996, the Company valued
shares of the Company's common stock, warrants and options issued to other
than employees at $154,700, $115,800 and $380,600, respectively.
New accounting pronouncements
The Financial Accounting Standards Board (the Company) issued SFAS No. 130,
"Reporting Comprehensive Income," in June 1997. This statement establishes
new standards for reporting and displaying comprehensive income in the
financial statements and was adopted by the Company during the quarter
ended March 31, 1998. SFAS 130 requires reclassification of prior periods
financial statements to reflect application of the provisions of this
statement. In addition to
43
net income, comprehensive income includes charges or credits to equity that
are not the result of transactions with shareholders.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the way that public business enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major
customers. The Company has adopted SFAS No. 131 and has provided the
disclosures needed to conform with its requirements.
Reclassifications
Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform to current year presentation.
3. Accrued liabilities
Accrued liabilities consist of the following:
December 31,
1998 1997
Bonuses $ 410,000 $ 414,300
Payroll 258,400
Vacation 115,400 103,000
Professional fees 140,200 155,500
Other 104,100 43,100
----------- -----------
$ 1,028,100 $ 715,900
=========== ===========
4. Property and equipment, net
Property and equipment consist of the following:
December 31,
1998 1997
Office furniture and equipment $ 283,000 $ 185,700
Lab equipment 897,100 270,900
Computer hardware and software 766,400 433,000
Leasehold improvements 88,400 55,000
----------- -----------
2,034,900 944,600
Less: Accumulated depreciation (640,800) (171,900)
---- ----------- -----------
$ 1,394,100 $ 772,700
=========== ===========
5. Non-recourse receivables assignment facility
The Company has established a non-recourse receivables purchasing facility
(the "Facility") with a financial institution. The Facility allows the
Company to assign accounts receivable to the financial institution on a
non-recourse basis for cash. At any time, the maximum amount of
44
assigned but uncollected receivables is $2,500,000. The Facility, which
carries an administration fee and an interest discount, expires on
September 24, 1999. As of December 31, 1998, approximately $696,800 of
receivables were assigned under this Facility and were recorded by the
Company as a reduction of trade accounts receivable. During 1998, the
Company recorded fees and interest expense of $44,900 under the facility.
6. Shareholders' equity
Common shares
On July 10, 1996, the Company issued 7% Convertible Subordinated Notes in
the amount of $750,000. The Notes bore interest at 7% payable in arrears on
December 15 and June 15 and were due July 10, 1997. The Notes were
convertible at any time following 90 days after the effective date of a
public offering of the Company's common stock generating proceeds of at
least $5 million into 18,000 shares of common stock for each $100,000 in
outstanding principal amount of Notes. Additionally, at any time following
90 days after the effective date of such a public offering and prior to
March 15, 1997, the holder could redeem the unpaid principal amount of
Notes plus accrued interest and receive 6,000 shares of common stock of the
Company for each $100,000 in principal redeemed. In late 1996, the Company
repaid the Notes on demand by holders and issued 45,000 shares of common
stock to the holders. The aggregate fair value of the shares of common
stock issued of $176,200 was charged to interest expense.
In August 1996, the Company completed an initial public offering (IPO) of
2,250,000 units, each consisting of one share of common stock and one
warrant to purchase one share of common stock. The Company received net
proceeds from the offering of $15,482,900. In anticipation of the IPO, on
July 10, 1996 the Company's Board of Directors approved a 1-for-3.2 reverse
stock split of the Company's common and preferred stock. All information in
these financial statements pertaining to shares of capital stock and per
share amounts has been adjusted to give retroactive effect to the reverse
split. In connection with this action, a nominal number of fractional
shares were redeemed in cash.
Preferred shares
In November 1994, the Company authorized the issuance and sale of 1,875,000
shares of Series A Preferred Stock which had liquidation and dividend
preferences over common stock. Dividends accrued when and if declared by
the Board of Directors. The Series A Preferred Stock was convertible into
an equal number of shares of common stock. The Series A Preferred Stock was
converted into 859,776 shares of common stock in conjunction with the IPO.
45
Warrants
In addition to the warrants issued in conjunction with the IPO (Public
Warrants), the Company has issued warrants for various services. The
following summarizes activity with respect to warrants during the three
years ended December 31, 1998:
Exercise
Shares price
Outstanding at December 31, 1995 932,813 $ 2.40-6.40
Granted 2,860,050 2.40-12.00
Exercised (412,500) 2.40-3.52
Canceled/expired (550,000) 2.40-6.40
--------- -----------
Outstanding at December 31, 1996 2,830,363 4.80-12.00
Exercised (140,625) 4.80-6.40
--------- -----------
Outstanding at December 31, 1997 2,689,738 4.80-12.00
Granted 17,676 12.00
Exercised (31,684) 8.00-9.60
Canceled/expired (69,566) 8.00-9.60
--------- -----------
Outstanding at December 31, 1998 2,606,164 $4.80-12.00
========= ===========
Exercisable at December 31, 1998 2,606,164 $4.80-12.00
========= ===========
Options
During 1993, the Company adopted the 1993 Stock Option Plan (the 1993 Plan)
which provides for granting incentive stock options (ISOs) and nonqualified
options (NSOs) to employees, directors, officers, and certain nonemployees
of the Company as determined by the Board of Directors, or its designated
committee (Plan Administrator), for the purchase of up to a total of
228,938 shares of the Company's authorized but unissued common stock. The
date of grant, option price, vesting period and other terms specific to
options granted under such plan were determined by the Plan Administrator.
In September 1995, an additional 625,000 shares were reserved for issuance
under the 1993 Plan.
During 1994, the Company adopted the 1994 Combined Incentive and
Nonqualified Stock Option Plan (the 1994 Plan) which provided for the
granting of ISOs and NSOs to employees, directors, officers, and certain
nonemployees of the Company as determined by the Plan Administrator for the
purchase of common shares not to exceed a total of 435,000 of the Company's
authorized but unissued shares of common stock. The date of grant, option
price, vesting terms and other terms specific to options granted under such
plan were determined by the Plan Administrator.
The Company expects to terminate the prior plans effective immediately
following the issuance of the shares of common stock subject to the
outstanding grants thereunder.
During 1996, the Company adopted the 1996 Stock Option Plan (the 1996 Plan)
and the 1996 Independent Director Stock Plan (the Director Plan). The 1996
Plan, as amended, provides for granting ISOs and NSOs to employees,
officers and agents of the Company as determined by the Plan Administrator,
for the purchase of up to 3,000,000 shares of the Company's authorized but
unissued common stock. The terms and conditions of any options granted,
including the exercise price and vesting period are to be determined by the
Plan Administrator. The Director Plan
46
provides for granting up to a total of 75,000 shares of common stock to
nonemployee directors of the Company as determined by the Board of
Directors or a committee thereof.
Stock options issued under the 1993 and 1994 Plans vest over three years
and expire five years after the vesting date. Stock options issued under
the 1996 Plan vest over three to four years and typically expire after ten
years. Stock issued under the Director Plan vests over one year.
In 1998, the three officers of the Company exercised a total of 43,000
stock options in exchange for recourse notes totaling $78,900. These notes
bear interest at 5.56% to 5.77% per annum. Each note is payable in full
upon the earliest of (1) a fixed date ranging from January 31, 2001 to
December 31, 2002, depending on the officer; (2) the sale of all of the
shares acquired with the note; or (3) within 90 days of the officer's
termination of employment. Each note is also payable on a pro rata basis
upon the partial sale of shares acquired with the note. The notes are
included in shareholders' equity on the balance sheet.
47
The following table summarizes activity with respect to options for the
three years ended December 31, 1998:
Weighted-
average
exercise
Shares price
Outstanding at December 31, 1995 645,892 $ 3.91
Granted:
Exercise price greater than fair value 307,875 7.31
Exercise price equal to fair value 79,249 5.10
Forfeited (53,650) 7.59
---------
Outstanding at December 31, 1996 979,366 4.88
Granted:
Exercise price greater than fair value 791,526 17.72
Exercise price equal to fair value 161,800 14.66
Exercise price less than fair value 176,250 9.77
Exercised (40,795) 6.09
Forfeited (84,680) 8.10
---------
Outstanding at December 31, 1997 1,983,467 11.07
Granted:
Exercise price greater than fair value 474,043 18.88
Exercise price equal to fair value 96,575 11.91
Exercise price less than fair value 5,000 7.88
Exercised (85,178) 4.05
Forfeited (108,756) 14.65
---------
Outstanding at December 31, 1998 2,365,151 $ 12.75
=========
The following table summarizes information about the weighted-average grant
date fair value of options granted:
Year ended December 31,
1998 1997 1996
Exercise price greater than fair value $4.71 $4.61 $2.03
Exercise price equal to fair value 6.70 7.56 2.65
Exercise price less than fair value 5.28 9.03
48
The following table summarizes information about stock options outstanding
and exercisable at December 31, 1998:
Options outstanding Options exercisable
-------------------------------------------- ---------------------------
Weighted-
Number average Weighted- Number Weighted-
Range of outstanding at remaining average exercisable at average
exercise December 31, contractual exercise December 31, exercise
prices 1998 life price 1998 price
$0.80 160,939 2.51 $ 0.80 160,939 $ 0.80
$3.20-$4.80 204,289 3.50 $ 3.41 204,289 $ 3.41
$5.25-$7.81 529,030 5.06 $ 6.68 497,697 $ 6.66
$8.00-$11.95 336,352 6.93 $ 9.56 54,895 $ 8.85
$12.00-$17.88 545,485 8.11 $15.49 240,597 $14.73
$18.00-$26.56 392,856 8.16 $21.73 5,264 $18.74
$27.34-$34.18 196,200 9.08 $28.56
--------- ---------
2,365,151 1,163,681
========= =========
At December 31, 1997, 784,980 stock options were exercisable at a
weighted-average exercise price of $4.48 per share. At December 31, 1996,
476,593 stock options were exercisable at a weighted-average exercise price
of $2.92 per share.
In 1998, 1997 and 1996, options to purchase 64, 6,624 and 10,605 shares
respectively, of the Company's common stock were issued to consultants and
other third parties in lieu of cash compensation. The Company recognized an
expense of $800, $37,200 and $21,000, respectively, related to the issuance
of the options.
The Company applies APB 25 and related interpretations in accounting for
its stock-based compensation to employees. Options issued to employees were
recorded at $5,300 and $785,000 during 1998 and 1997 based upon the
difference between the exercise price and fair value of the underlying
shares on the date of grant. However, no value was recorded related to the
time value of the options.
49
Had compensation cost for the Plans been determined based upon the fair
value at the grant date for awards under the Plans consistent with the
methodology prescribed under SFAS 123, the Company's net loss would have
been increased to the pro forma amounts indicated below:
1998 1997 1996
Net loss As reported $ (7,327,500) $ (4,945,000) $(3,456,600)
Pro forma $(10,689,200) $ (5,961,500) $(3,760,600)
Pro forma loss per share As reported $ (1.22) $ (.85) $ (.90)
Pro forma $ (1.78) $ (1.03) $ (.98)
The fair value of the options granted during 1998, 1997 and 1996 is
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions used for grants in 1998,
1997 and 1996, respectively: dividend yield of zero percent for all years,
expected volatility of 60% for all years, risk-free interest rate of 5.11%,
6.09% and 6.55%, assumed forfeiture rate of 5% for all years, and expected
lives of 5 years in 1998 and 4 years in 1997 and 1996.
7. Commitments and contingencies
Agreements with University of Washington
In October 1993, the Company concurrently entered into a Research Agreement
and Exclusive License Agreement (License Agreement) with the University of
Washington (UW). The Research Agreement provided for the Company to pay
$5,133,500 to fund agreed-upon VRD research and development activities to
be carried out by the UW. The research funding was required to be paid in
sixteen quarterly installments of $320,800 and was payable at the beginning
of each quarter. During 1997, the Company made its final payments under the
Research Agreement. Total payments made for 1997 and 1996 were $962,500 and
$1,283,400, respectively.
The License Agreement grants the Company the rights to certain intellectual
property including the technology being developed under the Research
Agreement whereby the Company has an exclusive, royalty-bearing license to
make, use and sell or sublicense the licensed technology. In consideration
for the license, the Company agreed to pay a one-time nonrefundable license
issue fee of $5,133,500. Payments under the Research Agreement were
credited to the license fee. In addition to the nonrefundable fee, which
has been paid in full, the Company is required to pay certain ongoing
royalties. In 1998, 1997 and 1996 these royalties were not material.
Beginning in 2000, the Company is required to pay the University of
Washington a nonrefundable license maintenance fee of $10,000 per quarter,
to be credited against royalties due.
In March 1994, the Company entered into an Exclusive License Agreement
(HALO Agreement) with UW. The HALO Agreement grants the Company the right
to receive certain technical information relating to HALO Display
technology and an exclusive right to market the technical information for
the purpose of commercial exploitation to unaffiliated entities. Under the
agreement, the Company has committed to pay to UW $75,000 and 31,250 common
shares upon filing of the first patent and $100,000 and 62,500 common
shares upon issuance of the first patent.
50
Bonus plan
The Board of Directors has approved a bonus plan as an incentive to senior
management to achieve the exercise of the Public Warrants. Pursuant to this
plan, the Company may distribute an aggregate of $250,000 to senior
management upon the successful completion of the exercise of the Public
Warrants.
Litigation
The Company is subject to various claims and pending or threatened lawsuits
in the normal course of business. Management believes that the outcome of
any such suits would not have a material adverse effect on the Company's
financial position or results of operations.
8. Lease commitments
The Company leases its office space and certain equipment under
noncancelable capital and operating leases with initial or remaining terms
in excess of one year. In October 1998, the Company entered into a new
facility lease that commences in April 1999. This lease includes an
extension provision and rent escalation provisions over the term of the
lease, and the future minimum rental commitments are included in the table
below.
Future minimum rental commitments under capital and operating leases for
years ending December 31 are as follows:
Capital Operating
Leases leases
1999 $ 184,000 $ 921,600
2000 184,000 1,172,800
2001 104,900 1,085,900
2002 30,000 1,388,600
2003 4,400 1,596,600
Thereafter 3,625,600
--------- -----------
Total minimum lease payments 507,300 $ 9,791,100
===========
Less: Amount representing interest (89,400)
---- ---------
Present value of capital lease obligations 417,900
Less: Current portion (136,100)
---- ---------
Long-term obligation at December 31, 1998 $ 281,800
=========
The capital leases are collateralized by the related assets financed and by
security deposits held by the lessors under the lease agreements. The cost
and accumulated depreciation of equipment under capital leases was $506,100
and $82,600, respectively, at December 31, 1998, and $94,500 and $2,800,
respectively, at December 31, 1997.
Rent expense was $294,000, $147,100 and $52,600 for 1998, 1997 and 1996,
respectively. In 1996, the Company exercised an option to occupy additional
office space at greater cost and issued 7,693 preferred shares and warrants
to purchase 1,563 shares of common stock to the landlord in lieu of paying
cash through July 1996. Rent expense of approximately $36,900 was recorded
for the share issuance and warrants granted in December 1995.
51
9. Income taxes
A current provision for income taxes has not been recorded for 1998, 1997
or 1996 due to taxable losses incurred during such periods. A valuation
allowance has been recorded for deferred tax assets because realization is
primarily dependent on generating sufficient taxable income prior to
expiration of net operating loss carry-forwards.
At December 31, 1998, the Company has net operating loss carry-forwards of
approximately $17,886,500 for federal income tax reporting purposes. The
net operating losses will expire beginning in 2005 if not previously
utilized. In certain circumstances, as specified in the Internal Revenue
Code, a 50% or more ownership change by certain combinations of the
Company's stockholders during any three-year period would result in
limitations on the Company's ability to utilize its net operating loss
carry-forwards. The Company has determined that such a change occurred
during 1995 and the annual utilization of loss carry-forwards generated
through the period of that change will be limited to approximately
$761,000. An additional change occurred in 1996; however, the amount of the
annual limitation is not significant.
Deferred tax assets are summarized as follows:
December 31,
1998 1997
Net operating loss carry-forward $ 6,081,000 $ 3,008,100
Capitalized research and development 1,287,000 1,718,000
Expenses related to issuance of equity instruments 801,000 636,500
Other 98,000 254,000
----------- -----------
8,267,000 5,616,600
Less: Valuation allowance (8,267,000) (5,616,600)
---- ----------- -----------
Deferred tax assets $ - $ -
=========== ===========
The difference between the zero provision for income taxes in 1998, 1997
and 1996 and the expected amount determined by applying the federal
statutory rate to losses before income taxes results primarily from
increases in the valuation allowance.
Certain net operating losses arise from the deductibility for tax purposes
of compensation under nonqualified stock options equal to the difference
between the fair value of the stock on the date of exercise and the
exercise price of the options. For financial reporting purposes, the tax
effect of this deduction when recognized will be accounted for as a credit
to shareholders' equity.
10. Retirement savings plan
On January 1, 1998 the Company established a retirement savings plan that
qualifies under Internal Revenue Code Section 401(k). The plan covers all
qualified employees. Contributions to this plan by the Company are made at
the discretion of the Board of Directors. The Company did not contribute to
the Plan in 1998.
52
11. Subsequent events
In January 1999, the Company raised $5,000,000 from the sale of convertible
preferred stock to a private investor in a private placement. Unless
converted sooner at the election of the investor, the convertible preferred
stock will automatically convert into 400,000 shares of common stock at the
end of its five year term. The convertible preferred stock carries a
cumulative dividend of 4% per annum, payable in cash or additional
convertible preferred stock at the election of the Company. The investor
also acquired two options to purchase additional convertible preferred
stock, one with a six month maturity and one with a nine month maturity
from the closing date of the transaction. Terms of the transaction include
certain rights for the investor to have the common stock underlying the
preferred stock registered by the Company.
In April 1999, the Company raised $6,000,000 from the sale of 440,893
shares of common stock to a private investment fund in a private placement.
The investor also acquired two warrants to purchase additional common
stock, one with a five year term and the other with a one year term. Under
the terms of the agreement, the Company will register the shares issued in
the initial sale and underlying the two warrants. Terms of the transaction
include a provision that could result in a one-time issuance of additional
shares, up to a fixed maximum, if the market price of the Company's common
stock on the date of effectiveness of the registration statement is less
than the market price of the common stock used in the initial sale.
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants in
accounting or financial disclosure matters during the Company's fiscal years
ended December 31, 1998 and 1997.
54
PART III
ITEMS 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Part III (Items 10-13) is set forth in
Microvision's definitive proxy statement, which will be filed pursuant to
Regulation 14A by April 30, 1999. Such information is incorporated herein by
reference and made a part hereof.
55
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Amended and Restated Articles of Incorporation of Microvision, Inc., as
filed on August 14, 1996 with the Secretary of State of the State of
Washington(1)
3.1.1 Articles of Amendment of Articles of Incorporation Containing the
Statement of Rights and Preferences of the Series B Convertible Preferred
Stock of Microvision, Inc., dated January 13, 1999(6)
3.2 Amended and Restated Bylaws of Microvision, Inc. (4)
4.1 Form of specimen certificate for Common Stock(1)
4.2 Form of Warrant for purchase of Common Stock(1)
4.3 Warrant Agreement(1)
4.4 Form of Representatives' Warrant for purchase of Units(1)
4.5 Form of specimen certificate for the Series B-1 Stock. (6)
4.6 Form of specimen certificate for the Series B-2 Stock(6)
4.7 Form of specimen certificate for the Series B-3 Stock(6)
4.8 Registration Rights Agreement, dated as of January 14, 1999, between
Microvision, Inc. and Margaret Elardi(6)
4.9 Registration Rights Agreement, dated as of April 1, 1999, between
Microvision, Inc. and Capital Ventures International.
4.10 Microvision, Inc. Series 1 Stock Purchase Warrant, dated April 1, 1999
issued to Capital Ventures International
4.11 Microvision, Inc. Series 2 Stock Purchase Warrant, dated April 1, 1999
issued to Capital Ventures International
10.1 Project I Research Agreement between The University of Washington and the
Washington Technology Center and the H. Group, dated June 10, 1993(1)
10.2 Assignment of License and Other Rights between The University of
Washington and the Washington Technology Center and the H. Group, dated
July 25, 1993(1)
10.3 Project II Research Agreement between The University of Washington and
the Washington Technology Center and Microvision, Inc., dated October 28,
1993 (1)+
10.4 Letter dated March 27, 1998 extending the term of the Research Agreement
between the University of Washington and Microvision.(3)
10.5 Exclusive License Agreement between The University of Washington and
Microvision, Inc., dated October 28, 1993 (1)+
10.6 Employment Agreement between Microvision, Inc., and Richard F. Rutkowski,
effective October 1, 1997(2)
10.7 Employment Agreement between Microvision, Inc., and Stephen R. Willey,
effective October 1, 1998
10.8 1993 Stock Option Plan(1)
10.9 1994 Combined Incentive and Nonqualified Stock Option Plan(1)
10.10 1995 Combined Incentive and Nonqualified Stock Option Plan(1)
10.11 1996 Stock Option Plan, as amended(5)
10.12 1996 Independent Director Stock Plan, as amended(2)
56
10.13 Exclusive License Agreement between the University of Washington and
Microvision, Inc. dated March 3, 1994(1)
10.14 Form of Executive Stock Loan Agreement(4)
10.15 Employment Agreement between Microvision, Inc., and Richard A. Raisig,
effective October 1, 1997(2)
10.16 Lease between S/I Northcreek II, LLC and Microvision, Inc., dated October
27, 1998(5)
10.17 Non-recourse Receivable Purchase Agreement dated as of September 30, 1998
between Silicon Valley Financial Services and Microvision, Inc.
10.18 Series B Convertible Preferred Stock Purchase Agreement, dated as of
January 14, 1999, between Microvision, Inc. and Margaret Elardi(6)
10.19 Securities Purchase Agreement, dated as of April 1, 1999, between
Microvision, Inc. and Capital Ventures International
11 Computation of Pro Forma Loss Per Share
23 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule
- --------------
(1) Incorporated by reference to the Company's Form SB-2 Registration
Statement, Registration No. 333-5276-LA.
(2) Incorporated by reference to the Company's Annual Report on form 10-K for
the year ended December 31, 1997, Registration No. 0-21221.
(3) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended March 31, 1998.
(4) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended June 30, 1998.
(5) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended September 30, 1998.
(6) Incorporated by reference to the Company's Current Report on Form 8-K filed
on January 28, 1999.
+ Subject to confidential treatment.
(b) Reports on Form 8-K.
Microvision filed no reports on Form 8-K during the last quarter of the
fiscal year ended December 31, 1998.
57
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
MICROVISION, INC.
Date: April 13, 1999 By /s/ RICHARD F. RUTKOWSKI
--------------------------------------
Richard F. Rutkowski
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the following
capacities on April 13, 1999.
Signature Title
- --------- -----
/s/ RICHARD F. RUTKOWSKI Chief Executive Officer, President and
- ---------------------------------- Director
Richard F. Rutkowski (Principal Executive Officer)
/s/ STEPHEN R. WILLEY Executive Vice President and Director
- ----------------------------------
Stephen R. Willey
/s/ RICHARD A. RAISIG Chief Financial Officer and Vice
- ---------------------------------- President, Operations and Director
Richard A. Raisig (Principal Financial and Accounting
Officer)
/s/ WALTER J. LACK Director
- ----------------------------------
Walter J. Lack
Director
- ----------------------------------
Robert A. Ratliffe
Director
- ----------------------------------
Jacob Brouwer
Director
- ----------------------------------
Richard A. Cowell
/s/ WILLIAM A. OWENS Director
- ----------------------------------
William A. Owens
/s/ DOUGLAS TRUMBULL Director
- ----------------------------------
Douglas Trumbull
Director
- ----------------------------------
Margaret Elardi
58
EXHIBIT INDEX
The following documents are filed herewith or have been included as
exhibits to previous filings with the Securities and Exchange Commission and are
incorporated by reference as indicated below.
3.1 Amended and Restated Articles of Incorporation of Microvision, Inc., as
filed on August 14, 1996 with the Secretary of State of the State of
Washington(1)
3.1.1 Articles of Amendment of Articles of Incorporation Containing the
Statement of Rights and Preferences of the Series B Convertible Preferred
Stock of Microvision, Inc., dated January 13, 1999(6)
3.2 Amended and Restated Bylaws of Microvision, Inc. (4)
4.1 Form of specimen certificate for Common Stock(1)
4.2 Form of Warrant for purchase of Common Stock(1)
4.3 Warrant Agreement(1)
4.4 Form of Representatives' Warrant for purchase of Units(1)
4.5 Form of specimen certificate for the Series B-1 Stock. (6)
4.6 Form of specimen certificate for the Series B-2 Stock(6)
4.7 Form of specimen certificate for the Series B-3 Stock(6)
4.8 Registration Rights Agreement, dated as of January 14, 1999, between
Microvision, Inc. and Margaret Elardi(6)
4.9 Registration Rights Agreement, dated as of April 1, 1999, between
Microvision, Inc. and Capital Ventures International.
4.10 Microvision, Inc. Series 1 Stock Purchase Warrant, dated April 1, 1999
issued to Capital Ventures International
4.11 Microvision, Inc. Series 2 Stock Purchase Warrant, dated April 1, 1999
issued to Capital Ventures International
10.1 Project I Research Agreement between The University of Washington and the
Washington Technology Center and the H. Group, dated June 10, 1993(1)
10.2 Assignment of License and Other Rights between The University of
Washington and the Washington Technology Center and the H. Group, dated
July 25, 1993(1)
10.3 Project II Research Agreement between The University of Washington and
the Washington Technology Center and Microvision, Inc., dated October 28,
1993 (1)+
10.4 Letter dated March 27, 1998 extending the term of the Research Agreement
between the University of Washington and Microvision.(3)
10.5 Exclusive License Agreement between The University of Washington and
Microvision, Inc., dated October 28, 1993 (1)+
10.6 Employment Agreement between Microvision, Inc., and Richard F. Rutkowski,
effective October 1, 1997(2)
10.7 Employment Agreement between Microvision, Inc., and Stephen R. Willey,
effective October 1, 1998
10.8 1993 Stock Option Plan(1)
10.9 1994 Combined Incentive and Nonqualified Stock Option Plan(1)
10.10 1995 Combined Incentive and Nonqualified Stock Option Plan(1)
10.11 1996 Stock Option Plan, as amended(5)
10.12 1996 Independent Director Stock Plan, as amended(2)
10.13 Exclusive License Agreement between the University of Washington and
Microvision, Inc. dated March 3, 1994(1)
10.14 Form of Executive Stock Loan Agreement(4)
10.15 Employment Agreement between Microvision, Inc., and Richard A. Raisig,
effective October 1, 1997(2)
10.16 Lease between S/I Northcreek II, LLC and Microvision, Inc., dated October
27, 1998(5)
10.17 Non-recourse Receivable Purchase Agreement dated as of September 30, 1998
between Silicon Valley Financial Services and Microvision, Inc.
10.18 Series B Convertible Preferred Stock Purchase Agreement, dated as of
January 14, 1999, between Microvision, Inc. and Margaret Elardi(6)
10.19 Securities Purchase Agreement, dated as of April 1, 1999, between
Microvision, Inc. and Capital Ventures International
11 Computation of Pro Forma Loss Per Share
23 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule
- --------------
(1) Incorporated by reference to the Company's Form SB-2 Registration
Statement, Registration No. 333-5276-LA.
(2) Incorporated by reference to the Company's Annual Report on form 10-K for
the year ended December 31, 1997, Registration No. 0-21221.
(3) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended March 31, 1998.
(4) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended June 30, 1998.
(5) Incorporated by reference to the Company's Form 10-QSB for the quarterly
period ended September 30, 1998.
(6) Incorporated by reference to the Company's Current Report on Form 8-K filed
on January 28, 1999.
+ Subject to confidential treatment.