UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM
10-K




þ
            ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the fiscal year ended December 31, 2009





 ̈
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





Commission
file number: 000-53846


Vuzix
Corporation


(Exact name of registrant as
specified in its charter)





Delaware
                  (State
      of incorporation)
                  75
      Town Centre Drive
                  Rochester, New
      York
                  (Address
      of principal executive office)
                04-3392453
                  (I.R.S.
      employer identification no.)
                  14623
                  (Zip
      code)


(585) 359-5900


(Registrant’s
telephone number including area code)





Securities registered pursuant to
Section 12(b) of the Act:none


Securities
registered pursuant to Section 12(g) of the Act:


common
stock, par value $0.001 per share


warrants
to purchase common stock








Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes  ̈ No
þ




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act. Yes  ̈ No
þ




Indicate
by check mark 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 preceding 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 þ No o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes  ̈ No
 ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference into Part III of this Form 10-K or any amendment
to this Form 10-K.  ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):




Large
      accelerated filer  ̈
            Accelerated
      filer  ̈
            Non-accelerated
      filer  ̈
              (Do
      not check if a smaller reporting company)
            Smaller
      reporting company þ





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes  ̈ No
þ





There was
no active trading market for the registrant’s common stock or warrants as of
June 30, 2009. As of January 5, 2010 (the date that the registrant’s common
stock and warrants began trading on the TSX Venture Exchange), the aggregate
market value of the voting and non-voting common equity of the registrant held
by non-affiliates was approximately Cdn$31,600,000 (based on the closing price
of the common stock of Cdn$0.175 per share on that date, as reported on the TSX
Venture Exchange and, for purposes of this computation only, the assumption that
all of the registrant’s directors and executive officers are affiliates and that
beneficial holders of 5% or more of the outstanding common stock are not
affiliates).





As of
March 30, 2010, there were 263,600,274 shares of the registrant’s common stock
outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE




Part III
of this Form 10-K incorporates by reference to portions of the registrant’s
proxy statement for its 2010 annual meeting of stockholders.












TABLE
OF CONTENTS


PageItem 1
                                                              Business
                                                              3Item 1A
                                                              Risk
      Factors
                                                              16Item 1B
                                                              Unresolved
      Staff Comments
                                                              32Item 2
                                                              Properties
                                                              32Item 3
                                                              Legal
      Proceedings
                                                              32Item 4
                                                              Submission
      of Matters to a Vote of Security Holders
                                                              32Item 5
                                                              Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                                              33Item 6
                                                              Selected
      Financial Data
                                                              33Item 7
                                                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                                              35Item 8
                                                              Financial
      Statements and Supplementary Data
                                                              44Item 9
                                                              Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                                              44Item 9A(T)
                                                              Controls
      and Procedures
                                                              44Item 9B
                                                              Other
      Information
                                                              45Item 10
                                                              Directors,
      Executive Officers and Corporate Governance
                                                              45Item 11
                                                              Executive
      Compensation
                                                              45Item 12
                                                              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                                              45Item 13
                                                              Certain
      Relationships and Related Transactions, and Director
      Independence
                                                              45Item 14
                                                              Principal
      Accounting Fees and Services
                                                              45Item 15
                                                              Exhibits
      and Financial Statement Schedules
                                                              45


2


PART
I


Item
      1.
              Business


FORWARD-LOOKING
STATEMENTS




This
annual report includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 (the “Exchange Act”). These statements are based
on our management’s beliefs and assumptions and on information currently
available to our management. The forward-looking statements are contained
principally under the headings “Risk Factors,” “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” and “Business.”
Forward-looking statements include statements concerning:




•
            our
      possible or assumed future results of
  operations;




•
            our
      business strategies;




•
            our
      ability to attract and retain
customers;




•
            our
      ability to sell additional products and services to
    customers;




•
            our
      cash needs and financing plans;




•
            our
      competitive position;




•
            our
      industry environment;




•
            our
      potential growth opportunities;




•
            expected
      technological advances by us or by third parties and our ability to
      leverage them;




•
            the
      effects of future
regulation; and




•
            the
      effects of competition.




All
statements in this annual report that are not historical facts are
forward-looking statements. We may, in some cases, use terms such as
“anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,”
“plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or
similar expressions that convey uncertainty of future events or outcomes to
identify forward-looking statements.




The outcome of the events
described in these forward-looking statements are subject to known and unknown
risks, uncertainties and other factors that may cause our actual results,
performance or achievements to be materially different from any future results,
performances or achievements expressed or implied by the forward-looking
statements. These important factors include our financial performance and the
other important factors we discuss in greater detail in “Risk Factors.” You
should read these factors and the other cautionary statements made in this
annual report as applying to all related forward-looking statements wherever
they appear in this annual report. Given these factors, you should not place
undue reliance on these forward-looking statements. Also, forward-looking
statements represent our management’s beliefs and assumptions only as of the
date on which the statements are made. We undertake no obligation to publicly
update any forward-looking statements, whether as a result of new information,
future events or otherwise, except as required by law. You should read this
annual report and the documents that we reference in and have filed as exhibits
to this annual report completely and with the understanding that our actual
future results may be materially different from what we currently
expect.


Company
Overview


We are
engaged in the design, manufacture, marketing and sale of devices that are worn
like eyeglasses and feature built-in video screens that enable the user to view
video and digital content, such as movies, computer data, the Internet or video
games. Our products (known commercially as Video Eyewear but also commonly
referred to as virtual displays, wearable displays, personal viewers, head
mounted displays, or near-to-eye displays) are used to view high-resolution
video and digital information from mobile electronic devices, such as cell
phones, portable media players, gaming systems and laptop computers. Our
products provide the user with a viewing experience that simulates viewing a
large screen television or a desktop computer monitor that can be viewed
practically anywhere, anytime.


3





Our Video Eyewear products
feature high performance miniature display modules, low power electronics and
related optical systems. We produce both monocular and binocular Video Eyewear
devices that we believe are excellent solutions for uses including many mobile
computer, mobile internet devices (MID) or video viewing requirements,
including general entertainment applications. We focus on two markets: the
consumer markets for gaming and mobile video and rugged mobile displays for
defense and industrial applications. We also offer low-vision assist Video
Eyewear products that are designed to assist and improve the remaining vision of
many people suffering from macular degeneration.




Owners of mobile display
devices increasingly want to use them to view high-resolution, full color
content. The displays currently used in these mobile devices do not work well
for this purpose because they are either too small, which makes it extremely
difficult for the human eye to view the detail of the images that they display,
or they are too large, making the device heavier, larger and difficult to carry.
Today, many mobile devices, like the iPhone, have employed a touch screen with
software capable of magnifying or zooming in on a small portion of the image. We
believe that many consumers consider this solution unsatisfactory because it is
not like their desktop computer viewing experience and they find it difficult to
navigate touch screens and to find information on the portion of the image being
viewed.




In contrast, our Video
Eyewear products enable users of many mobile devices to effectively view the
entire screen on a small, eyeglass-like device. They can be used as a wearable
replacement for any television or desktop computer monitor in almost any
environment. Our products employ microdisplays that are smaller than one-inch
diagonally, with some as small as one-quarter of an inch. They can display an
entire, detailed image with resolution of up to 1280×1080 pixels (High
Definition or HD). The images on the microdisplay are viewed through proprietary
magnifying optics that are usually designed by us and incorporated into our
Video Eyewear products. Using these optics and displays, our Video Eyewear
products provide a virtual image that appears to be similar to the image on a
full size computer screen from a normal desktop working distance or the image on
a large flat panel television from normal home TV viewing distance. For example,
when magnified through our optics, a high-resolution 0.44-inch diagonal
microdisplay can provide a viewing experience comparable to that on a 62-inch
diagonal television screen viewed at nine feet.




Overall Strategy




Our goal is to establish
and maintain a leadership position as a worldwide supplier of Video Eyewear and
virtual imaging technology solutions. We intend to offer our technologies across
major markets, platforms and applications. We will strive to be an innovator in
designing virtual display devices that enable new mobile video viewing and
general entertainment applications.




To maintain and enhance
our position as a leading provider of virtual display solutions, we intend
to:




•
            improve
      brand name recognition;




•
            provide
      excellent products and service;




•
            develop
      products for large markets;




•
            broaden
      and develop strategic relationships and
  partnerships;




•
            promote
      and enhance development of third party software that can take advantage of
      our products;




•
            expand
      market awareness for Video Eyewear, including use for Virtual Reality and
      Augmented Reality;




•
            obtain
      and maintain market leadership and expand customer
  base;




•
            Reduce
      production costs and exploit our technologies cost
    advantages;




•
            extend
      our proprietary technology
leadership;




•
            enhance
      and protect our intellectual property
portfolio;




•
            establish
      multiple revenue sources;




•
            continue
      to invest in highly qualified
personnel;




4




•
            build
      and maintain strong design
  capabilities; and




•
            leverage
      our outsourcing model.




The Market




We
believe that there is growing demand for mobile access to high-resolution
content in several major markets. Our business focuses on the consumer mobile
entertainment and gaming markets and the industrial and defense markets. The
demand for personal displays in these markets is being driven by such factors
as:




•
            Increasing use of the Internet in
      all aspects of society and business, which is increasing demand for
      Internet access “anywhere,
anytime”.




•
            Increased spending by consumers
      on mobile entertainment devices such as iPods and smart cellular
      telephones with video capabilities. Our Video Eyewear products can provide
      viewable high-resolution mobile displays for users of these devices, with
      better viewing capability and higher detailed resolution than the small
      screens on existing mobile
devices.




•
            Industrial, defense and security
      sectors are employing mobile communications, sensors and surveillance
      devices that are light, durable and easy to use but require displaying
      their high-resolution content on an external device and often in a
      hands-free way. Our wearable Video Eyewear products can be ideal for this
      and will allow a user their physical
  mobility.




•
            Video gaming on PCs and consoles
      continues to grow in North America and around the world. We believe that
      our Virtual Display technologies will significantly increase user
      satisfaction with gaming applications by engaging the user through the use
      of stereoscopic imagery and interactive head tracking. Our Virtual Reality
      and Augmented Reality Video Eyewear are designed to provide this
      capability.




•
            The widening distribution of new
      three dimensional (3D) movies and other 3D content in North America is
      creating a need for a method to play this content outside movie theaters.
      We believe that Video Eyewear, with its inherent dual display design, is
      well suited for the playback of 3D content. Stereoscopic 3D video playback
      on Video Eyewear also avoids many of the negative issues commonly
      encountered by shutter, polarized or color anaglyph glasses used in
      competing technologies and allows the user to view 3D content without
      purchasing new computer or television
  equipment.




•
            People with low-vision problems
      require devices to magnify and capture images that they wish to see and to
      display them in a manner that they can view with their remaining vision.
      Our Video Eyewear, with the addition of a camera and digital signal
      processing in a single device, can provide this capability to many people
      suffering from certain types of vision
  problems.




Target
Markets


Our
target markets and applications by major sector are:


Consumer


Entertainment
and Internet. We believe that
there is an increasing demand for convenient, high-resolution, 3D displays to
view content such as movies, entertainment and the Internet in a mobile
environment.


Gaming. We believe that
there is a need for high-resolution, interactive, stereoscopic 3D display
devices for use with desktop computers, consoles and other gaming products. We
believe that gaming on modern mobile devices with small, direct view screen is
not a satisfactory experience for many consumers. Our Video Eyewear products are
designed to significantly enhance a consumer’s experience by providing larger,
high-resolution images with stereoscopic 3D capabilities. We believe that there
is also a demand for display devices that enable the user to simulate and
experience movement within a three-dimensional environment when using either
gaming consoles or mobile devices. We anticipate that Virtual Reality (VR)
(which allows a user to interact with a computer-simulated environment, whether
that environment is a simulation of the real world or an imaginary world) and
Augmented Reality (AR) (which combines real-world and computer-generated data in
real time) will become increasingly popular entertainment applications. Both VR
and AR are difficult to implement using traditional desktop computer monitors
and televisions.
 
 5
  Industrial
and Defense




The US
government requires display devices for mobile and hands-free viewing of
computer and mapping information, remote viewing of sensor data, and remote
viewing of transmissions from targeting systems. These applications currently
include:




•
            Night vision and thermal sighting
      systems;




•
            Unmanned vehicle and robotic
      systems; and




•
            Training and simulation systems,
      including AR Video Eyewear.




These
systems typically are required to provide detailed, high-resolution images, with
limited power consumption and low external light emission, and to be
durable.


Our Video
Eyewear products are also used for a number of industrial applications,
including as remote camera displays and wearable computer displays, for viewing
of industrial thermal signature systems and for providing hands-free access to
manuals and other required information in remote and in-field maintenance
servicing.


Low-vision
Assist


We
believe that our Video Eyewear products may provide solutions for patients
suffering from certain types of visual handicaps. Our low-vision assist products
are designed to assist patients suffering from macular degeneration by signal
processing and re-focusing an integrated camera image into the areas of the
retina that are not affected by the patient’s macular degeneration.


Products


We
believe we provide the broadest range of consumer Video Eyewear product
offerings available in the market and that our products contain the most
advanced electronics and optics for their target markets and uses. Our products
include:


Binocular
Video Eyewear Products


The
features of our binocular Video Eyewear products, including their resolution and
apparent display size, microphones, tracking devices and support of
three-dimensional viewing are designed to suit consumer applications. Our
binocular Video Eyewear products contain two microdisplays, a separate display
for each eye, typically mounted in a frame attached to eyeglass style-temples.
These products enable mobile and hands-free private viewing of video content on
screens that simulate home theater-sized screens. Headphones are built into the
temples so that users can listen to accompanying audio in full stereo. They can
be employed as mobile high-resolution displays with products such as portable
DVD players, laptop computers, MIDs, cellular phones with video output
capability, and personal digital media/video players (video iPods).


For the
consumer markets, we currently produce four binocular Video Eyewear products,
all of which support 3D applications. Each has a different apparent display size
and native resolution. They are:


•
            Wrap 230 — QVGA (320x240
      three-color pixels) resolution and simulating a 44-inch screen at nine
      feet.




•
            Wrap 310 widescreen — WQVGA
      (420x240 three-color pixels) resolution and simulating a 52-inch screen at
      nine feet.




•
            Wrap 920 — VGA (640x480
      three-color pixels) resolution and simulating a 62-inch screen at nine
      feet.




•
            VR920 — VGA (640x480
      three-color pixels) resolution, simulating a 62-inch screen at nine feet,
      designed to plug into a computer’s USB and video ports, and containing our
      proprietary three degrees of freedom head tracking technology, which
      enables the user to look around the environment being displayed by simply
      moving his or her head. A microphone allows the user to communicate with
      others. We expect those features to be of particular interest to users
      playing games using the VR920, but they also can be used in commercial 3D
      applications and for exploring Internet virtual worlds like Second Life.
      The VR920 is currently compatible with over 80 titles that work with it
      out of the box, including popular games such as Microsoft’s Flight
      Simulator X and World of Warcraft. We currently have over 1700 software
      developers’ kits being used in applications from college research programs
      to commercial developers to develop additional titles for the VR920. With
      the addition of a clip-on camera which we are currently tooling the VR920
      can also used in AR
applications.


6


We sell
our current binocular products into the consumer marketplace under the brands
iWear® and Wraptm.
The iWear brand was introduced in 2007 and the Wrap brand in fall
2009.  We also anticipate that by summer 2010 we will be offering our
six degrees of freedom tracking technology and Wrap products with dual camera
heads for viewing the outside world. That technology is being designed to both
accurately track an object’s and the user’s position in 3D virtual space and to
combine that tracking capability with translational information about the three
rotational axes (roll, yaw, pitch). The addition of this translational
information will allow the device to report information about its X, Y and Z
position as it moves. This along with stereo cameras will expand the realism and
accuracy for users interacting in a VR or AR environment.


We
anticipate that future generations of our Video Eyewear products will have form
factors that should be even more appealing to consumers, with appearances and
sizes that are more like ordinary sunglasses, and be more ergonomic
and fashionable. Additionally our plans include the introduction of products
with see-through optics that will both allow the user to see through to the real
world when the display is off or be just partially transparent when the display
is on. This capability will provide better support for AR applications along
with higher display native resolution that will accept HD inputs. We intend to
sell our binocular products into the defense markets and have developed and
delivered prototypes of a rugged version for marine applications. We also intend
to sell our binocular products for industrial applications from training and
tools for maintenance and repair to interactive product design and
development.




Monocular
Video Eyewear Products


Our
Tac-Eye® monocular (single eye) high-resolution Video Eyewear models are
designed to clip onto a pair of ballistic sunglasses, a head set or conventional
safety goggles. They can be used with the large installed base of rugged
laptops, security and night vision cameras and thermal night vision sights,
including those systems that we currently act as a sub-contractor of display
drive electronics to the US defense department. Tac-Eye® enables users to have
wearable, private and hands-free access to high-resolution content or
information. They enable the viewing of material that is difficult or impossible
to accurately view on the lower-resolution direct view screens that are standard
on many of these devices without extensive zooming in or panning across the
screen.


Most of
our Tac-Eye® products have
an SVGA display and afford a 28 degree field of view, the equivalent of a
20-inch computer screen at three feet. They are also designed to be durable and
suitable for defense field use and industrial applications.


Defense
Sub-Assembly and Custom Solutions


We are
involved in two programs as part of contracting teams that produce display drive
electronic subassemblies for light, medium, and heavy weight thermal weapon
systems for US and other defense forces. We produce the display drive
electronics as part of these night-vision systems and since 2005 we have
delivered approximately 123,000 systems. These products accounted for over 50%
of our sales in 2008 and 2009.


We also
have provided full optics systems, including head mounted devices, wrist worn
displays, human computer interface devices, and wearable computers as prototypes
under several armed services test programs. These are being tested in
applications such as the remote control of unmanned vehicles. When possible, we
obtain a first right of refusal to be the volume manufacturer of our proprietary
display subassemblies as part of our contracting process for the custom design
of products.


Low-vision
Assist Products


We offer
two Video Eyewear products specifically for low-vision assist applications. The
first is a bundle of our AV920 Video Eyewear with an external handheld camera
that magnifies written information to help a user to read small print. The
second consists of binocular Video Eyewear that incorporates a camera and
digital signal processor that uses our proprietary digital signal processing
algorithms to increase contrast, magnification, color correction, edge
detection, histogram flattening, and using other video processing techniques.
The image received by the camera is processed, enhanced and transmitted to the
displays within the Video Eyewear to be viewed by a user suffering from macular
degeneration. These devices are designed to permit many users suffering from
macular degeneration to perform a number of normal daily functions, such as
reading or signing a check, that they could not perform unaided.
 
 7
  Technology




We
believe that it is important to make substantial investments in research and
development to maintain our competitive advantage. The development and
procurement of intellectual property rights relating to our technologies is a
key aspect of our business strategy. Near-to-eye virtual displays and their
components use relatively new technologies. We believe that it is
technologically feasible to improve the weight, ergonomics, optical performance,
luminance, power efficiency, design compactness, field of view and resolution of
the current generation of virtual displays and display components. We expect to
continue to improve our products through our ongoing research and development
and advancements made by our third party suppliers of key components. We also
develop intellectual property through our ongoing performance under engineering
service contracts for the US Government. During 2009, 2008 and 2007, we spent
$2,217,627, $3,366,518 and $2,365,412, respectively, on research and development
activities. We expect to continue to increase our research and development
expenditures in the future. We have also acquired technologies developed by
third parties and we may do so in the future.


We
believe that the range of our proprietary technologies gives us a significant
competitive advantage. Our technologies include motion tracking systems;
stereoscopic display assemblies; optic systems; display backlights; mobile and
wearable computing devices and user interface technology; low-power electronics;
software drivers; and software applications. Our technologies enable us to
provide low-cost, small form factor, high-resolution Video Eyewear products. To
protect our technologies, we have developed a patent portfolio which currently
consists of:


•
            51 total patents issued
      worldwide;




•
            31 US patents issued (14
      non-provisional, 17 design);




•
            10 US patents pending (1 design,
      8 non-provisional, 1
provisional);




•
            20 international (non-US) patents
      issued (18 design, 2
non-provisional);




•
            8 international (non-US) patents
      pending (6
non-provisional); and




•
            3 new invention disclosures are
      being prepared for purposes of preparing patent applications, covering
      additional aspects of our virtual display
    technology.




In
December 2005, we entered into a technology acquisition agreement with New Light
Industries, Ltd., pursuant to which we acquired two US patents covering an
extremely compact head-mounted virtual reality display, the Chinese patents
derived from those US patents and certain other related intellectual property.
In consideration for that technology, we paid New Light cash and issued to New
Light a warrant to purchase up to 1,142,864 shares of our common stock at
an exercise price of $0.01 per share. The warrant became exercisable over three
years from the date of issuance and remains exercisable at any time through
December 31, 2015. Under the agreement, New Light has the right to include
the shares of common stock issuable upon exercise of its warrant in any
registration of our securities under the Securities Act, subject to certain
exceptions. We are required to bear all costs, other than underwriting discounts
and commissions, related to any such registration. New Light has waived its
registration rights with respect to this offering. We also agreed to pay New
Light a continuing royalty on the sale of all products that incorporate or use
the acquired technology for a period of time after the successful
commercialization of the technology.  As of December 31, 2009, we had
not successfully commercialized the acquired technology or sold any products
that incorporate or use the acquired technology. The agreement also provides
that, if we sell or license the acquired technology to a third party, the buyer
or licensee must agree to assume our obligations under the technology
acquisition agreement. We are prohibited from using the acquired technology at
any time during which we are in breach of our indemnification obligations to New
Light or in breach of any other material term of the agreement if such breach
has not been cure within 30 days after notice. Our right to use the
acquired technology is reinstated upon the cure of any such breach. The
agreement remains in effect so long as any royalties are payable to New Light
under the agreement.


Our US
patents expire on various dates from May 7, 2010 until June 8, 2027.
Our international patents expire on various dates from May 30, 2015 until
October 4, 2032.


Major
technologies that we employ in our products include:
 
 8
  Hardware
Technology




Virtual Display Technology
(including Lens Technology and Optics Assemblies)


Microdisplay
optics represents a significant cost of goods for both us and our competitors.
Driving this cost is the significant trade off between the physical size of the
microdisplay and the cost of the supporting optics. Smaller displays require
larger and more sophisticated optics, while larger displays require less
magnification and less complex optics. The smaller a microdisplay is, the less
it costs to produce. But the smaller a microdisplay is, the more difficult it is
to make optics systems that have no user adjustments, large fields of view and
very low distortion specifications. To improve our Video Eyewear’s fashion and
ergonomics we are developing thin and lightweight optics that can be integrated
with display engines that match conventional eyewear frames in size and weight
and provide what we believe are significantly improved ergonomics compared to
competing wearable virtual displays.


Vuzix Quantum Optic:
  We believe we have developed revolutionary “first surface” optics
assemblies that include lenses, microdisplays, and backlights, all assembled
into a single sub-assembly. This technology permits the production of
inexpensive microdisplay engines that provide low-distortion and large field of
view images. We expect that this technology will also enable us to produce
sunglass-styled Video Eyewear products that will allow the user to see through
the display to the real world. In the fall of 2009 we introduced our first
“Wrap” line of video eyewear based on a hybrid of the quantum optic that employs
a mix of conventional refractive optics with a prism.  This hybrid allowed
us to fold the optics into tall thin design and therefore allowed the form
factor of the Video Eyewear themselves to be much closer to that of a
conventional pair of sunglasses.  We have both issued and pending patents
with respect to this technology.


Vuzix Blade Optic:
  We are developing an optical display engine that uses a blade of
glass or plastic as a wave guide, which we refer to as the BladeTM. The Blade
uses a “projected” image from a conventional microdisplay that is “squeezed”
into a thin blade of glass or plastic and, using a proprietary light guide
expander, the image exits from the glass in front of the user’s eye. We expect
this display engine will provide a large field of view from a very thin lens
system. The Blade can also function in see-through applications. Unlike
competing wearable virtual displays, a see-through display does not obstruct the
wearer’s vision or reduce his awareness of what is happening around him. Video
Eyewear employing this display engine will be closer to conventional sunglasses
than currently available products in comfort, size, weight and ergonomics. We
have filed patent applications with respect to this technology.


Holographic Display Engine:
  We have numerous patents and patents pending on our new Holographic
Display Engine (HSE). The HSE incorporates both a display subsystem and
associated optics in a single monolithic design. The image is projected into the
edge of a slim piece of glass where it is internally reflected and directed out
through a holographic element where it appears as a large virtual screen to the
user.  We have successfully prototyped a monochrome version of this
display engine in our design lab. If our continued research is successful we
believe we should ultimately have a low cost, very high-resolution display
engine that will be superior to existing microdisplay technology in terms of
price, resolution, weight, form factor and power consumption.


Low Power — LCD Drive
Electronics:   We believe that our numerous successful designs
for the defense market demonstrate that we can design and successfully implement
very low-power microdisplay electronics modules. The electronics required to
drive advanced microdisplays are a complex and costly piece of a virtual display
system. We may develop application-specific integrated circuits (ASICs) to
further reduce the cost, number of components, and size of our electronics
package while improving the performance with various input sources. While costly
and complicated to develop, we believe these ASICs could be critical to the
success of our cost reduction programs and, once completed, should also create
barriers to entry for competitors.


Position Tracking:
  Our tracking system incorporates patented, multi-axis, “source-less”
tracking technology to track the rotational orientation of the user’s head.
Using the earth’s magnetic field and gravity as references, a silicon sensor
supplies the yaw information and a silicon-based tilt sensor supplies pitch and
roll, as well as error correction. We have significantly reduced the cost of
tracking with our patented technology as compared to competitive alternative
solutions available today. We recently completed an upgrade from three to six
degrees of freedom tracking. This new tracker incorporates a multi axis gyro
into the mix of sensors already employed.  Doing this allows us to
determine the “absolute” values for the rotational accelerations.  Using
this input with the three axis accelerometers and magnetic field sensors we can
determine the three degrees of freedom (roll, pitch and yaw) much faster
than the current design and we can now extrapolate and determine the X, Y and Z
position of the users head in space.  The six degree unit is expected to be
introduced by summer 2010. We believe that cost-effective tracking technology is
fundamental to any Virtual and Augmented Reality Video Eyewear system’s success
and will help create a significant barrier to entry for the
competition.


9


3D Content
Delivery





Vuzix Automated 3D Watermark:
  In response to the proliferation of large-screen, HD home
entertainment systems, the motion picture industry has recently begun to invest
in stereoscopic 3D technologies to attract theater viewers and upgrade them to
show 3D motion pictures. Over 5,000 North American movie theaters are being
converted to both digital projection and full 3D and production of 3D motion
pictures is increasing including the release in 2010 of numerous High Definition
Blue Ray 3D videos for home use. Video Eyewear, with its immersive environment
and two separate displays, is well suited for viewing 3D content and avoids many
of the negative issues typically encountered by shutter, polarized or color
anaglyph glasses used in competing technologies such as video color distortion,
noticeable flicker, decreased contrast and bleed-through. Currently, in order to
effectively display 3D content, the viewer must manually switch the projection
system or display device to 3D mode as required by the content. We have
developed and have patents pending on a system that does this automatically for
the viewer. Using our system, a “watermark” is embedded into the video stream
that identifies it as being 3D content. Our Video Eyewear can decode the
watermark and reconfigure the Video Eyewear to view the content in 3D without
any involvement by the viewer. If the content is not in 3D, the Video Eyewear
remains functioning in two-dimensional mode. Our technology can be used with
both legacy and advanced Digital Rights Managed (DRM) delivery
systems.


Vuzix 3D Stereoscopic USB
Drivers:   We have developed a USB driver that will allow most
3D titles to work in 3D stereoscopic mode with our PC based Video Eyewear. This
driver allows 3D titles that have been and are being created utilizing
Microsoft’s Direct X 3D graphics drivers and Open GL, industry standards for
entertainment and other 3D graphic applications, to be viewed in stereoscopic 3D
using our Video Eyewear. We release support for the 3D titles using “Monitor
Software” on a title-by-title basis, typically coincident with added tracking
capabilities.


General Eyewear
Technology


Vuzix Ergonomics and Industrial
Designs:   We have developed ergonomic technologies that make
head-worn displays easier to use in a wide variety of applications. For example,
we are currently one of the only producers of Video Eyewear solutions to offer
focus adjustment on our products. Our Video Eyewear products also accommodate
glasses for those who need them. We generally file design patents on our more
advanced solutions.


Software/Firmware
Technology


We
believe that our substantial software portfolio provides a competitive
advantage. We have developed an extensive set of Microsoft Windows and Mac
drivers and core code capability that allows us to efficiently add new feature
sets centered around our hardware and their related software products. We
anticipate that this software technology will be the foundation for some of our
future products. Additionally, we have a base of embedded microprocessor and
field-programmable gate array (FPGA) code related to microdisplay drive
electronics. We also have a large library of internally developed,
copyright-protected software that is used throughout our products. Usable
software applications and add-on accessory hardware drivers can greatly increase
customer value of our Video Eyewear products.


Patents
and other Intellectual Property


We have a
comprehensive intellectual property policy which has as its objectives:
(i) the development of new intellectual property both to ensure and further
our intellectual property position in relation to personal display technology;
and (ii) the maintenance of our valuable trade secrets and know-how. We
seek to further achieve these objectives through the commencement of more
education and training of our engineering staff and the adoption of appropriate
systems and procedures for the creation, identification and protection of
intellectual property.


Our
general practice is to file patent applications for our technology in the United
States, Europe and Japan, while inventions which are considered to have the
greatest potential are further protected by the filing of patent applications in
additional countries, including Canada, Russia and China. We file and prosecute
our patent applications in pursuit of the most extensive protection including,
where appropriate, the applications of the relevant technology to the broader
display industry.


We
believe that our intellectual property portfolio, coupled with our key supplier
relationships and accumulated experience in the personal display field, gives us
an advantage over potential competitors. We also believe our copyrights,
trademarks, trade secrets, and patents are critical to our success, and we
intend, directly or indirectly, to maintain and protect these. We also rely on
proprietary technology, trade secrets, and know-how, which are not patented. To
protect our rights in these areas, we require all employees and, where
appropriate, contractors, consultants, advisors and collaborators to enter into
confidentiality, invention assignment and non-competition
agreements.
 10





In
addition to our various patents, Vuzix currently has nine registered US
trademarks and a total of 38 trademark registrations worldwide.


Competitors
and Competitive Advantage


The
personal display industry in which we operate is highly competitive. We compete
against both direct view display technology and against near-eye display
technology. We believe that the principal competitive factors in the personal
display industry include image size, image quality, image resolution, power
efficiency, manufacturing cost, weight and dimension, feature implementation,
ergonomics and finally the interactive capabilities of the overall display
system.


Most of
our competitors’ products are based on direct view display systems, in which the
user views the display device, or screen, directly without magnification. These
products have several disadvantages compared to virtual displays and our Video
Eyewear products. If the screens are large enough to read as conventional
internet page or HD video without external magnification or image zooming, the
products must be large and bulky, such as laptops, personal computers or
portable DVD players. If the displays are small, such as those incorporated in
cellular phones and PDA-like devices, the screens are difficult to read when
displaying higher resolution content. Despite the limitations of direct view
personal displays, advanced multi-media enabled or smart cellular phones are
being produced in ever increasing volumes by a number of manufacturers,
including Motorola, Inc., Nokia Corporation, Sony Ericsson Mobile Communications
AB, Research In Motion Limited, Samsung Electronics Co., Ltd., LG Electronics
and Apple Inc. (Apple). We expect that these large and well-funded companies, as
well as newer entrants into the marketplace, will make products that seek to
compete with ours based on improvements to their existing direct view display
technologies or on new technologies.


We also
have competitors who produce near eye personal displays or Video Eyewear.
However, most of our competitors’ current products lack one of more of the
following critical features: advanced optics, video up-scanning, 3D stereoscopic
support, on-screen video controls, and tracking. Furthermore, we believe that
most of our competitors’ near eye products have inferior optics, marginal
electronics and poor industrial design and that, as a result, our Video Eyewear
products are superior to those of our competitors in both visual performance and
ergonomics. They are lightweight and provide high-resolution images. They have
convenient and easy to use controls that enable the user to control the display.
Our systems are also typically more power-efficient than those of our
competitors. We believe that tracking technology is a critical component of any
VR or AR system and that our patented tracking technology gives us a competitive
advantage in the markets for those systems.


Competition —
Consumer Products


A number
of major companies, such as Sony, Olympus Corporation and Canon Inc., produced
head worn video display products for the consumer market in the late 1990s.
These products were not well accepted by consumers and were ultimately
discontinued. We believe that these products were not well accepted because they
were ergonomically unsatisfactory and provided only low resolution images and
because, at that time, there was little demand for mobile Video Eyewear. When
these products were available, video content was generally stored on video tape
and could only be viewed by playing the videotape on a videotape recorder
connected to a television. Currently there are a number of smaller companies
that have products which compete with our Video Eyewear products. Our major
competitors are MyVu, Zeiss, i-O Display Systems, LLC, DaeYang Co., Ltd.,
Cybermind Interactive Nederland, Mirage Innovations, Ltd., Lumus, Shenzhen
Oriscape Electronic Co., Ltd., Microvision Corporation (Microvision) and
Kopin.


Kopin
offers QVGA and VGA binocular display modules (BDM) complete with drive
electronics to original equipment manufacturers (OEMs). Those modules are
designed for easy customization by OEMs and include microdisplays, backlights,
optics and drive electronics. The availability of those BDMs has greatly reduced
the investment required for new competitors to enter the business. Currently,
Kopin products are primarily used by Asian-based Video Eyewear manufacturers.
Kopin does not currently compete with Vuzix at the retail level. Kopin is our
primary supplier of microdisplays.


In
addition to numerous Asian-based companies using Kopin BDMs, we currently have
two principal competitors in the consumer Video Eyewear market: MyVu and
Zeiss.


11




•
            MyVu
      has based its most recent product line on an optic design that results in
      relatively small virtual image sizes. While this allows for a smaller form
      factor, it does not provide the large virtual image that we believe
      consumers desire from Video Eyewear products. Images on our Video Eyewear
      products appear as much as four times larger than those on MyVu products.
      MyVu products also do not currently support 3D, VGA video from a PC or
      tracking. Finally, MyVu does not have a Video Eyewear product designed
      specifically for the gaming market.




•
            Zeiss
      introduced its first Video Eyewear product in the spring of 2008. This
      product is bigger and bulkier than ours and we believe it will be less
      acceptable in the mobile markets. And while Zeiss does provide some level
      of 3D video support, it does not currently offer PC products nor does it
      support the tracking technology that would allow its products to be
      interactive.




There are
also several Chinese manufacturers offering Video Eyewear products that have one
or more of the deficiencies described above.


Competition —
Industrial and Defense


Although
several companies produce monocular Video Eyewear, we believe that opportunities
for sales of their products to date have been limited. So far, the market
opportunity outside of the night vision products has been limited primarily to
trial tests, rather than commercial volume purchases for defense and industrial
applications. We are aware of only very limited commercial volume purchases in
the defense and industrial markets. Our current competitors in these markets are
Liteye Systems, Inc., Lumus, Shimadzu Corporation, Microvision, Kopin, Creative
Display Systems, LLC, OASYS Technology, LLC, Rockwell Collins, Inc. and its
subsidiary Kaiser. Some of these companies are currently shipping product and
others have only introduced prototypes and/or are offering only limited sample
quantities. We expect that we will encounter competition in the future from
major suppliers of imaging and information products for defense application,
including DRS Technologies, Inc. (DRS), Insight Technology Incorporated,
Raytheon Company and BAE Systems, Inc.


There is
competition in all classes of products manufactured by us, including from
divisions of the large companies, as well as many small companies. Our sales do
not represent a significant share of the industry’s market for any class of its
products. The principal points of competition for electronic products of both a
defense and industrial nature include, among other factors: price, product
performance, the experience of the particular company and history of its
dealings in such products. We, as well as other companies engaged in supplying
equipment for military use, are subject to various risks, including, without
limitation, dependence on US and foreign government appropriations and program
allocations, the competition for available military business, and government
termination of orders for convenience.


We
believe that most of the monocular Video Eyewear products offered by our
competitors are inferior to ours because they are bulky, have small image sizes
with poor optics and/or are currently priced higher than our
products.


Competition —
Low-Vision Assist


The
majority of competitors in the low-vision assist market offer magnification
systems that consist of a large desktop television or computer screen that
displays a magnified version of an image captured by a hand scanner or
stationary camera. Over 30 companies currently offer such vision tools. The
largest providers are Enhanced Vision Inc. (Enhanced Vision) (which markets its
product under the Merlin brand name), MagniSight, Inc., Optelec Holding B.V.,
REHAN Electronics Ltd. (which markets it product under the Affinity brand name),
Beirley Associates, Inc., Telesensory Corporation and eSight Corporation.
Although the products offered by these companies can provide effective
low-vision assistance to many users, they are not mobile and they are often
difficult to use. They generally require the user to sit in front of the large
screen to view the image. Recently, some companies, including Enhanced Vision,
have introduced mobile digital magnifiers that include a camera and an
integrated six-inch LCD screen. Enhanced Vision’s product is marketed under the
Amigo brand. We do not believe that any of these competitive products offers the
flexibility of usage, portability and some of the advanced digital video signal
processing capabilities of our LV920. Moreover, the utility of all of the other
competitive tools is generally limited to reading, whereas the LV920, which
employs a wearable camera and is mobile, can also be used for many other normal
vision applications.


12


In the
wearable low-vision assist market, our competitors are manufacturers of optical
loops and head worn optical systems and one manufacturer of a digital magnifying
system similar to our LV920. The optical loops are usually worn by dentists,
doctors, and jewelry makers for their fine work, and have gained limited use in
the low-vision assist market due to their lack of signal processing and image
brightness issues. The competitive digital magnifier is manufactured by Enhanced
Vision and is sold under the Jordy and Maxport brand names. While mobile low
vision products have been sold for several years now, market penetration has
been limited due to ergonomic issues and complexity for the majority of older
users. We believe our low-vision assist product is more ergonomic and offers
more advanced digital video signal processing techniques than those manufactured
by Enhanced Vision.


Sales
and Marketing


Sales


Our sales
strategy is to introduce our products to the widest possible audience within our
target markets. We focus today on the consumer and industrial and defense
markets. Historically, most of our sales efforts were directed toward obtaining
contracts to provide custom engineering solutions and products for the defense
and industrial markets. However, in 2005, as our products and technology
evolved, we began to also sell standard Video Eyewear products for the consumer
markets.  We began offering products for the low-vision assist market
in the fall of 2008.


We have
separate marketing and sales strategies for each of our target markets. We
regularly attend industry trade shows in our markets and have begun establishing
some level of separate branding for both of our divisions. The consumer division
sells under the Vuzix name and the industrial and defense division under the
Tac-Eye® name.


During
2009 and 2008, 58.4% and 63.6% of our sales were derived from providing goods
and services to the US government, directly and indirectly. Of those amounts,
71.1% in 2009 and 81.4% in 2008 were derived from subcontracts with Kopin and
DRS, and we are dependent upon continuing to be engaged as a subcontractor to
them. We derived 41.3% of our sales from consumer Video Eyewear products in 2009
and 35.6% of our sales from consumer Video Eyewear products in
2008.
  Marketing




Our
marketing group is responsible for product management, planning, advertising,
marketing communications, and public relations. We intend to become known as the
premier supplier of Video Eyewear in the consumer markets, where our products
are currently sold under the iWear® and WrapTM brands.
We also intend to become known as the premier supplier of virtual display
technology and systems for the industrial, defense, and low-vision assist
markets. We employ public relations firms in both the United States and England
and a marketing firm to help convey our message through brochures, packaging,
tradeshow messaging and advertising campaigns. We plan to undertake specific
marketing activities as needed, including, but not limited to:


•
            product reviews, case studies and
      promotions in trade
publications;




•
            enhancement and maintenance of
      our Website;




•
            Internet and web page advertising
      and targeted emails;




•
            public relations, print
      advertising, catalogs and point of purchase
  displays




•
            trade shows and sponsorships;
      and




•
            co-marketing relationships with
      relevant companies in selected
markets.




Industrial and
Defense


We
primarily solicit and manage our government/defense products and engineering
services directly. We expect to continue to obtain business through marketing
our existing reputation within the defense markets for quality, precision
electronics for defense night vision and thermal weapons systems. We believe
this market to be a relationship and “word of mouth” market in which large
contracts are generally awarded only to those who have performed well on
previous contracts. We employ, and expect to continue to employ, a
Washington-based lobbying firm to help increase our visibility as a potential
supplier in these markets and to assist us in uncovering new sales
opportunities. We also act as a value added supplier, supplying our products to
major defense suppliers, such as iRobot and DRS, to complement their products so
that they can offer a complete turn-key solution to their potential defense
customers. We are attempting to expand such partnerships and co-marketing
agreements with government- and defense-focused value added resellers and system
integrators, for our Tac-Eye® product lines. We market our products primarily
through our own direct sales organization. Business is solicited from large
industrial manufacturers and defense companies, the US government and foreign
governments and major foreign electronic equipment companies. In certain
countries we have and will use external sales representatives to help solicit
and coordinate foreign contracts. We are also on the eligible list of
contractors of many agencies of the US Department of Defense and may now be
solicited by such agencies for procurement needs falling within the major
classes of products we produce. We also search the various government contract
offering sites for procurement programs in which we believe we are qualified to
participate.


13




Consumer





We engage
in a variety of marketing efforts that are intended to drive customers to our
products and to grow awareness of our consumer products and Video Eyewear in
general. Public relations is an important aspect of our marketing and we intend
to continue to distribute samples of our products to key industry participants.
We currently plan to focus our marketing efforts for 2010 on:


•
                        distinguishing
      our Video Eyewear product category from current competitors and legacy
      head mounted displays;•
                        building
      consumer acceptance and momentum around the new Video Eyewear
      category;•
                        creating
      awareness of the benefits of Video Eyewear as compared to existing
      technologies; and•
                        creating
      brand awareness of the Vuzix, iWear® and WrapTM
  brands.


Our Video
Eyewear and VR Video Eyewear products are currently sold directly to consumers,
through select specialty retailers, through catalogue offerings and through
third party North American distributors including D&H and Wynit. Our
products are currently sold by the following US based resellers: SkyMall,
Brookstone, Hammacher Schlemmer, Amazon and Micro Center. Our website,
www.vuzix.com is an important part of our direct sales efforts.


If our
marketing efforts are successful and our sales volume increase we expect that
most of our products will then be sold through the traditional consumer
electronics and PC mass-market distribution channels and to a smaller extent
from our current specialty retailers. Therefore, we intend to spend the majority
of our marketing budget during this phase on website, direct sales support and
on reseller incentives and support. For resellers with physical retail locations
we began offering in the US, point of purchase systems that include a video
frame running a slide show presentation on the products as well as an integrated
fully functional Video Eyewear product that allows potential customers to use
our products.


We may
also explore and consider OEM and licensing relationships with manufacturing
partners, consumer electronics firms, and mobile phone makers.


We intend
to sell our products internationally through our growing network of
international distributors. Our distributorships are being established on a
country by country basis, where market size allows. Normally, we appoint two or
more distributors in each area.


Our
international focus is currently on Japan and the EU. In Japan, we have a branch
sales and service office in Tokyo, and a small warehouse outside of Tokyo. We
employ two full-time and two part-time staff. Their mandate includes seeking new
sales channels and partnerships with software, hardware and component providers
in Japan.


To serve
the EU market, in spring 2008 we established a wholly owned subsidiary, Vuzix
(Europe) Limited, through which to conduct our business. As of December 31, 2009
we had resellers in 23 countries that had placed orders with us during 2009.
While we do not currently maintain a European office, we have contracted with a
third-party end user technical support firm and fulfillment center to service
our customers in the EU. We have also retained a sales consultant (who acts as
our European Director of Operations), a UK public relations firm and a mobile
applications consultant to provide us with advice regarding the European
cellular phone market.
 14


In August
2009, we entered into a long-term exclusive distribution agreement for Mainland
China, Hong Kong, Macau, and Taiwan with YuView Holdings Ltd. Under this
agreement, YuView has the exclusive right to distribute our products in the
territory, subject to their achievement of minimum annual sales volumes. Also,
if YuView fails to establish a relationship with a major customer within a
certain period of time, their distribution rights may become non-exclusive at
our option. The agreement provides for us to sell our products to YuView at
specified price and volume discounts and not to sell our products to any other
resellers at greater discounts. Under the agreement, YuView has the option,
subject to its achievement of unit sales volume thresholds, to manufacture some
of our products in China for sale in that market only. If any of our competitors
offers to purchase a controlling equity interest in YuView, we have a right of
first refusal to purchase the same interest on the same terms and conditions as
those proposed by the offeror. The agreement has an initial term of five years
and will then renew automatically for an additional five year term unless YuView
is then in breach. YuView may terminate the agreement at any time on six months
written notice. We may terminate the agreement if YuView fails to sell the
required minimum amounts of our products. Either party may terminate the
agreement upon any material breach by the other party if that breach is not
cured within 30 days after notice.


Low-Vision
Assist


We intend
to market our low-vision assist products through low-vision clinics, catalogs
and the Internet. Our research indicates that most low-vision sufferers visit a
low-vision clinic after visiting a retinal specialist (of which there are
approximately 2,000 in the United States) or after a low-vision examination at
an optometrist or ophthalmologist. We intend to develop an awareness campaign
aimed at retina specialists and to provide demonstration systems and brochures
at low-vision clinics, which are the most common purchase point for low-vision
assist products. An internal sales force and independent sales representatives
will be used to sell our products through and to those clinics. We intend to
test our products against other low-vision aids and publish the results in
medical journals and present them at medical conventions. There are at least
five major trade shows each year for retina specialists in North America and we
intend to exhibit both our products and present the results of our testing at
those shows.


Manufacturing


Currently,
we purchase product components from our suppliers and perform the final assembly
of our Video Eyewear products ourselves in our Rochester, New York facility. We
are experienced in the successful production of our products in moderate
volumes. We expect to continue to perform final assembly of our Video Eyewear
products ourselves over the short term. However, if our assembly volume
increases and cost effective third party sourcing becomes feasible, we
anticipate that we will outsource the bulk of the final assembly, with the
possible exception of certain critical optical and display
components.


We
currently purchase almost all of the microdisplays used in our products from
Kopin and eMagin. Kopin accounts for approximately 95% of our microdisplays by
unit volume. Our relationships with both Kopin and eMagin generally are on a
purchase order basis and neither supplier has a contractual obligation to
provide adequate supply or acceptable pricing on a long-term basis. Products
incorporating Kopin microdisplays accounted for approximately 42% of our sales
in 2009 and products incorporating eMagin microdisplays accounted for
approximately 6% of our sales in 2009. We procure increasing percentages of our
microdisplays from other sources, but they are very limited currently. While we
do not manufacture our components, we own the tooling that is used to make our
custom components (with the exception of Apple iPod authentication chips and
connectors that we acquire directly under license from Apple). We do not believe
that we are dependent on our relationships with any supplier other than Kopin
and eMagin in order to continue to operate our business effectively. Some of our
accessory products, such as screen-less portable DVD players and mouse based
camera systems are sourced from third parties as finished goods. We typically
have them print our Vuzix brand name on the products. Such third party products
represented less than 1% of our sales in 2009.


We are
committed to globally sourcing all our components to minimize product costs. We
anticipate that procuring assembled products from third parties will result in
decreased labor force requirements, capital equipment costs, component
inventories, and the cost of maintaining inventories of work in progress. We
generally procure components and products from our vendors on a purchase order
basis without any long-term commitments. We currently use several Asian
manufacturing sources, where we have located some of our tooling.


Employees


As of
December 31, 2009, we had 59 full-time employees in North America: seven in
sales and marketing, distribution, and customer service; 16 in research and
development and engineering services support; 29 in manufacturing, operations
and purchasing; one in quality assurance; and seven in finance, management, and
administration. We also work with a group of sub-contractors mainly for
industrial, mechanical and optical design assistance in the Rochester, New York
area, some of which have been continually contracted over the last
36 months. In Japan we have two full-time employees and in the UK we have
one full-time contractor to manage our European sales and marketing
activities.
 15





History


We were
incorporated in Delaware in 1997 as VR Acquisition Corp. In 1997, we acquired
substantially all of the assets of Forte Technologies, Inc. (Forte), which was
engaged in the manufacture and sale of virtual reality headsets and the
development of related technologies. It was originally owned and controlled by
Kopin, our main current microdisplay supplier. Most of the technologies
developed by Forte are now owned and used by us.


Thereafter
in 1997 we changed our name to Kaotech Corporation. In 1998 we changed our name
to Interactive Imaging Systems, Inc. In 2004 we changed our name to Vicuity
Corporation and then to Icuiti Corporation. In 2007, we changed to our current
name, Vuzix Corporation. None of these name changes were the result of a change
in our ownership control.


Our
corporate offices are located at 75 Town Centre Drive, Rochester, New York
14623. Our phone number is (585) 359-5900. The URL for our website is
www.vuzix.com. The information contained on, connected to or that can be
accessed via our website is not part of this annual report. We have included our
website address in this annual report as an inactive textual reference only and
not as an active hyperlink.


Item
      1A
              Risk
      Factors


An
investment in our securities involves a high degree of risk. You should
carefully consider the risks described below, together with all of the other
information included in this annual report, before making an investment
decision. If any of the following risks actually occurs, our business, financial
condition or results of operations could suffer. In that case, the market value
of our securities could decline, and you may lose all or part of your
investment.


RISKS
RELATED TO OUR BUSINESS


Because
we have a limited operating history in the Video Eyewear industry, there is a
limited amount of past experience upon which to evaluate our business and
prospects.


We were
formed in 1997 to develop and sell virtual reality and other personal display
technology and products. Since our inception the majority of our sales have been
derived from the sale of night vision display drive electronics and from
research and development contracts with suppliers to the US government and
others. In 2003, we discontinued our original virtual reality product line to
focus on Video Eyewear products. Since that time, the market for Video Eyewear
products has developed more slowly than we anticipated. Although we sold our
first monocular Video Eyewear products in 2003 and our first binocular Video
Eyewear products in February 2005, since 2003 we have continued to earn the
majority of our revenues from defense related engineering contracts.
Accordingly, there is a limited amount of Video Eyewear-related experience upon
which to evaluate our business and prospects, and a potential investor should
consider the challenges, expenses, delays and other difficulties involved in the
development of our business, including the continued development of our
technology and the achievement of market acceptance for products using our
technology.


Because
our financial statements for 2009 include an explanatory paragraph regarding
substantial doubt about our ability to continue as a going concern, we may not
be able to obtain any necessary financing.


The
independent registered public accounting report for our consolidated financial
statements for the year ended December 31, 2009 includes an explanatory
paragraph regarding substantial doubt about our ability to continue as a going
concern. This "going concern" paragraph may have an adverse effect on our
ability to obtain financing for operations and to further develop and market
products. If we are not able to obtain adequate financing when and in the
amounts needed in the near future, and on terms that are acceptable, our
operations, financial condition and prospects could be materially and adversely
affected, our ability to continue as a going concern is in substantial
doubt.


Our plans
with respect to addressing these matters are discussed in greater detail under
“Item 7. Management’s Discussion and Analysis of Financial Conditional and
Results of Operations—Liquidity and Capital Resources” and in Note 2 to our
consolidated financial statements. Our future viability is dependent on our
ability to execute these plans successfully. If we fail to do so for any reason,
we would not have adequate liquidity to fund our operations, would not be able
to continue as a going concern and could potentially be forced to seek relief
through a filing under U.S. Bankruptcy Code.


16





We
have incurred net losses since our inception and if we continue to incur net
losses in the foreseeable future the market price of our common stock may
decline.


We
incurred annual net losses of $3,250,424 in 2009, $4,894,199 in 2008 and
$3,059,514 in 2007. We had an accumulated deficit of $18,032,430 as of December
31, 2009.


We may
not achieve or maintain profitability in the future. In particular, we expect
that our expenses relating to sales and marketing and product development and
support, as well as our general and administrative costs, will increase,
requiring us to increase sales in order to achieve and maintain profitability.
If we do not achieve and maintain profitability, our financial condition will be
materially and adversely affected. We would eventually be unable to continue our
operations unless we were able to raise additional capital. We may not be able
to raise any necessary capital on commercially reasonable terms or at all. If we
fail to achieve or maintain profitability on a quarterly or annual basis within
the timeframe expected by investors, the market price of our common stock may
decline.


We
have depended on defense related engineering contracts and two customers for
sales and our revenues would be materially reduced if we are unable to continue
to obtain sales from government contracts or if either of our two significant
customers reduce or delay orders from us.


Since
inception, the majority of our sales have been derived from the sale of night
vision display drive electronics to two suppliers to the US government. Sales of
night vision display drive electronics to these customers amounted to 42%, 51%
and 14% of our sales in 2009, 2008 and 2007, respectively. We have no long-term
contracts with these customers. A significant reduction or delay in orders from
either of our significant customers would materially reduce our revenue and cash
flow and adversely affect our ability to achieve or maintain profitability in
the future.


The next
largest source of revenues has been sales directly to the US Department of
Defense, primarily for engineering programs. Such sales amounted to 2%, 12% and
54% of our sales in 2009, 2008 and 2007, respectively. We have no long-term
contracts with the US government for engineering services. We plan to submit
proposals for additional development contract funding. However, development
contract funding is subject to legislative authorization and, even if funds are
appropriated, such funds may be withdrawn based on changes in government
priorities.


Together,
these two groups of customers accounted for 44%, 63% and 68% in 2009, 2008 and
2007, respectively. We may not be successful in obtaining new government
contracts or in receiving further night vision display electronics orders. Our
inability to obtain sales from government contracts could have a material
adverse effect on our results of operations and would likely cause us to delay
or slow our growth plans, resulting in lower net sales and adversely affect our
liquidity and profitability.


Because
our US government defense contracts and subcontracts are subject to procurement
laws and regulations, we may not receive all of the revenues we anticipate
receiving under those contracts and subcontracts.


Generally,
US government contracts are subject to procurement laws and regulations. Some of
the our contracts are governed by the Federal Acquisition Regulation (FAR),
which lays out uniform policies and procedures for acquiring goods and services
by the US government, and agency-specific acquisition regulations that implement
or supplement the FAR. For example, the Department of Defense implements the FAR
through the Defense Federal Acquisition Regulations (DFAR).


The FAR
also contains guidelines and regulations for managing a contract after award,
including conditions under which contracts may be terminated, in whole or in
part, at the government’s convenience or for default. If a contract is
terminated for the convenience of the government, a contractor is entitled to
receive payments for its allowable costs and, in general, the proportionate
share of fees or earnings for the work done. If a contract is terminated for
default, the government generally pays for only the work it has accepted. These
regulations also subject us to financial audits and other reviews by the
government of our costs, performance, accounting and general business practices
relating to our government contracts, which may result in adjustment of our
contract-related costs and fees.


17


Our US
government contract and subcontract orders are funded by government budgets that
are proposed by the President of the United States and reviewed and approved by
the Congress. Funds allocated to government agencies are administered by the
Executive Office of the President. There are two primary risks associated with
this process. First, the process may be delayed or disrupted because of
congressional schedules, negotiations over funding levels for programs or
unforeseen national or world events. Second, funding for multi-year contracts
can be changed in future appropriations. Either of these events could affect the
allocation, timing, schedule and program content of our government contracts and
subcontracts.


Our
lack of long-term purchase orders and commitments from our customers may lead to
a rapid decline in our sales and profitability.


All of
our significant consumer division customers issue purchase orders solely in
their own discretion, often only two to four weeks before the requested date of
shipment. Our customers are generally able to cancel orders (without penalty) or
delay the delivery of products on relatively short notice. In addition, our
customers may decide not to purchase products from us for any reason. Any of our
current customers may stop purchasing our products in the future. If those
customers do not continue to purchase our products, our sales volume and
profitability could decline rapidly with little or no warning
whatsoever.


We cannot
rely on long-term purchase orders or commitments to protect us from the negative
financial effects of a decline in demand for our products. The limited certainty
of product orders can make it difficult for us to forecast our sales and
allocate our resources in a manner consistent with our actual sales. Moreover,
our expense levels are based in part on our expectations of future sales and, if
our expectations regarding future sales are inaccurate, we may be unable to
reduce costs in a timely manner to adjust for sales shortfalls. Furthermore,
because we depend on a small number of customers for the vast majority of our
sales, the ramifications of these risks is greater than if we had a greater
number of customers. As a result of our lack of long-term purchase orders and
purchase commitments, we may experience a rapid decline in our sales and
profitability.


If
either of the two customers on whom we depend fails to pay us amounts owed in a
timely manner, we could suffer a significant decline in cash flow and liquidity
which, in turn, could cause us to fail to pay our liabilities and purchase
adequate inventory to sustain or expand our sales volume.


Our
accounts receivable represented approximately 21%, 30% and 53% of our total
current assets as of December 31, 2009, 2008 and 2007, respectively. As of
December 31, 2009, no customer exceeded 15% of our total accounts receivable and
our two major customers by revenue, represented less than 5% of our total
accounts receivable at that date. However as at December 31, 2008 those two
major customers represented 40% of our total accounts receivable. As a result,
at certain times there can be substantial amounts and concentrations of our
accounts receivable, and if any of our major customers fails to pay us amounts
owed in a timely manner, we could suffer a significant decline in cash flow and
liquidity which could adversely affect our ability to pay our liabilities and to
purchase inventory to sustain or expand our current sales volume and adversely
affect our ability to continue our business.


In addition, our business
is characterized by long periods for collection from our customers and short
periods for payment to our suppliers, the combination of which may cause us to
have liquidity problems. We experience an average accounts settlement period
ranging from one month to as high as three months from the time we deliver our
products to the time we receive payment from our customers. In contrast, we
typically need to place certain deposits and advances with our suppliers on a
portion of the purchase price. Because our payment cycle is considerably shorter
than our receivable collection cycle, we may experience working capital
shortages. Working capital management, including prompt and diligent billing and
collection, is an important factor in our results of operations and liquidity.
System problems, industry trends, our customers’ liquidity problems or payment
practices or other issues may extend our collection period, which would
adversely impact our liquidity, our ability to pay our liabilities and to
purchase inventory to sustain or expand our current sales volume, and adversely
affect our ability to continue our business.




Our
future growth and profitability may be adversely affected if our marketing
initiatives are not effective in generating sufficient levels of brand
awareness.


Since
inception, the majority of our sales have been derived from the sale of night
vision display electronics and from research and development contracts with
suppliers to, or directly to the US government and other customers. Our
long-term business plan contemplates that we will transition our business so
that the majority of our sales are earned from consumer products sales. In
connection with this transition, we are engaged in a variety of marketing
initiatives intended to promote sales of our consumer products. Our future
growth and profitability from our consumer products will depend in large part
upon the effectiveness and efficiency of these marketing efforts, including our
ability to:
 18




•
            create awareness of our brand and
      products, including general awareness of this new Video Eyewear product
      category;




•
            identify the most effective and
      efficient levels of spending for marketing expenditures in our new target
      market;




•
            effectively manage marketing
      costs (including creative and media) in order to maintain acceptable
      operating margins and return on marketing
    investment;




•
            select the right markets in which
      to market; and




•
            convert consumer awareness into
      actual product purchases.




Our
planned marketing expenditures may not result in increased total sales or
generate sufficient levels of product and brand name awareness. We may not be
able to manage our marketing expenditures on a cost-effective
basis.


If
we fail to accurately forecast seasonal demand for our consumer Video Eyewear
products, our results of operations for the entire fiscal year may be materially
adversely affected.


Historically,
a high percentage of our consumer Video Eyewear product annual sales have been
attributable to the winter holiday selling season. Like many manufacturers of
consumer electronics products, we must make merchandising and inventory
decisions for the winter holiday selling season well in advance of actual sales.
Further compounding this forecasting are other fluctuations in demand for the
consumer electronics products that work with our Video Eyewear products, often
due to the same seasonal influences, as well as technological advances and new
models which are often introduced later in the calendar year. Inaccurate
projections of demand or deviations in the demand for our products may cause
large fluctuations in both our fourth quarter results and could have a material
adverse effect on our results of operations for the entire fiscal year. We
expect that our fourth quarter sales of consumer products will remain dependent
on our performance during the winter holiday selling season.


Our
Video Eyewear products require ongoing research and development and we may
experience technical problems or delays and may not have the funds necessary to
continue their development which could lead our business to fail.


Our
research and development efforts remain subject to all of the risks associated
with the development of new products based on emerging and innovative
technologies, including, for example, unexpected technical problems or the
possible insufficiency of funds for completing development of these products. If
we experience technical problems or delays, further improvements in our products
and the introduction of future products could be delayed, and we could incur
significant additional expenses and our business may fail.


We
anticipate that we will require additional funds and further US government
engineering services contracts to maintain our current levels of expenditure for
research and development of new products and technologies, and to obtain and
maintain patents and other intellectual property rights in these technologies,
the timing and amount of which are difficult to forecast. Our cash on hand after
the successful completion of this offering coupled with the possibility of
further negative cash flow from operations may not be sufficient to meet all of
our future needs. We have no commitment for additional funds. Any funds we need
may not be available on commercially reasonable terms or at all. If we cannot
obtain any necessary additional capital when needed, we might be forced to
reduce our research and development efforts which would materially and adversely
affect our business. If we attempt to raise capital in an offering of shares of
our common stock, preferred stock, convertible securities or warrants, or if we
engage in acquisitions involving the issuance of such securities, our
then-existing stockholders’ interests will be diluted.


We
depend on advances in technology by other companies and if those advances do not
materialize, some of our products may not be successfully commercialized and our
anticipated new products could be delayed or cancelled.


We rely
on and will continue to rely on technologies (including microdisplays) that are
developed and produced by other companies. The commercial success of certain of
our planned future products will depend in part on advances in these and other
technologies by other companies. We may, from time to time, contract with and
support companies developing key technologies in order to accelerate the
development of them for our specific uses. Such activities might not result in
useful technologies or components for us.
 19





If
we fail to develop new products and adapt to new technologies, our business and
results of operations may be materially adversely affected.


The
market for our products is characterized by rapid changes in products, designs
and manufacturing process technologies. Our success depends to a large extent on
our ability to develop and manufacture new products and technologies to match
the varying requirements of different customers and groups in order to establish
a competitive position and become profitable. Furthermore, we must adapt our
products and processes to technological changes and emerging industry standards
and practices on a cost-effective and timely basis. Our failure to accomplish
any of the above could harm our business and operating results.


Consumer
electronics products are subject to rapid technological changes. Companies
within the consumer electronics industry are continuously developing new
products with increased performance and functionality. This puts pricing
pressure on existing products and constantly threatens to make them, or causes
them to be, obsolete. During the 2008 and 2007 fiscal years, we sold one product
below cost after introducing new product models and as a result incurred a
negative gross margin of approximately 20% or approximately $28,000 in negative
margin. This did not occur in fiscal 2009. As our unit sales increase, our
ability to manage and mitigate future clearance discounting activities may be
harder and greater sales with negative margins could increase. Our typical
product life cycle is relatively short, generating lower average selling prices
as the cycle matures. With cost reductions in component design and increased
manufacturing volumes we have not faced significant margin erosion as we
introduce new models of our Video Eyewear products. If we fail to accurately
anticipate the introduction of new technologies, we may possess significant
amounts of obsolete inventory that can only be sold at substantially lower
prices and gross margins than we anticipated. In addition, if we fail to
accurately anticipate the introduction of new technologies, we may be unable to
compete effectively due to our failure to offer products most demanded by the
marketplace. If any of these failures occur, our sales, profit margins and
profitability will be adversely affected.
  If
microdisplay-based personal displays do not gain some reasonable level of
acceptance in the market for mobile displays, our business strategy may
fail.




The
mobile display market is dominated by displays larger than one-inch, based on
direct view liquid crystal display (LCD) and organic light emitting display
(OLED) technology. A number of companies have made and continue to make
substantial investments in, and are conducting research to improve
characteristics of, small direct view LCDs. Many of the leading manufacturers of
these larger direct view LCDs, including LG Electronics, Royal Philips
Electronics, Samsung Electronics Co., Ltd., Sony Corporation and Sharp
Corporation, are large, established companies with global marketing
capabilities, widespread brand recognition and extensive financial resources.
Advances in LCD and OLED technology or other technologies may overcome their
current limitations and permit them to remain or become more attractive
technologies for personal viewing applications, which could limit the potential
market for our Video Eyewear technology and cause our business strategy to
fail.


It is
difficult to assess or predict with any certainty the potential size, timing and
viability of market opportunities for our microdisplay-based Video Eyewear
products or their market acceptance. Market acceptance of Video Eyewear
technology will depend, in part, upon consumer acceptance of near-to-eye
displays and upon microdisplay technology providing benefits comparable to or
greater than those provided by alternative direct view display technology at a
competitive price. If consumers fail to accept near-to-eye displays in the
numbers we anticipate or as soon as we anticipate, the sales of our Video
Eyewear products and our results of operations would be adversely affected and
our business strategy may fail.


There
are a number of competing providers of microdisplay-based personal display
technology and we may fail to capture a substantial portion of the personal
display market.


In
addition to competing with direct view displays, we also compete with
microdisplay-based personal display technologies that have been developed by
other companies. Our primary personal display competitors include DaeYang Co.,
Ltd., Ilixco Inc., MyVu Corporation (MyVu), Carl Zeiss, Inc. (Zeiss), 5DT Inc.,
eMagin Corporation (eMagin), Kopin Corporation (Kopin), Lumus Ltd. (Lumus) and
Kaiser Electro Optics Inc. (Kaiser). Additionally, at recent technology
exhibitions Sony and Brother International Corporation have demonstrated
personal display glasses that look like sunglasses. Most of our
microdisplay-based competitors have greater financial, marketing, distribution
and technical resources than we do. Certain of these competing
microdisplay-based technologies entered the marketplace prior to us. Moreover,
our competitors may succeed in developing new microdisplay-based personal
display technologies that are more affordable or have more or more desirable
features than our technology. If our products are unable to capture a
substantial portion of the personal display market, our business strategy may
fail.
 20





Our
business and products are subject to government regulation and we may incur
additional compliance costs or, if we fail to comply with applicable
regulations, may incur fines or be forced to suspend or cease
operations.


Our
products must comply with certain requirements of the US Federal Communications
Commission (FCC) regulating electromagnetic radiation in order to be sold in the
US and with comparable requirements of the regulatory authorities of the
European Union (EU) and other jurisdictions in order to be sold in those
jurisdictions. We are also subject to various governmental regulations related
to toxic, volatile, and other hazardous chemicals used in connection with parts
of our manufacturing process, including the Restriction of Certain Hazardous
Substances Directive (RoHS) issued by the EU effective July 1, 2006. This
directive restricts the distribution of products within the EU that exceed very
low maximum concentration values of certain substances, including
lead.


We
believe that all our current consumer products comply with the regulations of
the jurisdictions in which they are sold. Our failure to comply with these
regulations in the future could result in the imposition of fines or in the
suspension or cessation of our operations in the applicable jurisdictions.
Additional regulations applicable to our business may be enacted in the United
States or other jurisdictions in the future. Compliance with regulations enacted
in the future could substantially increase our cost of doing business or
otherwise have a material adverse effect on our results of operations and our
business.


Our
products will likely experience rapidly declining unit prices and we may not be
able to offset that decline with production cost decreases or higher unit
sales.


In the
markets in which we expect to compete, prices of established products tend to
decline significantly over time. In order to maintain our profit margins over
the long term, we believe that we will need to continuously develop product
enhancements and new technologies that will either slow price declines of our
products or reduce the cost of producing and delivering our products. While we
anticipate many opportunities to reduce production costs over time, we may not
be able to reduce our production costs. We expect to attempt to offset the
anticipated decrease in our average selling price by introducing new products,
increasing our sales volumes or adjusting our product mix. If we fail to do so,
our results of operations will be materially and adversely
affected.


If
we cannot obtain and maintain appropriate patent and other intellectual property
rights protection for our technology, our business will suffer.


The value
of our personal display and related technologies is dependent on our ability to
secure and maintain appropriate patent and other intellectual property rights
protection. We intend to continue to aggressively pursue additional patent
protection for our new products and technology. Although we own many patents
covering our technology that have already been issued, we may not be able to
obtain additional patents that we apply for, or that any of these patents, once
issued, will give us commercially significant protection for our technology, or
will be found valid if challenged. Moreover, we have not obtained patent
protection for some of our technology in all foreign countries in which our
products might be manufactured or sold. In any event, the patent laws and
enforcement regimes of other countries may differ from those of the United
States as to the patentability of our personal display and related technologies
and the degree of protection afforded.


Any
patent or trademark owned by us may be challenged and invalidated or
circumvented. Patents may not issue from any of our pending or future patent
applications. Any claims and issued patents or pending patent applications may
not be broad or strong enough and may not be issued in all countries where our
products can be sold or our technologies can be licensed to provide meaningful
protection against any commercial damage to us. Further, others may develop
technologies that are similar or superior to our technologies, duplicate our
technologies or design around the patents owned by us. Effective intellectual
property protection may be unavailable or limited in certain foreign countries.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise use aspects of our processes and devices that we
regard as proprietary. Policing unauthorized use of our proprietary information
and technology is difficult and our efforts to do so may not prevent
misappropriation of our technologies. In the event that our intellectual
property protection is insufficient to protect our intellectual property rights,
we could face increased competition in the market for our products and
technologies, which could have a material adverse effect on our business,
financial condition and results of operations.


We may
become engaged in litigation to protect or enforce our patent and other
intellectual property rights or in International Trade Commission proceedings to
abate the importation of goods that would compete unfairly with our products. In
addition, we may have to participate in interference or reexamination
proceedings before the US Patent and Trademark Office, or in opposition,
nullification or other proceedings before foreign patent offices, with respect
to our patents or patent applications. All of these actions would place our
patents and other intellectual property rights at risk and may result in
substantial costs to us as well as a diversion of management attention.
Moreover, if successful, these actions could result in the loss of patent or
other intellectual property rights protection for the key technologies on which
our business strategy depends.
 21





In
addition, we rely in part on unpatented proprietary technology, and others may
independently develop the same or similar technology or otherwise obtain access
to our unpatented technology. To protect our trade secrets, know-how and other
proprietary information, we require employees, consultants, financial advisors
and strategic partners to enter into confidentiality agreements. These
agreements may not provide meaningful protection for our trade secrets, know-how
or other proprietary information in the event of any unauthorized use,
misappropriation or disclosure of those trade secrets, know-how or other
proprietary information. In particular, we may not be able to fully or
adequately protect our proprietary information as we conduct discussions with
potential strategic partners. If we are unable to protect the proprietary nature
of our technology, it will harm our business.


Despite
our efforts to protect our intellectual property rights, intellectual property
laws afford us only limited protection. A third party could copy or otherwise
obtain information from us without authorization. Accordingly, we may not be
able to prevent misappropriation of our intellectual property or to deter others
from developing similar products or services. Further, monitoring the
unauthorized use of our intellectual property is difficult. Litigation may be
necessary to enforce our intellectual property rights or to determine the
validity and scope of the proprietary rights of others. Litigation of this type
could result in substantial costs and diversion of resources, may result in
counterclaims or other claims against us and could significantly harm our
results of operations. In addition, the laws of some foreign countries do not
protect our proprietary rights to the same extent as do the laws of the United
States.


As is
commonplace in technology companies, we employ individuals who were previously
employed at other technology companies. To the extent our employees are involved
in research areas that are similar to those areas in which they were involved at
their former employers, we may be subject to claims that such employees or we
have, inadvertently or otherwise, used or disclosed the alleged trade secrets or
other proprietary information of the former employers. Litigation may be
necessary to defend against such claims. Litigation of this type could result in
substantial costs to us and divert our resources.


We also
depend on trade secret protection through confidentiality and license agreements
with our employees, subsidiaries, licensees, licensors and others. We may not
have agreements containing adequate protective provisions in every case, and the
contractual provisions that are in place may not provide us with adequate
protection in all circumstances. The unauthorized reproduction or other
misappropriation of our intellectual property could diminish the value of our
brand, competitive advantages or goodwill and result in decreased
sales.


We
may incur substantial costs or lose important rights as a result of litigation
or other proceedings relating to our products, patents and other intellectual
property rights.


In recent
years, there has been significant litigation involving patents and other
intellectual property rights in many technology-related industries. Until
recently, patent applications were retained in secrecy by the US Patent and
Trademark Office until and unless a patent was issued. As a result, there may be
US patent applications pending of which we are unaware that may be infringed by
the use of our technology or a part thereof, thus substantially interfering with
the future conduct of our business. In addition, there may be issued patents in
the United States or other countries that are pertinent to our business of which
we are not aware. We and our customers could be sued by other parties for patent
infringement in the future. Such lawsuits could subject us and them to liability
for damages or require us to obtain additional licenses that could increase the
cost of our products, which might have an adverse affect on our
sales.


In
addition, in the future we may assert our intellectual property rights by
instituting legal proceedings against others. We may not be able to successfully
enforce our patents in any lawsuits we may commence. Defendants in any
litigation we may commence to enforce our patents may attempt to establish that
our patents are invalid or are unenforceable. Any patent litigation could lead
to a determination that one or more of our patents are invalid or unenforceable.
If a third party succeeds in invalidating one or more of our patents, that party
and others could compete more effectively against us. Our ability to derive
sales from products or technologies covered by these patents could be adversely
affected.


Whether
we are defending the assertion of third party intellectual property rights
against our business as a result of the use of our technology, or we are
asserting our own intellectual property rights against others, such litigation
can be complex, costly, protracted and highly disruptive to our business
operations by diverting the attention and energies of management and key
technical personnel. As a result, the pendency or adverse outcome of any
intellectual property litigation to which we are subject could disrupt business
operations, require the incurrence of substantial costs and subject us to
significant liabilities, each of which could severely harm our
business.


22





Plaintiffs
in intellectual property cases often seek injunctive relief. Any intellectual
property litigation commenced against us could force us to take actions that
could be harmful to our business and thus to our sales, including the
following:


•
            discontinuing selling the
      products that incorporate or otherwise use technology that contains our
      allegedly infringing intellectual
  property;




•
            attempting to obtain a license to
      the relevant third party intellectual property, which may not be available
      on reasonable terms or at
all; or




•
            attempting to redesign our
      products to remove our allegedly infringing intellectual
      property.




If we are
forced to take any of the foregoing actions, we may be unable to manufacture and
sell products that incorporate our technology at a profit or at all.
Furthermore, the measure of damages in intellectual property litigation can be
complex, and is often subjective or uncertain. If we were to be found liable for
infringement of proprietary rights of a third party, the amount of damages we
might have to pay could be substantial and is difficult to predict. Decreased
sales of our products incorporating our technology would adversely affect our
sales. Any necessity to procure rights to the third party technology might cause
us to negotiate the royalty terms of the third party license which could
increase our cost of production or, in certain cases, terminate our ability to
build some of our products entirely.


If
we fail to renew, register or otherwise protect our trademarks, the value of our
brand names may decline and we may be unable to use those names in certain
geographical areas.


We
believe our copyrights and trademarks are critical to our success. We rely on
trademark, copyright and other intellectual property laws to protect our
proprietary rights. If we fail to properly register and otherwise protect our
trademarks, service marks and copyrights, we may lose our rights, or our
exclusive rights, to them. In that case, our ability to effectively market and
sell our products and services could suffer, which could harm our
business.


Our
business and results of operations may suffer if there are, or if users claim
there are, negative effects on eyesight from the long-term use of our
products.


The
personal display products that we currently market or may introduce and market
in the future are new and utilize new technology. While virtual display
technology has been in use over the past 25 years, sales to the general
public have been limited. Extensive and continual viewing of any display,
including standard computer monitors, for hours each day has the potential to
negatively affect eyesight. Accordingly, it is possible that prolonged use of
our products may adversely affect a user’s eyesight. We design our products with
these considerations in mind to attempt to minimize any potential negative
impact. We warn users that extensive daily use without appropriate rest periods
may cause eye fatigue that could result in temporary or permanent damage (in
much the same way that a computer monitor manufacturers now warn users about
long-term computer use). Despite our efforts, we may be unable to overcome this
risk and such risk could result in claims against us by users of our products.
Any such claims, whether or not we are ultimately held liable for them, could
diminish the value of our brand, competitive advantages or goodwill and may
result in decreased sales and we could incur significant expense in defending
against any such claims. In addition, if we are ultimately held liable for any
such claims, the resulting liabilities may have a material adverse effect on our
business, financial condition and results of operations.


Product
liability claims, whether or not we are ultimately held liable for them, could
have a material adverse affect on our business and results of
operations.


Our
business may expose us to product liability claims. Although no such claims have
been brought against us to date, and to our knowledge no such claim is
threatened or likely, we may face liability to product users for damages
resulting from the design or manufacture of our products. Any such claims,
whether or not we are ultimately held liable for them, could diminish the value
of our brand, competitive advantages or goodwill and result in decreased sales
and we could incur significant expense in defending against any such claims.
While we plan to obtain and maintain product liability insurance coverage,
product liability claims made against us may exceed coverage limits or fall
outside the scope of such coverage. Also, insurance may not be available at
commercially reasonable rates or at all. We do not have any such product
liability insurance in effect.
 23


Our
results of operations may suffer if we are not able to successfully manage our
increasing exposure to foreign exchange rate risks.


A
substantial majority of our sales and cost of components are denominated in US
dollars. As our business grows both our sales and production costs may
increasingly be denominated in other currencies. Where such sales or production
costs are denominated in other currencies, they are converted to US dollars for
the purpose of calculating any sales or costs to us. Our sales may decrease as a
result of any appreciation of the US dollar against these other
currencies.


The
majority of our current expenditures are incurred in US dollars and many of our
components come from countries that currently peg their currency against the US
dollar. If the pegged exchange rates should change adversely or be allowed to
float up, additional US dollars will be required to fund our purchases of these
components.


Although
we do not currently enter into currency option contracts or engage in other
hedging activities, we may do so in the future. We can not assure you that we
will undertake any such hedging activities or that, if we do so, they will be
successful in reducing the risks to us of our exposure to foreign currency
fluctuations.


Due
to our significant level of international operations, we are subject to
international operational, financial, legal and political risks.


A
substantial part of our operations are expected to be outside of the United
States and many of our customers and suppliers have some or all of their
operations in countries other than the United States. Risks associated with our
doing business outside of the United States include:


•
            compliance with a wide variety of
      foreign laws and regulations, particularly labor, environmental and other
      laws and regulations that govern our operations in those
      countries;




•
            legal uncertainties regarding
      taxes, tariffs, quotas, export controls, export licenses, import controls
      and other trade barriers;




•
            economic instability in the
      countries of our suppliers and customers, particularly in the Asia-Pacific
      region, causing delays or reductions in orders for their products and
      therefore our sales;




•
            political instability in the
      countries in which our suppliers operate, particularly in China and
      Taiwan;




•
            difficulties in collecting
      accounts receivable and longer accounts receivable payment
      cycles; and




•
            potentially adverse tax
      consequences.




Any of
these factors could harm our own, our suppliers’ and our customers’
international operations and businesses and impair our and their ability to
continue expanding into international markets.


We
may lose the services of key management personnel and may not be able to attract
and retain other necessary personnel.


Changes
in our management could have an adverse effect on our business. This is
especially an issue while our staff is small. We are dependent upon the active
participation of several key management personnel, including
Paul J. Travers, our President and Chief Executive Officer (CEO). We
do not carry key person life insurance on any of our senior management or other
key personnel other than our CEO. While we have life insurance coverage on our
CEO, we do not believe the coverage would be sufficient to completely protect us
against losses we may suffer if his services were to become unavailable to us in
the future. Our Chief Financial Officer, Grant Russell, a Canadian citizen,
currently has his principal residence in Vancouver, Canada and a second
residence in Rochester, New York. If he becomes unable to legally travel to and
work in the United States, his ability to perform some of his duties could be
materially adversely affected.
 24


We must
hire highly skilled technical personnel as employees and as independent
contractors in order to develop our products. As of December 31, 2009, we had
59 full-time employees. The competition for highly skilled technical,
managerial and other personnel is intense and we may not be able to retain or
recruit such personnel. Our recruiting and retention success is substantially
dependent on our ability to offer competitive salaries and benefits to our
employees. We must compete with companies that possess greater financial and
other resources than we do and that may be more attractive to potential
employees and contractors. To be competitive, we may have to increase the
compensation, bonuses, stock options and other fringe benefits offered to
employees in order to attract and retain such personnel. The costs of retaining
or attracting new personnel may have a material adverse effect on our business
and operating results. If we fail to attract and retain the technical and
managerial personnel we need to be successful, our business, operating results
and financial condition could be materially adversely affected.


Our
failure to effectively manage growth could harm our business.


We have
rapidly and significantly expanded the number and types of products we sell, and
we will endeavor to further expand our product portfolio. We must regularly
introduce new products and technologies, enhance existing products, and
effectively stimulate customer demand for new products and upgraded versions of
our existing products.


This
expansion of our products places a significant strain on our management,
operations and engineering resources. Specifically, the areas that are strained
most by our growth include the following:


•
            New Product
      Launch:With the growth of our product portfolio, we experience
      increased complexity in coordinating product development, manufacturing,
      and shipping. As this complexity increases, it places a strain on our
      ability to accurately coordinate the commercial launch of our products
      with adequate supply to meet anticipated customer demand and effective
      marketing to stimulate demand and market acceptance. If we are unable to
      scale and improve our product launch coordination, we could frustrate our
      customers and lose retail shelf space and product
      sales;




•
            Forecasting,
      Planning and Supply Chain Logistics:With the growth of
      our product portfolio, we also experience increased complexity in
      forecasting customer demand, in planning for production, and in
      transportation and logistics management. If we are unable to scale and
      improve our forecasting, planning and logistics management, we could
      frustrate our customers, lose product sales or accumulate excess
      inventory; and




•
            Support
      Processes:To manage the growth of our operations, we will need to
      continue to improve our transaction processing, operational and financial
      systems, and procedures and controls to effectively manage the increased
      complexity. If we are unable to scale and improve these areas, the
      consequences could include: delays in shipment of product, degradation in
      levels of customer support, lost sales, decreased cash flows, and
      increased inventory. These difficulties could harm or limit our ability to
      expand.




Our
facilities and information systems and those of our key suppliers could be
damaged as a result of disasters or unpredictable events, which could have an
adverse effect on our business operations.


We
operate our business from three locations in the Rochester, New York area. We
also rely on third party manufacturing plants in China and third party
logistics, sales and marketing facilities in other parts of the world to provide
key components of our Video Eyewear products and services necessary for our
operations. If major disasters such as earthquakes, fires, floods, wars,
terrorist attacks, computer viruses, transportation disasters or other events
occur in any of these locations, or our information systems or communications
network or those of any of our key component suppliers breaks down or operates
improperly as a result of such events, our facilities or those of our key
suppliers may be seriously damaged, and we may have to stop or delay production
and shipment of our products. We may also incur expenses relating to such
damages. If production or shipment of our products or components is stopped or
delayed or if we incur any increased expenses as a result of damage to our
facilities, our business, operating results and financial condition could be
materially adversely affected.


We
generally do not have long-term contracts with our customers and therefore we
may not be able to accurately forecast inventory requirements and
sales.


Our
business is operated on the basis of short-term purchase orders and engineering
contracts that typically do not exceed 12 months in duration. We cannot
guarantee that we will be able to obtain long-term contracts in the future. The
purchase orders that we receive can often be cancelled or revised without
penalty. In the absence of a backlog of orders that can only be canceled with
penalty, we plan production on the basis of internally generated forecasts of
demand, which makes it difficult to accurately forecast inventory requirements
and sales. Large supply line commitments and large inventories of various
components will be required to support our business and provide reasonable order
fulfillment for customers. If we fail to accurately forecast operating
requirements, our business may suffer and the value of your investment in us may
decline.
 25


Terrorism
and the uncertainty of future terrorist attacks or war could reduce consumer
confidence which could adversely affect our operating results.


Terrorist
acts or acts of war may cause damage or disruption to our facilities,
information systems, vendors, employees and customers, which could significantly
harm our sales and results of operations. In the future, fears of war or
additional acts of terrorism may have a negative effect on consumer confidence
or consumer discretionary spending patterns, as well as have an adverse effect
on the economy in general. This impact may be particularly harmful to our
business because we expect to rely heavily on discretionary consumer spending
and consumer confidence levels.


RISKS
RELATED TO MANUFACTURING


We
do not manufacture our own microdisplays, one of the key components of our Video
Eyewear products, and we may not be able to obtain the microdisplays we
need.


We do not
currently own or operate any manufacturing facilities for microdisplays, one of
the key components in our Video Eyewear products. We currently purchase almost
all of the microdisplays used in our products from Kopin and eMagin. Kopin
accounts for approximately 95% of our microdisplays by unit volume. Products
incorporating Kopin microdisplays accounted for approximately 42% of our sales
in 2009 and products incorporating eMagin microdisplays accounted for
approximately 6% of our sales in 2009. Our relationships with both Kopin and
eMagin generally are on a purchase order basis and neither supplier has a
contractual obligation to provide adequate supply or acceptable pricing on a
long-term basis. Both Kopin and eMagin could discontinue sourcing merchandise
for us at any time. If Kopin or eMagin were to discontinue their relationships
with us, or discontinue providing specific products to us, and we are unable to
contract with a new supplier that can meet our requirements, or if Kopin or
eMagin or such other supplier were to suffer a disruption in their production,
we could experience disruption of our inventory flow, a decrease in sales and
the possible need to redesign our products. Any such event could disrupt our
operations and have an adverse effect on our business, financial condition and
results of operations.


Certain
other components and services necessary for the manufacture of our products are
available from only a limited number of sources, and other components and
services are only available from a single source.


Our
inability to obtain sufficient quantities of high quality components or services
on a timely basis could result in future manufacturing delays, increased costs
and ultimately in reduced or delayed sales or lost orders which could materially
and adversely affect our operating results.


The
consumer electronics industry is subject to significant fluctuations in the
availability of components. If we do not properly anticipate the need for
critical components, we may be unable to meet the demands of our customers and
end-users.


The
availability of certain of the components that we require to produce our Video
Eyewear products may decrease. As the availability of components decreases, the
cost of acquiring those components ordinarily increases. High growth product
categories have experienced chronic shortages of components during periods of
exceptionally high demand. If we do not properly anticipate the need for or
procure critical components, we may pay higher prices for those components, our
gross margins may decrease and we may be unable to meet the demands of our
customers and end-users, which could reduce our competitiveness, cause a decline
in our market share and have a material adverse effect on our results of
operations.


Unanticipated
disruptions in our operations or slowdowns by our suppliers, distributors and
shipping companies could adversely affect our ability to deliver our products
and service our customers.


Our
ability to provide high quality customer service, process and fulfill orders and
manage inventory depends on the efficient, timely and uninterrupted performance
of our manufacturing and distribution facilities and our management information
systems and the facilities and systems of our third party suppliers,
distributors and shipping companies.


Any
material disruption or slowdown in the operation of our manufacturing and
distribution facilities or our management information systems, or comparable
disruptions or slowdowns suffered by our principal suppliers, distributors or
shippers could cause delays in our ability to receive, process and fulfill
customer orders and may cause orders to be canceled, lost or delivered late,
goods to be returned or receipt of goods to be refused. If any of these events
occur, our sales and operating results could be materially and adversely
affected.
 26


If
we acquire any companies or technologies in the future, they could prove
difficult to integrate, disrupt our business, dilute stockholder value or have
an adverse effect on our results of operations.


We intend
to expand our business primarily through internal growth, but from time to time
we may consider strategic acquisitions. Any future acquisition would involve
numerous risks including:


•
            potential disruption of our
      ongoing business and distraction of
  management;




•
            difficulty integrating the
      operations and products of the acquired
  business;




•
            unanticipated expenses related to
      technology integration;




•
            exposure to unknown liabilities,
      including litigation against the companies we may
      acquire;




•
            additional costs due to
      differences in culture, geographic locations and duplication of key
      talent; and




•
            potential loss of key employees
      or customers of the acquired
company.




Additionally,
to finance an acquisition we may incur substantial amounts of indebtedness,
which would affect our balance sheet and results of operations, or we may issue
a substantial number of shares of our common stock, which may be dilutive to our
stockholders. If we make acquisitions in the future, acquisition-related
accounting charges may affect our balance sheet and results of operations. We
may not be successful in addressing these risks or any other problems
encountered in connection with any acquisitions.


RISKS
RELATING TO OUR SECURITIES


The price of our
common stock and warrants have been highly volatile and an investment in our
securities could suffer a decline in value.


The
market prices of our common stock and warrants have been highly volatile since
they began trading on the TSX-V in January 2010 will likely be characterized by
significant price volatility when compared to more established issuers for the
foreseeable future. The market prices of our common stock and warrants are
likely to be volatile for a number of reasons. First, our common stock and
warrants are likely to be sporadically and/or thinly traded. As a consequence of
this lack of liquidity, the trading of relatively small quantities of common
stock or warrants may disproportionately influence their prices in either
direction. The price of the common stock could, for example, decline
precipitously if even a relatively small number of shares are sold on the market
without commensurate demand, as compared to a market for shares of an
established issuer which could better absorb those sales without adverse impact
on its share price. Secondly, we are a speculative or “risky” investment due to
our small amount of sales and lack of profits to date and uncertainty of future
market acceptance for our current and potential products or engineering
services. As a consequence of this enhanced risk, more risk-adverse investors
may, under the fear of losing all or most of their investment in the event of
negative news or lack of progress, be more inclined to sell their common stock
or warrants on the market more quickly and at greater discounts than would be
the case with the securities of an established issuer. We cannot make any
predictions or projections as to what the prevailing market prices for our
securities will be at any time or as to what effect the sale of our securities
or the availability of our securities for sale at any time will have on the
prevailing market price.


If
we cannot maintain the listing of our common stock and warrants on the TSX-V
holders of our common stock and warrants may not be able to resell their
securities at or near the price they paid for them or at any price.


Our
common stock and warrants are currently listed on the TSX-V under the symbols
“VZX” and “VZX.WT”, respectively. The TSX-V has continuing listing requirements
and we may not be able to comply with those requirements and maintain our
listing. If our common stock and warrants are not listed on the TSX-V, we may
seek to have them quoted on the OTC Bulletin Board of the US Financial
Industry Regulatory Authority, Inc. (FINRA). The OTC Bulletin Board is an
inter-dealer, over-the-counter market that provides significantly less liquidity
and transparency than the TSX-V. Therefore, prices for securities traded solely
on the OTC Bulletin Board may be difficult to obtain and holders of
our common stock and warrants may be unable to resell their securities at
or near the price they paid for them or
at any price.


27


Holders
of our warrants may not be able to exercise their warrants if we cannot maintain
a current prospectus relating to the common stock underlying the
warrants.





The
warrants sold in our initial public offering in December 2009 may be exercised
only if at the time of exercise (i) a prospectus relating to the issuance
of the shares of our common stock underlying the warrants is then current and
(ii) those shares are registered or qualified for sale or exempt from
registration or qualification under the securities laws of the states in which
the holders of the warrants reside. The issuance of the shares of our common
stock underlying the warrants is covered by an effective prospectus
but we may not be able to keep that prospectus or any other prospectus we file
with the SEC covering the issuance of those shares current. We applied to
register or qualify the issuance of those shares in California, Connecticut,
Delaware, Georgia, Illinois, Maryland, Massachusetts, New Jersey, New York,
Pennsylvania and Virginia but we may not be able to maintain those registrations
or qualifications. If we are not able to do so and no exemption from
registration is available, the holders of the warrants will not able to exercise
their warrants and they will expire unexercised. We have no obligation to
compensate the holders if they are not able to exercise their warrants because
we have failed to maintain the effectiveness of a registration statement filed
with the SEC or the registration or qualification filed with any
state.


The
market price of our common stock and warrants may decline because of the number
of shares of our common stock eligible for future sale in the public
marketplace.


The price
of our common stock and warrants could decline if there are substantial sales of
our common stock in the public market in the future.  As of December
31, 2009, 263,600,274 shares of our common stock were issued and
outstanding.  31,180,157 shares of our common stock sold in our
initial public offering are freely tradable without restriction or further
registration under the Securities Act, except for any of those shares held by
our “affiliates,” as that term is defined in Rule 144 under the Securities
Act, whose sales would be subject to the volume and manner of sale limitations
of Rule 144 described below. In addition, 146,440,415 shares of our
common stock outstanding as of December 31, 2009, or approximately 56% of our
common stock outstanding as of December 31, 2009, may be resold at any time,
subject to the lock-up agreements and TSX-V escrow arrangements and seed share
resale restrictions described below. Our executive officers and directors
currently own 82,987,672 shares, or approximately 31% of our common stock
outstanding as of December 31, 2009, which are eligible for resale subject to
the volume and manner of sale limitations of Rule 144 and subject to the
lock-up agreements and TSX-V escrow arrangements described below.


Additionally,
under our fiscal advisory fee agreement with the Canadian agents in our initial
public offering, we issued to the Canadian agents at the closing of our initial
public offering, in payment of a fiscal advisory fee, 2,613,687 shares of our
common stock. The shares issued to our Canadian agents under the agreement will
be subject to resale restrictions in accordance with applicable US and Canadian
securities laws and contractual resale restrictions for a period of one year
following the closing of our initial public offering under the lock-up
agreements described below.


The
holders of an aggregate of 31,764,437 shares of our common stock have
rights, subject to some conditions, to require us to include their shares in
registration statements that we may file for ourselves or other stockholders. We
also intend to register for resale all shares of common stock that we have
issued and may issue under our option plans. Once we register these shares,
subject to any lock-up restrictions, if any, they can be freely sold in the
public market. Furthermore, our agents may, at their discretion and at any time
without notice, release all or any portion of the securities from the
restrictions on sale imposed by lock-up agreements. Due to these factors, sales
of a substantial number of shares of our common stock in the public market could
occur at any time. These sales, or the perception in the market that the holders
of a large number of shares are able to or intend to sell shares, could reduce
the market price of our common stock.


If
management continues to own a significant percentage of our outstanding common
stock management may prevent other stockholders from influencing significant
corporate decisions.


Our
officers and directors currently own approximately 31% of the outstanding shares
of our common stock. As a result, our management will exercise significant
control over matters requiring stockholder approval, including the election of
our board of directors, the approval of mergers and other extraordinary
transactions, as well as the terms of any of these transactions. This
concentration of ownership could have the effect of delaying or preventing a
change in our control or otherwise discouraging a potential acquirer from
attempting to obtain control of us, which could in turn have an adverse effect
on the fair market value of our company and our common stock. The interests of
these and other of our existing stockholders may conflict with the interests of
our other stockholders.


28


It
may be difficult for us to attract or retain qualified officers and directors
because of the rules and regulations that we are subject to as a public
company.





As a
public company, the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) and the related
rules and regulations of the SEC, as well as the rules and regulations of
applicable Canadian securities regulators and the rules of the TSX-V requires us
to implement corporate governance practices and adhere to a variety of reporting
requirements and complex accounting rules. Among other things, we are subject to
rules regarding the independence of the members of our board of directors and
committees of the board and their experience in finance and accounting matters
and certain of our executive officers will be required to provide certifications
in connection with our quarterly and annual reports filed with the SEC and
applicable Canadian securities regulators. The perceived increased personal risk
associated with these rules may deter qualified individuals from accepting these
positions. Accordingly, we may be unable to attract and retain qualified
officers and directors. If we are unable to attract and retain qualified
officers and directors, our business and our ability to maintain the listing of
our shares of common stock on a stock exchange could be adversely
affected.


If
we fail to implement and maintain an effective system of internal controls, we
may not be able to accurately report our financial results or prevent fraud and
may fail to comply with SEC rules and the rules and regulations of applicable
Canadian securities regulators.


We must
implement and maintain effective internal financial controls for us to provide
reliable and accurate financial reports and effectively prevent fraud.
Implementation and maintenance of effective internal financial controls will
depend on the effectiveness of our financial reporting and data systems and
controls. We expect these systems and controls to become increasingly complex to
the extent that our business grows. To effectively manage this growth, we will
need to continue to improve our operational, financial and management controls
and our reporting systems and procedures. We cannot be certain that these
measures will ensure that we design, implement and maintain adequate controls
over our financial processes and reporting in the future. Any failure to
implement required new or improved controls, or difficulties encountered in
their implementation or operation, could harm our operating results or cause us
to fail to meet our financial reporting obligations. Inferior internal controls
could also cause investors to lose confidence in our reported financial
information, which could have a negative effect on the market price of our
common stock and our access to capital.


Rules
adopted by the SEC pursuant to Section 404 of Sarbanes-Oxley require annual
assessment of our internal control over financial reporting, and attestation of
this assessment by our independent registered public accountants. Under the SEC
rules currently in effect, both the management assessment of our internal
control over financial reporting and the attestation of management’s assessment
by our independent registered public accountants will first apply to our annual
report for the 2010 fiscal year. The standards governing management’s assessment
of internal control over financial reporting are new and complex, and require
significant documentation, testing and possible remediation to meet the detailed
standards. In addition, the attestation process by our independent registered
public accountants is new and we may encounter problems or delays in completing
the implementation of any requested improvements and receiving an attestation of
our assessment by our independent registered public accountants. If we cannot
assess our internal control over financial reporting as effective, or our
independent registered public accountants are unable to provide an unqualified
attestation report on such assessment, investors could lose confidence in our
reported financial information, which could have a negative effect on the market
price of our common stock and our access to capital.


In
addition, management’s assessment of internal control over financial reporting
may identify weaknesses and conditions that need to be addressed in our internal
control over financial reporting or other matters that may raise concerns for
investors. Any actual or perceived weaknesses and conditions that need to be
addressed in our internal control over financial reporting, disclosure of
management’s assessment of our internal control over financial reporting, or
disclosure of our independent registered public accounting firm’s attestation to
our report on management’s assessment of our internal control over financial
reporting may have a negative effect on the market price of our common stock and
our access to capital.


The
additional expenses that we will incur as a public company, and the time our
management will be required to devote to new compliance initiatives, may have a
material adverse affect on our business and results of operations.


As a
public company, we will incur significant legal, accounting and other expenses
that we did not incur as a private company. In addition, Sarbanes-Oxley and the
related rules and regulations of the SEC, as well as the rules and regulations
of applicable Canadian securities regulators and the rules of the TSX-V, impose
various requirements on public companies, including requiring changes in
corporate governance practices. Our management and other personnel will need to
devote a substantial amount of time to these compliance initiatives. Moreover,
these rules and regulations will increase our legal and financial compliance
costs and will make some activities more time-consuming and costly. For example,
we expect these new rules and regulations to make it more difficult and more
expensive for us to obtain director and officer liability insurance, and we may
be required to incur substantial costs to maintain the same or similar coverage.
Compliance with Section 404 of Sarbanes-Oxley will also require that we
incur substantial accounting expenses and expend significant management
efforts.


29





If
our common stock is considered a “penny stock” it will be subject to additional
sale and trading regulations that may make it more difficult to
sell.


Our
common stock, which is not currently listed or quoted on any US national
securities exchange or national quotation system, may be considered to be a
“penny stock” if it does not qualify for one of the exemptions from the
definition of “penny stock” under Rule 3a51-1 under the Securities Exchange
Act of 1934 (Exchange Act). Our common stock may be a “penny stock” if it meets
one or more of the following conditions (i) the stock trades at a price
less than $5.00 per share; (ii) it is not traded on a “recognized” national
exchange; (iii) it is not quoted on the NASDAQ Capital Market, or even if
so, has a price less than $5.00 per share; or (iv) is issued by a company
that has been in business less than three years with net tangible assets less
than $5,000,000.


The
principal result or effect of being designated a “penny stock” is that US
securities broker-dealers participating in sales of our common stock will be
subject to the “penny stock” regulations set forth in Rules 15g-2 through
15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor’s account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account
of any investor for transactions in such stocks before selling any penny stock
to that investor. This procedure requires the broker-dealer to (i) obtain
from the investor information concerning his or her financial situation,
investment experience and investment objectives; (ii) reasonably determine,
based on that information, that transactions in penny stocks are suitable for
the investor and that the investor has sufficient knowledge and experience as to
be reasonably capable of evaluating the risks of penny stock transactions;
(iii) provide the investor with a written statement setting forth the basis
on which the broker-dealer made the determination in (ii) above; and
(iv) receive a signed and dated copy of such statement from the investor,
confirming that it accurately reflects the investor’s financial situation,
investment experience and investment objectives. Compliance with these
requirements may make it more difficult and time consuming for holders of our
common stock to resell their shares to third parties or to otherwise dispose of
them in the market or otherwise.


Because
we do not intend to pay dividends on our common stock, our stockholders will
only realize a return (or recovery of a portion of their initial investment) on
their investment upon the sale of their shares.


We have
never declared or paid any cash dividends on our common stock. We currently
intend to retain our future earnings, if any, to finance the operation and
growth of our business and do not expect to pay any cash dividends.


Our
certificate of incorporation, by-laws and Delaware law may discourage takeovers
and business combinations that our stockholders might consider in their best
interests


Provisions
in our certificate of incorporation and by-laws may delay, defer, prevent or
render more difficult a takeover attempt that our stockholders might consider in
their best interests. Even in the absence of a takeover attempt, the existence
of these provisions may adversely affect the market value of our common stock if
they are viewed as discouraging takeover attempts in the future.


Provisions
in the amended and restated certificate of incorporation and amended and
restated bylaws, as well as provisions of Delaware law, could make it more
difficult for a third party to acquire us, even if doing so would benefit our
stockholders. Our amended and restated certificate of incorporation and
bylaws:




•
            provide that the authorized
      number of directors may be changed only by resolution of the board of
      directors;




•
            provide that all vacancies,
      including newly created directorships, may, except as otherwise required
      by law, be filled by the affirmative vote of a majority of directors then
      in office, even if such number is less than a
    quorum;




30


•
            require that any action to be
      taken by our stockholders be effected at a duly called annual or special
      meeting of stockholders and not by written
  consent;




•
            provide that stockholders seeking
      to present proposals before a meeting of stockholders or to nominate
      candidates for election as directors at a meeting of stockholders must
      provide notice in writing in a timely manner, and also specify
      requirements as to the form and content of a stockholder’s
      notice;




•
            do not provide for cumulative
      voting rights, therefore allowing the holders of a majority of the shares
      of our common stock entitled to vote in any election of directors to elect
      all of the directors standing for election, if they should so
      choose; and




•
            provide that special meetings of
      our stockholders may be called only by the chairman of the board, our
      chief executive officer or by the board of directors pursuant to a
      resolution adopted by a majority of the total number of authorized
      directors.




The
amendment of any of these provisions would require approval by the holders of at
least two thirds of our voting stock then outstanding, voting together as a
single class.


In
addition, we may become subject to Section 203 of the Delaware General
Corporation Law, which generally prohibits a Delaware corporation from engaging
in any of a broad range of business combinations with an interested stockholder
for a period of three years following the date on which the stockholder became
an interested stockholder. This provision could have the effect of delaying or
preventing a change of control, whether or not it is desired by or beneficial to
our stockholders.


If
we issue new shares of preferred stock your rights as a holder of our common
stock or warrants may be materially adversely affected.


We are
authorized to issue up to 5,000,000 shares of preferred stock, none of which is
currently issued or outstanding. The designations, rights and preferences of our
preferred stock may be determined from time-to-time by our board of directors.
Accordingly, our board of directors is empowered, without shareholder approval,
to issue one or more series of preferred stock with dividend, liquidation,
conversion, voting or other rights superior to those of the holders of our
common stock. For example, an issuance of shares of preferred stock
could:


•
            adversely affect the voting power
      of the holders of our common
stock;




•
            make it more difficult for a
      third party to gain control of
us;




•
            discourage bids for our common
      stock;




•
            limit or eliminate any payments
      that the holders of our common stock could expect to receive upon our
      liquidation; or




•
            adversely affect the market price
      of our common stock.




Holders
of our common stock and warrants may be diluted if we raise additional
funds.


Our
operations to date have consumed substantial amounts of cash, and we expect our
capital and operating expenditures to increase in the next few years. The
independent registered public accounting firm report for our consolidated
financial statements for the year ended December 31, 2009 includes an
explanatory paragraph regarding substantial doubt about our ability to continue
as a going concern. Our plans to address this matter include raising additional
financing through the sale of our securities. We have no commitment for any such
financing and any such financing may not be available on acceptable terms or at
all. As of March 30, 2010, 359,729,736 shares of our common stock and 5,000,000
shares of our preferred stock are authorized and available for issuance at the
discretion of our board of directors.  As described above, our
preferred stock may be issued in one or more series with dividend, liquidation,
conversion, voting or other rights superior to those of the holders of our
common stock. If we raise additional funds by issuing equity securities or
convertible debt securities, further dilution to existing stockholders may
result. If adequate funds are not available, our business, financial condition
and results of operations and the market price of our common stock would be
materially adversely affected.


31


We
may not be able to meet our liquidity needs or to access capital when necessary
because of adverse capital and credit market conditions.





We have
historically relied on private placements of equity and debt to fund our
operating losses and capital expenditure. During the past 24 months, the capital
and credit markets experienced volatility and disruption. Disruptions,
uncertainty or volatility in the capital and credit markets may limit our
ability to access the capital necessary to operate and grow our business.
Adverse capital and credit market conditions may force us to delay raising
capital or bear an unattractive cost of capital which could significantly reduce
our financial flexibility. Our results of operations, financial condition, cash
flows and capital position and the market value of our common stock could be
materially adversely affected by disruptions in the financial
markets.


If
we sell additional shares of our common stock or preferred stock, we may not be
able to fully utilize our net operating loss carryforwards and certain other tax
attributes.


As of
December 31, 2009, we had net operating loss carryforwards of approximately
$14,500,000 for Federal and state income tax purposes. Under Section 382 of
the Internal Revenue Code, if a corporation undergoes an “ownership change,” the
corporation’s ability to use its pre-change net operating loss carryforwards and
other pre-change tax attributes to offset its post-change income may be limited.
An ownership change is defined for these purposes as a greater than 50% change
in its equity ownership by value over a three-year period. We may also
experience ownership changes in the future as a result of subsequent changes in
our stock ownership.


This
section describes circumstances or events that could have a negative effect on
our financial results or operations or that could change, for the worse,
existing trends in our businesses. The occurrence of one or more of the
circumstances or events described below could have a material adverse effect on
our financial condition, results of operations and cash flows or on the trading
prices of our common stock. The risks and uncertainties described in this annual
report are not the only ones facing us. Additional risks and uncertainties that
currently are not known to us or that we currently believe are immaterial also
may adversely affect our businesses and operations.




Item
      1B.
            Unresolved
      Staff Comments




Not
applicable.




Item 2. Properties




Our
manufacturing facility, consisting of approximately 8,800 square feet, is
located at 2166 Brighton Henrietta Townline Road, Rochester, New York 14623, and
our research and development, sales and administration offices, consisting of
approximately 9,600 square feet, are located in two different suites at 75
Town Centre Drive, Rochester, New York 14623. We currently pay approximately
$65,000 per year in rent for our manufacturing facility and $110,000 per year
for our research and development, sales and administration offices. The
manufacturing facility is leased on a calendar year term. Our lease on both our
office suites expires in June 2010 and we intend to renew the lease on
substantially the same terms before its expiration.


We
believe that each of our facilities is in good operating condition and
adequately serves our needs currently and if leases were renewed could for at
least the next 12 months. However we intend to start re-consolidating our
facilities within 24 months. This will be done for efficiency reasons. We
anticipate that, if required, suitable additional or alternative space would be
available on commercially reasonable terms to accommodate expansion of our
operations.


Item 3. Legal
Proceedings




As at
December 31, 2009, we are not a party to, and our property is not the subject
of, any legal proceedings, and we are not aware of any such proceedings
contemplated by or against us or our property.




Item 4. Submission of
Matters to a Vote of Security Holders




In
connection with the initial public offering of our comment stock and warrants,
by written consent dated as of December 7, 2009 in lieu of a meeting, pursuant
to Section 228 of the Delaware General Corporation Law and our bylaws, the
holders of a majority of our then outstanding common stock approved our amended
and restated certificate of incorporation, our amended and restated bylaws and
our 2009 Stock Option Plan.




32




PART
II




Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities




Market
for our Common Stock and Warrants




Our
common stock and warrants are currently traded on the TSX Venture Exchange, or
the “TSX-V”, under the symbols “VZX” and “VZX.WT”,
respectively.  Trading of our common stock and warrants on the TSX-V
began on January 5, 2010. Prior to January 5, 2010, there was no public market
for our common stock or warrants.  There is currently no established
public trading market for our common stock or warrants in the United
States.




Holders
of Record




On March
30, 2010, there were 196 holders of record of our common stock and
warrants. Because many shares of our common stock and warrants are held by
brokers and other institutions on behalf of individual owners, we are unable to
determine the exact number of beneficial owners represented by these record
holders.




Dividends




We
currently do not pay regular dividends on our outstanding stock. The declaration
of any future dividends and, if declared, the amount of any such dividends, will
be subject to our actual future earnings, capital requirements, regulatory
restrictions, debt covenants, other contractual restrictions and to the
discretion of our board of directors. Our board of directors may take into
account such matters as general business conditions, our financial condition and
results of operations, our capital requirements, our prospects and such other
factors as our board of directors may deem relevant.




Issuer
Purchases of Equity Securities




There
were no purchases by Vuzix during the quarter or year ended December 31, 2009 of
equity securities that are registered under Section 12 of the Exchange
Act.




Equity
Compensation Plan Information




The
following table provides information about our equity compensation plans as of
December 31, 2009.




Number of
                  Securities to
                
                
                Weighted
                  Averagebe Issued Upon
                  Exercise
                
                
                Exercise Price
                  of
                
                Number of
                  Securitiesof Outstanding
                  Options,
                
                
                Outstanding
                  Options,
                
                Remaining
                  Available forPlan Category
                
                Warrants and
                  Rights
                
                
                Warrants
                  and Rights
                
                Future Issuance
                  (1)Equity
      compensation plans approved by security holders
                
                
                15,885,578
                
                
                $
                0.0914
                
                35,800,000Equity
      compensation plans not approved by security holders
                
                
                —
                
                
                
                —
                
                —Total
                
                
                15,885,578
                
                
                $
                0.0914
                
                35,800,000





(1)
            The amount appearing under
      “Number of securities remaining available for future issuance under equity
      compensation plans” includes shares available under our 2009 Stock Option
      Plan.





Item
      6.
            Selected
      Financial Data


SELECTED
FINANCIAL AND OTHER DATA


The following tables
present our summary financial data and should be read together with our
financial statements and accompanying notes and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” appearing elsewhere
in this annual report. The summary financial data for the years ended
December 31, 2009, 2008 and 2007 are derived from our audited annual
financial statements, which are included elsewhere in this annual
report.




33




Year
      Ended December 31,Statement of Operations
Data
                                    
                                    2009
                                    
                                    
                                    2008
                                    
                                    
                                    2007Sales
                                    
                                    $
                                    11,886,098
                                    
                                    
                                    $
                                    12,489,884
                                    
                                    
                                    $
                                    10,146,379Cost
      of Sales
                                    
                                    
                                    7,609,091
                                    
                                    
                                    
                                    8,788,905
                                    
                                    
                                    
                                    6,783,473Gross
      Margin
                                    
                                    
                                    4,277,007
                                    
                                    
                                    
                                    3,700,979
                                    
                                    
                                    
                                    3,362,906Operating
      ExpensesResearch
      and development
                                    
                                    
                                    2,217,627
                                    
                                    
                                    
                                    3,366,518
                                    
                                    
                                    
                                    2,365,412Selling
      and marketing
                                    
                                    
                                    2,143,628
                                    
                                    
                                    
                                    2,128,625
                                    
                                    
                                    
                                    1,920,164General
      and administrative
                                    
                                    
                                    2,354,573
                                    
                                    
                                    
                                    2,299,685
                                    
                                    
                                    
                                    1,718,627Depreciation
      and amortization
                                    
                                    
                                    522,457
                                    
                                    
                                    
                                    510,133
                                    
                                    
                                    
                                    374,078Total
      operating expenses
                                    
                                    
                                    7,238,285
                                    
                                    
                                    
                                    8,304,961
                                    
                                    
                                    
                                    6,378,281Profit
      (Loss) from operations
                                    
                                    
                                    (2,961,278
                                    )
                                    
                                    
                                    (4,603,982
                                    )
                                    
                                    
                                    (3,015,375
                                    )Interest
      and other income (expense)
                                    
                                    
                                    63
                                    
                                    
                                    
                                    188
                                    
                                    
                                    
                                    2,549Foreign
      exchange (loss) gain
                                    
                                    
                                    (22,226
                                    )
                                    
                                    
                                    (24,216
                                    )
                                    
                                    
                                    —Interest
      expense
                                    
                                    
                                    (297,200
                                    )
                                    
                                    
                                    (260,977
                                    )
                                    
                                    
                                    (241,692
                                    )Legal
      settlement
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    96,632Tax
      (expense) benefit
                                    
                                    
                                    (30,217
                                    )
                                    
                                    
                                    (5,212
                                    )
                                    
                                    
                                    98,372Total
      tax and other income (expense)
                                    
                                    
                                    (349,580
                                    )
                                    
                                    
                                    (290,217
                                    )
                                    
                                    
                                    (44,139
                                    )Net
      (Loss)
                                    
                                    $
                                    (3,250,424
                                    )
                                    
                                    $
                                    (4,894,199
                                    )
                                    
                                    $
                                    (3,059,514
                                    )Income
      (loss) per share:Basic
      and fully diluted*
                                    
                                    $
                                    (0.0151
                                    )
                                    
                                    $
                                    (0.0240
                                    )
                                    
                                    $
                                    (0.0176
                                    )Weighted
      average common shares outstanding:Basic
      and fully diluted*
                                    
                                    
                                    221,469,554
                                    
                                    
                                    
                                    207,710,498
                                    
                                    
                                    
                                    185,263,660





*All
outstanding warrants, options, and convertible debt are anti-dilutive, therefore
basic and diluted earnings per share are the same for all
periods.


Year Ended
      December 31,Cash
      Flow Data
                          
                          2009
                          
                          
                          2008
                          
                          
                          2007Cash
      flows (used in) operating activities
                          
                          $
                          (2,318,827
                          )
                          
                          $
                          (1,285,449
                          )
                          
                          $
                          (3,295,900
                          )Cash
      flows (used in) investing activities
                          
                          
                          (472,456
                          )
                          
                          
                          (549,804
                          )
                          
                          
                          (316,743
                          )Cash
      flows provided by financing activities
                          
                          
                          4,473,087
                          
                          
                          
                          2,289,116
                          
                          
                          
                          3,408,328


34




As of
      December 31,Balance
      Sheet Data
                          
                          2009
                          
                          
                          2008
                          
                          
                          2007Cash
      and cash equivalents
                          
                          $
                          2,500,523
                          
                          
                          $
                          818,719
                          
                          
                          $
                          364,856Working
      Capital (deficiency)
                          
                          
                          1,042,257
                          
                          
                          
                          (1,846,289
                          )
                          
                          
                          966,658Total
      Assets
                          
                          
                          8,408,825
                          
                          
                          
                          6,221,897
                          
                          
                          
                          6,967,254Long-Term
      Liabilities
                          
                          
                          2,833,206
                          
                          
                          
                          1,754,379
                          
                          
                          
                          2,014,476Accumulated
      (deficit)
                          
                          
                          (18,032,430
                          )
                          
                          
                          (14,687,276
                          )
                          
                          
                          (9,691,977
                          )Total
      Stockholders’ equity (deficit)
                          
                          
                          (330,225
                          )
                          
                          
                          (2,089,942
                          )
                          
                          
                          423,236




Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations




You
should read the following discussion and analysis of financial condition and
results of operations in conjunction with the “Selected Financial and Other
Data” and our financial statements and related notes appearing elsewhere in this
annual report. In addition to historical information, the following discussion
and analysis includes forward looking statements that involve risks,
uncertainties and assumptions. Our actual results and the timing of events could
differ materially from those anticipated in these forward looking statements as
a result of a variety of factors, including those discussed in “Risk Factors”
and elsewhere in this annual report. See the discussion under “Forward Looking
Statements” beginning on page 3 of this annual report.
  Overview




We are
engaged in the design, manufacture, marketing and sale of devices that are worn
like eyeglasses and feature built-in video screens that enable the user to view
video and digital content, such as movies, computer data, the Internet or video
games. Our products (known commercially as Video Eyewear, but also commonly
referred to as virtual displays, wearable displays, personal viewers, head
mounted displays, or near-to-eye displays) are used to view high-resolution
video and digital information primarily from mobile electronic devices (such as
cell phones, portable media players, gaming systems and laptop computers) and
from desktop computers. Our products provide the user a viewing experience that
simulates viewing a large screen television or a desktop computer
monitor.


Our Video
Eyewear products feature high performance miniature display modules, low power
electronics and related optical systems. We produce both monocular and binocular
Video Eyewear devices that we believe are excellent solutions for many mobile
computer or video viewing requirements. We focus on two markets: the consumer
markets for gaming and mobile video and rugged mobile displays for defense and
industrial applications. We also offer low-vision assist Video Eyewear products
that are designed to assist and improve the remaining vision of many people
suffering from macular degeneration.


Since our
inception in 1997, we have derived the majority of our sales from fees paid to
us under research and development contracts and related volume manufacturing
services primarily of night vision display electronics as a sub-contractor to
defense suppliers to the US government. Since 2005, we have devoted significant
resources to the development and commercial launch of our industrial and
consumer products. During 2009, 2008 and 2007, we derived 41.3%, 35.6 and 32.4%,
respectively, of our sales from our consumer Video Eyewear
products.


We
believe our intellectual property portfolio gives us a leadership position in
microdisplay electronics, ergonomics, packaging, motion tracking and optical
systems.


Critical
Accounting Policies and Significant Developments and Estimates


The
discussion and analysis of our financial condition and results of operations are
based on our financial statements and related notes appearing elsewhere in this
annual report. The preparation of these statements in conformity with generally
accepted accounting principles requires the appropriate application of certain
accounting policies, many of which require us to make estimates and assumptions
about future events and their impact on amounts reported in our financial
statements, including the statement of operations, balance sheet, cash flow and
related notes. Since future events and their impact cannot be determined with
certainty, the actual results will inevitably differ from our estimates. Such
differences could be material to the financial
statements.


35





We
believe that our application of accounting policies, and the estimates
inherently required therein, are reasonable. These accounting policies and
estimates are periodically reevaluated, and adjustments are made when facts and
circumstances dictate a change. Historically, we have found our application of
accounting policies to be appropriate, and actual results have not differed
materially from those determined using necessary estimates.


Our
accounting policies are more fully described in the notes to our financial
statements included in this annual report. In reading our financial statements,
you should be aware of the factors and trends that our management believes are
important in understanding our financial performance. The critical accounting
policies, judgments and estimates that we believe have the most significant
effect on our financial statements are:




•
            valuation of
      inventories;




•
            carrying value of long-lived
      assets;




•
            valuation of intangible
      assets;




•
            revenue
      recognition;




•
            product
      warranty;




•
            stock-based
      compensation; and




•
            income
    taxes.




Valuation
of Inventories


Inventory
is stated at the lower of cost or market, with cost determined on a first-in,
first-out method. Inventory includes purchased parts and components, work in
process and finished goods. Provisions for excess, obsolete or slow moving
inventory are recorded after periodic evaluation of historical sales, current
economic trends, forecasted sales, estimated product lifecycles and estimated
inventory levels. Purchasing practices, electronic component obsolescence,
accuracy of sales and production forecasts, introduction of new products,
product lifecycles, product support and foreign regulations governing hazardous
materials are the factors that contribute to inventory valuation risks. Exposure
to inventory valuation risks is managed by maintaining safety stocks, minimum
purchase lots, managing product and end-of-life issues brought on by aging
components or new product introductions, and by utilizing certain inventory
minimization strategies such as vendor-managed inventories. The accounting
estimate related to valuation of inventories is considered a “critical
accounting estimate” because it is susceptible to changes from period-to-period
due to the requirement for management to make estimates relative to each of the
underlying factors, ranging from purchasing, to sales, to production, to
after-sale support. If actual demand, market conditions or product lifecycles
differ from estimates, inventory adjustments to lower market values would result
in a reduction to the carrying value of inventory, an increase in inventory
write-offs and a decrease to gross margins.


Carrying
Value of Long-Lived Assets


If facts
and circumstances indicate that a long-lived asset, including a products’ mold
tooling and equipment, may be impaired, the carrying value is reviewed in
accordance with FASB ASC Topic 360-10. If this review indicates that the
carrying value of the asset will not be recovered as determined based on
projected undiscounted cash flows related to the asset over its remaining life,
the carrying value of the asset is reduced to its estimated fair value. To date,
no impairment on long-lived assets has been booked. Impairment losses in the
future will be dependent on a number of factors such as general economic trends
and major technology advances, and thus could be significantly different than
historical results.


Valuation
of Intangible Assets


We
perform a valuation of intangible assets when events or circumstances indicate
their carrying amounts may be unrecoverable. We have not impaired the value of
certain intellectual property, such as patents and trademarks, which were valued
(net of accumulated amortization) at $759,356 as of December 31, 2009,
because management believes that its value is
recoverable.


36


Revenue
Recognition


Revenue
from product sales is recognized in accordance with FASB ASC Topic 605, Revenue Recognition
  Product sales represent the majority of our revenue. We recognize
revenue from these product sales when persuasive evidence of an arrangement
exists, delivery has occurred or services have been provided, the sale price is
fixed or determinable, and collectability is reasonably assured. Additionally,
we sell our products on terms which transfer title and risk of loss at a
specified location, typically shipping point. Accordingly, revenue recognition
from product sales occurs when all factors are met, including transfer of title
and risk of loss, which typically occurs upon shipment by us. If these
conditions are not met, we will defer the revenue recognition until such time as
these conditions have been satisfied. We collect and remit sales taxes in
certain jurisdictions and report revenue net of any associated sales taxes. We
also sell certain products through distributors who are granted limited rights
of return for stock balancing against purchases made within a prior 90 day
period, including price adjustments downwards on any existing inventory. The
provision for product returns and price adjustments is assessed for adequacy
both at the time of sale and at each quarter end and is based on recent
historical experience and known customer claims.


Revenue
from any engineering consulting and other services is recognized at the time the
services are rendered. For our longer-term development contracts, which to date
have all been firm, fixed-priced contracts, we recognize revenue on the
percentage-of-completion method. Under this method income is recognized as work
on contracts progresses, but estimated losses on contracts in progress are
charged to operations immediately. To date, all of our longer-term development
contracts have been less than one calendar year in duration. We generally submit
invoices for our work under these contracts on a monthly basis. The
percentage-of-completion is determined using the cost-to-cost
method.


The
accounting estimate related to revenue recognition is considered a “critical
accounting estimate” because terms of sale can vary, and judgment is exercised
in determining whether to defer revenue recognition. Such judgments may
materially affect net sales for any period. Judgment is exercised within the
parameters of GAAP in determining when contractual obligations are met, title
and risk of loss are transferred, sales price is fixed or determinable and
collectability is reasonable assured.


Product
Warranty


Warranty
obligations are generally incurred in connection with the sale of our products.
The warranty period for these products is generally one year, but can be
24 months in certain countries if required by law, such as in Europe.
Warranty costs are accrued, to the extent that they are not recoverable from
third party manufacturers, for the estimated cost to repair or replace products
for the balance of the warranty periods. We provide for the costs of expected
future warranty claims at the time of product shipment or over-builds to cover
replacements. The adequacy of the provision is assessed at each quarter end and
is based on historical experience of warranty claims and costs. The costs
incurred to provide for these warranty obligations are estimated and recorded as
an accrued liability at the time of sale. Future warranty costs are estimated
based on historical performance rates and related costs to repair given
products. The accounting estimate related to product warranty is considered a
“critical accounting estimate” because judgment is exercised in determining
future estimated warranty costs. Should actual performance rates or repair costs
differ from estimates, revision to the estimated warranty liability would be
required.


Research
and Development


Research
and development costs, are expensed as incurred consistent with the guidance of
FASB ASC Topic 730, “Research and Development,” and include employee
related costs, office expenses, third party design and engineering services, and
new product prototyping costs.


Stock-Based
Compensation


Our board
of directors approves grants of stock options to employees to purchase our
common stock.  A stock compensation expense is recorded based upon the
estimated fair value of the stock option at the date of grant. The accounting
estimate related to stock-based compensation is considered a “critical
accounting estimate” because estimates are made in calculating compensation
expense including expected option lives, forfeiture rates and expected
volatility. The fair market value of our common stock on the date of each option
grant was determined based on the most recent cash sale of common stock in an
arm’s length transaction with an unrelated third party. We engaged in at least
one such transaction during each of our last four fiscal years. Expected option
lives are estimated using vesting terms and contractual lives. Expected
forfeiture rates and volatility are calculated using historical information.
Actual option lives and forfeiture rates may be different from estimates and may
result in potential future adjustments which would impact the amount of
stock-based compensation expense recorded in a particular period.
 37


Income
Taxes





We have
historically incurred domestic operating losses from both a financial reporting
and tax return standpoint. Accordingly, we provide deferred income tax assets
and liabilities based on the estimated future tax effects of differences between
the financial and tax bases of assets and liabilities based on currently enacted
tax laws. A valuation allowance is established for deferred tax assets in
amounts for which realization is not considered more likely than not to occur.
The accounting estimate related to income taxes is considered a “critical
accounting estimate” because judgment is exercised in estimating future taxable
income, including prudent and feasible tax planning strategies, and in assessing
the need for any valuation allowance. To date we have determined a 100%
valuation allowance is required and accordingly no amounts have been reflected
in our consolidated financial statements. In the event that it should be
determined that all or part of a deferred tax asset in the future is in excess
of the nil amount currently recorded, an adjustment of the valuation allowance
would increase income to be recognized in the period such determination was
made.


In
addition, the calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. As a result we
recognize liabilities for uncertain tax positions based on the two-step process
prescribed within the interpretation. The first step is to evaluate the tax
position for recognition by determining if the weight of available evidence
indicates that it is more likely than not that the position will be sustained on
audit, including resolution of related appeals or litigation processes, if any.
The second step requires us to estimate and measure the tax benefit as the
largest amount that is more than 50% likely of being realized upon ultimate
settlement. It is inherently difficult and subjective to estimate such amounts,
as this requires us to determine the probability of various possible outcomes.
We re-evaluate these uncertain tax positions on a quarterly basis. This
evaluation is based on factors including, but not limited to, changes in facts
or circumstances, changes in tax law, effectively settled issues under audit and
new audit activity. Such a change in recognition or measurement would result in
the recognition of a tax benefit or an additional charge to the tax provision in
the period.


Finally,
any future recorded value of our deferred tax assets will be dependent upon our
ability to generate future taxable income in the jurisdictions in which we
operate. These assets consist of research credit carry-forwards, capital and net
operating loss carry-forwards and the future tax effect of temporary differences
between balances recorded for financial statement purposes and for tax return
purposes. It will require future pre-tax earnings in excess of $14,000,000 in
order to fully realize the value of our unrecorded deferred tax assets. If we
were to sustain future net losses, it may be necessary to record valuation
allowances against such deferred tax assets in order to recognize impairments in
their estimated future economic value.


Off
Balance Sheet Arrangements


We do not
have any off-balance sheet arrangements that have, or are reasonably likely to
have, an effect on our financial condition, financial statements, revenues or
expenses.


Recent
Accounting Pronouncements


The
Company adopted, as of July 1, 2009, the Financial Accounting Standards Board’s
(“FASB’s”) Accounting Standards Codification (“ASC”) as the source of
authoritative accounting principles recognized by the FASB to be applied to
nongovernmental entities in the preparation of financial statements in
conformity with GAAP. The ASC does not change authoritative guidance.
Accordingly, implementing the ASC did not change any of our accounting, and
therefore, did not have an impact on our consolidated results. References to
authoritative GAAP literature have been updated accordingly.


On
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 320-10-65
(formerly FSP FAS 107-1 and APB 28-1) “Interim Disclosures about Fair Value of
Financial Instruments”. This update requires fair value disclosures for
financial instruments that are not currently reflected on the balance sheet at
fair value on a quarterly basis. The adoption of ASC Topic 320-10-65 did not
have a material impact on our consolidated financial statements.


On
January 1, 2009, the Company adopted the provisions of ASC 815-10 (formerly FASB
Statement 161, “Disclosures about Derivative Instruments and Hedging Activities
— an amendment of FASB Statement No. 133”). FASB ASC 815-10 requires enhanced
disclosures about an entity’s derivative and hedging activities. FASB ASC 815-10
is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008 with early application encouraged. The
adoption of this pronouncement did not have a material impact on our
consolidated financial statements.


38





On
January 1, 2009, the Company adopted FASB ASC topic 815-40 “Determining Whether
an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock”
(formerly EITF 07-5). ASC topic 815-40 provides guidance on determining whether
an instrument (or an embedded feature) is indexed to an entity’s own stock,
which would qualify as a scope exception under prior authoritative literature
FASB No. 133. “Accounting for Derivative Instruments and Hedging Activities” ASC
815-40 is effective for fiscal years beginning after December 15, 2008. The
adoption ASC topic 815-40 did not have a material impact on our consolidated
financial statements.


In May
2009, the Company adopted FASB ASC topic 855, “Subsequent Events”. This
Statement sets forth: (i) the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements; (ii)
the circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and (iii)
the disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. The adoption of ASC topic 855 did not
have a material impact on our consolidated financial statements.


In June
2009, the FASB issued ASC topic 105 “Generally Accepted Accounting Principles”,
(formerly Statement of Financial Standards (SFAS) No. 168, The Hierarchy of
Generally Accepted Accounting Principles). ASC topic 105 contains guidance which
reduces the U.S. GAAP hierarchy to two levels, one that is authoritative and one
that is not. This pronouncement was effective September 15, 2009. The adoption
of this pronouncement did not have a material impact on our consolidated
financial statements.


In
September 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-08,
“Earnings Per Share” Amendments to Section 260-10-S99. This Codification Update
represents technical corrections to Topic 260-10-S99, Earnings per Share, based
on EITF Topic D-53, “Computation of Earnings Per Share for a Period that
Includes a Redemption or an Induced Conversion of a Portion of a Class of
Preferred Stock” and EITF Topic D-42, The Effect of the Calculation of Earnings
per Share for the Redemption or Induced Conversion of Preferred Stock goes into
effect in the period that includes a redemption or induced conversion. Adoption
of this new guidance did not have a material impact on our consolidated
financial statements.


In
October 2009, the FASB issued ASC 605-25 “Revenue Recognition — Multiple-
Deliverable Revenue Arrangement” that will become effective beginning July 1,
2010, with earlier adoption permitted. Under the new guidance, when vendor
specific objective evidence or third party evidence for deliverables in an
arrangement cannot be determined, a best estimate of the selling price is
required to separate deliverables and allocate arrangement consideration using
the relative selling price method. The new guidance includes new disclosure
requirements on how the application of the relative selling price method affects
the timing and amount of revenue recognition. We believe adoption of this new
guidance will not have a material impact on our consolidated financial
statements.


In
January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and
Disclosures” which improves disclosures about the measurement of the fair value
of financial instruments including (1) the different classes of assets and
liabilities measured at fair value, (2) the valuation techniques and inputs
used, (3) the activity in Level 3 fair value measurements, and (4) the transfers
between Levels 1, 2, and 3 of the fair value inputs hierarchy. The guidance is
effective for fiscal years and interim periods ended after December 15, 2009.
The adoption of the guidance did not have a material impact on our consolidated
financial statements.


Key
Performance Indicators


We
believe that a key indicator for our business is the trend for the volume of
orders received from customers, especially those orders related to night-vision
electronic modules. During weak economic periods, customers’ ability to forecast
their requirements deteriorates causing delays in the placement of orders.
Forward-looking visibility on customer orders is at an all time low. Our major
night-vision electronics modules customers (Kopin and DRS Technologies, Inc.)
are placing orders for product only when they have orders in hand from their
governmental customer. Total shipments of night vision electronics module
customers in 2009, 2008 and 2007 were $5,278,673, $6,068,449 and $1,418,249,
respectively.


39


Comparison
of Fiscal Years Ended December 31, 2009 and December 31,
2008


Sales.   Our sales
were $11,886,098 for 2009 compared to $12,489,884 for 2008. This represents a
4.8% decrease for the year 2009 over the year 2008. Our sales from defense
products decreased to $6,020,420 or 50.7% of our total sales in 2009 compared to
$6,397,221 or 51.2% of total sales in 2008, a decrease of $376,801 or 5.9%. The
decrease resulted primarily from lower shipments of night vision electronics in
2009 as compared to 2008. Sales from our defense-related engineering programs
decreased to $924,863 or 7.8% of total sales compared to $1,548,703 or 12.4% of
total sales in 2008. The decrease in 2009 was the result of delays in the
awarding of a new program and decreased engineering service awards received by
us. Consumer Video Eyewear product sales increased to $4,912,591 or 41.3% of
total sales for 2009 compared to $4,451,121 or 35.6% of our total sales for
2008. This increase resulted from the continued expansion of our reseller
network and the introduction of new products. Low-vision assist sales,
consisting mainly of sales of low-vision assist products, were $28,224 or 0.2%
of total sales in 2009 versus $92,839 or 0.7% of total sales in
2008.


Cost of Sales and Gross
Margin.   Gross margin increased to $4,277,007 for 2009 from
$3,700,979 for 2008, an increase of $576,028 or 15.6%. As a percentage of net
sales, gross margin increased to 36.0% for 2009 compared to 29.6% for 2008. This
increase was the result of lower production costs, increased sales of our high
resolution Video Eyewear models with their higher margins, and higher selling
prices of our products in Japan and Europe.


Research and Development.
  Our research and development expenses decreased by $1,148,891 or
34.1%, to $2,217,627 compared to $3,366,518 in 2008. This was due to less
reliance on more expensive external contractors and prototyping services and the
staff reductions that were implemented in late 2008. Expenses we incur under
government funded engineering programs are included in costs of goods
sold.


Selling and Marketing.
  Selling and marketing expenses were $2,143,628 for 2009 compared to
$2,128,625 for 2008, an increase of $15,003 or 0.7%. As a percentage of total
sales, the selling and marketing expenses increased to 18.2% of sales for 2009
compared to 17.0% for 2008 reflecting our higher overall percentage of consumer
Video Eyewear sales for which we invest more advertising dollars. The absolute
dollar increase was primarily due to increased advertising expenses in several
print publications and higher participation in paid catalog advertising with our
resellers in the USA.


General and Administrative.
  General and administrative expenses were $2,354,573 for 2009 as
compared to $2,299,685 for 2008, an increase of $54,888 or 2.4%. The higher
general and administrative related to increases in staff and personnel costs,
and increased legal expenses.


Depreciation and
Amortization.   Our depreciation and amortization expense for
2009 increased by $12,324, or 2.4% to $522,457, compared to $510,133 in 2008.
The increase was related to increased depreciation on new capital expenditures
in 2009 and 2008.


Other Income (Expense).
  Total other expenses, consisting primarily of interest expense, was
$(319,363) in 2009 compared to $(285,005) in 2008. The increase in expenses was
primarily attributable to interest costs on our increased borrowings and higher
interest rates in 2009 as compared to 2008.


Provision (Benefit) for Income
Taxes.   The provision for income taxes for 2009 was $(30,217)
compared to $5,212 for 2008.The balance of each year’s tax provision was
primarily for franchise taxes payable to the State of Delaware, our state of
incorporation. These taxes were $5,212 for 2008.


Net (Loss) and (Loss) per
Share.   Our net loss was $(3,250,424) or $(0.0151) per share
in 2009, a decreased loss of $1,643,775, or 33.6%, from $(4,894,199) or
$(0.0240) per share in 2008.


Comparison
of Fiscal Years Ended December 31, 2008 and December 31,
2007


Sales.   Our sales
were $12,489,884 for the year ended December 31, 2008 compared to
$10,146,379 for the year ended December 31, 2007. This represents a 23.1%
increase for the year 2008 over the year 2007. Our sales from defense products
increased to $6,397,221 or 51.2% of our total sales in 2008 versus $1,418,249 or
14.0% of total sales in 2007, an increase of $4,978,972 or 351.1%. The increase
resulted primarily from new orders of night vision drive electronics from prime
contractors and the introduction of our Tac-Eye® display product line in the
fourth quarter of 2008. Sales from our defense-related engineering programs
decreased in 2008 to $1,548,703 or 12.4% of total sales versus $5,445,375 or
53.7% of total sales in 2007. The large decrease in fiscal 2008 was the result
of the start and completion of a $4,300,000 engineering program in late 2007.
Consumer Video Eyewear product sales increased to $4,451,121 or 35.64% of total
sales for the year ended December 31, 2008 compared to $3,282,755 for our
2007 year or 32.4% of 2007’s total sales. This 35.6% sales dollar increase
resulted from a broader Video Eyewear product line and increased distribution in
the United Kingdom and Japan. Low-vision assist sales, consisting mainly of
sales of low-vision assist products, were $92,839 or 0.7% of total sales in
fiscal 2008 versus none in fiscal 2007.


40





Cost of Sales and Gross
Margin.   Gross margin increased to $3,700,979 for fiscal 2008
from $3,362,906 for fiscal 2007, an increase of $338,073 or 10.1%. As a
percentage of net sales, gross margin decreased to 29.6% for fiscal 2008
compared to 33.1% for fiscal 2007. This reduction was the result of changes in
our revenue mix and related margins. Generally, we earn a higher gross margin on
engineering only programs as compared to the gross margin on products, in which
we incur cost of goods or volume production costs. Engineering services revenues
decreased to 12.4% as a percentage of total sales in 2008 versus 53.7% of total
sales in 2007, resulting in the majority of the reduction in overall gross
margin in 2008 versus fiscal 2007.


Research and Development.
  Our research and development expenses in 2008 increased by
$1,001,106, or 42.3%, to $3,366,518 in fiscal 2008 versus $2,365,412 in 2007.
This was due to increased internal development activities and less direct
support of our research under government funded engineering programs. Expenses
we incur under government funded engineering programs are included in costs of
goods sold.


Selling and Marketing.
  Selling and marketing expenses were $2,128,625 for fiscal 2008 as
compared to $1,920,164 for fiscal 2007, an increase of $208,461 or 10.9%.
Despite the increase in absolute dollars, as a percentage of total sales, the
selling and marketing expenses decreased to 17.0% of sales for fiscal 2008 as
compared to 18.9% for fiscal 2007. The absolute dollar increase was primarily
due to increased advertising expenses along with increased marketing support
paid out to our expanded consumer products resellers and the introduction of
in-store point of purchase displays with US resellers.


General and Administrative.
  General and administrative expenses were $2,299,685 for fiscal 2008
as compared to $1,718,627 for fiscal 2007, an increase of $581,058 or 33.8%. The
higher general and administrative related to increases in staff and personnel
costs, and increased legal expenses.


Depreciation and
Amortization.   Our depreciation and amortization expense
increased by $136,055, or 36.4%, to $510,133 in 2008 versus $374,078 in 2007.
The increase was related to increased depreciation on new capital expenditures
in 2008 and 2007.


Other Income (Expense).
  Total other expenses, consisting primarily of interest expense, was
$(285,005) in 2008 versus $(142,511) for 2007. The increase in expenses was
primarily attributable to an offsetting legal settlement received during 2007 in
the amount of $96,632.


Provision (Benefit) for Income
Taxes.   The provision for income taxes for the year ended
December 31, 2008 was $5,212 versus a net benefit of ($98,372) in
2007. The 2007 net benefit includes our accrual of $130,130 in
New York State tax credits for our research and development activities. The
balance of each year’s tax provision was primarily for franchise taxes payable
to the State of Delaware, our state of incorporation. These taxes were $5,212
for 2008 and $31,758 for 2007. This decrease was a result of the 8-for-1 split
of our common stock in July 2008.


Net (Loss) and (Loss) per
Share.   Our net loss was $(4,894,199) or $(0.0240) per share
in 2008, an increased loss of $(1,834,685), or (60.0)%, from $(3,059,514) or
$(0.0176) per share in 2007.


Liquidity
and Capital Resources


As of
December 31, 2009, we had cash and cash equivalents of $2,500,523, an increase
of $1,681,804 from $818,719 as of December 31, 2008.


Our cash
requirements are primarily for research and development, product tooling, and
working capital. Historically, we have met these requirements through capital
generated from the sale and issuance of our common equity securities,
convertible debt and notes payable to private investors, cash flow provided by
operations and our revolving bank lines of credit. The large increase in cash
was a direct result of our IPO.


Operating Activities.
  Cash (used in) operating activities was $(2,318,827) in 2009 and
$(1,285,449) in 2008. Changes in operating assets and liabilities, excluding
cash, provided (used) cash were $53,941 in 2009 and $2,785,425 in fiscal 2008.
An increase in our inventories of $652,315 along with a $826,407 decrease in
accounts payable and customer deposits of $559,006 as of December 31, 2009 were
offset primarily by the securing of $1,746,500 in deferrals of trade
payables.


Investing Activities.
  Cash used in investing activities was $472,456 in 2009 and $549,804
in 2008. Cash used for investing activities in 2009 related primarily to the
purchase of production tooling and computer software equipment additions. The
costs of registering our intellectual property rights, included in the investing
activities totals described above, were $134,594 in 2009 and $125,638 in
2008.


41





Financing Activities.
  Cash provided by financing activities was $4,473,087 in 2009 and
$2,289,116 in 2008. In January 2009, we sold shares of our common stock in a
private placement for aggregate gross proceeds of $300,000. In August, September
and November 2009, we issued $246,417 in principal amount of promissory notes
for the same amount of gross proceeds. In December 2009, we completed the
initial public offering of our common stock and warrants for aggregate net
proceeds of $3,897,942 after direct IPO offering costs of $(1,912,715). We sold
shares of our common stock for aggregate gross proceeds of $2,138,646 in
2008.


Capital Resources.
  As of December 31, 2009, we had a cash balance of $2,500,523.
We had $34,393 available under our bank lines of credit (the outstanding
balances under our lines of credit as of December 31, 2009 were $178,107). The
credit lines are with two banks, are payable on demand and secured by the
personal guarantee of our President and Chief Executive Officer, Paul J.
Travers. The bank credit agreements contain various restrictions on
indebtedness, liens, guarantees, redemptions, mergers, acquisitions or sale of
assets, loans, transactions with any affiliates, and investments. They also
prohibit us from declaring and paying cash dividends without the bank’s prior
consent.


On
September 19, 2006, we borrowed $500,000 from an individual lender and
issued a convertible promissory note in the principal amount of $500,000 in
evidence of the loan. Interest on the outstanding principal amount of the note
accrues at the annual rate of 10.0%. The outstanding principal amount of the
note, together with all accrued and unpaid interest thereon, is convertible at
the option of the holder into shares of our common stock at the rate of $0.2333
per share. The outstanding principal amount of the note together with all unpaid
accrued interest thereon was due and payable on January 31, 2009. As of
January 31, 2009, the interest accrued and unpaid on the note was $118,493.
Since January 31, 2009 interest on the principal amount of the note has accrued
at the annual rate of 18.0% and we made monthly payments of interest only during
2009. The loan principal of $500,000 was repaid in mid-January but not the
accrued interest which was $126,137 at December 31, 2009. The unpaid accrued
interest will accrue further interest at an annual rate of 12.0% beginning
January 15, 2010 and lender has agreed to not request any payments before August
31, 2010.


In
August, September, and November 2009, we borrowed an aggregate amount of
$246,417 from three individual lenders, including a total of $100,000 from Mr.
Paul Churnetski, our Vice President of Quality Assurance and the beneficial
owner of approximately 9% of our issued and outstanding common stock and $46,417
from William Lee, one of our external directors. These loans bore interest at an
annual rate of 18.0% and were all due prior to December 31, 2009, however none
of these lenders requested payment prior to that date. $150,000 was due and
payable on October 31, 2009 and the remaining $50,000 was due and payable
on November 24, 2009. As of December 31, 2009, the holders of these loans
have not demanded payment. We borrowed these funds to finance part of our
working capital investment for a defense order in process. The entire loan
amount along with accrued interest was repaid to these individuals in January
2010.


Our cash
requirements depend on numerous factors, including new product development
activities, our ability to commercialize our products, their timely market
acceptance, selling prices and gross margins, and other factors. To the extent
we have sufficient operating funds, we expect to carefully devote capital
resources to continue our development programs, hire and train additional staff,
expand our research and development activities, new product marketing and
increased inventory levels. Assuming we are able to increase our sales and
achieve our planned gross margins, we anticipate that we will also experience
growth in our operating expenses for the foreseeable future. Our future net
operating losses, product tooling expenses, and related working capital
investments will be the principal use of our cash. In particular, we expect that
potentially significant amounts of working capital investments in accounts
receivable and inventories that are not offset by corresponding increases in
accounts payable will use cash with our planned growth.


During
the year ended December 31, 2009, we have been unable to generate cash
flows sufficient to support our operations and have been dependent on equity
financings, including our IPO and debt raised from qualified investors.  We
remain dependent on outside sources of funding until our results of operations
provide positive cash flows.  Our independent auditors issued a going
concern explanatory paragraph in their report dated March 30, 2010. With
our current level of funding and ongoing losses from operations, substantial
doubt exists about our ability to continue as a going concern.


42


The
consolidated financial statements contained in this report do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be necessary
should we be unable to continue in existence.  Our ability to continue as a
going concern is dependent upon our ability to generate sufficient cash flows to
meet our obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain profitable operations.  However, there
is no assurance that profitable operations or sufficient cash flows will be
achieved or that we will be able to obtain any additional
financing.   If we are unable to achieve profitable operations or
obtain additional financing when needed, we could be required to modify our
business plan in accordance with the extent of available financing. We also may
not be able to accelerate the development and deployment of our products,
respond to competitive pressures, develop new or enhanced products or take
advantage of unanticipated acquisition opportunities. Finally, we may be
required to sell all or a portion of our assets or shut down the company and
cease operations.





We have
supported current operations by raising additional operating cash through our
IPO, bridge loans and the private sale of our convertible debentures and
preferred stock.  This has provided us with the cash inflows to continue
our business plan, but we received the low end of our recent IPO funding range
and as a result its closing in late December has not resulted in significant
improvement in our financial position. We are considering alternatives to
address our cash flow situation that include raising capital through additional
sale of our equity and/or debt securities, modifying our business plan in
accordance with the extent of available financing, and/or entering into a
strategic partnership.





This
could result in substantial dilution of existing stockholders. There can be no
assurance that our current financial position can be improved, that we can raise
additional working capital, or that we can achieve positive cash flows from
operations. Our long-term viability as a going concern is dependent upon our
ability to (i) locate sources of debt or equity funding to meet current
commitments and near-term future requirements and (ii) achieve
profitability and ultimately generate sufficient cash flow from operations to
sustain our continuing operations.




Unless
otherwise noted, the following discussion and analysis relates only to results
from continuing operations. The following discussion and analysis should be read
in conjunction with the consolidated financial statements and related notes
appearing elsewhere in this Form 10-K. We have the intent and ability to take
actions necessary for the Company to continue as a going concern, as discussed
herein, and accordingly our consolidated financial statements have been prepared
assuming that we will continue as a going concern. Management’s plans concerning
these matters are also discussed under “Liquidity and Capital Resources” below
and in Note 2 to the consolidated financial statements. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.




On
December 24, 2009, we completed our IPO and the sale of $5,810,657 common stock
units that resulted in us raising a net $3,897,942 dollars after expenses of the
transaction. The gross amount received was near the low-end of our targeted IPO
offering range of $6,000,000 to $10,000,000 Canadian dollars. At the time our
working capital deficit was approximately $4.0 million and we had two of our
major trade suppliers extend their trade payable totaling $1,746,500 out 13
months to January 15, 2011 to improve our net working capital position. We used
substantially all of the net proceeds of the IPO to repay all indebtedness
outstanding to trade suppliers and notes payable. We used the remaining net
proceeds for general corporate purposes and ongoing operating losses. The
completion of our IPO came too late for us to take advantage of the seasonal
demand in our consumer Video Eyewear products, and as a result, our results of
operations and liquidity were negatively impacted.




As a
result, we expect cash on hand and cash by the end of April 2010, will not be
sufficient to fund our anticipated cash requirements for maintaining full
operations minimum capital expenditures, working capital purposes, as well as
commitments and payments of principal and interest on borrowings for at least
the next twelve months. Our current fiscal 2010 plan contemplates a need for
more money to fund operating losses and maintain or grow our revenues as we are
constrained by limited working capital and reduced credit lines from our key
suppliers. We rely upon vendor financing in managing our liquidity. As a result,
if our trade creditors were to impose unfavorable terms on us, it would
negatively impact our ability to obtain products and services on acceptable
terms and operate our business. Such events along with a further deterioration
in our working capital would adversely affect our results of operations, cash
flows and financial performance.




When and
if we obtain sufficient additional financing, we do plan to return to our
business original strategy in 2010 of introducing new and improved products, we
will be limited in our pursuit of this strategy while we continue to manage our
liquidity. We plan to manage our liquidity under an operational plan that
contemplates, among other things:




•
              anaging our working capital
      through better optimization of inventory
  levels;


43




•
              focusing
      on selling higher gross margin products, which will mean a greater
      emphasis on defense versus consumer
  products;


•
              restructuring
      and reengineering our organization and processes to increase efficiency
      and reduce our operating costs for fiscal
2010;





•
              reducing
      public relations expenses for fiscal
2010;




•
              minimizing
      our capital expenditures by eliminating, delaying or curtailing
      discretionary and non-essential
spending;


•
              reducing
      the square footage we rent;




•
              reducing and deferring some
      research and development and delaying some planned product and new
      technology introductions;
and




•
              exploring our options with
      respect to new debt
borrowings;





We cannot make assurances
as to whether any of these actions can be effected on a timely basis, on
satisfactory terms or maintained once initiated, and even if successful, our
liquidity plan will limit certain of our operational and strategic initiatives
designed to grow our business over the long term. Furthermore, if we are unable
to generate sufficient cash flow from operations to service our indebtedness or
otherwise fund our operations, or if we are unable to restructure our
outstanding debt and/or equity securities, we could be forced to file for
protection under the U.S. Bankruptcy Code.




Item 8. Financial
Statements and Supplementary Data




The
information required by this item is incorporated herein by reference to pages
F-1 through F-27 of this annual report and is indexed under Item 15(a)(1) and
(2).




Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure




None.




Item 9A(T). Controls and
Procedures




(a)        Evaluation
of Disclosure Controls and Procedures


Our
management, including our Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this annual report as required by Rule 13a-15 under
the Securities Exchange Act of 1934 (the “Exchange Act”).  Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of the period covered by this annual report, our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Exchange Act) are effective, in all material respects, to ensure that
information we are required to disclose in reports that we file or submit under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.


(b)        Management’s
Annual Report on Internal Control Over Financial Reporting and Report of
Independent Registered Public Accounting Firm


This
annual report does not include a report of management’s assessment regarding
internal controls over financial reporting or an attestation report of our
registered public accounting firm due to a transition period established by the
rules of the Securities and Exchange Commission for newly public
companies.


(c)        Change
in Internal Control Over Financial Reporting


44




No change in our internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act) occurred during our most recent fiscal quarter that has materially
affected, or is likely to materially affect, our internal control over financial
reporting.




Item 9B.
Other Information




None.




PART
III




Item 10. Directors,
Executive Officers and Corporate Governance




The
information required by this item will be presented in our definitive proxy
statement not later than 120 days after the end of the fiscal year covered by
this annual report and is incorporated in this annual report by reference
thereto.




Item 11. Executive
Compensation




The
information required by this item will be presented in our definitive proxy
statement not later than 120 days after the end of the fiscal year covered by
this annual report and is incorporated in this annual report by reference
thereto, except, however, the section entitled “Compensation Committee Report”
shall not be deemed to be “soliciting material” or to be filed with the
Securities and Exchange Commission or subject to Regulation 14A or 14C, or to
the liabilities of Section 18 of the Exchange Act of 1934, as
amended.




Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters




The
information required by this item will be presented in our definitive proxy
statement not later than 120 days after the end of the fiscal year covered by
this annual report and is incorporated in this annual report by reference
thereto.




Item 13. Certain
Relationships and Related Transactions, and Director
Independence




The
information required by this item will be presented in our definitive proxy
statement not later than 120 days after the end of the fiscal year covered by
this annual report and is incorporated in this annual report by reference
thereto.




Item 14. Principal
Accounting Fees and Services




The
information required by this item will be presented in our definitive proxy
statement not later than 120 days after the end of the fiscal year covered by
this annual report and is incorporated in this annual report by reference
thereto.




PART
IV




Item 15. Exhibits and
Financial Statement Schedules




(a)         The
following documents are filed as part of this report




(1)  Financial
Statements




PageReport of EFP Rotenberg, LLP,
      Independent Registered Public Accounting Firm
                          
                          F-2Report
      of Davie Kaplan, CPA, P.C. Independent Registered Public Accounting
      Firm
                          
                          F-3Consolidated Balance
      Sheets - For the Years Ended December 31, 2009 and
      2008
                          
                          F-4Consolidated Statements of
      Stockholders’ (Deficit) Equity - For the Years Ended
      December 31, 2009, 2008 and 2007
                          
                          F-5Consolidated Statements of
      Operations - For the Years Ended December 31, 2009, 2008 and
      2007
                          
                          F-6Consolidated Statement of Cash
      Flows - For the Years Ended December 31, 2009, 2008 and
      2007
                          
                          F-7Notes to Consolidated Financial
      Statements
                          
                          F-8




(2)  Financial
Statement Schedules




Financial
statement schedules have been omitted since they are not required, not
applicable or the information is otherwise included.


45




(3)  Exhibits




A list of
exhibits filed with this annual report, identifying which of those exhibits are
management contracts and compensation plans, is set forth in the Exhibit Index
and is incorporated in this Item 15(a)(3) by reference.




46




SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, on the 31st
day of March, 2010.




VUZIX
      CORPORATION/s/ Paul J. TraversPaul
      J. TraversChief
      Executive Officer




POWER
OF ATTORNEY




KNOW
BY ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints jointly and severally, Paul J. Travers and Grant
Russell, and each one of them, his or her attorneys-in-fact, each with the power
of substitution, for him or her in any and all capacities, to sign any and all
amendments to this Annual Report on Form 10-K and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each said attorneys-in-fact, or his substitute or substitutes, may do or cause
to be done by virtue hereof.




Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:




Signature
                
                Title
                
                Date/s/  Paul J.
    Travers
                
                President,
      Chief Executive Officer
                
                March
      31, 2010Paul
      J. Travers
                
                and
      Director(Principal
      Executive Officer)/s/  Grant
Russell
                
                Chief
      Financial Officer and Director
                
                March
      31, 2010Grant
      Russell
                
                (Principal
      Financial andAccounting
      Officer)/s/  William Lee
                
                Director
                
                March
      31, 2010William
      Lee/s/  Frank
    Zammataro
                
                Director
                
                March
      31, 2010Frank
      Zammataro/s/  Kathryn
Sayko
                
                Director
                
                March
      31, 2010Kathryn
      Sayko/s/  Bernard
    Perrine
                
                Director
                
                March
      31, 2010Bernard
      Perrine


47


Exhibit
Index




1
              .1(4)
              
              Form
      of Agency Agreement3
              .1(3)
              
              Amended
      and Restated Certificate of Incorporation to be effective immediately
      following the closing of the offering3
              .2(3)
              
              Amended
      and Restated Bylaws to be effective immediately following the closing of
      the offering4
              .1(4)
              
              Specimen
      certificate evidencing shares of common stock4
              .2(4)
              
              Specimen
      common stock purchase warrant4
              .3(6)
              
              Form
      of Warrant Indenture between the registrant and Computershare
      Trust Company of Canada Certain instruments defining the rights of
      the holders of long-term debt of the registrant, none of which authorize a
      total amount of indebtedness in excess of 10% of the total assets of the
      registrant and its subsidiary on a consolidated basis, have not been filed
      as exhibits. The registrant hereby agrees to furnish a copy of any of
      these agreements to the Commission upon request10
              .1(1)+
              
              2007
      Amended and Restated Stock Option Plan10
              .2(1)+
              
              2009
      Stock Option Plan10
              .3(2)+
              
              Form
      of Option Agreement under 2009 Stock Plan10
              .4(1)+
              
              Form
      of Indemnification Agreement by and between the registrant and each
      director and executive officer10
              .5(1)+
              
              Employment
      Agreement dated as of August 1, 2007 by and between the registrant
      and Paul J. Travers10
              .6(1)+
              
              Employment
      Agreement dated as of August 1, 2007 by and between the registrant
      and Grant Russell10
              .7(1)
              
              Shareholders
      Agreement dated as of October 11, 2000 by and among the registrant
      and Shareholders (as defined therein)10
              .81(1)
              
              Registration
      Rights Agreement dated as of October 11, 2000 by and among the
      registrant and the Investors (as defined therein)10
              .9(1)
              
              Registration
      Rights Agreement dated as of June 2005 by and among the registrant and the
      Investors (as defined therein)10
              .10(3)†
              
              Technology
      Purchase and Royalty Agreement dated as of December 23, 2005 between
      the registrant and New Light Industries, Ltd.10
              .11(1)
              
              Warrant
      to purchase common stock dated as of December 23, 2005 issued by the
      registrant to New Light Industries, Ltd.10
              .12(1)
              
              Rights
      Agreement dated as of December 23, 2005 by and between the registrant
      and New Light Industries, Ltd.10
              .13(1)
              
              Agency
      Agreement dated as of June 29, 2007 by and between the registrant and
      Canaccord Capital Corporation10
              .14(1)
              
              Form
      of warrant to purchase common stock issued by the registrant pursuant to
      the Agency Agreement dated as of June 29, 2007 by and between the
      registrant and Canaccord Capital Corporation10
              .15(1)
              
              Demand
      Note in the original principal amount of $247,690.92 by the registrant to
      the order of Paul J. Travers10
              .16(1)
              
              Loan
      Agreement dated as of October 2008 by and between the registrant and Paul
      J. Travers10
              .17(3)
              
              Promissory
      Note dated as of October 2008 by the registrant to the order of Paul J.
      Travers10
              .18(1)
              
              Fiscal
      Advisory Fee Agreement dated as of June 29, 2009 by and between the
      registrant and Canaccord Capital Corporation and Bolder Investment
      Partners, Ltd.10
              .19(6)†
              
              Distribution
      and Manufacturing Agreement dated August 27, 2009 between the
      registrant and YuView Holdings
Ltd.


10
              .20(3)
              
              Convertible
      Promissory Note dated September 19, 2006 in the original principal
      amount of $500,000 by the registrant to Sally Hyde
  Burdick10
              .21(5)
              
              Form
      of Escrow Agreement by and among the registrant, Canaccord Capital
      Corporation the other Offering Agents (as defined therein) and JP Morgan
      Chase Bank, National Association, as escrow agent10
              .22(5)
              
              Amended
      and Restated Fiscal Advisory Fee Agreement dated as of November 12,
      2009 by and between the registrant and Canaccord Capital Corporation and
      Bolder Investment Partners Ltd.10
              .23(6)
              
              Amendment
      No. 1 to Amended and Restated Fiscal Advisory Fee Agreement dated as of
      November 12, 2009 by and among the registrant and Canaccord Capital
      Corporation and Bolder Investment Partners Ltd.10
              .24(6)
              
              Form
      of Escrow Agreement by and among the Registration of Computershare
      Investor Services, Inc., as escrow agent, and the Securityholders (as
      defined therein) entered into pursuant to Canadian National Policy 46-201
      and TSX Venture Exchange
Policy 5.4


48




(1)
            
            Previously
      filed as exhibit to the Registration Statement on Form S-1 filed on
      July 2, 2009(2)
            
            Previously
      filed as exhibit to Amendment No. 2 to the Registration Statement on
      Form S-1 filed on September 4, 2009(3)
            
            Previously
      filed as exhibit to Amendment No. 3 to the Registration Statement on
      Form S-1 filed October 16, 2009(4)
            
            Previously
      filed as exhibit to Amendment No. 4 to the Registration Statement on
      Form S-1 filed November 10, 2009(5)
            
            Previously
      filed as exhibit to Amendment No. 5 to the Registration Statement on
      Form S-1 filed November 27, 2009(6)
            
            Previously
      filed as exhibit to Amendment No. 6 to the Registration Statement on
      Form S-1 filed December 7,
2009





+
            
            Management
      contract or compensation plan or arrangement†
            
            Confidential
      treatment granted as to certain
portions




49


VUZIX
CORPORATION




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport
      of EFP Rotenberg, LLP, Independent Registered Public Accounting
      Firm
                              
                              F-2Report
      of Davie Kaplan, CPA, P.C., Independent Registered Public Accounting
      Firm
                              
                              F-3Consolidated
      Balance Sheets — For the Years Ended December 31, 2009 and
      2008
                              
                              F-4Consolidated
      Statements of Stockholders’ (Deficit) Equity — For the Years Ended
      December 31, 2009, 2008 and 2007
                              
                              F-5Consolidated
      Statements of Operations — For the Years Ended December 31,
      2009, 2008 and 2007
                              
                              F-6Consolidated
      Statements of Cash Flows — For the Years Ended December 31,
      2009, 2008 and 2007
                              
                              F-7Notes
      to Consolidated Financial Statements
                              
                              F-8




F-1


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and


Stockholders
of Vuzix Corporation




As
successor by merger, effective October 1, 2009, to the registered public
accounting firm Rotenberg & Co., LLP., we have audited the accompanying
consolidated balance sheets of Vuzix Corporation and its subsidiary as of
December 31, 2009 and 2008, and the related consolidated statements of
operations, changes in stockholders’ equity and cash flows for each of the years
in the two-year period ended December, 31, 2009. Vuzix Corporation’s management
is responsible for these consolidated financial statements. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall
financial statement presentation. We believe that our audits provides a
reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Vuzix Corporation and its
subsidiary as of December 31, 2009 and 2008, and the results of its operations,
changes in stockholders’ equity and its cash flows for each of the years in the
two-year period ended December 31, 2009 in conformity with accounting principles
generally accepted in the United States of America.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As described in Note 2 to the
consolidated financial statements, the Company has incurred substantial losses
from operations in recent years. In addition, the Company is dependent on its
various debt and compensation agreements, described in Notes 2, 10, 11 12, to
fund its working capital needs. And while there are no financial covenants with
which the Company must comply with, these debts are past due in some cases.
These conditions raise substantial doubt about its ability to continue as a
going concern. Management’s plans in regards to these matters are also described
in Note 2. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.




/s/ EFP
Rotenberg, LLP




Rochester,
New York


March 31,
2010


F-2


INDEPENDENT AUDITORS’
REPORT




To the
Board of Directors and Stockholders


Vuzix
Corporation




We have
audited the balance sheets of Vuzix Corporation (F/K/A Icuiti Corporation) as of
December 31, 2007, and the related statements of operations, changes in
stockholders’ equity and cash flows for the year then ended. 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 audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Vuzix Corporation (F/K/A Icuiti
Corporation) as of December 31, 2007, and the results of its operations,
changes in stockholders’ equity and its cash flows for the year then ended in
conformity with U.S. generally accepted accounting
principles.




/s/ Davie
Kaplan, CPA, P.C.




June 17,
2008


Rochester,
New York


F-3


VUZIX
CORPORATION


CONSOLIDATED
BALANCE SHEETS




December 31,
                                                          2009
                                                        
                                                        
                                                        December 31,
                                                          2008
                                                        
                                                        
                                                        December 31,
                                                          2007Current
      AssetsCash
      and Cash Equivalents
                                                        
                                                        $
                                                        2,500,523
                                                        
                                                        
                                                        $
                                                        818,719
                                                        
                                                        
                                                        $
                                                        364,856Accounts
      Receivable, Net (Note 3)
                                                        
                                                        
                                                        1,446,750
                                                        
                                                        
                                                        
                                                        1,413,611
                                                        
                                                        
                                                        
                                                        2,908,224Inventories
      (Note 4)
                                                        
                                                        
                                                        2,959,636
                                                        
                                                        
                                                        
                                                        2,307,321
                                                        
                                                        
                                                        
                                                        1,984,465Prepaid
      Income Taxes
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        130,130
                                                        
                                                        
                                                        
                                                        130,130Prepaid
      Expenses and Other Assets
                                                        
                                                        
                                                        41,192
                                                        
                                                        
                                                        
                                                        41,390
                                                        
                                                        
                                                        
                                                        108,525Total
      Current Assets
                                                        
                                                        
                                                        6,948,101
                                                        
                                                        
                                                        
                                                        4,711,171
                                                        
                                                        
                                                        
                                                        5,496,200Tooling
      and Equipment, Net (Note 5)
                                                        
                                                        
                                                        701,368
                                                        
                                                        
                                                        
                                                        825,924
                                                        
                                                        
                                                        
                                                        857,170Patents
      and Trademarks, Net (Note 6)
                                                        
                                                        
                                                        759,356
                                                        
                                                        
                                                        
                                                        684,802
                                                        
                                                        
                                                        
                                                        613,884Total
      Assets
                                                        
                                                        $
                                                        8,408,825
                                                        
                                                        
                                                        $
                                                        6,221,897
                                                        
                                                        
                                                        $
                                                        6,967,254Current
      LiabilitiesAccounts
      Payable
                                                        
                                                        $
                                                        3,936,914
                                                        
                                                        
                                                        $
                                                        4,763,321
                                                        
                                                        
                                                        $
                                                        4,029,630Lines
      of Credit (Note 7)
                                                        
                                                        
                                                        178,107
                                                        
                                                        
                                                        
                                                        202,290
                                                        
                                                        
                                                        
                                                        78,400Current
      Portion of Long-term Debt
                                                        
                                                        
                                                        715,500
                                                        
                                                        
                                                        
                                                        500,000
                                                        
                                                        
                                                        
                                                        —Notes
      Payable (Note 26)
                                                        
                                                        
                                                        246,417
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —Current
      Portion of Capital Leases
                                                        
                                                        
                                                        100,661
                                                        
                                                        
                                                        
                                                        139,800
                                                        
                                                        
                                                        
                                                        171,778Customer
      Deposits (Note 8)
                                                        
                                                        
                                                        170,671
                                                        
                                                        
                                                        
                                                        729,677
                                                        
                                                        
                                                        
                                                        46,637Accrued
      Interest
                                                        
                                                        
                                                        154,016
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —Accrued
      Expenses (Note 9)
                                                        
                                                        
                                                        399,966
                                                        
                                                        
                                                        
                                                        185,960
                                                        
                                                        
                                                        
                                                        171,872Income
      Taxes Payable
                                                        
                                                        
                                                        3,592
                                                        
                                                        
                                                        
                                                        36,412
                                                        
                                                        
                                                        
                                                        31,225Total
      Current Liabilities
                                                        
                                                        
                                                        5,905,844
                                                        
                                                        
                                                        
                                                        6,557,460
                                                        
                                                        
                                                        
                                                        4,529,542Long-Term
      LiabilitiesAccrued
      Compensation (Note 10)
                                                        
                                                        
                                                        445,096
                                                        
                                                        
                                                        
                                                        445,096
                                                        
                                                        
                                                        
                                                        445,096Long
      Term Portion of Long-Term Debt (Note 12)
                                                        
                                                        
                                                        209,208
                                                        
                                                        
                                                        
                                                        379,208
                                                        
                                                        
                                                        
                                                        784,208Long
      Term Portion of Trade Payables (Note 11)
                                                        
                                                        
                                                        1,746,500
                                                        
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        —Long
      Term Portion of Capital Leases (Note 13)
                                                        
                                                        
                                                        94,176
                                                        
                                                        
                                                        
                                                        180,328
                                                        
                                                        
                                                        
                                                        247,052Accrued
      Interest
                                                        
                                                        
                                                        338,226
                                                        
                                                        
                                                        
                                                        425,448
                                                        
                                                        
                                                        
                                                        314,921Cumulative
      Dividends Payable on Preferred Stock
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        324,299
                                                        
                                                        
                                                        
                                                        223,199Total
      Long-Term Liabilities
                                                        
                                                        
                                                        2,833,206
                                                        
                                                        
                                                        
                                                        1,754,379
                                                        
                                                        
                                                        
                                                        2,014,476Total
      Liabilities
                                                        
                                                        
                                                        8,739,050
                                                        
                                                        
                                                        
                                                        8,311,839
                                                        
                                                        
                                                        
                                                        6,544,018Stockholders’
      EquityPreferred
      Stock — $.001 Par Value, 5,000,000 Shares Authorized;
      0, 168,500 and 168,500 Shares Issued and Outstanding December
      31, Respectively (Note 15)
                                                        
                                                        
                                                        —
                                                        
                                                        
                                                        
                                                        169
                                                        
                                                        
                                                        
                                                        169Common
      Stock — $.001 Par Value,
      700,000,000 Shares Authorized; 263,600,274, 218,268,927, and
      197,973,139 Shares Issued and Outstanding December 31,
      Respectively
                                                        
                                                        
                                                        263,600
                                                        
                                                        
                                                        
                                                        218,269
                                                        
                                                        
                                                        
                                                        197,972Additional
      Paid-in Capital
                                                        
                                                        
                                                        17,665,941
                                                        
                                                        
                                                        
                                                        12,700,413
                                                        
                                                        
                                                        
                                                        10,238,589Accumulated
      (Deficit)
                                                        
                                                        
                                                        (18,032,430
                                                        )
                                                        
                                                        
                                                        (14,687,276
                                                        )
                                                        
                                                        
                                                        (9,691,977
                                                        )Subscriptions
      Receivable (Note 20)
                                                        
                                                        
                                                        (227,336
                                                        )
                                                        
                                                        
                                                        (321,517
                                                        )
                                                        
                                                        
                                                        (321,517
                                                        )Total
      Stockholders’ Equity
                                                        
                                                        
                                                        (330,225
                                                        )
                                                        
                                                        
                                                        (2,089,942
                                                        )
                                                        
                                                        
                                                        423,236Total
      Liabilities and Stockholders’ Equity
                                                        
                                                        $
                                                        8,408,825
                                                        
                                                        
                                                        $
                                                        6,221,897
                                                        
                                                        
                                                        $
                                                        6,967,254


The
accompanying notes are an integral part of these consolidated financial
statements.


F-4


VUZIX
CORPORATION


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY




Common Stock
                                                  
                                                  Additional
                                                  
                                                  
                                                  Accumulated
                                                  
                                                  
                                                  Preferred Stock
                                                  
                                                  
                                                  SubscriptionsShares
                                                  
                                                  
                                                  Amount
                                                  
                                                  Paid-In Capital
                                                  
                                                  
                                                  Deficit
                                                  
                                                  
                                                  Shares
                                                  
                                                  
                                                  Amount
                                                  
                                                  
                                                  Receivable
                                                  
                                                  
                                                  TotalBalance —
      December 31,
      2006
                                                  
                                                  
                                                  173,268,048
                                                  
                                                  
                                                  
                                                  173,268
                                                  
                                                  
                                                  6,115,622
                                                  
                                                  
                                                  
                                                  (6,531,363
                                                  )
                                                  
                                                  
                                                  168,500
                                                  
                                                  
                                                  
                                                  169
                                                  
                                                  
                                                  
                                                  (361,650
                                                  )
                                                  
                                                  
                                                  (603,954
                                                  )Warrants
      Issued for
      Services
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  78,275
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  78,275Exercise
      of Stock
      Options
                                                  
                                                  
                                                  402,483
                                                  
                                                  
                                                  
                                                  402
                                                  
                                                  
                                                  5,328
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  5,730Exercise
      of Stock
      Warrants
                                                  
                                                  
                                                  177,136
                                                  
                                                  
                                                  
                                                  177
                                                  
                                                  
                                                  1,373
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,550Issuance
      of Common
      Stock
                                                  
                                                  
                                                  23,125,472
                                                  
                                                  
                                                  
                                                  23,125
                                                  
                                                  
                                                  3,767,686
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  3,790,811Conversion
      of Debt into
      Stock
                                                  
                                                  
                                                  1,000,000
                                                  
                                                  
                                                  
                                                  1,000
                                                  
                                                  
                                                  199,000
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  200,000Stock
      Compensation
      Expense
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  111,438
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  111,438Dividends
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (101,100
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (101,100
                                                  )Extension
      of Subscriptions
      Receivable
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  (40,133
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  40,133
                                                  
                                                  
                                                  
                                                  —2007
      Net
      Loss
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (3,059,514
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (3,059,514
                                                  )Balance —
      December 31,
      2007
                                                  
                                                  
                                                  197,973,139
                                                  
                                                  
                                                  
                                                  197,972
                                                  
                                                  
                                                  10,238,589
                                                  
                                                  
                                                  
                                                  (9,691,977
                                                  )
                                                  
                                                  
                                                  168,500
                                                  
                                                  
                                                  
                                                  169
                                                  
                                                  
                                                  
                                                  (321,517
                                                  )
                                                  
                                                  
                                                  423,236Exercise
      of
      Options
                                                  
                                                  
                                                  2,450,888
                                                  
                                                  
                                                  
                                                  2,451
                                                  
                                                  
                                                  14,245
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  16,696Issuance
      of Common
      Stock
                                                  
                                                  
                                                  15,847,517
                                                  
                                                  
                                                  
                                                  15,848
                                                  
                                                  
                                                  2,122,798
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2,138,646Exercise
      of Stock
      Warrants
                                                  
                                                  
                                                  1,552,936
                                                  
                                                  
                                                  
                                                  1,553
                                                  
                                                  
                                                  12,033
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  13,586Stock
      Issued for
      Services
                                                  
                                                  
                                                  444,447
                                                  
                                                  
                                                  
                                                  444
                                                  
                                                  
                                                  66,223
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  66,667Dividends
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (101,100
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (101,100
                                                  )Warrants
      Issued for
      Services
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  66,227
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  66,227Stock
      Compensation
      Expense
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  180,298
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  180,2982008
      Net
      Loss
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (4,894,199
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (4,894,199
                                                  )Balance —
      December 31,
      2008
                                                  
                                                  
                                                  218,268,927
                                                  
                                                  
                                                  $
                                                  218,269
                                                  
                                                  $
                                                  12,700,413
                                                  
                                                  
                                                  $
                                                  (14,687,276
                                                  )
                                                  
                                                  
                                                  168,500
                                                  
                                                  
                                                  $
                                                  169
                                                  
                                                  
                                                  $
                                                  (321,517
                                                  )
                                                  
                                                  $
                                                  (2,089,942
                                                  )Exercise
      of
      Options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Issuance
      of Common Stock from Private Placement of
      Cash
                                                  
                                                  
                                                  2,000,000
                                                  
                                                  
                                                  
                                                  2,000
                                                  
                                                  
                                                  298,000
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  300,000Issuance
      of Common Stock in IPO
                                                  
                                                  
                                                  33,790,060
                                                  
                                                  
                                                  
                                                  33,790
                                                  
                                                  
                                                  5,776,867
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  5,810,657Conversion
      of Preferred Stock and Accrued Dividends
                                                  
                                                  
                                                  7,213,797
                                                  
                                                  
                                                  
                                                  7,214
                                                  
                                                  
                                                  411,815
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (168,500
                                                  )
                                                  
                                                  
                                                  (169
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  418,860Conversion
      of Convertible Debt
                                                  
                                                  
                                                  2,327,490
                                                  
                                                  
                                                  
                                                  2,327
                                                  
                                                  
                                                  130,546
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  132,873Repurchase
      of Fractional
      Shares
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  (2
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (2
                                                  )Dividends
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (94,730
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (94,730
                                                  )Warrants
      Issued for
      Services
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Stock
      Compensation
      Expense
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  274,152
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  274,152Direct
      IPO Associated
      Expense
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  (1,912,715
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (1,912,715
                                                  )Adjustment
      of Subscriptions
      Receivable
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  (13,135
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  94,181
                                                  
                                                  
                                                  
                                                  81,0462009
      Net
      Loss
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (3,250,424
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (3,250,424
                                                  )Balance —
      December 31,
      2009
                                                  
                                                  
                                                  263,600,274
                                                  
                                                  
                                                  $
                                                  263,600
                                                  
                                                  $
                                                  17,665,941
                                                  
                                                  
                                                  $
                                                  (18,032,430
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  $
                                                  —
                                                  
                                                  
                                                  $
                                                  (227,336
                                                  )
                                                  
                                                  $
                                                  (330,225
                                                  )




The
accompanying notes are an integral part of these consolidated financial
statements.


F-5


VUZIX
CORPORATION


CONSOLIDATED
STATEMENTS OF OPERATIONS




For
      Years EndedDecember 31,2009
                                      
                                      
                                      2008
                                      
                                      
                                      2007Sales
      of Products
                                      
                                      $
                                      10,961,235
                                      
                                      
                                      $
                                      10,941,181
                                      
                                      
                                      $
                                      4,701,004Sales
      of Engineering Services
                                      
                                      
                                      924,863
                                      
                                      
                                      
                                      1,548,703
                                      
                                      
                                      
                                      5,445,375Total
      Sales
                                      
                                      
                                      11,886,098
                                      
                                      
                                      
                                      12,489,884
                                      
                                      
                                      
                                      10,146,379Cost
      of Sales — Products
                                      
                                      
                                      7,157,573
                                      
                                      
                                      
                                      7,769,916
                                      
                                      
                                      
                                      3,407,340Cost
      of Sales — Engineering Services
                                      
                                      
                                      451,518
                                      
                                      
                                      
                                      1,018,989
                                      
                                      
                                      
                                      3,376,133Total
      Cost of Sales
                                      
                                      
                                      7,609,091
                                      
                                      
                                      
                                      8,788,905
                                      
                                      
                                      
                                      6,783,473Gross
      Profit
                                      
                                      
                                      4,277,007
                                      
                                      
                                      
                                      3,700,979
                                      
                                      
                                      
                                      3,362,906Operating
      Expenses:Research
      and Development
                                      
                                      
                                      2,217,627
                                      
                                      
                                      
                                      3,366,518
                                      
                                      
                                      
                                      2,365,412Selling
      and Marketing
                                      
                                      
                                      2,143,628
                                      
                                      
                                      
                                      2,128,625
                                      
                                      
                                      
                                      1,920,164General
      and Administrative
                                      
                                      
                                      2,354,573
                                      
                                      
                                      
                                      2,299,685
                                      
                                      
                                      
                                      1,718,627Depreciation
      and Amortization
                                      
                                      
                                      522,457
                                      
                                      
                                      
                                      510,133
                                      
                                      
                                      
                                      374,078Total
      Operating Expenses
                                      
                                      
                                      7,238,285
                                      
                                      
                                      
                                      8,304,961
                                      
                                      
                                      
                                      6,378,281Loss
      from Operations
                                      
                                      
                                      (2,961,278
                                      )
                                      
                                      
                                      (4,603,982
                                      )
                                      
                                      
                                      (3,015,375
                                      )Other
      Income (Expense)Interest
      and Other (Expense) Income
                                      
                                      
                                      63
                                      
                                      
                                      
                                      188
                                      
                                      
                                      
                                      2,549Foreign
      Exchange Gain (Loss)
                                      
                                      
                                      (22,226
                                      )
                                      
                                      
                                      (24,216
                                      )
                                      
                                      
                                      —Legal
      Settlement
                                      
                                      
                                      —
                                      
                                      
                                      
                                      —
                                      
                                      
                                      
                                      96,632Interest
      Expenses
                                      
                                      
                                      (297,200
                                      )
                                      
                                      
                                      (260,977
                                      )
                                      
                                      
                                      (241,692
                                      )Total
      Other Income (Expense)
                                      
                                      
                                      (319,363
                                      )
                                      
                                      
                                      (285,005
                                      )
                                      
                                      
                                      (142,511
                                      )Loss
      Before Provision for Income Taxes
                                      
                                      
                                      (3,280,641
                                      )
                                      
                                      
                                      (4,888,987
                                      )
                                      
                                      
                                      (3,157,886
                                      )Provision
      (Benefit) for Income Taxes (Note 14)
                                      
                                      
                                      (30,217
                                      )
                                      
                                      
                                      5,212
                                      
                                      
                                      
                                      (98,372
                                      )Net
      Loss
                                      
                                      $
                                      (3,250,424
                                      )
                                      
                                      $
                                      (4,894,199
                                      )
                                      
                                      $
                                      (3,059,514
                                      )Basic
      and Diluted Loss per Share
                                      
                                      $
                                      (0.0151
                                      )
                                      
                                      $
                                      (0.0240
                                      )
                                      
                                      $
                                      (0.0176
                                      )Weighted-average
      SharesOutstanding —
      Basic and Diluted
                                      
                                      
                                      221,469,554
                                      
                                      
                                      
                                      207,710,498
                                      
                                      
                                      
                                      185,263,660





The
accompanying notes are an integral part of these consolidated financial
statements.


F-6


VUZIX
CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For Years EndedDecember 31,2009
                                                            
                                                            
                                                            2008
                                                            
                                                            
                                                            2007Cash
      Flows from Operating ActivitiesNet
      Loss
                                                            
                                                            $
                                                            (3,250,424
                                                            )
                                                            
                                                            $
                                                            (4,894,199
                                                            )
                                                            
                                                            $
                                                            (3,059,514
                                                            )Non-Cash
      AdjustmentsDepreciation
      and Amortization
                                                            
                                                            
                                                            522,458
                                                            
                                                            
                                                            
                                                            510,133
                                                            
                                                            
                                                            
                                                            374,078Stock-Based
      Compensation Expense
                                                            
                                                            
                                                            274,152
                                                            
                                                            
                                                            
                                                            180,298
                                                            
                                                            
                                                            
                                                            111,438Non-Cash
      Compensation
                                                            
                                                            
                                                            81,046
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Stock
      Issued for Services
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            66,667
                                                            
                                                            
                                                            
                                                            —Warrants
      Issued for Services
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            66,227
                                                            
                                                            
                                                            
                                                            78,275(Increase)
      Decrease in Operating AssetsAccounts
      Receivable
                                                            
                                                            
                                                            (33,139
                                                            )
                                                            
                                                            
                                                            1,494,613
                                                            
                                                            
                                                            
                                                            (931,121
                                                            )Inventories
                                                            
                                                            
                                                            (652,315
                                                            )
                                                            
                                                            
                                                            (322,856
                                                            )
                                                            
                                                            
                                                            (826,732
                                                            )Prepaid
      Income Taxes
                                                            
                                                            
                                                            130,130
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (130,130
                                                            )Prepaid
      Expenses and Other Assets
                                                            
                                                            
                                                            198
                                                            
                                                            
                                                            
                                                            67,135
                                                            
                                                            
                                                            
                                                            (106,025
                                                            )Increase
      (Decrease) in Operating LiabilitiesAccounts
      Payable
                                                            
                                                            
                                                            (826,407
                                                            )
                                                            
                                                            
                                                            733,691
                                                            
                                                            
                                                            
                                                            1,580,255Long
      Term Portion of Trade Payables
                                                            
                                                            
                                                            1,746,500
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Accrued
      Expenses
                                                            
                                                            
                                                            214,006
                                                            
                                                            
                                                            
                                                            14,088
                                                            
                                                            
                                                            
                                                            (175,574
                                                            )Customer
      Deposits
                                                            
                                                            
                                                            (559,006
                                                            )
                                                            
                                                            
                                                            683,040
                                                            
                                                            
                                                            
                                                            (78,947
                                                            )Income
      Taxes Payable
                                                            
                                                            
                                                            (32,820
                                                            )
                                                            
                                                            
                                                            5,187
                                                            
                                                            
                                                            
                                                            31,225Accrued
      Commissions
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (266,475
                                                            )Accrued
      Interest
                                                            
                                                            
                                                            124,498
                                                            
                                                            
                                                            
                                                            110,527
                                                            
                                                            
                                                            
                                                            103,347Net
      Cash Flows Used in Operating Activities
                                                            
                                                            
                                                            (2,261,123
                                                            )
                                                            
                                                            
                                                            (1,285,449
                                                            )
                                                            
                                                            
                                                            (3,295,900
                                                            )Cash
      Flows from Investing ActivitiesPurchases
      of Tooling and Equipment
                                                            
                                                            
                                                            (337,862
                                                            )
                                                            
                                                            
                                                            (424,166
                                                            )
                                                            
                                                            
                                                            (180,310
                                                            )Investments
      in Patents and Trademarks
                                                            
                                                            
                                                            (134,594
                                                            )
                                                            
                                                            
                                                            (125,638
                                                            )
                                                            
                                                            
                                                            (136,433
                                                            )Net
      Cash Used in Investing Activities
                                                            
                                                            
                                                            (472,456
                                                            )
                                                            
                                                            
                                                            (549,804
                                                            )
                                                            
                                                            
                                                            (316,743
                                                            )Cash
      Flows from Financing ActivitiesNet
      Change in Lines of Credit
                                                            
                                                            
                                                            (24,183
                                                            )
                                                            
                                                            
                                                            123,890
                                                            
                                                            
                                                            
                                                            (13,837
                                                            )Issuance
      of Common Stock
                                                            
                                                            
                                                            6,110,657
                                                            
                                                            
                                                            
                                                            2,138,646
                                                            
                                                            
                                                            
                                                            3,792,362Repayment
      of Capital Leases
                                                            
                                                            
                                                            (125,291
                                                            )
                                                            
                                                            
                                                            (98,702
                                                            )
                                                            
                                                            
                                                            (168,947
                                                            )Prepayment
      of Long-Term Debt
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (206,980
                                                            )Exercise
      of Stock Options
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            16,696
                                                            
                                                            
                                                            
                                                            5,730Exercise
      of Stock Warrants
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            13,586
                                                            
                                                            
                                                            
                                                            —Repurchase
      of Fractional Shares
                                                            
                                                            
                                                            (2
                                                            )
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Direct
      IPO Associated Costs
                                                            
                                                            
                                                            (1,912,715
                                                            )
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Proceeds
      from Notes Payable
                                                            
                                                            
                                                            246,417
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Proceeds
      from Long-Term Debt
                                                            
                                                            
                                                            120,500
                                                            
                                                            
                                                            
                                                            95,000
                                                            
                                                            
                                                            
                                                            —Net
      Cash Flows Provided by Financing Activities
                                                            
                                                            
                                                            4,415,383
                                                            
                                                            
                                                            
                                                            2,289,116
                                                            
                                                            
                                                            
                                                            3,408,328Net
      Increase (Decrease) in Cash and Cash Equivalents
                                                            
                                                            
                                                            1,681,804
                                                            
                                                            
                                                            
                                                            453,863
                                                            
                                                            
                                                            
                                                            (204,315
                                                            )Cash
      and Cash Equivalents — Beginning of Year
                                                            
                                                            
                                                            818,719
                                                            
                                                            
                                                            
                                                            364,856
                                                            
                                                            
                                                            
                                                            569,171Cash
      and Cash Equivalents — End of Year
                                                            
                                                            $
                                                            2,500,523
                                                            
                                                            
                                                            $
                                                            818,719
                                                            
                                                            
                                                            $
                                                            364,856Supplemental
      DisclosuresInterest
      Paid
                                                            
                                                            
                                                            172,533
                                                            
                                                            
                                                            
                                                            149,214
                                                            
                                                            
                                                            
                                                            138,345Interest
      Accrued Converted into Common Stock
                                                            
                                                            
                                                            57,874
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Income
      Tax Credit (Refund)
                                                            
                                                            
                                                            (164,214
                                                            )
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Income
      Taxes Paid
                                                            
                                                            
                                                            36,687
                                                            
                                                            
                                                            
                                                            425
                                                            
                                                            
                                                            
                                                            3,725Non-Cash
      Investing TransactionsEquipment
      Acquired Under Capital Lease
                                                            
                                                            
                                                            12,924
                                                            
                                                            
                                                            
                                                            89,833
                                                            
                                                            
                                                            
                                                            221,633Dividends
      Declared but Not Paid
                                                            
                                                            
                                                            94,730
                                                            
                                                            
                                                            
                                                            101,100
                                                            
                                                            
                                                            
                                                            101,100Debt
      Converted to Equity
                                                            
                                                            
                                                            75,000
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            200,000Non-Cash Financing
      TransactionsConversion
      of Preferred Shares and Accrued Dividends
                                                            
                                                            
                                                            418,860Conversion
      of Convertible Debt and Interest
                                                            
                                                            
                                                            132,874





The
accompanying notes are an integral part of these consolidated financial
statements.


F-7




VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS




Note 1 —
Summary of Significant Accounting Policies




Operations





Vuzix
Corporation (the Company) was formed in 1997 under the laws of the State of
Delaware and maintains its corporate offices in Rochester, New York. The Company
changed its name to Vuzix Corporation in September 2007, being previously known
as Icuiti Corporation. The Company is engaged in the design, manufacture,
marketing and sale of devices that are worn like eyeglasses and which feature
built-in video screens that enable the user to view video and digital content,
such as movies, computer data, the Internet or video games. Our products (known
commercially as “Video Eyewear”) are used to view high resolution video and
digital information from portable devices, such as cell phones, portable media
players, gaming systems and laptop computers and from personal computers. Our
products provide the user with a virtual viewing experience that emulates
viewing a large screen television or desktop computer monitor practically
anywhere, anytime.





Principles
of Consolidation




The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiary, Vuzix Europe. All significant inter-company
transactions have been eliminated.





Segment
Data, Geographic Information and Significant Customers




The
Company is not organized by market and is managed and operated as one business.
A single management team that reports to the chief operating decision maker
comprehensively manages the entire business. The Company does not operate any
material separate lines of business or separate business entities. Accordingly,
the Company does not accumulate discrete information, other than product revenue
and material costs, with respect to separate product lines and does not have
separately reportable segments as defined by FASB ASC Topic 280,
“Disclosures about Segments of an Enterprise and Related
Information,”.





Shipments
to customers outside of the United States approximated 16%, 20% and 12% of sales
in 2009, 2008 and 2007, respectively. No single international country
represented more than 10% of revenues. The Company does not maintain significant
amounts of long-lived assets outside of the United States other than tooling
held by its third party manufacturers, primarily in China.




The
Company has at times had a concentration of sales to the U.S. government
and they amounted to approximately 2%, 12% and 54% of sales in 2009, 2008 and
2007, respectively. Accounts receivable from the U.S. government accounted
for nil% and 31% of accounts receivable at 2009 and 2008, respectively. Another
customer, who is also a minority stockholder, represented 42%, 20%, and 17% of
sales in 2009, 2008 and 2007, respectively.


F-8





VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Foreign
Currency Translation




The
U.S. dollar is the functional currency of the Company’s foreign subsidiary.
Monetary assets and liabilities are re-measured at year-end exchange rates.
Non-monetary assets and liabilities are re-measured at historical rates.
Revenues, expenses, gains and losses are re-measured using the rates on which
those elements were recognized during the period.




Use
of Estimates




The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
year end and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.




Concentration
of Credit Risk




The
Company performs ongoing credit evaluations of its customers’ financial
condition and maintains an allowance for uncollectible accounts receivable based
upon the expected collectability of all accounts receivable. As of
December 31, 2008, one customer, represented 31% of net accounts receivable
and was subsequently received during 2009.




For cash
management purposes, the Company concentrates its cash holdings in two accounts
at the JP Morgan Chase Bank. The balance in these accounts may exceed the
federally insured limit of $250,000 per customer by the Federal Deposit
Insurance Corporation in case of bank failure. At December 31, 2009 and
2008, the Company had $2,141,915 and $462,808 in excess of the insurance limit
at this bank.




Cash
and Cash Equivalents




The
Company’s cash received is applied against its two revolving lines of credit on
a periodic basis based on projected monthly cash flows, reducing interest
expense. Cash and cash equivalents can include highly liquid investments with
original maturities of three months or less.




Fair
Value of Financial Instruments




The
Company’s financial instruments primarily consists of cash and cash equivalents,
accounts receivable, inventories, prepaid income taxes, prepaid expenses and
other assets, accounts payable, lines of credit, current portion of long-term
debt and capital leases, customer deposits, accrued expenses, and income taxes
payable.





As of the
consolidated balance sheet date, the estimated fair values of the financial
instruments were not materially different from their carrying values as
presented due to the short maturities of these instruments and that the interest
rates on the borrowing approximate those that would have been available for
loans for similar remaining maturity and risk profiles at respective year
ends.





Allowance
for Doubtful Accounts




The
Company establishes an allowance for uncollectible trade accounts receivable
based on the age of outstanding invoices and management’s evaluation of
collectability of outstanding balances. These provisions are established when
the aging of outstanding amounts exceeds allowable terms and are re-evaluated at
each quarter end for adequacy. In determining the adequacy of the provision, the
Company considers known uncollectible or at risk receivables.


F-9


VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)





Provision
for Future Warranty Costs




Warranty
costs are accrued, to the extent that they are not recoverable from third party
manufacturers, for the estimated cost to repair or replace products for the
balance of the warranty periods. The Company’s products are covered by standard
warranty plans that extend normally 12 months to 24 months from the
date of product shipment. The Company provides for the costs of expected future
warranty claims at the time of product shipment or over-builds to cover
replacements. The adequacy of the provision is assessed at each quarter end and
is based on historical experience of warranty claims and costs. As of
December 31, 2009, the Company’s provision for future warranty claims was
$258,476 compared to $106,865 as of December 31, 2008, with the increase
attributable primarily to increased revenue from product
shipments.




Inventories




Inventories
are valued at the lower of cost, or market using the first-in, first-out method.
The Company does not include any direct overheads costs in its inventory
valuation costing, as such amounts have been immaterial in its current and prior
fiscal years. The Company records provisions for excess, obsolete or slow moving
inventory based on changes in customer demand, technology developments or other
economic factors. The Company’s products have product life cycles that range on
average from two to three years currently. At both the product introduction and
product discontinuation stage, there is a higher degree of risk of inventory
obsolescence. The provision for obsolete and excess inventory is evaluated for
adequacy at each quarter end. The estimate of the provision for obsolete and
excess inventory is partially based on expected future product sales, which are
difficult to forecast for certain products.




Revenue
Recognition




The
Company recognizes revenue from product sales in accordance with FASB ASC Topic
605 “Revenue Recognition”. Product sales represent
the majority of the Company’s revenue. The Company recognizes revenue from these
product sales when persuasive evidence of an arrangement exists, delivery has
occurred or services have been provided, the sale price is fixed or
determinable, and collectability is reasonably assured. Additionally, the
Company sells its products on terms which transfer title and risk of loss at a
specified location, typically shipping point. Accordingly, revenue recognition
from product sales occurs when all factors are met, including transfer of title
and risk of loss, which typically occurs upon shipment by the Company. If these
conditions are not met, the Company will defer revenue recognition until such
time as these conditions have been satisfied. The Company collects and remits
sales taxes in certain jurisdictions and reports revenue net of any associated
sales taxes. The Company also sells certain products through distributors who
are granted limited rights of return for stock balancing against purchases made
within a prior 90 day period, including price adjustments downwards that
the Company implements on any existing inventory. The provision for product
returns and price adjustments is assessed for adequacy both at the time of sale
and at each quarter end and is based on recent historical experience and known
customer claims.





Revenue
from any engineering consulting and other services is recognized at the time the
services are rendered. The Company accounts for its longer-term development
contracts, which to date have all been firm fixed-priced contracts, on the
percentage-of-completion method, whereby income is recognized as work on
contracts progresses, but estimated losses on contracts in progress are charged
to operations immediately. The percentage-of-completion is determined using the
cost-to-cost method. Amounts are generally billed on a monthly basis. To date
all such contracts have been less than one calendar year in
duration.


F-10




VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Tooling
and Equipment




Tooling
and equipment are stated at cost. Depreciation of tooling and equipment is
provided for using the straight-line method over the following estimated useful
lives:




Computers
      and Software
            
            
            3 yearsManufacturing
      Equipment
            
            
            5 yearsTooling
            
            
            3 yearsFurniture
      and Equipment
            
            
            5 years





Repairs
and maintenance costs are expensed as incurred. Asset betterments are
capitalized.




Patents
and Trademarks




The
Company capitalizes the costs of obtaining its patents and registration of
Trademarks. Such costs are accumulated and capitalized during the filing
periods, which can take several years to complete. Successful applications that
result in the granting of a patent or trademark are then amortized over
15 years on a straight-line basis. Unsuccessful applications are written
off and expensed in the fiscal period where application is abandoned or
discontinued.




Long-Lived
Assets




The
Company regularly assesses all of its long-lived assets for impairment when
events or circumstances indicate their carrying amounts may not be recoverable,
in accordance with FASB ASC Topic 360-10, “Accounting for the Impairment or
Disposal of Long-Lived Assets,”




Research
and Development




Research
and development costs, are expensed as incurred consistent with the guidance of
FASB ASC Topic 730, “Research and Development,” and include employee
related costs, office expenses, third party design and engineering services, and
new product prototyping costs.




Shipping
and Handling Costs




Amounts
charged to customers and costs incurred by the Company related to shipping and
handling are included in net sales and cost of goods sold, respectively, in
accordance with EITF Issue No. 00-10, “Accounting for Shipping and Handling
Fees and Costs.”





Advertising




Advertising
costs are expensed as incurred and recorded in “Selling and marketing” in the
Consolidated Statements of Operations. Advertising expense amounted to $703,306,
$1,009,992 and $893,973 for 2009, 2008 and 2007,
respectively.





Income
Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109.
Accordingly, the Company provides deferred income tax assets and liabilities
based on the estimated future tax effects of differences between the financial
and tax bases of assets and liabilities based on currently enacted tax laws. A
valuation allowance is established for deferred tax assets in amounts for which
realization is not considered more likely than not to occur.




The
Company reports any interest and penalties accrued relating to uncertain income
tax positions as a component of the income tax provision.




F-11


VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Earnings
Per Share




Basic
earnings per share is computed by dividing the net (loss) income less accrued
dividends on the Series C preferred stock by the weighted average number of
common shares outstanding for the period. Diluted earnings per share
calculations reflect the assumed exercise of all dilutive employee stock options
applying the treasury stock method promulgated by FASB ASC Topic 260, “Earnings
Per Share” and the conversion of any outstanding convertible preferred shares or
notes payable that are-in-the-money, applying the as-if-converted method.
However, the assumed exercise of stock options and warrants and the conversion
of preferred shares or notes payable are anti-dilutive, therefore basic and
diluted earnings per share are the same for all periods. All share and per-share
amounts in the accompanying consolidated financial statements and notes to the
consolidated financial statements have been adjusted to apply the effect of the
reverse stock split (one-for-seven) in 2007 and the forward stock split
(eight-for-one) in 2008.




Stock-Based
Employee Compensation




The
Company accounts for share-based compensation to employees and directors in
accordance with FASB ASC Topic 718 “Compensation Stock Expense,” which requires
that compensation expense be recognized in the consolidated financial statements
for share-based awards based on the grant-date fair value of those awards. The
Company elected to not account for any stock options granted prior to
December 31, 2005 which had unrecognized compensation expense at
January 1, 2006, and has instead applied it to only new share-based awards
granted subsequent to December 31, 2005, based on the grant-date fair value
estimated. In all cases the Company used the fair market value of our common
stock on the date of each option grant was determined based on last most recent
cash sale of common stock in an arm’s length transaction with an unrelated third
party. During each of the last four fiscal years, we engaged in at least one
such transaction that was used to determine the fair market value of stock-based
compensation in each year. Stock-based compensation expense includes an estimate
for pre-vesting forfeitures and is recognized over the requisite service periods
of the awards on a straight-line or graded vesting basis, which is generally
commensurate with the vesting term. As a result of the adoption of FASB ASC
Topic 718, stock-based compensation expense associated with stock option grants
of $274,152, $180,298 and $111,438 was recorded in 2009, 2008 and 2007
respectively.




The
Company issues new shares upon stock option exercises. Please refer to
Note 18, Stock-based
Compensation Expense, for further information.





Fair Value
Measurements




The Company has adopted the provisions
of FASB ASC Topic 820, “Fair Value Measurements and Disclosures as of
January 1, 2008 for financial instruments. This standard defines fair
value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements.
ASC 820 clarifies that fair value is an exit price, representing the amount that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. ASC 820 permits an entity to measure
certain financial assets and financial liabilities at fair value with
changes in fair value recognized
in earnings each period. The adoption of FASB ASC Topic 820 was not material to
the Company’s consolidated financial statements or results of
operations.




ASC 820
establishes a fair value hierarchy which prioritizes the inputs to valuation
techniques used to measure fair value. Level 1 inputs are quoted prices in
active markets for identical assets or liabilities. Level 2 inputs are
inputs other than quoted prices included in Level 1 that are directly or
indirectly observable for the asset or liability. Such inputs include quoted
prices in active markets for similar assets and liabilities, quoted prices for
identical or similar assets or liabilities in markets that are not active,
inputs other than quoted prices that are observable for the asset or liability,
or inputs derived principally from or corroborated by observable market data by
correlation or other means. Level 3 inputs are unobservable inputs for the
asset or liability. Such inputs are used to measure fair value when observable
inputs are not available.


F-12




VUZIX
CORPORATION AND SUBSIDIARY





NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Recent
Accounting Pronouncements




The
Company adopted, as of July 1, 2009, the Financial Accounting Standards
Board’s (“FASB’s”) Accounting Standards Codification (“ASC”) as the source of
authoritative accounting principles recognized by the FASB to be applied to
nongovernmental entities in the preparation of financial statements in
conformity with GAAP. The ASC does not change authoritative guidance.
Accordingly, implementing the ASC did not change any of our accounting, and
therefore, did not have an impact on our consolidated results. References to
authoritative GAAP literature have been updated accordingly.




On
January 1, 2009, the Company adopted the provisions of FASB ASC Topic
320-10-65 (formerly FSP FAS 107-1 and APB 28-1) “Interim Disclosures about Fair
Value of Financial Instruments”. This update requires fair value
disclosures for financial instruments that are not currently reflected on the
balance sheet at fair value on a quarterly basis. The adoption of ASC Topic
320-10-65 did not have a material impact on our consolidated financial
statements.




On
January 1, 2009, the Company adopted the provisions of ASC 815-10 (formerly
FASB Statement 161, “Disclosures about Derivative
Instruments and Hedging Activities — an amendment of FASB Statement
No. 133”). FASB ASC 815-10 requires enhanced disclosures about
an entity’s derivative and hedging activities. FASB ASC 815-10 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008 with early application encouraged. The adoption of this
pronouncement did not have a material impact on our consolidated financial
statements.




On
January 1, 2009, the Company adopted FASB ASC topic 815-40 “Determining Whether an Instrument
(or Embedded Feature) is indexed to an Entity’s Own Stock” (formerly
EITF 07-5). ASC topic 815-40 provides guidance on determining whether an
instrument (or an embedded feature) is indexed to an entity’s own stock, which
would qualify as a scope exception under prior authoritative literature FASB
No. 133. “Accounting for Derivative Instruments and Hedging Activities” ASC
815-40 is effective for fiscal years beginning after December 15, 2008. The
adoption ASC topic 815-40 did not have a material impact on our consolidated
financial statements.




F-13


VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




In May
2009, the Company adopted FASB ASC topic 855, “Subsequent Events”. This
Statement sets forth: (i) the period after the balance sheet date during
which management of a reporting entity should evaluate events or transactions
that may occur for potential recognition or disclosure in the financial
statements; (ii) the circumstances under which an entity should recognize
events or transactions occurring after the balance sheet date in its financial
statements; and (iii) the disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. The adoption
of ASC topic 855 did not have a material impact on our consolidated financial
statements.




In June
2009, the FASB issued ASC topic 105 “Generally Accepted Accounting
Principles”, (formerly Statement of Financial Standards (SFAS)
No. 168, The Hierarchy of
Generally Accepted Accounting Principles). ASC topic 105 contains
guidance which reduces the U.S. GAAP hierarchy to two levels, one that is
authoritative and one that is not. This pronouncement was effective
September 15, 2009. The adoption of this pronouncement did not have a
material impact on our consolidated financial statements.




In
September 2009, the FASB issued Accounting Standards Update (“ASU”)
No. 2009-08, “EarningsPer Share” Amendments to Section 260-10-S99. This Codification
Update represents technical corrections to Topic 260-10-S99, Earnings per
Share, based on EITF Topic D-53, “Computation of Earnings Per Share
for a Period that Includes a Redemption or an Induced Conversion of a Portion of
a Class of Preferred Stock” and EITF Topic D-42, The Effect of the
Calculation of Earnings per Share for the Redemption or Induced Conversion of
Preferred Stock goes into effect in the period that includes a redemption or
induced conversion. Adoption of this new guidance did not have a material impact
on our consolidated financial statements.




In
October 2009, the FASB issued ASC 605-25 “Revenue Recognition —
Multiple- Deliverable Revenue Arrangement” that will become effective
beginning July 1, 2010, with earlier adoption permitted. Under the new
guidance, when vendor specific objective evidence or third party evidence for
deliverables in an arrangement cannot be determined, a best estimate of the
selling price is required to separate deliverables and allocate arrangement
consideration using the relative selling price method. The new guidance includes
new disclosure requirements on how the application of the relative selling price
method affects the timing and amount of revenue recognition. We believe adoption
of this new guidance will not have a material impact on our consolidated
financial statements.





In
January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and
Disclosures” which improves disclosures about the measurement of the fair
value of financial instruments including (1) the different classes of assets and
liabilities measured at fair value, (2) the valuation techniques and inputs
used, (3) the activity in Level 3 fair value measurements, and (4) the transfers
between Levels 1, 2, and 3 of the fair value inputs hierarchy. The guidance is
effective for fiscal years and interim periods ended after December 15, 2009.
The adoption of the guidance did not have a material impact on our consolidated
financial statements.


F-14


VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Note 2 —
Liquidity and Going Concern Issues





The
Company’s independent registered public accounting firm’s report issued on the
consolidated financial statements for the year ended December 31, 2009 included
an explanatory paragraph describing the existence of conditions that raise
substantial doubt about the Company’s ability to continue as a going concern,
including continued operating losses and the potential inability to pay
currently due debts. The Company has incurred annual net losses of $3,250,424 in
2009, $4,894,199 in 2008 and $3,059,514 in 2007 and has an accumulated deficit
of $18,032,430 as of December 31, 2009. The Company’s losses in fiscal years
2009 and 2008 have had a significant negative impact on the Company’s financial
position and liquidity.





The
Company’s cash requirements are primarily for funding operating losses, working
capital, research, principal and interest payments on debt obligations, and
capital expenditures. Historically, these cash needs have been met by borrowings
of notes and convertible debt and the sales of securities.  These
factors raise substantial doubt about the ability of the Company to continue as
a going concern. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of assets carrying
amounts or the amount of and classification of liabilities that may result
should the Company be unable to continue as a going concern.





In
this regard, management is expecting to raise any necessary additional funds
through loans and additional sales of its common stock. There is no assurance
that the Company will be successful in raising additional capital. Although the
Company believes its business plan is achievable if such funds are raised,
should the Company fail to achieve the sales or gross margin levels anticipated,
or if the Company were to incur significant unplanned cash outlays, it would
become necessary for the Company to obtain additional sources of liquidity or
make further cost cuts to fund its operations. However, there is no assurance
that the Company would be able to obtain such financing on favorable terms, if
at all, or to successfully further reduce costs in such a way that would
continue to allow the Company to operate its business.





The
Company’s business plan for fiscal year 2010 is based on a reductions and tight
control over selling, general and administrative expenses, lower total
investment dollars in research and development costs with a shorter term
development horizon, and a focus on sales of products with the higher margins
and lower working capital requirements.  The business plan for fiscal
year 2010 reflects a reduction in the cash used in operations, but does not
indicate a turn to profitability. However, there is no assurance that the
Company will achieve the sales, margin, new financing or cash flow
contemplated in its business plan.





Note 3 —
Accounts Receivable, Net




Accounts
receivable consisted of the following:




December
      31,
              
              2009
              
              
              2008Accounts
      Receivable
              
              $
              1,446,750
              
              
              $
              1,417,870Less:
      Allowance for Doubtful Accounts
              
              
              —
              
              
              
              (4,259
              )Net
              
              $
              1,446,750
              
              
              $
              1,413,611





Note 4 —
Inventories, Net




Inventories
consisted of the following:




December
      31,
              
              2009
              
              
              2008Purchased
      Parts and Components
              
              $
              1,992,894
              
              
              $
              2,091,734Work
      in Process
              
              
              926,343
              
              
              
              130,351Finished
      Goods
              
              
              508,636
              
              
              
              539,883Less:
      Reserve for Obsolescence
              
              
              (468,237
              )
              
              
              (454,647
              )Net
              
              $
              2,959,636
              
              
              $
              2,307,321





Note 5 —
Tooling and Equipment, Net




Tooling
and equipment consisted of the following:




December
      31,
              
              2009
              
              
              2008Tooling
      and Manufacturing Equipment
              
              $
              1,849,663
              
              
              $
              1,567,537Computers
      and Software
              
              
              496,980
              
              
              
              522,274Furniture
      and Equipment
              
              
              380,385
              
              
              
              360,695$
              2,727,028
              
              
              $
              2,450,506Less:
      Accumulated Depreciation
              
              
              (2,025,660
              )
              
              
              (1,624,582
              )Net
              
              $
              701,368
              
              
              $
              825,924





Total
depreciation expense for tooling and equipment for 2009, 2008 and 2007 was
$462,417, $455,412 and $326,752, respectively.




Note 6 —
Patents and Trademarks, Net




December
      31,
              
              2009
              
              
              2008Patents
      and Trademarks
              
              $
              1,034,546
              
              
              $
              899,952Less:
      Amortization
              
              
              (275,190
              )
              
              
              (215,150
              )Net
              
              $
              759,356
              
              
              $
              684,802





Total
amortization expense for patents and trademarks for 2009, 2008 and 2007 was
$60,040, $54,720 and $47,326, respectively. The estimated aggregate amortization
expense for each of the next five fiscal years is $64,286.


F-15


VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Note 7 —
Lines of Credit




The
Company has available a $100,000 line of credit secured by the personal
guarantee of an officer of the Company with interest payable at the bank’s prime
rate plus 4.24%. The outstanding balance on the line of credit amounted to
$75,365, $96,040 and $78,400 at December 31, 2009, 2008 and 2007,
respectively. The prime rate at December 31, 2009 was 3.25%.




The
Company also has available a $112,500 line of credit with interest payable at
the bank’s prime rate plus 1%. The line is unsecured and personally guaranteed
by an officer of the Company. The outstanding balance on the line of credit
amounted to $102,742, $106,250 and $0 at December 31, 2009, 2008 and 2007,
respectively.




Note 8 —
Customer Deposits




Customer
deposits represents money the Company received in advance of providing a product
or engineering services to a customer. Such deposits are short term in nature as
the Company delivers the product or engineering services to the customer before
the end of its next annual fiscal period.




Note 9 —
Accrued Expenses




Accrued
expenses consisted of the following:




December
      31,
              
              2009
              
              
              2008Accrued
      Wages and Related Costs
              
              $
              64,529
              
              
              $
              25,478Accrued
      Professional Services
              
              
              52,000
              
              
              
              40,000Accrued
      Warranty Obligations
              
              
              258,476
              
              
              
              106,865Other
      Accrued Expenses
              
              
              24,961
              
              
              
              13,617Total
              
              $
              399,966
              
              
              $
              185,960





The
Company has warranty obligations in connection with the sale of certain of its
products. The warranty period for its products is generally one year except in
European countries where it is two years. The costs incurred to provide for
these warranty obligations are estimated and recorded as an accrued liability at
the time of sale. The Company estimates its future warranty costs based on
product-based historical performance rates and related costs to repair. The
changes in the Company’s accrued warranty obligations for 2009, 2008 and 2007
were as follows:




Accrued
      Warranty Obligations at December 31, 2006
                        
                        $
                        42,475Actual
      Warranty Experience
                        
                        
                        (48,710
                        )Warranty
      Provisions
                        
                        
                        79,299Accrued
      Warranty Obligations at December 31, 2007
                        
                        $
                        73,064Actual
      Warranty Experience
                        
                        
                        (71,244
                        )Warranty
      Provisions
                        
                        
                        105,045Accrued
      Warranty Obligations at December 31, 2008
                        
                        $
                        106,865Actual
      Warranty Experience
                        
                        
                        (172,317
                        )Warranty
      Provisions
                        
                        
                        323,928Accrued
      Warranty Obligations at December 31, 2009
                        
                        $
                        258,476


F-16




VUZIX
CORPORATION AND SUBSIDIARY




NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)




Note 10 —
Accrued Compensation




Accrued compensation represents amounts
owed to officers of the Company for services rendered prior to 2007 that remain
outstanding. The principal is not subject to a fixed repayment schedule, and
interest on the outstanding balances is payable at 8% per annum, which effective
2009 and onwards compounds annually due to its continuing deferral post the
Company’s IPO. Interest expense related to accrued compensation amounts
to $48,436, $35,608,
$35,608 for the years ended December 31, 2009, 2008 and 2007, respectively.
Total accrued interest on the accrued compensation was $208,789 and $160,353 as
of December 31, 2009 and 2008, respectively and these amounts are included
in Accrued Interest, under the Long-Term Liabilities portion of the consolidated
balance sheet.




Note 11 —
Long-Term Trade Payable




Long-term
trade payable represent amounts owed to two suppliers of the Company for
component purchases in 2009 that have been deferred and remain outstanding. The
principal amount of $1,746,500 is due and payable on January 15, 2011. The
deferred trade payables are secured by all of the assets of the Company and
interest on the outstanding balances is payable at 10% per annum. In the event
the Company consummates an equity financing subsequent to its recent IPO that
results in gross proceeds of at least US$2,000,000 then the Company must,
subject to regulatory approvals apply not less than 50% of the proceeds from
such equity financings to the prompt payment of the deferred trade
payable.





Note 12 —
Long-Term Debt




Long-term
debt consisted of the following at December 31:




December
      31,
              
              2009
              
              
              2008Note
      payable to an officer of the Company. The principal is not subject to a
      fixed repayment schedule, bears interest at 8% per annum and is secured by
      all of the assets of the Company
              
              $
              209,208
              
              
              $
              209,208During
      October 2008, entered into an agreement with an officer of the Company,
      whereby the officer agrees to make loans from time to time to the Company
      through December 31, 2010, accruing interest on the outstanding
      balance at 12%, secured by all of the assets of the
Company
              
              
              215,500
              
              
              
              95,000Bridge
      loans in the original amount of $15,000 to stockholders of the Company
      with no fixed date of repayment, accruing interest at 7.5% and are
      unsecured. The Company has granted holders the same conversion terms as
      the $60,000 in notes below
              
              
              —
              
              
              
              15,000Convertible
      promissory notes in the original amount of $60,000. These notes bear
      interest at 8% and are unsecured. There is no set date of
      repayment
              
              
              —
              
              
              
              60,000Convertible
      Notes payable bearing interest at 10% and is secured by all the assets of
      the Company
              
              
              500,000
              
              
              
              500,000$
              924,708
              
              
              $
              879,208Less:
      Amount Due Within One Year
              
              
              715,500
              
              
              
              500,000Amount
      Due After One Year
              
              $
              209,208
              
              
              $
              379,208





The
aggregate maturities for all long-term borrowings as of December 31, 2009
are as follows:




2010
                                                
                                                2011
                                                
                                                2012
                                                
                                                2013
                                                
                                                
                                                Thereafter
                                                
                                                
                                                Total$
                                                715,500
                                                
                                                $
                                                209,208
                                                
                                                $
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                924,708





Included
above are convertible promissory notes and bridge loans that the Company has
issued. The convertible promissory notes and bridge loans were converted into
the Company’s common stock at $0.0571 per share. Unpaid, accrued interest on
these notes and loans amounts to $0 and $48,717 at December 31, 2009 and
2008, respectively. All accrued interest and principal was converted into common
shares pursuant the Company’s IPO in December 2009. The total potential
conversions of these notes and loans along with accrued interest had amounted to
2,144,522 shares as of December 31, 2008.




F-17






VUZIX
CORPORATION AND SUBSIDIARY  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  Included
above is a $500,000 convertible note payable. The note may be converted into the
Company’s common stock at $0.2333 per share. Unpaid accrued interest on this
note amounted to $126,137 and $114,247 at December 31, 2009 and 2008,
respectively. The total potential note conversion along with accrued interest
amounted to 2,683,122 and 2,632,454 shares at December 31, 2009 and
2008, respectively. The note’s principal was repaid in January 2010, however the
accrued interest was not repaid. The interest rate on the unpaid accrued
interest is 12% per annum and is now due on September 30,
2010.
 
 Note 13 —
Capital Lease Obligations
  The
Company maintains equipment held under capital lease obligations due in monthly
installments ranging from $62 to $2,811 including interest at rates ranging from
0.00% to 20.08%. The related equipment is collateral to the leases. Final
payments are due through September, 2011.
  December
      31,
                
                2009
                
                
                2008Total
      Principal Payments
                
                $
                194,837
                
                
                $
                320,128Less:
      Amount Due Within One Year
                
                
                (100,661
                )
                
                
                (139,800
                )Amount
      Due After One Year
                
                $
                94,176
                
                
                $
                180,328
 
 Annual
requirements for retirement of the capital lease obligations are as
follows:
  December
      31,
                
                Amount2010
                
                $
                122,1012011
                
                
                72,6742012
                
                
                30,3922013
                
                
                —2015
                
                
                —Total
      Minimum Lease Payments
                
                $
                225,167Less:
      Amount Representing Interest
                
                
                (30,330
                )Present
      Value of Minimum Lease Payments
                
                $
                194,837
  The
following is a summary of assets held under capital leases:
  December
      31,
                
                2009
                
                
                2008Tooling
      and Manufacturing Equipment
                
                $
                140,637
                
                
                $
                390,940Computers
      and Software
                
                
                184,604
                
                
                
                315,591Furniture
      and Equipment
                
                
                91,893
                
                
                
                112,648$
                417,134
                
                
                
                819,179Less:
      Accumulated Depreciation
                
                
                (239,432
                )
                
                
                (490,866
                )Net
                
                $
                177,702
                
                
                $
                328,313
  Depreciation
expense related to the assets under capital lease amounted to $104,527, $204,739
and $175,114 for years ended December 31, 2009, 2008 and 2007,
respectively.
  F-18
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  Note 14 —
Income Taxes
 The
Company files U.S. federal and U.S. state tax returns. At
December 31, 2009, the Company had unrecognized tax benefits totaling
$3,659,000, of which would have a favorable impact on our tax provision
(benefit), if recognized.
  Pre-tax
earnings consisted of the following for the years ended December 31, 2009,
2008 and 2007:
 
 December
      31,
                    
                    2009
                    
                    
                    2008
                    
                    
                    2007Total
      Pre-Tax (Loss) Earnings
                    
                    $
                    (3,250,424
                    )
                    
                    $
                    (4,888,987
                    )
                    
                    $
                    (3,157,886
                    )
 
 The
provision (benefit) for income taxes was as follows:
  December
      31,
              
              2009
              
              
              2008
              
              
              2007Current
      Income Tax Provision (Benefit)Federal
              
              $
              —
              
              
              $
              —
              
              
              $
              —State
              
              
              3,867
              
              
              
              5,212
              
              
              
              31,758State
      Tax Credit Refund
              
              
              (34,084
              )
              
              
              
              
              
              
              (130,130
              )Net
      Change in Liability for Unrecognized Tax Benefits
              
              
              —
              
              
              
              —
              
              
              
              —$
              (30,217
              )
              
              $
              5,212
              
              
              $
              (98,372
              )Deferred
      Provision (Benefit)
              
              
              —
              
              
              
              —
              
              
              
              —Total
      Provision (Benefit)
              
              $
              (30,217
              )
              
              $
              5,212
              
              
              $
              (98,372
              )
  A
reconciliation of the statutory U.S. federal income tax rate to the
effective rates is as follows:
  December
      31,
                
                2009
                
                
                2008
                
                
                2007Federal
      Income Tax at Statutory Rate
                
                
                34.0
                %
                
                
                34.0
                %
                
                
                34.0
                %State
      Tax Provision, Net of Federal Benefit
                
                
                —
                
                
                
                —
                
                
                
                (0.3
                )%Meals
      and Entertainment
                
                
                (0.3
                )%
                
                
                (0.3
                )%
                
                
                (0.3
                )%Stock
      Compensation Expense
                
                
                —
                
                
                
                (1.3
                )%
                
                
                (1.2
                )%Research
      and Development Credits
                
                
                (0.9
                )%
                
                
                (2.1
                )%
                
                
                (2.5
                )%Other
                
                
                —
                
                
                
                —
                
                
                
                —
                )%Effective
      Tax Rate
                
                
                32.8
                %
                
                
                30.3
                %
                
                
                29.7
                %Change
      in Valuations Allowance
                
                
                (32.8
                )%
                
                
                (30.3
                )%
                
                
                (29.7
                )%Net
      Effective Tax Rate
                
                
                0.0
                %
                
                
                0.0
                %
                
                
                0.0
                %
  F-19
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  Deferred
tax assets (liabilities) consist of the following:
  December
      31,
                
                2009
                
                
                2008AssetsCurrentInventory
      and Inventory Related Items
                
                $
                70,000
                
                
                $
                68,000Bad
      Debt and Note Receivable Reserves
                
                
                —
                
                
                
                1,000Warranty
      Reserves
                
                
                39,000
                
                
                
                16,000Accrued
      Interest
                
                
                46,000
                
                
                
                39,000Non-CurrentNet
      Operating Loss Carryforwards
                
                
                2,177,000
                
                
                
                1,825,000Stock
      Compensation Expense
                
                
                108,000
                
                
                
                67,000Tax
      Credit Carryforwards
                
                
                1,209,000
                
                
                
                946,000Depreciation
                
                
                10,000
                
                
                
                —Total
      Gross Deferred Tax Assets
                
                $
                3,659,000
                
                
                $
                2,962,000Valuation
      Allowance — 100%
                
                
                (3,659,000
                )
                
                
                (2,962,000
                )Total
      Net Deferred Tax Assets
                
                $
                —
                
                
                $
                —LiabilitiesCurrentNew
      York State Refund
                
                $
                —
                
                
                $
                (19,000
                )Total
      Gross Deferred Tax Liabilities
                
                
                —
                
                
                
                (19,000
                )Valuation
      Allowance — 100%
                
                
                —
                
                
                
                19,000Total
      Net Deferred Tax Liability
                
                $
                —
                
                
                $
                —Net
      Deferred Tax
                
                $
                —
                
                
                $
                —
 
 December
      31,
                
                2009
                
                
                2008Net
      Current Deferred Tax Assets
                
                $
                —
                
                
                $
                —Net
      Long-Term Deferred Tax Assets
                
                $
                —
                
                
                $
                —
 
 In 2009
and 2008, the Company generated federal and state net operating losses for
income tax purposes. These federal and state net operating loss carryforwards,
which total approximately $14,500,000 at December 31, 2009 and begin to
expire in 2018, if not utilized. Of the Company’s tax credit carryforwards,
$1,209,000 expire between 2017 and 2018, if not utilized.
  Deferred
tax assets, including carryforwards and other attributes, are reviewed for
expected realization and a valuation allowance is established when appropriate
to reduce the assets to their estimated net realizable value. Expected
realization of deferred tax assets is dependent upon sufficient taxable income
in the appropriate jurisdiction and period that is also of the appropriate
character. The Company has evaluated the availability of such taxable income,
the nature of its deferred tax assets and the relevant tax laws in determining
the net realizable value of its deferred tax assets.
  In
addition, the calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax regulations. As a result of the
implementation of FASB Interpretation No. 48, “Accounting for Uncertainty
in Income Taxes” (FIN 48), we recognize liabilities for uncertain tax
positions based on the two-step process prescribed within the interpretation.
The first step is to evaluate the tax position for recognition by determining if
the weight of available evidence indicates that it is more likely than not that
the position will be sustained on audit, including resolution of related appeals
or litigation processes, if any. The second step requires us to estimate and
measure the tax benefit as the largest amount that is more than
50% likely of being realized upon ultimate settlement. It is inherently
difficult and subjective to estimate such amounts, as this requires us to
determine the probability of various possible outcomes. We re-evaluate these
uncertain tax positions on a quarterly basis. This evaluation is based on
factors including, but not limited to, changes in facts or circumstances,
changes in tax law, effectively settled issues under audit and new audit
activity. Such a change in recognition or measurement would result in the
recognition of a tax benefit or an additional charge to the tax provision in the
period.
  F-20
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  The
following table summarizes the activity in the valuation allowance account for
2008 and 2007:
  Balance,
      December 31, 2007
                            
                            $
                            2,005,000Additions
      Relating to Uncertain Future Realization ofNet
      Operating Losses
                            
                            
                            855,000State
      Research and Development Tax Credits
                            
                            
                            102,000Balance,
      December 31, 2008
                            
                            $
                            2,962,000Additions
      Relating to Uncertain Future Realization ofNet
      Operating Losses
                            
                            
                            453,000Federal
      Tax Credits
                            
                            
                            82,000State
      Research and Development Tax Credits
                            
                            
                            162,000Balance,
      December 31, 2009
                            
                            $
                            3,659,000
  Note 15 —
Preferred Stock
  Preferred
stock
  Shares of
undesignated preferred stock may be issued in one or more series. The Board of
Directors is authorized to establish and designate the different series and to
fix and determine the voting powers and other special rights and qualifications.
A total of 5,000,000 shares of preferred authorized was authorized as of
December 31, 2009 and 0 shares were issued or outstanding. A total of
168,500 preferred shares were outstanding as of December 31, 2008 and these were
converted into common stock pursuant the Company’s IPO in December
2009.
  F-21
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 Preferred
dividends
  Cumulative
preferred dividends totaled $0 and $324,299 as of December 31, 2009 and
2008, respectively. These cumulative dividends in arrears represented an average
$1.92 per share as of December 31, 2008 and an average of $1.32 per share
as of December 31, 2007. All cumulative dividends were converted into
common shares pursuant to the Company’s IPO in December 2009.
  Note 16 —
Stock Split
  Effective
July 16, 2008, the Company effected a stock split of its common stock
whereby each one share of Common Stock, par value $0.001 per share, of the
Company’s outstanding stock were reclassified and changed into eight shares of
Common Stock, par value $0.001 per share.
  Effective
June 28, 2007 the Company effected a reverse stock split of its common
stock whereby each seven shares of Common Stock, par value $0.001 per share, of
the Company’s outstanding stock were reclassified and changed into one share of
Common Stock, par value $0.001 per share.
  Both the
stock split and reverse stock split affected the shares outstanding and pricing
for convertible debt, stock subscriptions, incentive stock options, stock
warrants and stockholders’ equity disclosures. All share and per-share amounts
in the accompanying consolidated financial statements and notes to the
consolidated financial statements have been adjusted to apply the effect of the
reverse stock split (one-for-seven) in 2007 and the forward stock split
(eight-for-one) in 2008.
  Note 17 —
Stock Warrants and Agent Options
  During
2009, the Company issued warrants to purchase 1,000,000 and
15,590,079 shares, respectively, of common stock to an investor in a
private placement and pursuant to the Company’s IPO in December 2009. The
exercise price on the 1,000,000 warrants was $0.20 per share and $0.285 ($0.30
Canadian dollars) per share for warrants issued pursuant to the Company’s IPO
unit offering in December 2009.
  In exchange for services performed by
vendors who worked at a reduced rate, warrants were issued to purchase
380,699 shares of common stock in 2008. The exercise prices range from
$0.00875 to $0.2334 per share. During 2008, 1,552,936 warrants were
exercised at a price of $.00875 per share.
  The
following table shows the various changes in warrants for the years
December 31, 2009 and 2008.
 
 December
      31,
                
                2009
                
                
                2008Warrants
      Outstanding, Beginning of Year
                
                
                4,998,771
                
                
                
                6,171,008Exercised
      During the Year
                
                
                —
                
                
                
                (1,552,936
                )Issued
      During the Year
                
                
                16,590,079
                
                
                
                380,699Forfeited
      During the Year
                
                
                (2,521,656
                )
                
                
                —Warrants
      Outstanding, End of Year
                
                
                19,067,194
                
                
                
                4,998,771
 F-22
 VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  The
outstanding warrants as of December 31, 2009 expire from December 31, 2010
to December 31, 2015. The weighted average remaining contractual term on
the warrants is 3.2 years. The weighted average exercise price is $0.2537
per share.
 
 During
2006, pursuant to a convertible note payable, a warrant was issued that would
only be exercisable if the note holder converted their note along with any
unpaid accrued interest. The exercise price if this warrant came into effect
would be $0.35 per share and the warrant would have to be exercised within three
years of the conversion date. Excluding accrued interest, the conversion of the
principal of the note and exercise of the resulting warrant would result in the
issuance of up to 1,071,444 shares as of December 31, 2009. This warrant is
not included in the totals above. The Company repaid the principal of this note
payable in January 2010 but not the accrued interest. Accordingly the unpaid
accrued interest is still convertible and exercise of the resulting warrant
would result in the issuance of up to 540,532shares based on the unpaid accrued
interest of $126,140.
 
 As
consideration for their services, the agents involved in the Company’s IPO
received special options entitling the agents to purchase that number of shares
our common stock and warrants equal to 12.5% of the aggregate number of shares
of our common stock and warrants sold under the IPO, at the offering price per
share and warrant, respectively, for a period of 12 months from the closing date
of December 23, 2009. As of December 31, 2009 the agents held options to
purchase 3,897,519 common shares along with 1,948,760 whole warrants. The
options expire on December 31, 2010 and the common shares must be purchased to
receive any corresponding half warrants, which would expire on December 23,
2012. The purchase prices are set in Canadian dollars. The common share purchase
price is Canadian $0.20 or US $0.19 per share and the warrant exercise price is
Canadian $0.30 of US$0.285 per share (the US$ amounts based on exchange rates at
December 31, 2009).
 
 Note 18 —
Stock Option Plans
  The
Company has the following Stock Option Plans (the “Plan”) that allow for the
granting of both incentive stock options or ISOs, which can result in
potentially favorable tax treatment to the participant, and non-statutory stock
options. The exercise price per share subject to an option is determined by the
administrator, but in the case of an ISO must not be less than the fair market
value of a share of our common stock on the date of grant and in the case of a
non-statutory stock option must not be less than 100% of the fair market value
of a share of our common stock on the date of grant.
 
 2007
      Plan
                      
                      
                      2009
      Plan
                      
                      
                      TotalOutstanding
      as of  December 31, 2009
                      
                      
                      14,685,578
                      
                      
                      
                      1,200,000
                      
                      
                      
                      15,885,578Available
      for future issuance under plan
                      
                      
                      —
                      
                      
                      
                      35,800,000
                      
                      
                      
                      35,800,000Totals
      authorized by plan
                      
                      
                      14,685,578
                      
                      
                      
                      37,000,000
                      
                      
                      
                      51,685,578
 
 The Plan
gives the Board of Directors of the Company the ability to determine vesting
periods for all options granted under the Plan, and allows option terms to be up
to ten years from the original grant date. Employees’ incentive stock options
must vest at a minimum rate of 20% per year over a five year period, commencing
on the date of grant. Most vest ratably over four years commencing on the date
of the option grant. In the case of directors, such options are granted annually
and they expire ten years after the date of their grant and vest ratably, on a
monthly basis, over the next 12 months. Non-employee directors have vesting
of 50% immediately on grant and the balance vest ratably, on a monthly basis,
over the next 12 months. Advisors or consultants can have vesting range from
100 percent of the option grants vesting immediately to ratably, on a
monthly basis, over the next a period of up to 48 months.
  F-23
 VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  The
following table summarizes stock option activity for the two years ended
December 31, 2009:
 
 WeightedAverageNumber
      of
                            
                            
                            Exercise
                            
                            
                            Exercise
      PriceShares
                            
                            
                            Price
                            
                            
                            RangeOutstanding
      at December 31, 2007
                            
                            
                            14,546,950
                            
                            
                            $
                            0.07254
                            
                            
                            $
                            0.0061
      – $ 0.2334Granted
                            
                            
                            1,917,288
                            
                            
                            $
                            0.1846
                            
                            
                            $
                            0.15
      – $   0.20Exercised
                            
                            
                            (2,450,888
                            )
                            
                            $
                            0.00694
                            
                            
                            $
                            0.06123
      – $ 0.0875Expired
      or Forfeited
                            
                            
                            (934,336
                            )
                            
                            $
                            0.1949
                            
                            
                            $
                            0.20
      – $ 0.2334Outstanding
      at December 31, 2008
                            
                            
                            13,079,014
                            
                            
                            $
                            0.0914
                            
                            
                            $
                            0.0061
      – $ 0.2334Granted
                            
                            
                            3,535,940
                            
                            
                            $
                            0.1676
                            
                            
                            $
                            0.15
      – $   0.20Exercised
                            
                            
                            —
                            
                            
                            $
                            —
                            
                            
                            $
                            —Expired
      or Forfeited
                            
                            
                            (729,376
                            )
                            
                            $
                            0.1996
                            
                            
                            $
                            0.15
      – $ 0.2334Outstanding
      at December 31, 2009
                            
                            
                            15,885,578
                            
                            
                            $
                            0.0914
                            
                            
                            $
                            0.0061
      – $ 0.2334
 
 As of
December 31, 2009, there were 12,014,553 options that were fully vested and
exercisable at weighted average exercise price of $0.1041 per share. The
weighted average remaining contractual term on the vested options is
5.0 years.
  The
unvested balance of 3,871,025 options as of December 31, 2009, are
exercisable at a weighted average exercise price of $0.167 per share. The
weighted average remaining contractual term on the vested options is
9.0 years.
 
 The
following tables summarize stock option information at December 31,
2009:
 
 Total
      Options OutstandingWeighted averageremaining life
                        
                        
                        Weighted averageRange
      of exercise price
                        
                        Shares
                        
                        
                        (yrs)
                        
                        
                        exercise price$0.0062
      to $0.0087
                        
                        
                        2,995,192
                        
                        
                        
                        2.4
                        
                        
                        $
                        0.0076$0.0227
      to $0.0289
                        
                        
                        3,560,702
                        
                        
                        
                        3.9
                        
                        
                        $
                        0.0249$0.1500
      to $0.2000
                        
                        
                        5,759,292
                        
                        
                        
                        9.0
                        
                        
                        $
                        0.1676$0.2100
      to $0.2334
                        
                        
                        3,570,392
                        
                        
                        
                        6.3
                        
                        
                        $
                        0.230115,885,578
                        
                        
                        
                        6.0
                        
                        
                        $
                        0.1195
 
 Exercisable
      Options OutstandingWeighted averageremaining life
                          
                          
                          Weighted averageRange
      of exercise price
                          
                          Shares
                          
                          
                          (yrs)
                          
                          
                          exercise price$0.0062
      to $0.0087
                          
                          
                          2,995,192
                          
                          
                          
                          2.4
                          
                          
                          $
                          0.0076$0.0227
      to $0.0289
                          
                          
                          3,560,702
                          
                          
                          
                          3.9
                          
                          
                          $
                          0.0249$0.1500
      to $0.2000
                          
                          
                          2,167,424
                          
                          
                          
                          8.8
                          
                          
                          $
                          0.1767$0.2100
      to $0.2334
                          
                          
                          3,291,235
                          
                          
                          
                          6.2
                          
                          
                          $
                          0.229812,014,553
                          
                          
                          
                          5.0
                          
                          
                          $
                          0.1041
 F-24
 
 VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 Unvested
      Options OutstandingWeighted averageremaining life
                        
                        
                        Weighted averageRange
      of exercise price
                        
                        Shares
                        
                        
                        (yrs)
                        
                        
                        exercise price$0.0062
      to $0.0087
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        $
                        —$0.0227
      to $0.0289
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        $
                        —$0.1500
      to $0.2000
                        
                        
                        3,591,868
                        
                        
                        
                        9.1
                        
                        
                        $
                        0.1621$0.2100
      to $0.2334
                        
                        
                        279,157
                        
                        
                        
                        7.1
                        
                        
                        $
                        0.23323,871,025
                        
                        
                        
                        9.0
                        
                        
                        $
                        0.1672
 
 The weighted average fair
value of options granted during 2009 was $0.1676 with an aggregate value of
$357,967. The weighted average fair value of options granted during 2008 was
$0.1828 with an aggregate total value of $224,020. The weighted average fair
value of options granted during 2007 was $0.2159 with an aggregate total value
of $246,214.
 
 Cash
received from option exercises in 2009, 2008 and 2007, amounted to $0, $16,696
and $5,730, respectively. All of the shares issued out of common
stock.
  With
respect to any non-qualified stock options and incentive stock options that are
exercised and held for less than one year, the Company recognizes a tax benefit
upon exercise in an amount equal to the tax effect of the difference between the
option price and the fair market value of the common stock on the exercise
date.
  Note 19 — Stock-based
Compensation Expense
  The table
below summarizes the impact of outstanding stock options on the results of
operations for the years ended December 31, 2009, 2008 and
2007:
 
 December
      31,
                
                2009
                
                
                2008
                
                
                2007Stock-Based
      Compensation Expense:Stock
      Options
                
                $
                274,152
                
                
                $
                180,298
                
                
                $
                111,438Income
      Tax Benefit
                
                
                —
                
                
                
                —
                
                
                
                —Net
      Decrease in Net Income
                
                $
                274,152
                
                
                $
                180,298
                
                
                $
                111,438Decrease
      in Earnings Per Share:Basic
      and Diluted
                
                $
                0.0012
                
                
                $
                0.0008
                
                
                $
                0.0006
 
 The
Black-Scholes-Merton option pricing model was used to estimate the fair value of
share-based awards under FASB ASC Topic 718. The Black-Scholes-Merton option
pricing model incorporates various and highly subjective assumptions, including
expected term and expected volatility. For valuation purposes, stock option
awards were categorized into two groups, stock option grants to employees and
stock option grants to members of the Board of Directors.
  The
expected term of options granted was estimated to be the average of the vesting
term, historical exercise and forfeiture rates, and the contractual life of the
option. The expected volatility at the grant date is estimated using historical
stock prices based upon the expected term of the options granted. The risk-free
interest rate assumption is determined using the rates for U.S. Treasury
zero-coupon bonds with maturities similar to those of the expected term of the
award being valued. Cash dividends have never been paid and are not anticipated
to be paid in the foreseeable future. Therefore, the assumed expected dividend
yield is zero.
  F-25
  VUZIX CORPORATION
AND SUBSIDIARY
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
  The
following table shows the detailed assumptions used to compute the fair value of
stock options granted during 2009, 2008 and 2007:
 December
      31,
                        
                        2009
                        
                        
                        2008
                        
                        
                        2007Expected
      Term (Years)
                        
                        
                        6.25 years
                        
                        
                        6.25 years
                        
                        
                        6.25 yearsVolatility
                        
                        
                        
                        58.2
                        %
                        
                        
                        60.9
                        %
                        
                        
                        63.7
                        %Risk
      Free Interest Rate
                        
                        
                        
                        2.95
                        %
                        
                        
                        4.39
                        %
                        
                        
                        4.39
                        %
 
 FASB ASC
Topic 718 requires pre-vesting option forfeitures at the time of grant to be
estimated and periodically revised in subsequent periods if actual forfeitures
differ from those estimates. Stock-based compensation expense is recorded only
for those awards expected to vest using an estimated forfeiture rate based on
historical pre-vesting forfeiture data.
 
 Unrecognized
stock-based compensation expense was approximately $447,434 as of
December 31, 2009, relating to a total of 3,871,025 unvested stock options
under the Company’s stock option plans. This stock-based compensation expense is
expected to be recognized over a weighted average period of approximately
2.3 years.
 
 Note 20 —
Stock Subscriptions Receivable
  During
the year ended December 31, 2002, the Company’s Board of Directors
authorized to make loans to certain senior employees to allow them to
participate in a rights offering and purchase 32,537,135 shares of common
stock at a price of $0.0085 per share. While the loans were initially due
September, 2007, the due date was extended to December 2012. The loans bear
interest at 6% and are shown as stock subscriptions receivable in the
accompanying consolidated financial statements. During 2009 a stock subscription
inclusive of gross interest to maturity totaling $94,181 was forgiven. An
adjustment to subscription receivables of $94,181 was made along with a $81,046
non-cash wage expense and a reduction of $13,145 in Additional Paid-In Capital
to reduce the unearned gross interest that was previously
accrued.
  Note 21 —
Commitments
  The Company leases office
and manufacturing space under an operating lease that expired in December, 2009.
The manufacturing facility is leased on a calendar year term. It requires
monthly payments of $4,200 plus insurance, taxes and common
charges.
  The
Company leases office space under an operating lease expiring in June 2010
requiring monthly payments of $3,819 plus insurance, taxes and common charges.
We intend to renew the lease on substantially the same terms before its
expiration.
  On
June 1, 2007 the Company acquired an operating lease for additional office
space. The lease expires on June 30, 2010 and requires monthly payments of
$3,973 plus insurance, taxes and common charges.
  Rent
expense for the years ended December 31, 2009, 2008 and 2007 totaled
$200,358, $178,657, and $161,410 respectively.
  Future
minimum payments required under operating lease obligations are as
follows:
 
 Total Minimum2010
                                
                                2011
                                
                                
                                Lease Payments$
                                120,066
                                
                                $
                                $22,914
                                
                                
                                $
                                142,980
 
 For the
lease agreements described above, the Company is required to pay the pro rata
share of the real property taxes and assessments, expenses and other charges
associated with these facilities.
  F-26
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 Note 22 —
Employee Benefit Plans
  The
Company has a Section 401(k) Savings Plan which covers employees who meet
certain age and length of service requirements. To date the plan is comprised of
100% employee deferrals.
  Note 23 —
Litigation
  The
Company is not subject to any legal proceedings or claims at the current time.
The Company indemnifies its directors and officers who are, or were, serving at
the Company’s request in such capacities. The fair value of the indemnifications
that the Company issued during 2009 or 2008 was not material to the Company’s
financial position, results of operations or cash flows.
 
 Note 24 —
Product Revenue
  The
following table represents the Company’s total sales for 2009, 2008 and 2008
classified by product category:
  December
      31,
                
                2009
                
                
                2008
                
                
                2007Consumer
      Video Eyewear
                
                $
                4,912,591
                
                
                $
                4,451,121
                
                
                $
                3,282,755Defense
      Products
                
                
                6,020,420
                
                
                
                6,397,221
                
                
                
                1,418,249Engineering
      Services
                
                
                924,863
                
                
                
                1,548,703
                
                
                
                5,445,375Low
      Vision Products
                
                
                28,224
                
                
                
                92,839
                
                
                
                —Total
                
                $
                11,886,098
                
                
                $
                12,489,884
                
                
                $
                10,146,379
 
 Note 25 —
Concentrations
  For 2009,
2008 and 2007, one customer accounted for approximately 42%, 20% and 17% of
sales, respectively and sales to the U.S. government accounted for
approximately 2%, 12% and 54%, respectively.
  Accounts
receivable from the U.S. government accounted for nil%, and 31% of accounts
receivable at December 31, 2009 and 2008, respectively and the other one
customer mentioned above represented nil% and 6% of accounts receivable at
December 31, 2009 and 2008, respectively.
  Note 26 —
Related Party Transactions
  During
2009, $5,023,429 and $ 1,076,072 of revenues and purchases, respectively were
derived from a minority stockholder (less than 5%) of the Company who also
represented $nil of the accounts receivable balance and $nil of the accounts
payable balance at December 31, 2009 and $746,500 of the Long Term Portion
of Trade Payable balance.
 
 During 2008, $2,472,824
and $827,307 of revenues and purchases, respectively were derived from a
minority stockholder (less than 5%) of the Company who also represented $90,606
of the accounts receivable balance and $ nil of the accounts payable balance at
December 31, 2008.
 
 During
2007, $1,737,285 and $2,009,500 of revenues and purchases, respectively were
derived from a minority stockholder (less than 5%) of the Company who also
represented $1,145,472 of the accounts receivable balance and $1,493,956 of the
accounts payable balance at December 31, 2007.
  F-27
  VUZIX
CORPORATION AND SUBSIDIARY
  NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 Included
in long-term debt is a note payable to an officer of the Company. Interest
expense related to the note payable amounted to $24,773, $16,737 and $16,737 for
the years ended December 31, 2009, 2008 and 2007. Total accrued interest on
the note payable was $124,652 as of December 31, 2009. See Note 12 for
details.
 Included
in long-term debt in 2008 and most of fiscal 2009, prior to the Company’s IPO,
there were bridge loans payable and convertible notes payable to related
parties, minority stockholders owning less than 1% of the Company. Total accrued
interest related to these loans payable amounted to $57,874, $48,717 and $40,085
for the years ended December 31, 2009, 2008 and 2007, respectively. The
entire $57,874 in accrued interest was converted pursuant to the Company’s IPO
in December 2009.
 
 The
Company has accrued compensation owed to officers of the Company. Interest
expense related to accrued compensation amounts to $48,436, $35,608 and $35,608
for the years ended December 31, 2009, 2008 and 2007, respectively. Total
accrued interest on the accrued compensation was $208,788 as of
December 31, 2009. See Note 10 for details.
 
 Included
in current liabilities are $246,417 of Notes Payable borrowed from four
individual lenders ($150,000 from two employee shareholders of the Company,
$46,417 from a director, and $50,000 from an external shareholder who owns 1.7%
of the Company). The notes bear interest at an annual rate of 18.0% and were all
due as of December 31, 2009. The Company repaid these notes in January from the
proceeds of its IPO.
  F-28