**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K/A**

**Amendment No. 3**

 

| **x**                                                 | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES  EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                  |       |                                                                                                     |
| **For the fiscal year ended December 31,  2005** |
|                                                  |       |                                                                                                     |
| **o**                                                 | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**For the transition period from                     to                    **

 

**Commission File No. 000-31332**

 

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**LIQUIDMETAL TECHNOLOGIES, INC.**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **33-0264467**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of incorporation or  organization) |       | (I.R.S. Employer  Identification No.) |

 

**25800 Commercentre Drive, Suite 100Lake Forest, California 92630**(address of principal executive office, zip code)

 

Registrant’stelephone number, including area code: **(949) 206-8000**

 

Securities registered pursuant to Section 12(b) ofthe Act: **None**

 

**Securities registered pursuant to Section 12(g) ofthe Act:**

 

**Title of each Class**Common Stock, .001 par value

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes  o    No  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes  o   No  ý

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for at least the past 90 days. Yes  ý    No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K   o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 ofthe Act).
| Large accelerated filer o |   | Accelerated filer ý |   | Non-accelerated filer o |
|--------------------------------|--------|-------------------------------|--------|------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes  o    No  ý

 

Theaggregate market value of the registrant’s Common Stock held by non-affiliatesof the registrant as of June 30, 2005 was approximately $55,919,320. Forpurposes of this calculation only, (i) shares of Common Stock are deemedto have a market value of $1.93 per share, the closing price of the CommonStock as reported on the Nasdaq National Market on June 30, 2005, and (ii) eachof the executive officers, directors and persons holding more than 10% of theoutstanding Common Stock as of June 30, 2005 is deemed to be an affiliate.

 

 

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**LIQUIDMETAL TECHNOLOGIES, INC.**

**Amendment No. 3 to the Annual Report of Form 10-K**

**For the Fiscal Year ended December 31, 2005**

 

**EXPLANATORY NOTE**

 

We are filing this Amendment No. 3to our Annual Report on Form 10-K for the fiscal year ended December 31,2005, as filed with the U.S. Securities and Exchange Commission (SEC) on March 16,2006, as amended on March 31, 2006 and on April 25, 2006, to 1)restate our financial statements to properly account for the conversion featureof the senior convertible notes and 2) to make certain changes to the disclosure in Item 9A.

 

Otherthan the changes referred to above, all other information included in the abovedescribed Form 10-K, as amended, remains unchanged. This amendment doesnot reflect events occurring after the filing of such Form 10-K, asamended, and does not modify or update the disclosures therein in any way otherthan as required to reflect the amendment as described above and set forthbelow.

 

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**TABLE OF CONTENTS**

 
| PART I   |
|----------|
|     |   | Item 1. |   | Business |   |
|     |   | Item 1A. |   | Risk Factors |   |
|     |   | Item 1B. |   | Unresolved  Staff Comments |   |
|     |   | Item 2. |   | Properties |   |
|     |   | Item 3. |   | Legal Proceedings |   |
|     |   | Item 4. |   | Submission  of Matters to a Vote of Security Holders |   |
| PART II  |   |   |
|     |   | Item 5. |   | Market For  Registrant’s Common Equity and Related Stockholder Matters |   |
|     |   | Item 6. |   | Selected  Consolidated Financial Data |   |
|     |   | Item 7. |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|     |   | Item 7A. |   | Quantitative  and Qualitative Disclosures About Market Risks |   |
|     |   | Item 8. |   | Financial  Statements and Supplementary Data |   |
|     |   | Item 9. |   | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure |   |
|     |   | Item 9A. |   | Controls and  Procedures |   |
|     |   | Item 9B. |   | Other Information |   |
| PART III |   |   |
|     |   | Item 10. |   | Directors  and Executive Officers of the Registrant |   |
|     |   | Item 11. |   | Executive  Compensation |   |
|     |   | Item 12. |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |   |
|     |   | Item 13. |   | Certain  Relationships and Related Transactions |   |
|     |   | Item 14. |   | Principal  Accounting Fees and Services |   |
| PART IV  |   |   |
|     |   | Item 15. |   | Exhibits,  Financial Statement Schedules and Reports on Form 8-K |   |
|          |  |  |  |  |  |  |  |

 

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**PART I**

 

**Forward-Looking Statements**

 

This annual report on Form 10-Kof Liquidmetal Technologies, Inc. contains “forward-looking statements”that may state our management’s current expectations, estimates,forecasts, and projections about the company and its business. Any statement inthis report that is not a statement of historical fact is a forward-lookingstatement, and in some cases, words such as “believe,” “estimate,” “project,” “expect,”“intend,” “may,” “anticipate,” “plans,” “seeks,” and similar expressionsidentify forward-looking statements. Forward-looking statements involve risksand uncertainties that could cause actual outcomes and results to differmaterially from the anticipated outcomes or result. These statements are notguarantees of future performance, and undue reliance should not be placed onthese statements. It is important to note that Liquidmetal Technologies, Inc.’sactual results could differ materially from what is expressed in ourforward-looking statements due to the risk factors described in the section ofthis report entitled “Risk Factors” in Item 1A of this report as well as thefollowing risks and uncertainties:

 

•      Our history of losses and uncertaintysurrounding our ability to achieve profitability;

•      Our limited history of manufacturing productsfrom bulk amorphous alloys;

•      Lengthy customer adoption cycles andunpredictable customer adoption practices;

•      Our ability to identify, develop, andcommercialize new product applications;

•      Competition from other materials;

•      Our ability to consummate strategicpartnerships in the future;

•      The potential for manufacturing problems ordelays;

•      Potential difficulties associated withprotecting or expanding our intellectual property position; and

•      Pending shareholder litigation against ourcompany

 

LiquidmetalTechnologies, Inc. undertakes no obligation to update publicly anyforward-looking statements, whether as a result of new information, futureevents or otherwise.

 

**Item 1. Business**

 

In this annual reporton Form 10-K, unless the context indicates otherwise, references to “theCompany”, “Liquidmetal Technologies”, “our Company”, “we”, “us”, and similarreferences refer to Liquidmetal Technologies, Inc. and its subsidiaries.

 

**Overview**

 

We are amaterials technology company that develops and commercializes products madefrom amorphous alloys. Our Liquidmetal® family of alloys consists of a varietyof proprietary coatings, powders, bulk alloys, and composites that utilize theadvantages offered by amorphous alloy technology. We develop, manufacture, andsell products and components from bulk amorphous alloys to customers in variousindustries, and we also partner with third-party licensees such as Rawlings,Head, and Socket Communications and distributors such as Matech and LLPG todevelop and commercialize bulk Liquidmetal alloy products. We believe that ourproprietary bulk alloys are the only commercially viable bulk amorphous alloyscurrently available in the marketplace. In addition to our bulk alloys, wemarket and sell a line of proprietary amorphous alloy-based industrial coatingsunder the Liquidmetal® ArmacorTM coatings brand.

 

Amorphousalloys are unique materials that are distinguished by their ability to retain arandom atomic structure when they solidify, in contrast to the crystallineatomic structure that forms in other metals and alloys when they solidify.Liquidmetal alloys possess a combination of performance, processing, andpotential cost advantages that we believe will make them preferable to other materialsin a variety of applications. The amorphous atomic structure of our alloysenables them to overcome certain performance limitations caused by inherentweaknesses in crystalline atomic structures, thus facilitating performance andprocessing characteristics superior in many ways to those of their crystallinecounterparts. For example, our zirconium-titanium Liquidmetal alloys areapproximately 250% stronger than commonly used titanium alloys such asTi-6Al-4V, but they also have some of the beneficial processing characteristicsmore commonly associated with plastics. We believe these advantages couldresult in Liquidmetal alloys supplanting high-performance alloys, such astitanium and stainless steel, and other incumbent materials in a wide variety ofapplications. Moreover, we believe these advantages could enable theintroduction of entirely new products and applications that are not possible orcommercially viable with other materials.

 

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**GeneralCorporate Information**

 

We wereoriginally incorporated in California in 1987, and we reincorporated inDelaware in May 2003. Our principal executive offices are located at 25800Commercentre Dr., Suite 100, Lake Forest, California 92630. Our telephonenumber at that address is (949) 206-8000. Previously, our principal executiveoffices were located in Tampa, Florida. In December 2003, we consolidatedall corporate functions into our Lake Forest facility, which had previouslyserved as our principal research and development office. Our Internet websiteaddress is www.liquidmetal.com and all of our filings with the Securities andExchange Commission are available free of charge on our website.

 

**Subsidiariesand Other Locations**

** **

We currentlyown and operate a manufacturing facility in Pyongtaek, South Korea, whichbecame operational in the third quarter of 2002. This Korean subsidiary handlesour Bulk Liquidmetal alloy business which includes market opportunities tomanufacture and sell casing components for electronic devices, medical devices,sporting goods, tooling, prototype sampling, defense applications and metalprocessing equipment. We also opened a post processing facility in Weihai,China in the third quarter of 2004. This Chinese subsidiary facilitates ourbulk alloy manufacturing business by handling most of our post manufacturingprocesses. Lastly, we operate a distribution warehouse division in Conroe,Texas to handle our Liquidmetal alloy industrial coatings which are usedprimarily as protective coatings for industrial machinery and equipment, suchas drill pipe used by the oil drilling industry and boiler tubes used by coalburning power plants.

 

**Segments**

 

In April 2002,we began classifying operations into two reportable segments: Liquidmetal alloyindustrial coatings and bulk Liquidmetal alloys. The Liquidmetal alloyindustrial coatings are used primarily as a protective coating for industrialmachinery and equipment, such as drill pipe used by the oil drilling industryand boiler tubes used by coal burning power plants. Bulk Liquidmetal alloysinclude market opportunities to manufacture and sell casing components forelectronic devices, medical devices, sporting goods, tooling, prototypesampling, defense applications and metal processing equipment. The expensesincurred by the bulk Liquidmetal alloy segment are manufacturing, research anddevelopment costs, and selling expenses associated with identifying anddeveloping market opportunities. Bulk Liquidmetal alloy products can bedistinguished from Liquidmetal alloy coatings in that the bulk Liquidmetalalloy can have significant thickness, up to approximately one inch, whichallows for their use in a wider variety of applications other than a thinprotective coating applied to machinery and equipment. Revenue and expensesassociated with research and development services are included in the bulkLiquidmetal alloy segment.

 

Results ofsegment operations and assets are included in Note 20 to the ConsolidatedFinancial Statements contained in thisForm 10-K.

 

**OurTechnology**

 

Theperformance, processing, and potential cost advantages of Liquidmetal alloysare a function of their unique atomic structure and their proprietary materialcomposition.

 

***Unique Atomic Structure***

 

The atomicstructure of Liquidmetal alloys is the fundamental feature that differentiatesthem from other alloys and metals. In the molten state, the atomic particles ofall alloys and metals have an amorphous atomic structure, which means that theatomic particles appear in a completely random structure with no discerniblepatterns. However, when non-amorphous alloys and metals are cooled to a solidstate, their atoms bond together in a repeating pattern of regular andpredictable shapes, or crystalline grains. This process is analogous to the wayice forms when water freezes and crystallizes. In non-amorphous metals andalloys, the individual crystalline grains contain naturally occurringstructural defects that limit the potential strength and performancecharacteristics of the material. These defects, known as dislocations, consistof discontinuities or inconsistencies in the patterned atomic structure of eachgrain. Unlike other alloys and metals, bulk Liquidmetal alloys can retain theiramorphous atomic structure throughout the solidification process and thereforedo not develop crystalline grains and the associated dislocations.Consequently, bulk Liquidmetal alloys exhibit superior strength and othersuperior performance characteristics compared to their crystallinecounterparts. Our Liquidmetal alloy coatings, in contrast to our bulk alloys,have a crystalline atomic structure when initially applied, but their atomicstructure becomes amorphous as the coatings rub against surfaces under force,thus improving their performance over time.

 

Prior to1993, commercially viable amorphous alloys could be created only in thin forms,such as coatings, films, or ribbons. However, in 1993, researchers at theCalifornia Institute of Technology (Caltech) developed the first commerciallyviable amorphous alloy in a bulk form. Today, bulk Liquidmetal alloys can beformed into objects that

 

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are upto one inch thick, and we are not aware of any other commercially availableamorphous alloys that can achieve this thickness. We have the exclusive rightto commercialize bulk amorphous alloy technology through a license agreementwith Caltech and other patents that we own.

 

***Proprietary Material Composition***

 

Theconstituent elements and percentage composition of Liquidmetal alloys arecritical to their ability to solidify into an amorphous atomic structure. Wehave several different alloy compositions that have different constituentelements in varying percentages. These compositions are protected by various patentsthat we own or exclusively license from third parties, including Caltech. Theraw materials that we use in Liquidmetal alloys are readily available and canbe purchased from multiple suppliers.

 

**Advantagesof Liquidmetal Alloys**

 

Liquidmetalalloys possess a unique combination of performance, processing and costadvantages that we believe makes them superior in many ways to othercommercially available materials for a variety of existing and potential futureproduct applications.

 

***Performance Advantages***

 

Our bulkLiquidmetal alloys provide several distinct performance advantages over othermaterials, and we believe that these advantages make the alloys desirable inapplications that require high yield strength, strength-to-weight ratio,elasticity and hardness.

 

The highyield strength of bulk Liquidmetal alloys means that a high amount of stressmust be exerted to create permanent deformation. However, because the yieldstrength is so high, the yield strength of many of our bulk Liquidmetal alloycompositions is very near their ultimate strength, which is the measure ofstress at which total breakage occurs. Therefore, very little additional stressmay be required to break an object made of bulk Liquidmetal alloys oncethe yield strength is exceeded. Although we believe that the yield strength ofmany of our bulk alloys exceeds the ultimate strength of most other commonlyused alloys and metals, our bulk alloys may not be suitable for certainapplications, such as pressurized tanks, in which the ability of the materialto yield significantly before it breaks is more important than its strengthadvantage. Additionally, although our bulk alloys show a high resistance tocrack initiation because of their very high strength and hardness, certain ofour bulk alloys are sensitive to crack propagation under certain long-term,cyclical loading conditions. Crack propagation is the tendency of a crack togrow after it forms. We are currently developing new alloy compositions thathave improved material properties to overcome these limitations.

 

***Processing Advantages***

 

Theprocessing of a material generally refers to how a material is shaped, formed,or combined with other materials to create a finished product. Bulk Liquidmetalalloys possess processing characteristics that we believe make them preferableto other materials in a wide variety of applications. In particular, our alloysare amenable to processing options that are similar in many respects to thoseassociated with plastics. For example, we believe that bulk Liquidmetal alloyshave superior net-shape casting capabilities as compared to high-strengthcrystalline metals and alloys. “Net-shape casting” is a type of casting thatpermits the creation of near-to-net shaped products that reduce costlypost-cast processing or machining. Additionally, unlike most metals and alloys,our bulk Liquidmetal alloys are capable of being thermoplastically molded inbulk form. Thermoplastic molding consists of heating a solid piece of materialuntil it is transformed into a moldable state, although at temperatures muchlower than the melting temperature, and then introducing it into a mold to form near-to-netshaped products. Accordingly, thermoplastic molding can be beneficial andeconomical for net shape fabrication of high-strength products.

 

BulkLiquidmetal alloys also permit the creation of composite materials that cannotbe created with most non-amorphous metals and alloys. A composite is a materialthat is made from two or more different types of materials. In general, the abilityto create composites is beneficial because constituent materials can becombined with one another to optimize the composite’s performancecharacteristics for different applications. In other metals and alloys, thehigh temperatures required for processing could damage some of the composite’sconstituent materials and therefore limit their utility. However, therelatively low melting temperatures of bulk Liquidmetal alloys allow mildprocessing conditions that eliminate or limit damage to the constituentmaterials when creating composites. In addition to composites, we believe thatthe processing advantages of Liquidmetal alloys will ultimately allow for avariety of other finished forms, including a coating or a spray. Mosthigh-strength metals and alloys cannot be processed into these forms.

 

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Notwithstandingthe foregoing advantages, our bulk Liquidmetal alloys possess certainlimitations relative to processing. The beneficial processing features of ourbulk alloys are made possible in part by the alloys’ relatively lowmelting temperatures. Although a lower melting temperature is a beneficialcharacteristic for processing purposes, it renders certain bulk alloycompositions unsuitable for certain high-temperature applications, such as jetengine exhaust components. Additionally, the current one-inch thicknesslimitation of our zirconium-titanium bulk alloy renders our alloys currentlyunsuitable for use as structural materials in large-scale applications, such asload-bearing beams in building construction. We are currently engaged inresearch and development with the goal of developing processing technology andnew alloy compositions that will enable our bulk alloys to be formed intothicker objects.

 

***Cost Advantages***

 

Liquidmetalalloys have the potential to provide cost advantages over other high-strengthmetals and alloys in certain applications. Because bulk Liquidmetal alloy hasprocessing characteristics similar in some respects to plastics, which lendsitself to near-to-net shape casting and molding, Liquidmetal alloys can in manycases be shaped efficiently into intricate, engineered products. Thiscapability can eliminate or reduce certain post-casting steps, such asmachining and re-forming, and therefore has the potential to significantlyreduce processing costs associated with making parts in high volume.

 

Additionally,because the near-to-net shape processing of Liquidmetal alloys reduces the needfor capital-intensive heavy industrial equipment such as that found in foundryand forging operations, Liquidmetal alloys can be processed with a smallermachinery footprint, which allows for more efficient development of facilitiesand reduced permitting and regulatory costs. We believe that these advantages may allowour customers an opportunity to maintain or improve the performance of theirproducts without a commensurate increase in cost.

 

**OurStrategy**

 

As aresult of the experience and knowledge that we have gained through ouractivities to date, and recognizing that developing and commercializing arevolutionary new technology is an evolutionary process, we are continuallymodifying our business strategy to enable us to better capitalize on ourevolving core strengths and more effectively pursue revenue growth andprofitability. The key elements of our strategy include:

 

•      *Identifying and Developing New Applications for OurLiquidmetal Alloy Technology.* We intend to continue to identify anddevelop new applications that will benefit from the performance, processing,and cost advantages of Liquidmetal alloys.

 

•      *Focusing Our Marketing and Internal ManufacturingActivities on Select Products with Expected Higher Gross-Margins.*Weintend to focus our marketing and internal manufacturing activities on selectproducts with anticipated higher gross margins. This strategy is designed toalign our product development initiatives with our manufacturing processes andmanufacturing cost structure, and to reduce our exposure to more commodity-typeproduct applications that are prone to unpredictable demand and fluctuatingpricing. Our focus is primarily on higher-margin products that possess designfeatures that take optimal advantage of our existing and developingmanufacturing technology and that command a price commensurate with theperformance advantages of our alloys. In addition to our focus on products withhigher gross margins, we will continue to engage in prototype manufacturing,both for internally manufactured products and for products that will ultimatelybe licensed to or manufactured by third parties.

 

•      *Further Developing Our Manufacturing Processes,Capabilities, and Efficiencies for Bulk Liquidmetal Alloys.* Weintend to improve and enhance our internal manufacturing processes,capabilities, and efficiencies in order to maintain quality control overproducts made from bulk Liquidmetal alloys, to focus on improvements to theprocessing of our alloys, and to protect our intellectual property. As ouralloys become more pervasive, however, we expect to enter into additionalstrategic relationships that would involve the licensing of Liquidmetaltechnology to third parties for certain market segments.

 

•      *Pursuing Strategic Partnerships In Order to MoreRapidly Develop and Commercialize Products*. We intend to activelypursue and support strategic partnerships that will enable us to leverage theresources, strength, and technologies of other companies in order to morerapidly develop and commercialize products. These partnerships may includelicensing transactions in which we license full commercial rights to ourtechnology in a specific application area, or they may includetransactions of a more limited scope in which, for example, we outsourcemanufacturing activities or grant distribution rights. We believe thatutilizing such a partnering strategy will enable us to reduce our workingcapital burden, better fund product development efforts, better

 

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understand customer adoption practices,leverage the technical and financial resources of our partners, and moreeffectively handle product design and process challenges. As this partneringstrategy evolves, a growing portion of our revenue mix may be comprised ofrevenue from the provision of product development services, technical support,and engineering services, as well as revenues from royalties on the sale ofLiquidmetal alloy products by our partners.

 

•      *Advancing the Liquidmetal® Brand*. Webelieve that building our corporate brand will foster continued adoption of ourtechnology. Our goal is to position Liquidmetal alloys as a superior substitutefor materials currently used in a variety of products across a range ofindustries. Furthermore, we seek to establish Liquidmetal alloys as an enablingtechnology that will facilitate the creation of a broad range of commerciallyviable new products. To enhance industry awareness of our company and increasedemand for Liquidmetal alloys, we are reviewing various brand developmentstrategies that could include collaborative advertising and promotionalcampaigns with select customers, industry conference and trade showappearances, public relations, and other means.

 

**Applications for Liquidmetal Alloys**

 

We havefocused our commercialization efforts for Liquidmetal alloys on five identifiedproduct areas. We believe that these areas are consistent with our strategy interms of market size, building brand recognition, and providing an opportunityto develop and refine our processing capabilities. Although we believe thatstrategic partnering transactions could create valuable opportunities beyondthe parameters of these target markets, we anticipate continuing to pursuethese markets both internally and in conjunction with partners.

 

***Components for Electronic Products***

 

We producecomponents for electronic devices using our bulk Liquidmetal alloys and believethat our alloys offer enhanced performance and design benefits for thesecomponents in certain applications. Bulk Liquidmetal alloys can be used forvarious structural components of a cellular phone, including the shield,faceplate, hinge, hinge housings, back plate, side plates, brackets, and thecover on the phones. We initially targeted the electronic casings marketbecause of its potential for high product volumes and branding opportunities;however, unpredictable customer adoption practices, short product model lives,processing limitations, and intense pricing pressures make it very challengingto compete in this high-volume market. Accordingly, we are currently limitingour focus in this market to higher-margin applications that have the potentialto benefit from the unique performance characteristics of bulk Liquidmetalalloys. We continue to believe that the high strength-to-weight ratio andelastic limit of bulk Liquidmetal alloys enable the production of stronger andthinner electronic devices as compared to plastic, zinc, and magnesium, and weintend to focus on products that require these design and performance benefits.

 

Through ourshipments to date, we have demonstrated that bulk Liquidmetal alloys can beused for structural components of cellular phones and other electronic devices.During 2004 and 2005, we shipped production quantities of cell phone componentsto Samsung Electronics Company and Vertu Limited, the luxury communicationproducts subsidiary of Nokia, for inclusion in various cellular phone models.

 

***Sporting Goods and Leisure Products***

 

We aredeveloping a variety of applications for Liquidmetal alloys in the sportinggoods and leisure products area.

 

In thesporting goods industry, we believe that the high strength, hardness, andelasticity of our bulk alloys have the potential to enhance performance in avariety of products, and we further believe that many sporting goods productsare conducive to our internal manufacturing strategy of focusing on high-marginproducts that meet our design criteria. Substantial opportunities also existfor our amorphous alloy coatings, powders and composites. In 2003, RawlingsSporting Goods Company launched a new line of baseball and softball bats thatutilize a Liquidmetal alloy coating, and HEAD NV Sport launched a new line ofHEAD® Liquidmetal® tennis racquets that incorporates Liquidmetal alloy incomposite form in their racquet design. In 2005, we have also launchedgoods that utilize Liquidmetal alloy including skis. Other potentialapplications for our alloys in this industry include golf clubs, eyewear,fishing, hunting, and other sport products.

 

In theleisure products category, we believe that bulk Liquidmetal alloys can be usedto efficiently produce intricately engineered designs with high-qualityfinishes, such as premium watchcases, and we further believe that Liquidmetalalloy technology can be used to make high-quality, high-strength jewelry from preciousmetals. We have successfully produced prototype rings made from an amorphousLiquidmetal platinum alloy that is harder (and hence more scratch resistant)than conventional platinum jewelry.

 

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In order toaccelerate the commercialization of Liquidmetal alloys in the jewelry andhigh-end luxury products market, in June 2003 we entered into a strategiclicensing transaction with LLPG, Inc., a corporation headed by a formerdirector of our company with ties to the Swiss jewelry and luxury goods market.While we have not generated revenues to date, under this agreement, LLPG wasgranted a 10-year exclusive worldwide license to manufacture and sell a varietyof luxury goods, including watchcases and precious-metal jewelry, utilizingLiquidmetal alloys. Under the agreement, we are entitled to royalties over thelife of the contract on all products produced and sold by LLPG.

 

***Medical Devices***

 

We areengaged in product development efforts relating to various medical devices thatcould be made from Liquidmetal alloys. We believe that the unique properties ofbulk Liquidmetal alloys provide a combination of performance and cost benefitsthat could make them a desirable replacement to incumbent materials, such as stainlesssteel and titanium, currently used in various medical device applications. Ourongoing emphasis in 2004 and 2005 has been on surgical instrument applicationsfor Liquidmetal alloys. These include, but are not limited to, specializedblades, orthopedic instruments utilized for implant surgery procedures, dentaldevices, and general surgery devices. The potential value offered by our alloysis high performance in some cases and cost reduction in others, the latterstemming from the ability of Liquidmetal alloys to be net shape cast intocomponents, thus reducing costs of secondary processing. The status of mostcomponents in the prototyping phase is subject to non-disclosure agreementswith our customers.

 

We believethat our future success in the medical device market will be driven largely bystrategically aligning ourselves with well-established companies that areuniquely positioned to facilitate the introduction of Liquidmetal alloys intothis market, especially as it relates to the unique processing challenges andstringent material qualification requirements that are prevalent in thisindustry. We also believe that our prospects for success in this market will beenhanced through our focus on optimizing existing alloy compositions anddeveloping new alloy compositions to satisfy the industry’s rigorous materialqualification standards.

 

***Industrial Coatings and Powders***

 

We continueto market and sell amorphous alloy industrial coatings and powders under theLiquidmetal® ArmacorTM Coatings brand name. Liquidmetal alloy coatings are usedprimarily as a protective coating for industrial machinery and equipment. Sincethe inception of this business in the late 1980s, our proprietary coatings havedemonstrated a high degree of hardness and low coefficient of friction which,when combined with their strong adhesion properties, reduce the wear andconsequent failure of the machinery and equipment on which they are used. Incontrast to our bulk alloys, we sell Liquidmetal coatings primarily in the form ofa wire or powder feedstock that is melted and applied to machinery or equipmentthrough welding or thermal spray processes.

 

OurLiquidmetal coatings are widely used in the oil drilling industry as aprotective coating on drill pipe and casings, and we estimate that our coatingsrepresent a dominant share of annual worldwide sales of hard band coatings fornew oil drill pipe. Drilling often places tremendous stress on pipes andcasings, especially whenever the drill changes direction. Both the drill pipeand casing experience excessive wear, which leads to higher replacement costsand greater failure rates. Liquidmetal coatings are used to provide aprotective coating, or hard band, around the outside of the drill pipe and theinside of casings to reduce wear and failure rates and accordingly reduceoperating costs.

 

Liquidmetalcoatings have also been sold into the power generation industry specificallyfor the purpose of coating boiler tubes in coal-burning power plants in orderto extend the lives of these boilers. Boiler tubes are subject to high heat,erosion, and corrosion and often require costly replacement, both in terms ofreplacement parts and length of downtime for installation. Additionally,residue build-up in boiler tubes of coal burning power plants creates operatinginefficiencies. Historic performance and testing of Liquidmetal coatings havedemonstrated that our coatings extend the life of these boiler tubesmeaningfully beyond their current average life depending on the specificenvironment. In addition, our coatings have demonstrated the ability to reducebuild-up of residue on boiler tubes, helping to improve the efficiencies of theboilers. Historically, we have not concentrated sales efforts on the boilertube market in a substantial way. However, given the size of the market andpotential opportunities for our coatings, we have recently dedicated greatereffort to this area.

 

***Defense Applications***

 

We are working with the U.S.Department of Defense, as well as a variety of defense-related research anddevelopment agencies and large defense contractors, to develop variousdefense-related applications for Liquidmetal alloys. For example, we arecurrently developing prototype kinetic energy penetrator rods for use inarmor-piercing ammunition systems. Kinetic energy penetrators, or KEPs, arearmor piercing munitions that are currently made primarily from depleteduranium or tungsten alloys. Initial ballistic tests under the Liquidmetal KEPprogram have demonstrated that

 

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tungsten KEPs perform betterwhenever Liquidmetal alloy is combined with the tungsten to create a compositematerial. In August 2003, we signed a new $3.0 million research anddevelopment contract with the U.S. Army for the development of KEPs. Ourstrategy is to orient the KEP program toward future systems such as the JointStrike Fighter program and the Army’s Future Combat System.

 

We also continue to workwith a number of defense-related research and development agencies and largedefense companies to identify additional military applications that may benefitfrom using Liquidmetal alloys. We believe that our alloys are well-positionedto capitalize on the trend toward lighter but stronger weapon systems in theU.S. military, and our strategy is to align ourselves with the largest and mostsignificant players in this industry. Product development programs for defenseapplications are currently underway with several leading defense contractors,including Alliant Techsystems and General Dynamics.

 

**GoingConcern**

** **

We haveexperienced significant operating losses since our inception. Our net loss forthe fiscal years ended December 31, 2005 and 2004 was $7.1 million and $14.9million, respectively. In our audit reports on our financial statements for ourfiscal years ended December 31, 2005 and 2004, our present and formerauditors have included a going-concern qualification indicating that oursignificant operating losses and working capital deficit cause substantialdoubt about our ability to continue as a going concern. By issuing an opinionstating that there is substantial doubt about our ability to continue as agoing concern, our former and current auditors have indicated that they areuncertain as to whether we have the capability to continue our operationswithout additional funding. Accordingly, we anticipate that we will needadditional funding during the next 12 months and would seek to raise such fundsthrough public or private equity financing, bank debt financing, or from othersources. Adequate funds may not be available when needed, and if we raiseadditional funds by issuing equity securities, existing stockholders may bediluted.

 

**LiquidmetalGolf**

 

From 1997until September 2001, we engaged in the retail marketing and sale of golfclubs through a majority owned subsidiary, Liquidmetal Golf. The retailbusiness of Liquidmetal Golf was discontinued in September 2001 and is nowtreated as a discontinued operation in our consolidated financial statements.Although the retail golf club business has been discontinued, Liquidmetal Golfwill be engaged in the business of manufacturing and selling golf clubcomponents to golf original equipment manufacturers that will integrate thesecomponents into their own clubs and then sell them under their respective brandnames. Liquidmetal Technologies owns 79% of the outstanding common stock inLiquidmetal Golf.

 

OurLiquidmetal Golf subsidiary has the exclusive right and license to utilize ourLiquidmetal alloy technology for purposes of golf equipment applications. Thisright and license is set forth in an intercompany license agreement betweenLiquidmetal Technologies and Liquidmetal Golf. This license agreement providesthat Liquidmetal Golf has a perpetual and exclusive license to use Liquidmetalalloy technology for the purpose of manufacturing, marketing, and selling golfclub components and other products used in the sport of golf. In considerationof this license, Liquidmetal Golf has issued 4,500,000 shares of LiquidmetalGolf common stock to Liquidmetal Technologies.

 

**OurIntellectual Property**

 

Ourintellectual property consists of patents, trade secrets, know-how, andtrademarks. Protection of our intellectual property is a strategic priority forour business, and we intend to vigorously protect our patents and otherintellectual property. Our intellectual property portfolio includes 27 owned orlicensed U.S. patents and numerous patent applications relating to thecomposition, processing, and application of our alloys, as well as variousforeign counterpart patents and patent applications.

 

Our initialbulk amorphous alloy technology was developed by researchers at the CaliforniaInstitute of Technology (“Caltech”). We have purchased patent rights thatprovide us with the exclusive right to commercialize the amorphous alloy andother amorphous alloy technology acquired from Caltech through a licenseagreement (“Caltech License Agreement”) with Caltech. Under the Caltech licenseagreement, we have the exclusive worldwide right to make, use, and sellproducts from all of Caltech’s inventions, proprietary information, know-how,and other technology relating to amorphous alloys existing as of September 1,2001. We also have an exclusive worldwide license to eleven issued patents andtwo patent applications held by Caltech relating to amorphous alloy technology,as well as all related foreign counterpart patents and patentapplications. Of the patents currently issued to Caltech and licensed by us,the earliest expiration date is 2013 and the latest expiration date is 2021. Furthermore,the license agreement gives us the exclusive right to make, use, and sellproducts from substantially all amorphous alloy technology that is developed inProfessor William Johnson’s Caltech laboratory during the period September 1,2001 through August 31, 2005. All fees and other

 

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amountspayable by us for these rights and licenses have been paid in full, and nofurther royalties, license fees, or other amounts will be payable in the futureunder this license agreement.

 

Our rightsunder the license agreement are perpetual in duration. However, Caltech has theright to convert the license to a non-exclusive license if we fail to utilizethe licensed technology for a period of 18 or more consecutive months, providedthat Caltech must give us 180-days advance written notice of the conversion andwe may cure the failure at any time during the 180-day notice period. Ifwe cure the failure, then the license will not be converted into anon-exclusive license.

 

Under thelicense agreement, we have the right to sublicense any of the licensedtechnology or patents. The license agreement also provides that Caltechreserves the right to use the licensed technology and patents for noncommercialeducational and research purposes. The patents and patent applications that welicense from Caltech relate primarily to the composition and processing of ouralloys. The currently issued U.S. patents covered by the license agreement willexpire between 2012 and 2013.

 

Under theCaltech license agreement, the parties are obligated to provide reasonablecooperation to each other in connection with any threatened or actualinfringement of the licensed technology by third parties. We have the right tocommence an action for infringement of any of the licensed technology, andalthough Caltech is not obligated to bring suit or take action againstinfringers, Caltech is obligated to join in any such lawsuit upon our request.

 

In additionto the patents and patent applications that we license from Caltech, we arebuilding a portfolio of our own patents to expand and enhance our technologyposition. These patents and patent applications primarily relate to variousapplications of our bulk amorphous alloys, the composition of our coatings andpowders, and the processing of our alloys. The patents relating to our coatingsexpire on various dates between 2006 and 2017, and the patents relating to ourbulk amorphous alloys expire on various dates between 2013 and 2021. Our policyis to seek patent protection for all technology, inventions, and improvementsthat are of commercial importance to the development of our business, except tothe extent that we believe it is advisable to maintain such technology orinvention as a trade secret.

 

In order toprotect the confidentiality of our technology, including trade secrets,know-how, and other proprietary technical and business information, we requirethat all of our employees, consultants, advisors and collaborators enter intoconfidentiality agreements that prohibit the use or disclosure of informationthat is deemed confidential. The agreements also obligate our employees,consultants, advisors and collaborators to assign to us developments,discoveries and inventions made by such persons in connection with their workwith us.

 

**Researchand Development**

 

We areengaged in ongoing research and development programs that are driven by thefollowing key objectives:

 

•      *Enhance Material Processingand Manufacturing Efficiencies.*We plan to continue research anddevelopment of processes and compositions that will decrease our cost of makingproducts from Liquidmetal alloys.

 

•      *Optimize Existing Alloys and Develop NewCompositions.*We believe that the primary technology driver of ourbusiness will continue to be our proprietary alloy compositions. We plan tocontinue research and development on new alloy compositions to generate abroader class of amorphous alloys with a wider range of specializedperformance characteristics. During 2003 and continuing into 2005, we havesuccessfully expanded our portfolio of bulk amorphous alloys to includeadditional zirconium-titanium alloys, as well as alloys based on other metals,such as iron, gold, and platinum. Although these various compositions are atdifferent stages of development and only a few are currently suitable forcommercial use, we believe that a larger alloy portfolio will enable us toincrease the attractiveness of our alloys as an alternative to incumbent materialsand, in certain cases, drive down product costs. We also believe that ourability to optimize our existing alloy compositions will enable us to bettertailor our alloys to our customers’ specific application requirements.

 

•      *Develop New Applications.* We will continueresearch and development of new applications for Liquidmetal alloys. We believethe range of potential applications will broaden by expanding the forms,compositions, and methods of processing of our alloys.

 

We conductour research and development programs internally and also through strategicrelationships that we enter into with third parties. Our internal research anddevelopment efforts are currently focused on product and process development.Our internal research and development efforts are conducted by a team of 15scientists, engineers and researchers whom we either employ directly or engageas consultants. Included among this team are Professor William Johnson, whodiscovered our initial bulk amorphous alloy at Caltech in 1993, and hisgraduate student at the time, Atakan Peker, who is employed as our VicePresident of Technology. Professor Johnson was an employee of our company from

 

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October 2001through December 2003 and then became a consultant to the Company. ProfessorJohnson continues to be a member of our board of directors.

 

In additionto our internal research and development efforts, we enter into cooperativeresearch and development relationships with leading academic institutions.Professor Johnson continues to supervise a laboratory at Caltech, and throughour license agreement with Caltech, we have a continuing relationship with theother researchers in Professor Johnson’s Caltech laboratory. We have alsoentered into research relationships with several other academic institutionsfor the conduct of research relating to the properties and characteristics ofour alloys.

 

We haveentered into development relationships with other companies for the purpose ofidentifying new applications for our alloys and establishing customerrelationships with such companies. Some of our product development programs arepartially funded by our customers. We are also engaged in negotiations withother potential customers regarding possible product development relationships.Our research and development expenses for the years ended December 31,2005, 2004, and 2003 were $1.1 million, $1.5 million, and $8.8 million,respectively.

 

**Manufacturing**

 

Wecurrently own and operate a 166,000 square foot manufacturing facility inPyongtaek, South Korea, which became operational in the third quarter of 2002. Weopened a 14,400 square foot facility in Weihai, China in August 2004 tofacilitate our bulk alloy manufacturing business. We believe that these facilitieswill meet our anticipated manufacturing needs for the foreseeable future,although these needs may change depending upon the actual and forecastedorders we receive for our products. We currently intend to develop supplementalresearch and development, prototyping and manufacturing capabilities elsewhere,including the United States, for purposes of meeting our long-termmanufacturing needs and our customers’ requirements. In December 2003, weentered into a license agreement with Florida Custom Mold, Inc., aClearwater, Florida-based company that specializes in high-quality mold designand injection molding services, under which Florida Custom Mold is currentlyacting as a contract manufacturer to our company for purposes of producingprototypes of certain defense and medical products in the US.

 

**RawMaterials**

 

Liquidmetalalloy compositions are comprised of many elements, all of which are availablecommodity products. We believe that each of these raw materials is readilyavailable in sufficient quantities from multiple sources on commerciallyacceptable terms. However, any substantial increase in the price orinterruption in the supply of these materials could have an adverse effect onour profitability.

 

**Customers**

 

During2005, one customer accounted for 10% or more of our revenue from continuingoperations. Revenues from Samsung represented 10% of revenues from continuingoperation for the year ended 2005. During 2004, four customers accounted for10% or more of our revenue from continuing operations. Revenues from Charm Techand Pntel, both of which are direct suppliers to Samsung, represented 62% ofrevenue from continuing operations for the year ended 2004. Also, revenues fromdefense related contracts with the United States of America represented 10% andGrowell Metal represented 12% of revenue from continuing operations for theyear ended 2004. We expect that a significant portion of our revenue may continueto be concentrated in a limited number of customers, even as our bulkLiquidmetal alloy business grows. During 2003, three customers accounted for10% or more of our revenue from continuing operations. Revenue from Samsungrepresented 10% of revenue, revenue from LLPG, Inc. represented 12% anddefense-related contracts with three departments of the United States ofAmerica represented 16% of revenue from continuing operations for the yearended December 31, 2003.

 

**Competition**

 

We are notaware of any other company or business that manufactures, markets, distributes,or sells bulk amorphous alloys or products made from bulk amorphous alloys. Webelieve it would be difficult to develop a competitive bulk amorphous alloywithout infringing our patents. However, our bulk Liquidmetal alloys facecompetition from other materials, including metals, alloys, plastics andcomposites, which are currently used in the commercial applications that wepursue. For example, we face significant competition from plastics and zinc inour electronics components business, and titanium and composites will continueto be used widely in medical devices and sporting goods. Based on ourexperience with developing products for a variety of customers, we believe thatthe selection of materials by potential customers will continue to beproduct-specific in nature, with the decision for each product being drivenprimarily by the performance

 

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needs of theapplication and secondarily by cost considerations and design flexibility.Because of the relatively high strength of our alloys and the designflexibility of our process, we are most competitive when the customer isseeking a higher strength as well as greater design flexibility than currentlyavailable with other materials. However, if currently available materials, suchas plastics, are strong enough for the application, our alloys are often notcompetitive those applications with respect to price. We also believe that ouralloys are generally not competitive with the cost of some of the basic metals,such as steel, aluminum or copper, when such basic metals can be used inspecific applications, but our alloys are generally more competitive with priceon more exotic metals, such as titanium. Our alloys could also face competitionfrom new materials that may be developed in the future, including newmaterials that could render our alloys obsolete.

 

OurLiquidmetal alloy coatings face competition from industrial coatings currentlymanufactured or sold by other companies. At present, the primary competitors ofour coatings business are Varco International, Inc. and Arnco TechnologyTrust, Limited. Although we believe, based on market data gathered by us, thatour coatings compete favorably with these companies’ products and that wecontinue to maintain the dominant market share with respect to protectivecoatings for oil drill pipe and casings, these competitors are largerwell-established businesses that have substantially greater financial,marketing, and other resources than we do.

 

We willalso experience indirect competition from the competitors of our customers.Because we will rely on our customers to market and sell finished goods thatincorporate our components or products, our success will depend in part onthe ability of our customers to effectively market and sell their own productsand compete in their respective markets.

 

**Backlog**

 

In ourbulk alloy segment, because of the minimal lead-time associated with orders ofbulk alloy parts, we generally do not carry a significant backlog. In ourcoatings segment, we typically ship our coating products shortly after receiptof an order, and our coatings backlog is therefore also insignificant. In bothour bulk alloy segment and coatings segment, the backlog as of any particulardate gives no indication of actual sales for any succeeding period.

 

**Salesand Marketing**

 

Wedirect our marketing efforts towards customers that will incorporate ourcomponents and products into their finished goods. To that end, we willcontinue to hire business development personnel who, in conjunction withengineers and scientists, will actively identify potential customers that may beable to benefit from the introduction of Liquidmetal alloys to their products.In some cases, we will develop applications in conjunction with existing orpotential customers. By adopting this strategy, we intend to take advantage ofthe sales and marketing forces and distribution channels of our customers tofacilitate the commercialization of our alloys. We also direct businessdevelopment efforts toward companies who we believe could be viable candidatesfor potential partnering transactions, such as licensing relationships,distribution arrangements, joint ventures, and the like.

 

**Employees**

 

As of December 31,2005, we had 352 full-time employees. As of that date, 78 of our Koreanoperation employees were represented by a labor union. We have not experiencedany work stoppages and we consider our employee relations to be favorable.

 

**GovernmentalRegulation**

 

Medicalinstruments incorporating our Liquidmetal alloys will be subject to regulationin the United States by the FDA and corresponding state and foreign regulatoryagencies. Any orthopedic devices that we develop will be regulated in a similarmanner. Medical device manufacturers to whom we intend to sell our products may needto obtain FDA approval before marketing their medical devices that incorporateour products. Medical device manufacturers may need to obtain similarapprovals before marketing these medical device products in foreign countries.

 

Because weintend to sell our medical device products to medical device manufacturers, wedo not believe that we will need to obtain FDA approval or similar foreignapprovals before selling products to medical device manufacturers. Nonetheless,as a manufacturer of medical device components, we would be subject to qualitycontrol and record keeping requirements of FDA and other federal and statestatutes and regulations, as well as similar regulations in foreign countries.

 

The processof obtaining and maintaining required FDA and foreign regulatory approvals formedical devices that incorporate our products could be lengthy, expensive, anduncertain for our customers. Additionally, regulatory agencies

 

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can delay orprevent product introductions. Generally, before a medical device manufacturercan market a product incorporating one of our products, our customer mustobtain for their finished product marketing clearance through a 510(k)premarket notification or approval of a pre-market approval application, orPMA. The FDA will typically grant a 510(k) clearance if the applicant canestablish that the device is substantially equivalent to a predicate device. Itgenerally takes a number of months from the date of a 510(k) submission toobtain clearance, but it may take longer, particularly if a clinical trialis required.

 

The FDA may findthat a 510(k) is not appropriate for a medical device that incorporates ourproduct or that substantial equivalence has not been shown and as a result willrequire a PMA. A PMA application must be submitted if a proposed medical devicedoes not qualify for a 510(k) pre-market clearance procedure. PMA applicationsmust be supported by valid scientific evidence to demonstrate the safety andeffectiveness of the device, typically including the results of clinicaltrials, bench tests, and laboratory and animal studies. The PMA process can beexpensive, uncertain and lengthy, requires detailed and comprehensive data, andgenerally takes significantly longer than the 510(k) process. Additionally, theFDA may never approve the PMA.

 

Similarregulations in foreign countries vary significantly from country to country andwith respect to the nature of the particular medical device. The time requiredto obtain these foreign approvals to market our products may be longer orshorter than that required in the United States, and requirements for suchapproval may differ from FDA requirements.

 

**Environmental Law Compliance**

 

Ourmanufacturing operations are subject to national, state, and localenvironmental laws in China, South Korea, and the United States. We believethat we are in material compliance with all applicable environmentalregulations. While we continue to incur costs to comply with environmental regulations,we do not believe that such costs will have a material effect on our capitalexpenditures, earnings, or competitive position.

 

**Item 1A. Risk Factors**

 

This report containsforward-looking statements (within the meaning of the Private Securities LitigationReform Act of 1995) that are based on management’s current expectations,estimates, forecasts, and projections about the Company and its business. Inaddition, other written or oral statements which constitute forward-lookingstatements may be made from time to time by or on behalf of LiquidmetalTechnologies, Inc. Any statement in this report that is not a statement ofhistorical fact is a forward-looking statement, and in some cases, words suchas “believe,” “estimate,” “project,” “expect,” “intend,” “may,” “anticipate,” “plans,”“seeks,” and similar expressions identify forward-looking statements.Forward-looking statements involve risks and uncertainties that could causeactual outcomes and results to differ materially from the anticipated outcomesor result. These statements are not guarantees of future performance, and unduereliance should not be placed on these statements. Liquidmetal Technologies, Inc.undertakes no obligation to update publicly any forward-looking statements,whether as a result of new information, future events or otherwise.

 

Factors that couldcause actual results to differ materially from what is expressed or forecastedin our forward-looking statements include, but are not limited to, thefollowing:

 

**We have incurred significant operating losses in the past and may notbe able to achieve or sustain profitability in the future.**

 

We haveexperienced significant operating losses since our inception. Our net loss forthe fiscal years ended December 31, 2005, 2004, and 2003 was $7.1 million,$14.9 million and $33.6 million, respectively. We had an accumulated deficit ofapproximately $134.5 million at December 31, 2005. Of this accumulateddeficit, $44.5 million was attributable to losses generated by our discontinuedequipment manufacturing and retail golf businesses through December 31,2005. We anticipate that we may continue to incur operating losses for theforeseeable future. Consequently, it is possible that we may never achievepositive earnings and, if we do achieve positive earnings, we may not beable to achieve them on a sustainable basis.

 

**We mayrequire additional funding, which may not be available on favorable terms or atall.**

 

Our futurecapital requirements will depend on the amount of cash generated by our operations.Our projections of cash flows from operations and, consequently, future cashneeds are subject to substantial uncertainty. In addition, in our audit reporton our financial statements for our fiscal years ended December 31, 2005and 2004, our auditors included a going-concern qualification indicating thatour significant operating losses and working capital deficit cause substantialdoubt about our ability to continue as a going concern. Our operating plan isbased on assumptions that are uncertain or otherwise subject to change. If ouravailable funds and cash generated from operations are insufficient to satisfyour liquidity requirements, we will need additional funds in the future tosupport our working capital requirements and for

 

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otherpurposes, and we anticipate that we will to raise additional funds throughpublic or private equity financing, bank debt financing, or from other sources.Adequate funds may not be available when needed or may not beavailable on favorable terms. If we raise additional funds by issuing equitysecurities, existing stockholders may be diluted. If funding isinsufficient at any time in the future, we may not be able to develop orenhance our products or services, take advantage of business opportunities, orrespond to competitive pressures, any of which could harm our business.

 

**We have a limited history of developing, manufacturing, and sellingproducts made from our bulk amorphous alloys.**

 

We havemarketed and sold industrial coatings to distributors in the coatings industrysince 1987. Prior to the third quarter of 2002, our experience selling productsmade from bulk amorphous alloys has been limited to our discontinued retailgolf business, which had a different marketing strategy than the one we arecurrently employing. Therefore, we have a relatively limited history ofproducing bulk amorphous alloy components and products on a mass-productionbasis. Furthermore, our ability to produce our products in desired quantitiesand at commercially reasonable prices is uncertain and is dependent on avariety of factors that are outside of our control, including the nature anddesign of the component, the customer’s specifications, and required deliverytimelines.

 

**We rely on assumptions about the markets for our products andcomponents that, if incorrect, may adversely affect our profitability.**

 

We havea relatively short history producing bulk amorphous alloy components on amass-production basis. We have made assumptions regarding the market size for,and the manufacturing requirements of, our products and components based in part oninformation we received from third parties and also from our limited history.If these assumptions prove to be incorrect, we may not achieve anticipatedrevenue targets or profitability.

 

**If we cannot establish and maintain relationships with customers thatincorporate our components and products into their finished goods, we will notbe able to increase our revenue and commercialize our products.**

 

Ourbusiness is based upon the commercialization of a new and unique materialstechnology. Our ability to increase our revenues will depend on our ability tosuccessfully maintain and establish relationships with customers who arewilling to incorporate our proprietary alloys and technology into theirfinished products. However, we believe that the size of our company and thenewness of our technology and manufacturing process may continue to makeit challenging to maintain and establish such relationships. In addition, werely and will continue to rely to a large extent on the manufacturing,research, and development capabilities, as well as the marketing anddistribution capabilities, of our customers in order to commercialize ourproducts. Our future growth and success will depend in large part on ourability to enter into these relationships and the subsequent success of theserelationships. If our products are selected for use in a customer’s products,we still may not realize significant revenue from that customer if thatcustomer’s products are not commercially successful.

 

**It may take significant time and cost for us to develop newcustomer relationships, which may delay our ability to generate additionalrevenue or achieve profitability.**

 

Ourability to generate revenue from new customers is generally affected by theamount of time it takes for us to, among other things:

 

•      identifya potential customer and introduce the customer to Liquidmetal alloys;

 

•      workwith the customer to select and design the parts to be fabricated fromLiquidmetal alloys;

 

•      makethe molds and tooling to be used to produce the selected part;

 

•      makeprototypes and samples for customer testing;

 

•      workwith our customers to test and analyze prototypes and samples; and

 

•      withrespect to some types of products, such as medical devices, to obtainregulatory approval.

 

Wecurrently do not have a sufficient history of selling products made from ourbulk amorphous alloys to predict accurately the length of our average salescycle. We believe that our average sales cycle from the time we deliver an

 

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activeproposal to a customer until the time our customer fully integrates our bulkamorphous alloys into its product could be a significant period of time. Ourhistory to date has demonstrated that the sales cycle could extendsignificantly longer than we anticipate. The time it takes to transition acustomer from limited production to full-scale production runs will depend uponthe nature of the processes and products into which our alloys are integrated. Moreover,we have found that customers often proceed very cautiously and slowly beforeincorporating a fundamentally new and unique type of material into theirproducts.

 

**After we develop a customer relationship, it may take asignificant amount of time for that customer to develop, manufacture, and sellfinished goods that incorporate our components and products.**

 

Ourexperience has shown that our customers will perform numerous tests andextensively evaluate our components and products before incorporating them intotheir finished products. The time required for testing, evaluating, anddesigning our components and products into a customer’s products, and in somecases, obtaining regulatory approval, can take a significant amount of time,with an additional period of time before a customer commences volume productionof products incorporating our components and products, if ever. Moreover,because of this lengthy development cycle, we may experience a delaybetween the time we accrue expenses for research and development and sales andmarketing efforts and the time when we generate revenue, if any. We may incursubstantial costs in an attempt to transition a customer from initial testingto prototype and from prototype to final product. If we are unable to minimizethese transition costs, or to recover the costs of these transitions from ourcustomers, our operating results will be adversely affected.

 

**A limited number of our customers generate a significant portion of ourrevenue.**

 

For thenear future, we expect that a significant portion of our revenue will beconcentrated in a limited number of customers. For example, for the year ended December 31,2005, revenues from one customer, Samsung, represented approximately 10% oftotal revenue from continuing operations, and for the year ended December 31,2004, revenue from two customers represented approximately 62% of total revenuefrom continuing operations, and for the year ended December 31, 2003,revenue from two customers represented approximately 26% of total revenue fromcontinuing operations. Revenues from direct suppliers to Samsung representedapproximately 14% and 62% of total revenues from continuing operations for theyear ended December 31, 2005 and 2004, respectively. Also, revenues fromdefense related contracts with the United States of America represented 10%,and Growell Metal represented 12%, of revenue from continuing operations forthe year ended 2004. A reduction, delay, or cancellation of orders from one ormore of these customers or the loss of one or more customer relationships couldsignificantly reduce our revenue. Unless we establish long-term salesarrangements with these customers, they will have the ability to reduce ordiscontinue their purchases of our products on short notice.

 

**We expect to rely on our customers to market and sell finished goodsthat incorporate our products and components, a process over which we will havelittle control.**

 

Ourfuture revenue growth and ultimate profitability will depend in part onthe ability of our customers to successfully market and sell their finishedgoods that incorporate our products. We will have little control over ourcustomers’ marketing and sales efforts. These marketing and sales efforts may beunsuccessful for various reasons, any of which could hinder our ability toincrease revenue or achieve profitability. For example, our customers may nothave or devote sufficient resources to develop, market, and sell their finishedgoods that incorporate our products. Because we typically will not haveexclusive sales arrangements with our customers, they will not be precludedfrom exploring and adopting competing technologies. Also, productsincorporating competing technologies may be more successful for reasonsunrelated to the performance of our customers’ products or the marketingefforts of our customers.

 

**Our growth depends on our ability to identify, develop, andcommercialize new applications for our technology.**

 

Ourfuture growth and success will depend in part on our ability to identify,develop, and commercialize, either alone or in conjunction with our customers,new applications and uses for Liquidmetal alloys. If we are unable to identifyand develop new applications, we may be unable to develop new products orgenerate additional revenue. Successful development of new applications for ourproducts may require additional investment, including costs associatedwith research and development and the identification of new customers. Inaddition, difficulties in developing and achieving market acceptance of newproducts would harm our business.

 

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**We may not be able to effectively compete with current suppliersof incumbent materials or producers of competing products.**

 

The futuregrowth and success of our bulk amorphous alloy business will depend in part onour ability to establish and retain a technological advantage over othermaterials for our targeted applications. For many of our targeted applications,we will compete with manufacturers of similar products that use differentmaterials. These different materials may include plastics, titaniumalloys, or stainless steel, among others. For example, we have targeted thecellular phone component market as an application for bulk Liquidmetal alloys.In this market, we believe we will compete with other manufacturers of cellularphone components who use plastics or metal to construct their components. Theseother manufacturers may be able to manufacture their cellular phonecomponents, particularly those made from plastics, at significantly less costthan our alloys. In other markets, we will compete directly with suppliers ofthe incumbent material. In addition, in each of our targeted markets, oursuccess will depend in part on the ability of our customers to competesuccessfully in their respective markets. Thus, even if we are successful inreplacing an incumbent material in a finished product, we will remain subjectto the risk that our customer will not compete successfully in its own market.

 

**Our bulk amorphous alloy technology is stillat an early stage of commercialization relative to many other materials.**

 

Our bulkamorphous alloy technology is a relatively new technology as compared to manyother material technologies, such as plastics and widely-used high-performancecrystalline alloys. Historically, the successful commercialization of a newmaterials technology has required the persistent improvement and refining ofthe technology over a sometimes lengthy period of time. Accordingly, we believethat our Company’s future success will be dependent on our ability to continueexpanding and improving our technology platform by, among other things,constantly refining and improving our manufacturing processes, optimizing ourexisting amorphous alloy compositions for various applications, and developingand improving new bulk amorphous alloy compositions. Our failure to furtherexpand our technology base could limit our growth opportunities and hamper ourcommercialization efforts.

 

**Futureadvances in materials science could render Liquidmetal alloys obsolete.**

 

Academicinstitutions and business enterprises frequently engage in the research andtesting of new materials, including alloys and plastics. Advances in materialsscience could lead to new materials that have a more favorable combination ofperformance, processing, and cost characteristics than our alloys. The futuredevelopment of any such new materials could render our alloys obsolete andunmarketable or may impair our ability to compete effectively.

 

**Our growthdepends upon our ability to retain and attract a sufficient number of qualifiedemployees.**

 

Our businessis based upon the commercialization of a new and unique materials technology.Our future growth and success will depend in part on our ability to retainkey members of our management and scientific staff, who are familiar with thistechnology and the potential applications and markets for it. For example, as aresult of their experience and knowledge of our alloy technology, we believethat our future growth and success will depend in large part on theefforts of John Kang, our Chairman of the board of directors, and Dr. AtakanPeker, our Vice President of Technology. We do not have “key man” or similarinsurance on any of these individuals. If we lose their services or theservices of other key personnel, our financial results or business prospects may beharmed. Additionally, our future growth and success will depend in part onour ability to attract, train, and retain scientific engineering,manufacturing, sales, marketing, and management personnel. We cannot be certainthat we will be able to attract and retain the personnel necessary to manageour operations effectively. Competition for experienced executives andscientists from numerous companies and academic and other research institutionsmay limit our ability to hire or retain personnel on acceptable terms. Inaddition, many of the companies with which we compete for experienced personnelhave greater financial and other resources than we do. Moreover, the employmentof non-citizens may be restricted by applicable immigration laws.

 

On December 15,2005, an indictment naming as defendants ten former officers and directors ofMedical Manager Corporation, including our Chairman, John Kang, was filed inthe United States District Court for the District of South Carolina (BeaufortDivision). Medical Manager Corporation was a publicly traded company in which Mr. Kangwas formerly the President and Chief Executive Officer. Mr. Kang wascharged in counts for conspiracy to commit securities fraud, conspiracy tocommit mail fraud and conspiracy to launder money instruments relating to a series ofacquisitions that were made by Medical Manager during the years 1996 through2003, the accounting practices of Medical Manager during that time frame, andthe filing of various financial statements during that time frame. Although theindictment is unrelated to Mr. Kang’s service as a director and officer ofour company, Mr. Kang resigned as our President and Chief ExecutiveOfficer on December 30, 2005; however, he continues to serve as Chairmanof the Board of our company and continues to work for the company on a full-timebasis. Mr. Kang as pled “not guilty” to the indictment and plans tocontest the charges vigorously. At this time, however, we cannot estimate thepotential impact on our company, if any, that might result from these charges.

 

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**We may notbe able to successfully identify, consummate, or integrate strategicpartnerships.**

 

As a part ofour business strategy, we intend to pursue strategic partnering transactionsthat provide access to new technologies, products, markets, and manufacturingcapabilities. These transactions could include licensing agreements, jointventures, or even business combinations. We believe that these transactionswill be particularly important to our future growth and success due to the sizeand resources of our company and the newness of our technology. For example, wemay determine that we may need to license our technology to a largermanufacturer in order to penetrate a particular market. In addition, we may pursuetransactions that will give us access to new technologies that are useful inconnection with the composition, processing, or application of Liquidmetalalloys. We may not be able to successfully identify any potentialstrategic partnerships. Even if we do identify one or more potentiallybeneficial strategic partnering, we may not be able to consummate thesetransactions on favorable terms or obtain the benefits we anticipate from sucha transaction.

 

**We may encountermanufacturing problems or delays or may be unable to produce high-qualityproducts at acceptable costs.**

 

We haverelatively limited experience in manufacturing our products and may berequired to manufacture a range of products in high volumes while ensuring highquality and consistency. Although we currently own and operate a 166,000 squarefeet and a 14,400 square feet manufacturing facilities in South Korea andChina, respectively, we cannot guarantee that these facilities will be able toproduce the intended products with production yields, quality controls, andproduction costs that provide us with acceptable margins or profitability orsatisfy the requirements of our customers.

 

**We expectto derive a substantial portion of our revenue from sales outside the UnitedStates, and problems associated with international business operations couldaffect our ability to manufacture and sell our products.**

 

We expectthat we will continue to manufacture a substantial portion of our initial bulkLiquidmetal alloy products in our South Korean facility and derive a materialportion of our revenues from customers in South Korea. For our fiscal yearsended December 31, 2005, 2004, and 2003, approximately 31%, 54%, and 34%of our revenues came from customers located in South Korea, respectively. As aresult, our manufacturing operations and financial results are subject to risksof political instability, including the risk of conflict between North Koreaand South Korea and tensions between the United States and North Korea. Inaddition, we anticipate that the trend of foreign customers accounting for asignificant portion of our total revenues may continue. Specifically, weexpect to continue to derive a significant amount of revenue from sales tocustomers located in Asia. A downturn in the economies of Asian countries whereour products will be sold, particularly South Korea’s economy, could materiallyharm our business.

 

Consequently,our operations and revenue likely will be subject to a number of risksassociated with foreign commerce, including:

 

•      staffing and managing our manufacturingfacility located in South Korea and post-processing facility located in China;

 

•      product or material transportation delays ordisruption, including the availability and costs of air and othertransportation between our South Korean and Chinese facilities and the UnitedStates;

 

•              political and economic instability, includinginstability involving China and North Korea that may disrupt ouroperations in China and South Korea;

 

•              potentially adverse tax consequences, which may reducethe profitability of products manufactured overseas or sold to overseascustomers;

 

•              burden of complying with complex foreign laws andtreaties, which could limit our ability to conduct our business as contemplatedin South Korea and China; and

 

•              trade protection laws, policies, and measures andother regulatory requirements affecting trade and investment that couldadversely affect the profitability of our South Korean and Chinese Operations,including loss or modification of exemptions for taxes and tariffs.

 

Moreover,customers may sell finished goods that incorporate our components andproducts outside of the United States, which exposes us indirectly toadditional foreign commerce risks.

 

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**Asubstantial increase in the price or interruption in the supply of rawmaterials for our alloys could have an adverse effect on our profitability.**

 

Ourproprietary alloy compositions are comprised of many elements, all of which areavailable commodity products. Although we believe that each of these rawmaterials is currently readily available in sufficient quantities from multiplesources on commercially acceptable terms, if the prices of these materialssubstantially increases or there is an interruption in the supply of thesematerials, such increase or interruption could adversely affect ourprofitability. For example, if the price of one of the elements included in ouralloys substantially increases, we may not be able to pass the priceincrease on to our customers.

 

**Ourbusiness is subject to the potential adverse consequences of exchange ratefluctuations.**

 

We expect toconduct business in various foreign currencies and will be exposed to marketrisk from changes in foreign currency exchange rates and interest rates. Fluctuationsin exchange rates between the U.S. dollar and such foreign currencies may havea material adverse effect on our business, results of operations, and financialcondition and could specifically result in foreign exchange gains and losses.The impact of future exchange rate fluctuations on our operations cannot beaccurately predicted. To the extent that the percentage of our non-U.S. dollarrevenue derived from international sales increases in the future, our exposureto risks associated with fluctuations in foreign exchange rates will increasefurther. Moreover, as a result of operating a manufacturing facility in SouthKorea, a substantial portion of our costs are and will continue to bedenominated in the South Korean won. Adverse changes in the exchange rates ofthe South Korean won to the U.S. dollar will affect our costs of goods sold andoperating margins and could result in exchange losses. The average foreignexchange rates for the years ended December 31, 2005, 2004, and 2003 were1,028, 1,151, and 1,195 South Korean Won to the U.S. dollar, respectively. Thefluctuations in the exchange rates resulted in foreign currency translationgains of $0.3 million, $1.7 million, and $0.2 million for the years ended December 31,2005, 2004, and 2003, respectively.

 

**Ourinability to protect our licenses, patents, and proprietary rights in theUnited States and foreign countries could harm our business because thirdparties may take advantage of our research and development efforts.**

 

We have anexclusive license from Caltech to several patents and patent applicationsrelating to amorphous alloy technology, and we have obtained several of our ownpatents. We also have the exclusive right to Caltech’s inventions, proprietaryinformation, know-how, and other technology relating to bulk amorphous alloysexisting as of September 1, 2001. Our success depends in part on ourability to obtain and maintain patent and other proprietary right protectionfor our technologies and products in the United States and other countries. Ifwe are unable to obtain or maintain these protections, we may not be ableto prevent third parties from using our proprietary rights. Specifically, wemust:

 

•              protect and enforce our license agreement with Caltechand our own patents and intellectual property;

 

•              exploit our license of the patented technology underour license agreement with Caltech as well as our own patents; and

 

•              operate our business without infringing on theintellectual property rights of third parties.

 

Caltech owns severalissued United States patents covering the composition and method ofmanufacturing of the family of Liquidmetal alloys. We also hold several UnitedStates and corresponding foreign patents covering the manufacturing processesof Liquidmetal alloys and their use. The patents relating to our coatingsexpire on various dates between 2005 and 2022, and those relating to our bulkamorphous alloys between 2013 and 2025. If we are unable to protect ourproprietary rights prior to the expiration of these patents, we may losethe advantage we have established as being the first to market bulk amorphousalloy products. In addition, the laws of some foreign countries do not protectproprietary rights to the same extent as the laws of the United States, and we may encountersignificant problems and costs in protecting our proprietary rights in theseforeign countries.

 

Patent law isstill evolving relative to the scope and enforceability of claims in the fieldsin which we operate. Our patent protection involves complex legal and technicalquestions. Our patents and those patents for which we have license rights may bechallenged, narrowed, invalidated, or circumvented. We may be able toprotect our proprietary rights from infringement by third parties only to the extentthat our proprietary technologies are covered by valid and enforceable patentsor are effectively maintained as trade secrets. Furthermore, others may independentlydevelop similar or alternative technologies or design around our patentedtechnologies. Litigation or other proceedings to defend or enforce ourintellectual property rights could require us to spend significant time andmoney and could otherwise adversely affect our business.

 

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**Other companiesmay claim that we infringe their intellectual property rights, which couldcause us to incur significant expenses or prevent us from selling our products.**

 

Our successdepends, in part, on our ability to operate without infringing on valid,enforceable patents or proprietary rights of third parties and not breachingany licenses that may relate to our technology and products. Futurepatents issued to third parties may contain claims that conflict with ourpatents and that compete with our products and technologies, and third partiescould assert infringement claims against us. Any litigation or interferenceproceedings, regardless of their outcome, may be costly and may requiresignificant time and attention of our management and technical personnel. Litigationor interference proceedings could also force us to:

 

•              stop or delay using our technology;

 

•              stop or delay our customers from selling,manufacturing or using products that incorporate the challenged intellectualproperty;

 

•              pay damages; or

 

•              enter into licensing or royalty agreements that may beunavailable on acceptable terms.

 

**Our levelof indebtedness reduces our financial flexibility and could impede our abilityto operate.**

 

As of December 31,2005, our long-term debt was $15.1 million, including the current portion ofsuch debt. Our long-term debt (including the current portion) includes thefollowing:

 

•              $2.8 million in principal outstanding under our Koreansubsidiary’s loan from Kookmin Bank of South Korea;

 

•              $2.4 million in principal outstanding underconvertible notes issued in our August 19, 2004 private exchange; and

 

•              $9.9 million in principal outstanding underconvertible notes issued in our August 2, 2005 private placement.

 

Under ourloan from Kookmin Bank, we are obligated to make equal monthly payments ofprincipal and interest of $0.11 million each through the period ending in September 2007.Under our 6% Senior Secured Notes due July 2007 and 7% Senior SecuredNotes due August 2007, we are required to make cash interest payments tothe noteholders of $0.22 million per quarter until such notes are converted orpaid. Unless such notes are converted, the $2.4 million in aggregate principalamount under our 6% Senior Secured Notes due July 2007 will become due in July 2007,provided that the holders of such notes may demand payment thereunder in July 2006.The $9.9 million in aggregate principal amount under our 7% Senior SecuredNotes due August 2007 will become due in August 2007.

 

Ourlevel of debt affects our operations in several important ways, including thefollowing:

 

•              a significant portion of our cash flow from operationsis likely to be dedicated to the payment of the principal of and interest onour indebtedness;

 

•              we may be unable to refinance our indebtedness onterms acceptable to us or at all;

 

•              our cash flow may be insufficient to meet ourrequired principal and interest payments; and

 

•              we may be unable to obtain additional loans as aresult of covenants and agreements with existing debt holders.

 

In addition,our convertible notes and related documents contain restrictive covenantspursuant to which we generally may not (i) incur any indebtednessthat would be senior to, or on the same rank as, the convertible notes withrespect to payment or security, (ii) grant any liens or security interestsin any of our assets which serve as collateral for the convertible notes (whichcollateral consists of substantially all of our assets), (iii) withcertain exceptions, sell any of the assets that constitute collateral for thenotes, (iv) become a guarantor for a third-party’s obligation (other thanguarantees in the ordinary course of business not in excess of $500,000 in theaggregate), (v) acquire any shares or securities of any other person orentity in excess of an aggregate of $1.0 million over any rolling 12-monthperiod, (vi) purchase or otherwise acquire any assets in excess of anaggregate of $3.0 million over any rolling 12-month period, (vii) engagein any transaction resulting in the issuance to any person of more than 40% ofthe equity of our company, or (viii) engage in any merger or sale of allor substantially all of our business assets. These covenants may curtailour ability to raise capital in the future or otherwise restrict our ability toenter into a transaction that we believe would be in the best interest of ourstockholders.

 

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**If wedefault on the convertible notes that we have issued, the noteholders may acceleratethe amounts due under such notes and may foreclose on the securityinterests that secure the notes.**

 

As of December 31,2005, we had approximately $12.3 million in principal amount of convertiblenotes outstanding. Approximately $2.4 million in principal amount ofconvertible notes will become due in July 2007, with the balance becomingdue in August 2007. Interest on our convertible notes is payable quarterlyin cash. These notes are secured by substantially all of the assets of ourcompany. We will be deemed to be in default under these notes if we fail to payany principal or interest when it becomes due, and we will also be deemed to bein default if we breach any other material provision of our other agreementswith the noteholders and we fail to cure such breach within thirty days of noticeof default. Upon a default under these notes, the noteholders have the right toaccelerate the maturity date of the notes and demand that they be immediatelyrepaid by us. If we fail to pay such notes, either at maturity or uponacceleration, then the noteholders may elect to foreclose upon the assetssecuring the notes.

 

**We havenot complied with Section 404 of the Sarbanes-Oxley Act of 2002 for ourfiscal years ended December 31, 2005, and 2004.**

 

As directedby Section 404 of the Sarbanes-Oxley Act of 2002, or SOX, the SEC hasadopted rules requiring public companies to include a report of managementon the company’s internal controls over financial reporting in their annualreports on Form 10-K. In addition, the public accounting firm auditing apublic company’s financial statements must attest to and report on management’sassessment of the effectiveness of the company’s internal controls overfinancial reporting. Although these requirements were first applicable to ourannual report on Form 10-K for our fiscal year ending December 31,2004, we were unable to comply with these requirements for such fiscal year. Asdisclosed in our amended Form 10-K filed with the SEC on May 10,2005, the time and resources necessary to complete the restatement of prior periods’financial statements delayed our ability to complete the internaldocumentation, assessment and evaluation of internal control over financialreporting, all of which are required to be undertaken to comply with Section 404of SOX. This delay prevented our independent auditor from being able tosatisfactorily complete a timely audit of our internal control over financialreporting as of December 31, 2004. As a result, investors may not beable to rely on our financial statements for the fiscal year ended December 31,2004 and 2005.

 

Due to thesedelays, we and our independent auditor determined that it would not be possibleto complete the management’s assessment and auditor’s audit of our internalcontrols over financial reporting as of December 31, 2004, and accordinglyour independent auditor has issued a disclaimer of opinion with respect to ourinternal control over financial reporting as of December 31, 2004, andsuch disclaimer was filed with our amended Form 10-K filed on May 10,2005. The filing of this disclaimer does not comply with the SEC’s rules andregulations under Section 404, and this noncompliance has resulted in usbeing in violation of Section 13(a) under the Securities Exchange Actof 1934. Section 13(a) establishes the general requirement thatpublic companies must file with the SEC, in accordance with such rules andregulations as the SEC may prescribe, such information, documents, andreports as the SEC may from time to time require for the protection ofinvestors, including Form 10-Ks and 10-Qs.

 

In general,the SEC has broad authority under the Securities Exchange Act of 1934 toinstitute investigations, to seek injunctions, to seek monetary penalties, andto otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K. Therefore, a violation under Section 404of SOX or Section 13(a) of the Securities Exchange Act of 1934 couldpotentially subject an issuer to these same investigations and penalties. Section 404of SOX is a relatively new legal requirement, and there is very littleprecedent establishing the consequences or appropriate response to a publiccompany’s failure to comply with Section 404. Accordingly, we cannotpredict what action, if any, the SEC may take against our company as aresult of a failure to be compliant with our obligations under Section 404of SOX or Section 13(a) of the Securities Exchange Act of 1934.

 

Effective December 27,2005, the SEC announced final rulings on revisions to accelerated filerdefinition and deadlines for periodic reports. The ruling revised thedefinition of the term “accelerated filer” to permit an accelerated filer thathas voting and non-voting common equity held by non-affiliates of less than $50million to exit accelerated filer status at the end of the fiscal year in whichits equity falls below $50 million and to file its annual report for that yearand subsequent periodic reports on a non-accelerated basis. As of the fiscalyear ended December 31, 2005, we are considered an accelerated filer andare required to comply with SOX 404 requirements for the 2005 fiscal year.

 

In additionto the foregoing, although our common stock was admitted to the OTC BulletinBoard for quotation on June 15, 2005, as a result of our noncompliancewith Section 404 for our 2005 fiscal year, it may not have beenappropriate for the OTC Bulletin Board to admit our common stock for quotationon June 15, 2005. Consequently, there is no assurance that our commonstock will remain eligible for quotation on the OTC Bulletin Board.

 

****The Company has devotedsignificant amount of financial and internal resources during 2005 and early part of2006 to ensure compliance with SOX 404, and on January 16, 2006, Company’smanagement has completed and concluded its****

**** ****

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**** ****

****documentation, assessment andevaluation of its internal controls over financial reporting as of December 31,2005. However, our independent auditors, Stonefield Josephson Inc., resigned onDecember 1, 2005, and on January 20, 2006, the Company hired Choi,Kim & Park LLP (“CKP”) as its new independent registered publicaccounting firm. While the Company has advised CKP of the foregoing weaknessesin internal controls, due to the untimeliness of the foregoing events, CKP wasunable to satisfactorily complete their audit of the Company’s internal controlover financial reporting pursuant to SOX 404, and thus, have issued adisclaimer of an opinion on the company’s internal control over financialreporting as of December 31, 2005. The Company’s management will continueto monitor potential changes in the legal and regulatory requirements of SOX404, particularly the requirements for small public companies.****

 

**We haveidentified material weaknesses in our internal control over financial reportingand have determined that our disclosure controls and procedures are noteffective.**

 

Our formerindependent auditors, Stonefield Josephson, Inc., have notified the AuditCommittee of our Board of Directors that they believed there were reportableconditions during 2004 and 2005 which constituted material weaknesses in ourinternal controls. The following material weaknesses have been identified:

 

•              Lack of adequate segregation of duties in our SouthKorean operations in accounts receivable involving cash receipts, shipping,delivery of products and customer invoice reconciliations.

 

•              Lack of adequate segregation of duties in our CoatingsDivision in Texas in order processing and invoicing.

 

•              Lack of adequate controls and documentation in ourSouth Korean operations to evidence proper customer invoicing and revenuerecognition in the proper period.

 

•              Lack of progress in documenting, assessing andevaluating our internal controls in our South Korean operations.

 

•              Lack of controls over internal access to our SAPsystem of reporting by unauthorized users.

 

•              Manual performance of numerous procedures that couldbe automated using current reporting systems.

 

In additionto the foregoing, after a review of our operating results for the fiscal yearended December 31, 2004 and for the quarters ended March 31, 2005, June 30,2005, and September 30, 2005, and pursuant to Rule 13a-15 under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), our ChiefExecutive Officer and our Chief Financial Officer have determined that, as ofeach such date, our disclosure controls and procedures were not effective toprovide reasonable assurance that information that we are required to disclosein reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms. This conclusion wasbased on the Company’s determination in March 2006 that it had previouslyfailed to properly account for the senior convertible notes issued by theCompany in August 2005. In particular, the Company had previously failedto identify and properly account for the derivative feature of such convertiblenotes in accordance with applicable accounting standards. As a result of thisfailure, the Company restated its financial statements contained in its 2004and 2005 Form 10-Q’s and 10-K’s. .

 

Effectiveinternal control over financial reporting and disclosure controls andprocedures are necessary for us to provide reliable financial reports andeffectively prevent fraud and to operate successfully as a public company. Wehave in the past discovered, as described above, and may in the futurediscover, areas of our disclosure and internal controls that need improvement.We are in the process of addressing these issues to ensure that our internalcontrol over financial reporting and disclosure controls and procedures areimproved so as to provide reasonable assurance that information we are requiredto disclose in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission rules and forms. If, however, wecannot provide reliable financial reports or prevent fraud, our reputation andoperating results would be harmed.

 

We cannot becertain that our efforts to improve the material weaknesses in our internalcontrol over financial reporting and the ineffectiveness of our disclosurecontrols and procedures will be successful or that we will be able to maintainadequate controls over our financial processes and reporting in the future. Wewill need to commit substantial resources, including substantial time from ourmanagement team’s accounting personnel and from external consultants, toimplement and integrate into our organization improved disclosure controls andadditional procedures generally and to improve systems to report financialinformation on a timely basis. Any failure or delay to develop or maintaineffective controls, or difficulties encountered in their implementation or inother effective improvement of our internal and disclosure controls couldmaterially harm our operating results or cause us to fail to meet our reportingobligations. Ineffective internal and disclosure controls could also causeinvestors to lose confidence in our reported financial information, which wouldlikely have a significant negative effect on the trading price of oursecurities.

 

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**The restatement of our 2003 and 2002consolidated financial statements has had a material adverse impact on us.**

 

We previouslydetermined that our consolidated financial statements for the years ended December 31,2003 and 2002, as described in more detail in Note 2 to our consolidatedfinancial statements included in the form 10-K for the year ended December 31,2003, filed on November 10, 2004, should be restated. As a result of thisrestatement, we have become subject to a number of additional risks anduncertainties.

 

•                                          We incurred substantial unanticipatedcosts for accounting and legal fees in 2004 in connection with the restatement.

 

•                                          Due to the time and resources necessaryto complete the restatement, we and our independent auditor determined that itwas not possible to complete the management’s assessment and auditor’s audit ofour internal controls over financial reporting as of December 31, 2004, asrequired by Section 404 of the Sarbanes-Oxley Act of 2002, and,accordingly, our independent auditor issued a disclaimer of opinion withrespect to our internal control over financial reporting for such year. Ourfailure to comply with these requirements has resulted in us being in violationof Section 13(a) of the Securities Exchange Act of 1934.

 

•                                          The restatement has resulted in a series ofstockholder class action and derivative lawsuits against us. See “RiskFactors — We are currently a defendant in several stockholder class-actionlawsuits and derivative actions.”

 

**We are currently a defendant in severalstockholder class-action lawsuits and derivative actions.**

 

We and certain of our present and former officers and directors werenamed as defendants in nine purported class action complaints filed in theUnited States District Court for the Middle District of Florida, TampaDivision, and the Central District of California, Southern Division, allegingviolations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder. In August 2004, four complaints were consolidated in theMiddle District of Florida under the caption*Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,Case No. 8:04-CV-919-T-23EAJ. John Lee, Chris Cowley, Dwight Mamanteo, ScottPurcell and Mark Rabold were appointed co-lead plaintiffs (the “Lead Plaintiffs”),but Mr. Mamanteo later withdrew. In September 2004, the fivecomplaints filed in the Central District of California were transferred to theMiddle District of Florida for consolidation with the*Primavera Investors* action. The Lead Plaintiffs servedtheir Consolidated Amended Class Action Complaint on January 12,2005. The Amended Complaint alleges that the Prospectus issued in connectionwith our initial public offering in May 2002 contained materialmisrepresentations and omissions regarding our historical financial conditionand regarding a personal stock transaction by our former chief executiveofficer. The Lead Plaintiffs further generally allege that during the proposed Class Periodof May 21, 2002, through May 13, 2004, the defendants engaged inimproper revenue recognition with respect to certain of our businesstransactions, failed to maintain adequate internal controls, and knowinglydisclosed unrealistic but favorable information about market demand for andcommercial viability of our products to artificially inflate the value of ourstock. The Amended Complaint seeks unspecified compensatory damages and otherrelief. We, along with other defendants, filed a Motion to Dismiss Plaintiffs’Consolidated Amended Class Action Complaint in March 2005. TheMotion to Dismiss was denied in December 2005, and the defendants servedtheir Answer and Affirmative Defenses to the Consolidated Amended Class ActionComplaint on December 16, 2005. The Lead Plaintiffs Motion for Class Certificationis presently due April 2006. We intend to vigorously defend against the class action.We cannot currently predict the impact or resolution of this litigation orreasonably estimate a range of possible loss, which could be material. Theresolution of this lawsuit may harm our business and have a materialadverse impact on our financial condition.

 

In addition to the above, certain of our present and former officersand directors, as well as the company as a nominal defendant, havebeen named in three shareholder derivative actions. Two shareholder derivativecomplaints were filed in California state court styled*Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00551,and*Joseph Durgin, Derivatively on Behalf ofLiquidmetal Technologies, Inc. v. John Kang, et al.*, Case No. 04CC00553,both commenced in the Superior Court of Orange County, California.  A third shareholder derivative complaint wasfiled in the United States District Court for the Middle District ofFlorida, Tampa Division, styled*RobertStory v. John Kang, et al.*, Case No. 8:04-CV-1587-T-23TBM.These shareholder derivative lawsuits allege that the defendants breachedvarious fiduciary duties and otherwise violated state law based primarily uponthe same underlying facts and circumstances as alleged in the federalshareholder class action. The plaintiffs seek unspecified compensatorydamages, restitution and disgorgement of profits, equitable and/or injunctiverelief as permitted by law and other relief.

 

The two shareholder derivative complaints in California state courthave been consolidated. We, along with other defendants, have thrice succeededin having the Plaintiffs’ complaints dismissed for their failure to adequatelyplead

 

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demand futility. Most recently, on September 15, 2005, we,along with other defendants, filed a demurrer to the Plaintiffs’Consolidated Second Amended Shareholder Derivative Complaint dated August 16,2005. In hearings on October 19, 2005, and January 20,2006, the presiding judge sustained the demurrer, dismissing the second amendedcomplaint but giving the plaintiffs until February 3, 2006, withinwhich to serve a third amended complaint. The plaintiffs filed theirConsolidated Third Amended Shareholder Derivative Complaint on February 3,2006. We anticipate filing a demurer, seeking dismissal of the third amendedcomplaint.

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004. We, along withother defendants, filed a Motion to Dismiss in December 2004, towhich the Plaintiff responded in opposition in February 2005. On January 20,2006, the presiding judge granted our Motion to Dismiss, dismissing thecomplaint based upon the plaintiff’s failure to adequately plead futility. On February 17,2006, the plaintiff filed its Notice of Appeal of the Court’s Order grantingthe Motion to Dismiss.  We intend tovigorously defend against the derivative actions. We cannot currently predictthe impact or resolution of this litigation or reasonably estimate a range ofpossible loss, which could be material. The resolution of this lawsuit may harmour business and have a material adverse impact on our financial condition.

 

**Evolving regulation of corporate governanceand public disclosure may result in additional expenses and continuinguncertainty.**

 

Changinglaws, regulations and standards relating to corporate governance and publicdisclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations,are creating uncertainty for public companies. As a result of these new rules andthe size and limited resources of our company, we will incur additional costsassociated with our public company reporting requirements, and we may notbe able to comply with some of these new rules. For example, we have not beenable to comply with Section 404 of the Sarbanes-Oxley Act of 2002 for our2005 and 2004 fiscal years. In addition, these new rules could make itmore difficult or more costly for us to obtain certain types of insurance,including director and officer liability insurance, and this could make itdifficult for us to attract and retain qualified persons to serve on our boardof directors.

 

We arepresently evaluating and monitoring developments with respect to new andproposed rules and cannot predict or estimate the amount of the additionalcosts we may incur or the timing of such costs. These new or changed laws,regulations, and standards are subject to varying interpretations, in manycases due to their lack of specificity, and as a result, their application inpractice may evolve over time as new guidance is provided by regulatoryand governing bodies. This could result in continuing uncertainty regardingcompliance matters and higher costs necessitated by ongoing revisions todisclosure and governance practices.

 

We arecommitted to maintaining high standards of corporate governance and publicdisclosure. As a result, we intend to invest resources to comply with evolvinglaws, regulations, and standards, and this investment may result inincreased general and administrative expenses and a diversion of managementtime and attention from revenue-generating activities to compliance activities.If our efforts to comply with new or changed laws, regulations, and standardsdiffer from the activities intended by regulatory or governing bodies due toambiguities related to practice, regulatory authorities may initiate legalproceedings against us and we may be harmed.

 

**The time and cost associated with complyingwith government regulations to which we could become subject could have amaterial adverse effect on our business.**

 

Some of theapplications that we have identified or may identify in the future may besubject to government regulations. For example, any medical devices such asprecision ophthalmic instruments and orthopedic devices made from our alloyslikely will be subject to extensive government regulation in the United Statesby the Food and Drug Administration, or FDA. Any medical device manufacturersto whom we sell Liquidmetal alloy products may need to comply with FDArequirements, including premarket approval or clearance under Section 510(k)of the Food Drug and Cosmetic Act before marketing in the United StatesLiquidmetal alloy medical device products. These medical device manufacturers may berequired to obtain similar approvals before marketing these medical devices inforeign countries. Any medical device manufacturers with which we jointlydevelop and sell medical device products may not provide significantassistance to us in obtaining required regulatory approvals. The process ofobtaining and maintaining required FDA and foreign regulatory approvals couldbe lengthy, expensive, and uncertain. Additionally, regulatory agencies candelay or prevent product introductions. The failure to comply with applicableregulatory requirements can result in substantial fines, civil and criminalpenalties, stop sale orders, loss or denial of approvals, recalls of products,and product seizures.

 

In addition,the processing of beryllium, a minor constituent element of some of our alloys,can result in the release of beryllium into the workplace and the environmentand in the creation of beryllium oxide as a by-product. Beryllium is classifiedas a hazardous air pollutant, a toxic substance, a hazardous substance, and aprobable human carcinogen under environmental, safety, and health laws, andvarious acute and chronic health effects may result from exposure toberyllium.

 

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We arerequired to comply with certain regulatory requirements and to obtain a permitfrom the U.S. Environmental Protection Agency or other government agencies toprocess beryllium. Our failure to comply with present or future governmentalregulations related to the processing of beryllium could result in suspensionof manufacturing operations and substantial fines or criminal penalties.

 

To the extentthat our products have the potential for dual use, such as military andnon-military applications, they may be subject to import and exportrestrictions of the U.S. government, as well as other countries. The process ofobtaining any required U.S. or foreign licenses or approvals could betime-consuming, costly, and uncertain. Failure to comply with import and exportregulatory requirements can lead to substantial fines, civil and criminalpenalties, and the loss of government contracting and export privileges.

 

**The existence of minority stockholders in ourLiquidmetal Golf subsidiary creates potential for conflicts of interest.**

 

We directlyown 79% of the outstanding capital stock of Liquidmetal Golf, our subsidiarythat has the exclusive right to commercialize out technology in the golfmarket. The remaining 21% of Liquidmetal Golf stock is owned by approximately95 stockholders of record. As a result, conflicts of interest may developbetween us and the minority stockholders of Liquidmetal Golf. To the extentthat our officers and directors are also officers or directors of LiquidmetalGolf, matters may arise that place the fiduciary duties of theseindividuals in conflicting positions. John Kang, our Chairman, President, and ChiefExecutive Officer, is also director of Liquidmetal Golf. In addition, JamesKang, Founder and Director, is also a director of Liquidmetal Golf.

 

**Our stock price has experienced volatilityand may continue to experience volatility.**

 

During 2005,the highest bid price for our common stock was $2.85 per share, while thelowest bid price during that period was $0.64 per share. The trading price ofour common stock could continue to fluctuate widely due to:

 

•                                          quarter-to-quarter variations in resultsof operations;

 

•                                          loss of a major customer;

 

•                                          announcements of technologicalinnovations by us or our potential competitors;

 

•                                          changes in, or our failure to meet, theexpectations of securities analysts;

 

•                                          new products offered by us or ourcompetitors;

 

•                                          announcements of strategic relationshipsor strategic partnerships; or

 

•                                          other events or factors that may bebeyond our control.

 

In addition,the securities markets in general have experienced extreme price and tradingvolume volatility in the past. The trading prices of securities of manycompanies at our stage of growth have fluctuated broadly, often for reasonsunrelated to the operating performance of the specific companies. These generalmarket and industry factors may adversely affect the trading price of ourcommon stock, regardless of our actual operating performance. If our stockprice is volatile, we could face securities class action litigation, whichcould result in substantial costs and a diversion of management’s attention andresources and could cause our stock price to fall.

 

**Our convertible notes and warrants containanti-dilution provisions that, if triggered, could cause substantial dilutionto our then-existing stockholders.**

 

As of December 31,2005, we had outstanding approximately $2.4 million in aggregate principalamount of July 2007 Notes with a conversion price of $1.00 per share and$9.9 million in aggregate principal amount of August 2007 Notes with aconversion price of $2.00 per share. We also had outstanding warrants topurchase up to 563,151 shares of our common stock at an exercise price of $2.73per share and warrants to purchase an aggregate of 3,777,715 shares at anexercise price of $2.00 per share. Each of these notes and warrants containweighted-average anti-dilution provisions whereby, if we issue shares in thefuture for consideration below such conversion or exercise prices, then (withcertain exceptions, including the issuance of stock options) the conversionprice for our convertible notes would automatically be reduced (allowing theholders of the notes to receive additional shares of common stock uponconversion) and the exercise price of the warrants would automatically bereduced. Further, the warrants from our outstanding convertible Notes and theembedded conversion features of our convertible notes have been accounted foras derivatives under SFAS 133 “Accounting for Derivative Instruments andHedging Activities” and EITF 00-19 “Accounting for Derivative Financial

 

25

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InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock.” If ouravailable funds and cash generated from operations are insufficient to satisfyour liquidity requirements in the future, then we may need to raisesubstantial additional funds in the future to support our working capitalrequirements and for other purposes. If shares of our common stock orsecurities convertible into or exercisable for our common stock are issued inconsideration of such funds at an effective per share price lower than theconversion and exercise prices of our convertible notes and warrants, thenthese anti-dilution provisions would be triggered, thus possibly causingsubstantial dilution to our then-existing stockholders if the notes areconverted or the warrants are exercised. Further, subsequent sales of theshares in the public market could depress the market price of our stock bycreating an excess in supply of shares for sale.

 

**We have never paid dividends on our commonstock, and we do not anticipate paying any cash dividends in the foreseeablefuture.**

 

We have paidno cash dividends on our common stock to date. We currently intend to retainour future earnings, if any, to fund the development and growth of ourbusinesses, and upon the completion of this offering, we do not anticipatepaying any cash dividends on our capital stock for the foreseeable future. Inaddition, the terms of existing or any future debts may preclude us frompaying dividends on our stock. As a result, capital appreciation, if any, ofour common stock will be your sole source of gain for the foreseeable future.

 

**Antitakeover provisions of our certificate ofincorporation and bylaws and provisions of applicable corporate law could delayor prevent a change of control that you may favor.**

 

Provisions inour certificate of incorporation, our bylaws, and Delaware law could make itmore difficult for a third party to acquire us, even if doing so would bebeneficial to our stockholders. These provisions could discourage potentialtakeover attempts and could adversely affect the market price of our shares.Because of these provisions, you might not be able to receive a premium on yourinvestment. These provisions:

 

•                                          authorize our board of directors, withoutstockholder approval, to issue up to 10,000,000 shares of “blank check”preferred stock that could be issued by our board of directors to increase thenumber of outstanding shares and prevent a takeover attempt;

 

•                                          limit stockholders’ ability to call aspecial meeting of our stockholders;

 

•                                          provide for a classified board ofdirectors; and

 

•                                          establish advance notice requirements tonominate directors for election to our board of directors or to propose mattersthat can be acted on by stockholders at stockholder meetings.

 

The provisions described abovecould delay or make more difficult transactions involving a change in controlof us or our management.

 

##### **Item 1B. Unresolved Staff Comments**

 

**By a letter dated January 5,2006, the Securities and Exchange Commission provided the following commentswith respect to our Form l0-K/A forthe fiscal year ended December 31, 2004 and Forms 10-Q for the fiscalquarters ended March 31, 2005, June 30, 2005 and September 30,2005.**

** **

**Form l0-K/A for thefiscal year ended December 31, 2004**

 

**General**

** **

# 1.                                       Please comply with the following comments ineach of your Forms 10-Q for the fiscal quarters ended March 31, 2005, June 30,2005 and September 30, 2005:

#  

**Item9A. Controls and Procedures, page 3**

** **

# 2.                                       Amend the second paragraph to read that yourevaluation of Disclosure Controls and Procedures was performed as of the end ofthe period covered by the report as required by Item 307 of Regulation S-K.

#  

# 3.                                       We note the conclusions of your certifyingofficers in the second paragraph that your disclosure controls and proceduresare not effective. The description of your disclosure controls and proceduresappears to be based on the definition set forth in Rule 13a-15(e) underthe Exchange Act. As described, however, the

 

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# description does not fully conform to that definition. Pleaserevise accordingly. Alternatively, you may state that your certifyingofficers concluded that your disclosure controls and procedures, as of the endof the period covered by the report, were not effective.

#  

# 4.                                       We note the conclusions of your managementregarding the effectiveness of your internal control over financial reporting.Please reconcile with the disclosure indicating that your management has notcompleted its assessment of your internal control over financial reporting.

#  

# 5.                                       We note the disclosure in the fourth and fifthparagraphs and have the following comments:

#  

Please disclose when the material weaknesses began.

 

Please disclose in greater detail the material weaknesses and their impacton your financial statements.

 

Please disclose the specific steps you have taken to remediate thematerial weaknesses.

 

Please disclose the identity of the independent consulting firm you haveretained and disclose the findings of this consultant.

 

# 6.                                       Please disclose any changes in your internalcontrol over financial reporting that occurred during the last fiscal quarterthat was materially affected or is reasonably likely to materially affect yourinternal control over financial reporting. See Item 308(c) of RegulationS-K.

#  

**Exhibits31.3 and 31.4**

** **

# 7.                                       Amend your December 31, 2004certifications to include the missing two sections relating to internal controlover financial reporting required for accelerated filers. Also please note thatthe certifying officers should not include their positions in the first line ofthe certification. Also amend your 2005 10-Q certifications to reflect themissing sections of the certifications relating to internal control overfinancial reporting. See Item 601(b)(31) of Regulation S-K.

#  

**Form 10-Qfor the fiscal quarter ended September 30, 2005**

** **

**Item 4. Controls andProcedures. page 34**

** **

# 8.                                       We note that the conclusion of your certifyingofficers in the third paragraph refers to the first quarter of 2005. Yourcertifying officers must assess the effectiveness of your disclosure controlsand procedures as of the end of the period covered by the report in which theconclusion is stated. Please revise accordingly. See Item 307 of RegulationS-K.

#  

# 9.                                       We note the disclosure under the heading “ChangesIn Internal Controls” on page 36. Please disclose in reasonable detail thechanges that were made to your internal control over financial reporting.

#  

As of thefiling of this Form 10-K for the fiscal year ended December 31, 2005, the Companyaddressed the foregoing comments in Amendment No. 2 to the Form l0-K for thefiscal year ended December 31, 2004 and Forms 10-Q/A for the fiscal quartersended March 31, 2005, June 30, 2005 and September 30, 2005, all of which werefiled on March 16, 2006.

 

**Item 2. Properties**

 

Our principalexecutive offices and principal research and development offices are located inLake Forest, California and consist of approximately 30,000 square feet. Thisfacility is occupied pursuant to a lease agreement that expires in June 2007.

 

In Conroe,Texas, we lease an office and warehouse for our coatings business segment. Thisfacility, which is approximately 10,000 square feet, is leased through September 2006.

 

Our principalprototyping and manufacturing facility is in Pyongtaek, South Korea, andconsists of approximately 166,000 square feet. We lease the land on which thisfacility is located, although we own the buildings, fixtures, and all personalproperty located on the land. The parcel of land consists of approximately fouracres and is leased through 2022.

 

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On August 2004,we entered into a 3 year lease for a post-processing facility located inWeihai, China, which consists of approximately 14,400 square feet, tofacilitate our bulk alloy manufacturing.

 

Wecurrently expect that the foregoing facilities will meet our anticipatedinternal manufacturing, research, warehousing, and administrative needs for theforeseeable future.

 

**Item 3. Legal Proceedings**

 

We and certain of our present and former officers and directors werenamed as defendants in nine purported class action complaints filed in theUnited States District Court for the Middle District of Florida, TampaDivision, and the Central District of California, Southern Division, allegingviolations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder. In August 2004, four complaints were consolidatedin the Middle District of Florida under the caption*Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,Case No. 8:04-CV-919-T-23EAJ. John Lee, Chris Cowley, Dwight Mamanteo,Scott Purcell and Mark Rabold were appointed co-lead plaintiffs (the “LeadPlaintiffs”), but Mr. Mamanteo later withdrew. In September 2004, thefive complaints filed in the Central District of California were transferred tothe Middle District of Florida for consolidation with the*Primavera Investors* action. The LeadPlaintiffs served their Consolidated Amended Class Action Complaint on January 12,2005. The Amended Complaint alleges that the Prospectus issued in connectionwith our initial public offering in May 2002 contained materialmisrepresentations and omissions regarding our historical financial conditionand regarding a personal stock transaction by our former chief executiveofficer. The Lead Plaintiffs further generally allege that during the proposed Class Periodof May 21, 2002, through May 13, 2004, the defendants engaged inimproper revenue recognition with respect to certain of our businesstransactions, failed to maintain adequate internal controls, and knowinglydisclosed unrealistic but favorable information about market demand for andcommercial viability of our products to artificially inflate the value of ourstock. The Amended Complaint seeks unspecified compensatory damages and otherrelief. We, along with other defendants, filed a Motion to Dismiss Plaintiffs’Consolidated Amended Class Action Complaint in March 2005. TheMotion to Dismiss was denied in December 2005, and the defendants servedtheir Answer and Affirmative Defenses to the Consolidated Amended Class ActionComplaint on December 16, 2005. The Lead Plaintiffs will likely servetheir Motion for Class Certification in March 2006. We intend tovigorously defend against the class action. We cannot currently predictthe impact or resolution of this litigation or reasonably estimate a range ofpossible loss, which could be material. The resolution of this lawsuit may harmour business and have a material adverse impact on our financial condition.

 

In addition to the above, certain of our present and former officersand directors, as well as the company as a nominal defendant, havebeen named in three shareholder derivative actions. Two shareholder derivativecomplaints were filed in California state court styled*Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00551,and*Joseph Durgin, Derivatively on Behalf ofLiquidmetal Technologies, Inc. v. John Kang, et al.*, Case No. 04CC00553,both commenced in the Superior Court of Orange County, California.  A third shareholder derivative complaint wasfiled in the United States District Court for the Middle District ofFlorida, Tampa Division, styled*RobertStory v. John Kang, et al.*, Case No. 8:04-CV-1587-T-23TBM.These shareholder derivative lawsuits allege that the defendants breachedvarious fiduciary duties and otherwise violated state law based primarily uponthe same underlying facts and circumstances as alleged in the federalshareholder class action. The plaintiffs seek unspecified compensatorydamages, restitution and disgorgement of profits, equitable and/or injunctiverelief as permitted by law and other relief.

 

The two shareholder derivative complaints in California state courthave been consolidated. We, along with other defendants, have thrice succeededin having the Plaintiffs’ complaints dismissed for their failure to adequatelyplead demand futility. Most recently, on September 15, 2005, we,along with other defendants, filed a demurrer to the Plaintiffs’Consolidated Second Amended Shareholder Derivative Complaint dated August 16,2005. In hearings on October 19, 2005, and January 20,2006, the presiding judge sustained the demurrer, dismissing the second amendedcomplaint but giving the plaintiffs until February 3, 2006, withinwhich to serve a third amended complaint. We anticipate filing a demurer,seeking dismissal of the third amended complaint.

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004. We, along withother defendants, filed a Motion to Dismiss in December 2004, towhich the Plaintiff responded in opposition in February 2005. On January 20,2006, the presiding judge granted our Motion to Dismiss, dismissing thecomplaint based upon the plaintiff’s failure to adequately plead futility. On February 17,2006, the plaintiff filed its Notice of Appeal of the Court’s Order grantingthe Motion to Dismiss.  We intend tovigorously defend against the derivative actions. We cannot currently predictthe impact or resolution of this litigation or reasonably estimate a range ofpossible loss, which could be material. The resolution of this lawsuit may harmour business and have a material adverse impact on our financial condition.

 

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**Item 4. Submission of Matters to a Vote of SecurityHolders**

 

Nomatters were submitted to a vote of our security holders during the fourthquarter of 2005.

 

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**PART II**

 

**Item 5. Market For Registrant’s Common Equity andRelated Stockholder Matters**

 

Our commonstock is currently quoted on the Nasdaq OTC Bulletin Board under the symbol “LQMT.OB.”  From the period July 16, 2004 through June 14,2005, we were delisted from the Nasdaq Stock Market and our common stock wasquoted on the “pink sheets”. We were admitted for quotation on the Nasdaq’s OTCBulletin Board on June 15, 2005. On March 16, 2006, the last reportedsales price of our common stock was $1.45 per share. As of March 16, 2006,we had 247 record holders of our common stock.

 

The followingtable sets forth, on a per share basis, the range of high and low bidinformation for the shares of our common stock for each full quarterly periodwithin the two most recent fiscal years and any subsequent interim period forwhich financial statements are included. These quotations reflect inter-dealer prices,without retail mark-up, mark-down or commission and may not necessarilyrepresent actual transactions.

 

| **2005**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| Fourth Quarter |       | $        | 1.76       |    | $          | 0.64 |   |
| Third Quarter  |       | $        | 2.15       |    | $          | 1.52 |   |
| Second Quarter |       | $        | 2.25       |    | $          | 1.28 |   |
| First Quarter  |       | $        | 2.85       |    | $          | 1.10 |   |

 

| **2004**            | ** ** | **High** | ** ** | **Low** | ** ** |
|---------------------|------------|----------|------------|---------|------------|
| Fourth Quarter      |       | $        | 4.00       |    | $          | 1.75 |   |
| Third Quarter  |       | $        | 2.33       |    | $          | 0.71 |   |
| Second Quarter |       | $        | 3.68       |    | $          | 0.55 |   |
| First Quarter       |       | $        | 4.52       |    | $          | 2.50 |   |

 

We have never paid acash dividend on our common stock. We do not anticipate paying any cashdividends on our common stock in the foreseeable future, and we plan to retainour earnings to finance future growth.

 

**Item 6. Selected Consolidated Financial Data**

 

The followingtable shows our selected consolidated financial data as of and for the yearsended December 31, 2001 through 2005. The selected consolidated financialdata as of and for the years ended December 31, 2003, 2004 and 2005 arederived from our audited consolidated financial statements and related notesthereto include elsewhere in this annual report on Form 10-K and 2003annual report on Form 10-K filed on November 10, 2004. The followinginformation should be read with “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations “ and our Consolidated FinancialStatements and Notes thereto included elsewhere in this annual report on Form 10-K.

 

These statements should be read in conjunction with restatement Note 2in the notes to the consolidated financial statements hereto and Note 2 in thenotes to consolidated financial statements in the fiscal 2003 annual report on Form 10-Kfiled on November 10, 2004, which reflects the restatements of prior yeartransactions.

 

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| ** **                                                                                                                   | ** ** | **For the Years Ended December 31,**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                                   | ** ** | **(Restated)**                              | ** ** | **(Restated)** | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                                   | ** ** | **(in thousands, except per share  data )** | ** ** |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| **Consolidated  Statement of Operations Data:**                                                                              | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                   | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                                      |       | 16,365                                      |       | $ | 17,429 |   | $ | 13,658 |   | $ | 9,138 |   | $ | 3,882 |   |
| Cost of  sales                                                                                                               |       | 15,129                                      |       | 12,168 |   | 18,162 |   | 5,656 |   | 1,924 |   |
| Gross Profit                                                                                                                 |       | 1,236                                       |       | 5,261 |   | (4,504 | ) | 3,482 |   | 1,958 |   |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative                                                                                         |       | 8,534                                       |       | 11,591 |   | 17,729 |   | 13,099 |   | 5,239 |   |
| Research and  development                                                                                                    |       | 1,120                                       |       | 1,467 |   | 8,780 |   | 11,825 |   | 1,726 |   |
| Impairment  of goodwill                                                                                                      |       | —                                      |       | — |   | 184 |   | — |   | — |   |
| Impairment  of long lived assets                                                                                             |       | 4,487                                       |       | — |   | 2,684 |   | — |   | — |   |
| Total  operating expenses                                                                                                    |       | 14,141                                      |       | 13,058 |   | 29,377 |   | 24,924 |   | 6,965 |   |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Income  (loss) before interest, other income, income taxes, minority interest and  discontinued operations                   |       | (12,905                                     | )          | (7,797 | ) | (33,881 | ) | (21,442 | ) | (5,007 | ) |
| Loss from  extinguishments of debt                                                                                           |       | (1,247                                      | )          | (2,941 | ) | — |   | — |   | — |   |
| Change in  value of warrants, gain                                                                                           |       | 3,985                                       |       | 747 |   | — |   | — |   | — |   |
| Change in  value of conversion feature, gain                                                                                 |       | 9,118                                       |       | 2,093 |   | — |   | — |   | — |   |
|  Other income                                                                                                           |       | —                                      |       | 302 |   | — |   | — |   | — |   |
| Interest  expense, net                                                                                                       |       | (6,004                                      | )          | (6,540 | ) | (86 | ) | (603 | ) | (1,095 | ) |
| Gain on sale  of marketable securities held-for-sale                                                                         |       | —                                      |       | — |   | 1,178 |   | 832 |   | — |   |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Income  (loss) before income taxes, minority interest and discontinued operations                                            |       | (7,053                                      | )          | (14,136 | ) | (32,789 | ) | (21,213 | ) | (6,102 | ) |
| Income taxes                                                                                                                 |       | —                                      |       | — |   | — |   | — |   | — |   |
| Minority  interest in loss of consolidated subsidiary                                                                        |       | —                                      |       | — |   | 21 |   | 118 |   | — |   |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Income  (loss) from continuing operations                                                                                    |       | (7,053                                      | )          | (14,136 | ) | (32,768 | ) | (21,095 | ) | (6,102 | ) |
| Income  (loss) from operations of discontinued operations, net                                                               |       | —                                      |       | (749 | ) | (964 | ) | 83 |   | (5,973 | ) |
| Gain (loss)  from disposal of discontinued operations, net                                                                   |       | —                                      |       | — |   | 127 |   | 1,556 |   | (11,949 | ) |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                                                     |       | $                                           | (7,053     | ) | $ | (14,885 | ) | $ | (33,605 | ) | $ | (19,456 | ) | $ | (24,024 | ) |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Income  (loss) per share from continuing operations – basic and diluted                                                 |       | $                                           | (0.17      | ) | $ | (0.34 | ) | $ | (0.79 | ) | $ | (0.54 | ) | $ | (0.18 | ) |
|                                                                                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted  average common shares used to compute income (loss) per share from continuing  operations – basic and diluted |       | 41,833                                      |       | 41,610 |   | 41505 |   | 38,714 |   | 33,323 |   |

 

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| ** **                                                  | ** ** | **As of December 31,**                 | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                  | ** ** | **(Restated)**                              | ** ** | **(Restated)** | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                  | ** ** | **(in thousands, except per share  data )** | ** ** |
| ** **                                                  | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consolidated  Balance Sheet Data:**                       |       |                                        |       |   |   |   |   |   |   |   |   |
|                                                        |       |                                        |       |   |   |   |   |   |   |   |   |
| Cash and  cash equivalents                                  |       | $                                           | 1,392      |   | $ | 742 |   | $ | 3,127 |   | $ | 25,058 |   | $ | 2,230 |   |
| Working  capital (deficiency)                               |       | (10,993                                     | )          | (14,910 | ) | (698 | ) | 25,812 |   | (9,573 | ) |
| Total assets                                                |       | 21,563                                      |       | 28,508 |   | 30,852 |   | 24,845 |   | 6,680 |   |
| Long-term debt,  including current portion, net of discount |       | 6,776                                       |       | 6,628 |   | 4,047 |   | — |   | 2,988 |   |
| Shareholders’  equity (deficiency)                     |       | (1,320                                      | )          | 4,191 |   | 16,163 |   | 50,599 |   | (7,504 | ) |
|                                                             |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

*This management’s discussion and analysis should beread in the conjunction with the condensed consolidated financial statementsand notes included elsewhere in this report on Form 10-K.*

 

*This management’s discussion and analysis, as well asother sections of this report on Form 10-K, may contain “forward-lookingstatements” that involve risks and uncertainties, including statementsregarding our plans, future events, objectives, expectations, forecasts, orassumptions. Any statement that is not a statement of historical fact is aforward-looking statement, and in some cases, words such as “believe,” “estimate,”“ project,” “expect,” “intend,” “may,” “anticipate,” “plans,” “seeks,” andsimilar expressions identify forward-looking statements. These statementsinvolve risks and uncertainties that could cause actual outcomes and results todiffer materially from the anticipated outcomes or results, and undue relianceshould not be placed on these statements. These risks and uncertaintiesinclude, but are not limited to, the matters discussed under the caption “RiskFactors” in Item 1A of this report and other risks and uncertaintiesdiscussed in filings made with the Securities and Exchange Commission (includingrisks described in subsequent reports on Form 10-Q, Form 10-K, Form 8-K,and other filings). Liquidmetal Technologies, Inc. disclaims any intentionor obligation to update or revise any forward-looking statements, whether as aresult of new information, future events, or otherwise.*

 

##### **OVERVIEW**

 

We are amaterials technology company that develops and commercializes products madefrom amorphous alloys. Our Liquidmetal® family of alloys consists of a varietyof proprietary coatings, powders, bulk alloys, and composites that utilize theadvantages offered by amorphous alloy technology. We develop, manufacture, andsell products and components from bulk amorphous alloys to customers in variousindustries, and we also partner with third-party licensees such as Rawlings,Head, and Socket Communications and distributors such as Matech and LLPG todevelop and commercialize bulk Liquidmetal alloy products. We believe that ourproprietary bulk alloys are the only commercially viable bulk amorphous alloyscurrently available in the marketplace. In addition to our bulk alloys, wemarket and sell a line of proprietary amorphous alloy-based industrial coatingsunder the Liquidmetal® ArmacorTM coatings brand.

 

Amorphous alloys are unique materialsthat are distinguished by their ability to retain a random atomic structurewhen they solidify, in contrast to the crystalline atomic structure that formsin other metals and alloys when they solidify. Liquidmetal alloys possess acombination of performance, processing, and potential cost advantages that webelieve will make them preferable to other materials in a variety ofapplications. The amorphous atomic structure of our alloys enables them toovercome certain performance limitations caused by inherent weaknesses in crystallineatomic structures, thus facilitating performance and processing characteristicssuperior in many ways to those of their crystalline counterparts. For example,our zirconium-titanium Liquidmetal alloys are approximately 250% stronger thancommonly used titanium alloys such as Ti-6Al-4V, but they also have some of thebeneficial processing characteristics more commonly associated with plastics.We believe these advantages could result in Liquidmetal alloys supplantinghigh-performance alloys, such as titanium and stainless steel, and otherincumbent materials in a wide variety of applications. Moreover, we believethese advantages could enable the introduction of entirely new products andapplications that are not possible or commercially viable with other materials.

 

Our revenuesare derived from two principal operating segments: Liquidmetal alloy industrialcoatings and bulk Liquidmetal alloy products. Liquidmetal alloy industrialcoatings are used primarily as a protective coating for industrial machineryand equipment, such as drill pipe used by the oil drilling industry and boilertubes used in coal-burning power plants. Bulk Liquidmetal alloy segment revenueincludes sales of parts or components of electronic devices, medical products,and sports and leisure goods; tooling and prototype parts (includingdemonstration parts and test samples) for customers with products indevelopment, product licensing and arrangements, and research and developmentrevenue relating primarily to defense and medical applications. We expect thatthese sources of revenue will continue to significantly change the character ofour revenue mix.

 

The cost ofsales for our Liquidmetal coatings segment consists primarily of the costs ofoutsourcing our manufacturing to third parties. Consistent with ourexpectations, our cost of sales has been increasing over historical results aswe further build our bulk Liquidmetal alloy business. Although we plan tocontinue outsourcing the manufacturing of our coatings, we will internally manufacturemany products derived from our bulk Liquidmetal alloys.

 

Selling,general, and administrative expenses currently consist primarily of salariesand related benefits, severance costs, travel, consulting and professionalfees, depreciation and amortization, insurance, office and administrativeexpenses, and other expenses related to our operations.

 

Research anddevelopment expenses represent salaries, related benefits expense, stock-basedcompensation, depreciation of research equipment, consulting and contractservices, expenses incurred for the design and testing of new processingmethods, expenses for the development of sample and prototype products, andother expenses related to the research and development of Liquidmetal alloys.Costs associated with research and development activities are expensed asincurred.

 

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We plan toenhance our competitive position by improving our existing technologies anddeveloping advances in amorphous alloy technologies. We believe that ourresearch and development efforts will focus on the discovery of new alloycompositions, the development of improved processing technology, and theidentification of new applications for our alloys.

 

We maintaincertain of our raw material inventories in amounts in excess of our operatingcycle of one year due to the nature of our manufacturing process, productionlead time, and the recyclability of our raw material. These inventories wereclassified as long-term inventory as of December 31, 2004. We havedetermined that its current and projected raw material requirements are notsufficient enough to warrant the use of such raw materials in the foreseeablefuture. As a result, we determined that the carrying value of raw materialsheld by its subsidiary, Liquidmetal Korea, exceeded its fair value in theamount of $2.7 million during the fiscal year 2005.

 

Idleequipment consists of certain equipment held by the Company for use inexpansion of bulk alloy parts manufacturing. Due to excess manufacturingcapacity, the Company classified the equipment as idle equipment asof December 31, 2005 and 2004. While the equipment may be usedinternally to meet future capacity requirements, considering our currentrevenue and foreseeable production requirements, we do not anticipate utilizingthis equipment internally in the near future. As a result, we determined thatthe carrying value of idle equipment held by its subsidiary, Liquidmetal Korea,exceeded its fair value in the amount of $1.7 million during the second quarterof fiscal year 2005.

 

On August 4,2004, we established a sub-assembly plant in the city of Weihai in Shandongprovince of China under Weihai Liquidmetal Company Limited, which is 100percent owned by Liquidmetal Korea, to facilitate our bulk alloy manufacturingbusiness. Weihai Liquidmetal is consolidated into Liquidmetal Technologies withall intercompany transactions eliminated.

 

Inconjunction with the divestiture of our Dongyang and Taesung subsidiaries in March andJune 2004, respectively, we decided to discontinue our equipmentmanufacturing business in order to conform our operations to our broadercorporate business strategy. Pursuant to Accounting Principles Board Opinion No. 30,Reporting the Results of Operations — Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions, we reclassified our consolidated financial statementsto reflect the discontinuation of our equipment manufacturing operations. Therevenue, costs and expenses, assets and liabilities, and cash flows of theequipment manufacturing business were segregated in our financial statements.

 

Impairment ofgoodwill represents the write-down of the goodwill balance of Dongyang Yudoro (“Dongyang”),our 51% owned subsidiary in South Korea. During 2003, Dongyang experienced netlosses as a result of a continuing economic downturn in markets for itsmachinery products. These events, along with Dongyang’s operating cash flowlosses and uncertainty surrounding its future cash flows, led us to evaluateour investment for recoverability as of December 31, 2003. As a result, wedetermined that the carrying value of our investment in Dongyang exceeded itsfair value as of December 31, 2003 in the amount of $0.2 million. In March 2004,we sold our 51% investment in Dongyang to the 49% minority stockholder.

 

Impairment ofLong-Lived Assets consists of a write-down of the building of our manufacturingfacility in South Korea on the basis that the fair value of this building wasdetermined to be less than the book value as of December 31, 2003. Oursignificant operational difficulties in 2003 along with our history ofoperating or cash flow losses and uncertainty surrounding our future cashflows, led us to evaluate our long-lived assets for recoverability as of December 31,2003. As a result, we determined that the carrying value of our manufacturingplant in Pyongtaek, South Korea exceeded its fair value as of December 31,2003 in the amount of $2.7 million. The fair value of the building was based onthe average of two independent appraisals of the building obtained in the firstquarter of 2004.

 

Wehave restated our previously issued financial statements for the fiscal yearsended December 31, 2004 and 2005 due to an error related to our accountingfor the embedded convertible feature of the senior convertible notes issued in March 2004,which were exchanged in August 2004, in accordance with Statement ofFinancial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” (SFAS 133).

 

The correction of the error to properly state the fairvalue of the embedded conversion feature of senior convertible notes inaccordance with SFAS 133 resulted in recognition of $7.6 million as aconversion feature liability as of the issuance of the senior convertible notesin March 2004 as the convertible notes are considered a non-conventionalconvertible debt instrument. The correction resulted in recognition of thechange in fair value of the embedded conversion feature in our earnings as again of $2.1 million and $5.3 million for the years ended December 31,2004 and 2005, respectively, as well as adjustments to amortization of debtdiscount as interest expense of $3.0 million and $1.1 million for the yearsended December 31, 2004 and 2005, respectively, and an additional loss onextinguishment of debt of $1.3 million for the year ended December 31,2004. Additionally, we recognized $0.9 million and $0.5 million in additionalpaid in capital from redemption and conversion of convertible notes as of December 31,2004 and 2005, respectively.

 

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Change in Value of Warrants consists of changes to the fairvalue of warrants outstanding at each period. The warrants have been accountedfor as a liability in accordance with Emerging Issues Task Force Issue No. 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock,” with the change in fair values reported inearnings. The fair values are determined using a Black-Scholes pricing modeland fluctuations in our stock price have had the greatest impact on thevaluation of outstanding warrants.

 

Change in Value of Conversion Feature consists of changesto the fair value of the embedded conversion feature of our senior convertiblenotes. The embedded conversion feature has been accounted for as a separatederivative instrument in accordance with SFAS 133 with a change in fair valuesreported in earnings. The change in fair values are determined using aBlack-Scholes pricing model and fluctuations in our stock price have had thegreatest impact on the valuation of outstanding conversion features.

 

On May 21,2003, we completed a reincorporation by transitioning from a Californiacorporation to a Delaware corporation. The reincorporation was effected throughthe merger of the former California entity into a newly created wholly ownedDelaware subsidiary. The reincorporation changed the legal domicile of ourcompany but did not result in any change to our business, management,employees, fiscal year, assets or liabilities, or location of facilities. As part ofthe reincorporation, each share of the California corporation was automaticallyconverted into one share of the Delaware corporation. In addition, totalauthorized shares decreased from 200,000,000 shares to 100,000,000 shares.

 

The followingdiscussion and analysis of our financial condition and results of operationsfocuses on the historical results of our continuing operations and reflects theeffect of restating our 2002 and 2003 (2003 quarterly filings) financialstatements for proper revenue recognition as disclosed in Note 2 in the notesto the consolidated financial statements in the fiscal 2003 annual report on Form 10-Kfiled on November 10, 2004.

 

***Results of Operations***

 

***Comparison of the years ended December 31,2005 and 2004***

 

*Revenue*. Revenue decreased to $16.4 million in the twelve months ended December 31,2005 from $17.4 million in the twelve months ended December 31, 2004.The decrease included a $2.6 million decrease from restatement of revenues from2003 to 2004 as part of our 2003 financial statement restatement whichresulted in one-time recognition of revenues during the first quarter of 2004,and $0.9 million decrease from our research and development services relatedprimarily to reduced activity from defense, leisure, and luxury goodsapplications during 2005. The decreases were offset by a $0.4 million increasein bulk alloy parts primarily to increased sales to sporting goodsmanufacturers and $1.9 million increase from sale of our coatings products fromincreased demand for drill pipe coatings during 2005.

 

*Cost of Sales*. Cost of sales increased to $15.1 million, or 92% of revenue, duringthe twelve months ended December 31, 2005 from $12.2 million, or 70%of revenue, in the twelve months ended December 31, 2004. The increase wasa result of decreases in bulk Liquidmetal alloy business. Cost of sales as apercentage of revenue has increased as a result of ramp up of lower marginelectronic casing and prototypes during the year. Further, significant portionof our manufacturing costs continue to remain fixed. We believe that highermanufacturing volumes and greater mix of higher margin products in the futurewill cause the gross profit to improve over time. The cost to manufacture partsfrom our bulk Liquidmetal alloys is variable and differs based on the uniquedesign of each product. However, the cost of sales for the products sold by thecoatings business segment is generally consistent because the Liquidmetalcoatings products are produced by third parties and sold wholesale to variousindustries.

 

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses decreased to $8.5 million, or 52% of revenue, in the twelvemonths ended December 31, 2005 from $11.6 million, or 67% of revenue,in the twelve months ended December 31, 2004. This decrease wasprimarily a result of decrease in professional and contracted services of $1.8million, decrease in advertising and promotions expense of $0.2 million,decrease in bad debt expenses of $0.1 million, decrease in product warrantyexpense of $0.2 million, decrease in insurance costs of $0.6 million, anddecrease in amortization and depreciation costs of $0.2 million. These andother decreases in selling, general and administrative expenses represent theCompany’s efforts to manage costs and focus on our core business whilecontinuing to build our corporate infrastructure required to prepare for andsupport the anticipated growth of our bulk Liquidmetal alloy business.

 

*Research and Development Expenses*. Research and development expenses decreasedto $1.1 million, or 7% of revenue, in the twelve months ended December 31,2005 from $1.5 million, or 8% of revenue, in the twelve months ended December 31,2004. The decrease was primarily a result of decreases in salaries,wages and related expenses by $0.3 million and decrease in laboratory andprototyping expenses by $0.1 million. The decreases were a result of theCompany focusing primarily on our core business associated with our bulkLiquidmetal alloy business while managing our costs. The Company continues toperform research and development efforts on new Liquidmetal alloys andrelated

 

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processing capabilities, develop new manufacturing techniques, andcontract with consultants and provide research grants to various institutionsto advance the development of Liquidmetal alloys.

 

*Impairment of Long Lived Assets*.Impairment of long lived assets increased to $4.5 million, or 27% of revenue,for the twelve months ended December 31, 2005 from $0 for the twelvemonths ended December 31, 2004. Impairment expense represents primarilywrite-down of $2.7 million of raw materials considered to be long terminventory and $1.7 million of idle equipment. While we may use the excessraw materials beyond one year to fulfill future customer order, we havedetermined that our current capacity was not significant enough to warrantholding this inventory as a long term asset. Further, while we have activelymarketed the idle equipment for ultimate sale since early 2004, we were unableto sell this equipment. In addition, while the equipment may be usedinternally to meet future capacity requirements, considering our currentrevenue, we do not anticipate utilizing this equipment internally in the nearfuture. As such, we have reduced the carrying values of the excess raw materialand idle equipment.

 

*Loss from Extinguishments of Debt.*Lossfrom extinguishments of debt decreased to $1.2 million, or 8% of revenue, forthe twelve months ended December 31, 2005 from $2.9 million, or 17% ofrevenue, for the twelve months ended December 31, 2004. The $1.2 millionloss from extinguishments of debt was recognized from the exchange of our 6%Convertible Notes due 2006 in August 2005. The $2.9 million loss fromextinguishments of debt was recognized from exchange of our 6% Senior ConvertibleNotes due March 2007 in August 2004.

 

*Change in Value of Warrants.*Changein value of warrants was a net gain of $4.0 million, or 24% of revenue, and$0.7 million, or 4.3% of revenue, during the twelve months ended December 31,2005 and 2004, respectively from the change in value of warrants issued fromthe senior convertible debt funded in March 2004 and exchanged in August 2004,convertible debt funded in June 2005, and senior convertible debt fundedin August 2005 primarily as a result of fluctuations in our stock price.

 

*Change in Value of Conversion Feature.*Changein the value of our conversion feature liability from our senior convertibledebt funded in March 2004 and exchanged in August 2004 and August 2005resulted in a Change in value of conversion feature gain of $9.1 million, or56% of revenue, and a gain of $2.1 million, or 12% of revenue, for the twelvemonths ended December 31, 2005 and 2004, respectively, primarily due tofluctuations in our stock price (see Note 15).

 

*Other Income.*Otherincome was $0.3 million, or 2% of revenue, during the twelve months ended December 31,2004 from certain stock transactions with John Kang, our Chairman, President,and Chief Executive Officer during 2002 (see Note 24). There were no amountsrecorded as other income for the twelve months ended December 31, 2005.

 

*Interest Expense*.Interest expense was $6.0 million, or 37% of revenue, for the twelve monthsended December 31, 2005 and was $6.6 million, or 38% of revenue, for thetwelve months ended December 31, 2004. During each of the twelve monthsended December 31, 2005 and 2004, the interest expense was primarily dueto the interest accrued on the Kookmin Bank loan funded on February 4,2003, senior convertible debt funded on March 3, 2004 and exchanged in August 2004,convertible debt funded on June 13, 2005, and senior convertible debtfunded in August 9, 2005, as well as amortization of debt issuance costsand discount on the convertible debt. During 2005, $0.1 million of interestexpense was accrued from default interest rates applied to the seniorconvertible notes effective April 1, 2005 from non-payment of quarterlyscheduled interest payments and $1.0 million of late registration penalty feeof our senior convertible debt was accrued as interest expense. The defaultinterest and late registration penalty were paid as of December 31, 2005.

 

*Interest Income.*Interestincome was $17 thousand for the twelve months ended December 31, 2005, and$37 thousand for the twelve months ended December 31, 2004 from interestearned on cash deposits.

 

***Comparison of the years ended December 31,2004 and 2003***

 

*Revenue*. Revenue increased to $17.4 million in the twelve months ended December 31,2004 from $13.7 million in the twelve months ended December 31, 2003.The increase was due to increases in revenue earned by our bulk Liquidmetalalloy and coatings segments in the twelve months ended December 31, 2004.This increase in revenue consisted of $3.8 million from the sale andprototyping of parts manufactured from bulk Liquidmetal alloys, offset by adecrease of $1.9 million from research and development services relatedprimarily from reduced activity from defense and medical applications. Ourcoatings business contributed $1.0 million to the increase in revenues as comparedto the twelve months ended December 31, 2003 from increased demand fordrill pipe coatings.

 

*Cost of Sales*. Cost of sales decreased to $12.2 million, or 70% of revenue,during the twelve months ended December 31, 2004 from $18.2 million,or 133% of revenue, in the twelve months ended December 31, 2003. Thisdecrease was a result of the continued maturing of our manufacturing processand represents the Company’s efforts to manage costs and focus on our corebusiness while continuing to build production pipeline and manufacturing

 

36

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infrastructure required to prepare for and support the anticipatedgrowth of our bulk Liquidmetal alloy business. The cost of sales for theproducts sold by the coatings business segment is generally consistent fromyear to year because the Liquidmetal coatings products are produced by thirdparties and sold wholesale to various industries.

 

*Selling, General, and Administrative Expenses*. Selling, general, and administrative expensesdecreased to $11.6 million, or 66% of revenue, in the twelve months ended December 31,2004 from $17.7 million, or 130% of revenue, in the twelve months ended December 31,2003. This decrease was primarily a result of decrease in wages andrelated expense by $5.0 million, decreases in travel and communicationexpenses by $0.8 million, decreases in rent by $0.8 million, decrease inrelocation expenses by $0.7 million, offset by an increase in professionalfees, consultant fees, and contract services by $0.8 million, and anincrease in insurance costs by $0.4 million. These and other decreases inselling, general and administrative expenses represent the Company’s efforts tomanage costs and focus on our core business while continuing to build ourcorporate infrastructure required to prepare for and support the anticipatedgrowth of our bulk Liquidmetal alloy business.

 

*Research and Development Expenses*. Research and development expenses decreasedto $1.5 million, or 8% of revenue, in the twelve months ended December 31,2004 from $8.8 million, or 64% of revenue, in the twelve months ended December 31,2003. The decrease was primarily a result of decreases in salaries,wages and the related expenses by $3.0 million, decrease in laboratory andprototyping expenses by $2.0 million, decrease in depreciation expense by$0.7 million, decrease in professional fees, consultant fees, and contractservices by $0.6 million, decrease in research grants by $0.3 million, anddecrease in travel related expenses by $0.2 million. The decreases were aresult of the Company focusing primarily on our core business associated withour bulk Liquidmetal alloy business while managing our costs. The Companycontinues to perform research and development efforts on new Liquidmetalalloys and related processing capabilities, develop new manufacturingtechniques, and contract with consultants and provide research grants tovarious institutions to advance the development of Liquidmetal alloys.

 

*Impairment of Goodwill*. Impairment of goodwill was $0.2million , or 1% of revenue, in thetwelve months ended December 31, 2003. Impairment of goodwill represents the write-down of the goodwill balanceof Dongyang Yudoro (“Dongyang”), our 51% owned subsidiary in South Korea. During2003, Dongyang experienced net losses as a result of a continuing economicdownturn in the market for its machinery products. These events along withDongyang’s operating, and cash flow losses, and uncertainty surrounding itsfuture cash flows, led us to evaluate our investment for recoverability as of December 31,2003. As a result, we determined that the carrying value of our investment inDongyang exceeded its fair value as of December 31, 2003 in the amount of$0.2 million. In March 2004, we sold our 51% investment in Dongyang to the49% minority shareholder (see Note 18). There was no impairment charge togoodwill in the twelve months endedDecember 31, 2004.

 

*Impairment of Long Lived Assets*. Impairment of long lived assets was $2.7million, or 20% of revenue, in the twelve months ended December 31, 2003. Impairmentexpense represents a write-down of the building of our manufacturing facilityin South Korea. Due to the decreased production and usage of our Pyongtaekmanufacturing operation, we decided to obtain independent appraisals as to thefair value of this building. Accordingly, the fair value of the building asdetermined by the average of the two independent appraisals was less than thecarrying value of the building as of December 31, 2003. There was noimpairment charge to long lived assets in the twelve months ended December 31,2004.

 

*Loss from Extinguishment of Debt.*Lossfrom extinguishment of debt was $2.9 million, or 17% of revenue, during thetwelve months ended December 31, 2004 due to the extinguishment of our March Notesas it relates to the exchange in August 2004. There was no such lossrecorded during twelve months ended December 31, 2003.

 

*Change in value of warrants, net.*Changein value of warrants was a net gain of $0.7 million, or 4% of revenue, duringthe twelve months ended December 31, 2004 from the change in valuation of warrant payable issued related to thesenior convertible debt funded in March 2004, which was exchanged in August 2004(see note 15). There were no such amounts recorded for the twelve months ended December 31,2003.

 

*Change in value of conversion feature.*Changein the value of our conversion feature liability from our senior convertibledebt funded in March 2004 and exchanged in August 2004 resulted in aChange in value of conversion feature gain of $2.1 million, or 12% of revenue,during the twelve months ended December 31, 2004, primarily due tofluctuations in our stock price (See Note 15). There were no such amountsrecorded for the twelve months ended December 31, 2003.

 

*Other Income.*Otherincome was $0.3 million, or 2% of revenue, during the twelve months ended December 31,2004 from certain stock transactions with John Kang, our Chairman, President,and Chief Executive Officer during 2002 (see Note 24). There were no amountsrecorded as other income for the twelve months ended December 31, 2003.

 

*Interest Expense*. Interest expense was $6.6 million, or38% of revenue, in the twelve months ended December 31, 2004 and was$0.4 million, or 3% of revenue, in the twelve months ended December 31,2003. During the twelve

 

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months ended December 31, 2004, the interest expense was primarilydue to the interest accrued, amortization of debt discount and deferredissuance costs on new senior convertible debt originally sold on March 3,2004 and exchanged in August 2004, and interest accrued on Kookmin Bankloan funded on February 4, 2003. During the twelve months ended December 31,2003, interest expense was primarily due to interest accrued on the KookminBank loan to our South Korean subsidiary made on February 4, 2003.

 

*Interest Income.* Interest income was $37 thousand forthe twelve months ended December 31, 2004 for interest earned oncertificate of deposits. Interest income was $0.3 million or 2% of revenue forthe twelve months ended December 31, 2003 for interest earned onshort-term, investment grade, interest-bearing securities.

 

*Gain from Sale of Investment.*In April 2003 we sold our remaining shares of Growell Metal Co., Ltd. thatwere purchased in July 2002. We recognized a $1.2 million gain on thesale of these shares during the twelve months ended December 31, 2003. Therewere no such gains in the twelve months ended December 31, 2004.

 

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##### **QUARTERLY RESULTS**

 

The followinginformation presents our unaudited quarterly operating results for 2005 and2004. The data has been prepared by Liquidmetal Technologies, Inc. on abasis consistent with the Consolidated Financial Statements included elsewherein this Form 10-K, and includes all adjustments, consisting of normalrecurring accruals, that we consider necessary for a fair presentation thereof.These operating results are not necessarily indicative of our futureperformance.

 

We haverestated our quarterly results for 2005 and 2004 to properly account for the conversion feature of our seniorconvertible notes. See Note 2 to the consolidated financial statements includedin this annual report on Form 10-K

 

During the fourth quarter of 2005, although annual revenuesdecreased relative to 2004, we had an increase in revenue of $1.1 millioncompared to the third quarter due to increases in orders from our consumerelectronics casings customers for Liquidmetal bulk alloy parts for cellularphone components and other consumer electronics casings, and increases indemand for Liquidmetal coatings products from the oil drilling industry. Theincreases in were a result of expanded sales and marketing efforts into various electronic componentsincluding sliding hinges, brackets and antenna. The Company experienced an increase gross profit of $0.3million for the fourth quarter of 2005 from the third quarter due to increasein mix of higher margin products. Significant portion of our manufacturingcosts continue to remain fixed. We believe that higher manufacturing volumesand greater mix of higher margin products in the future will cause the grossprofit to improve over time. In addition, the company wrote-down $0.3 millionof primarily raw material inventory considered to be long term as the carryingvalue of the inventory held as an impairment charge. While we may use the excess raw materials beyond one year to fulfillfuture demand, we did not foresee use of this inventory in the foreseeablefuture.

 

In the third quarter of 2005, the company wrote-down $0.8 million of primarily rawmaterial inventory considered to be long term as the carrying value of theinventory held as an impairment charge. While we may use the excess raw materials beyond one year to fulfillfuture demand, we did not foresee use of this inventory in the foreseeablefuture.

 

Included inthe second quarter of 2005 was an impairment charge for long lived assets of$3.4 million. Impairment charge represents write-down of $1.7 million of rawmaterials considered to be long term inventory and $1.7 million of idleequipment. While we may use the excess raw materials beyond one year tofulfill future demand, we did not foresee use of this inventory in theforeseeable future. Further, while we have marketed the idle equipment forultimate sale since early 2004, we were unable to sell this equipment.

 

Duringthe fourth quarter of 2004, although our revenues were comparable to prioryear, we had a decrease in revenue of $2.1 million compared to the thirdquarter due to an unanticipated and temporary decrease in orders from one ofour customers, Samsung. In addition, included in our fourth quarter cost ofsales is a $0.4 million charge related to certain hinge finished goods used inSamsung’s cell phone models which were nearing its end of life. The Companyexperienced a gross loss of $0.4 million for the fourth quarter due to the onetime charge of cost of sales and also due to the fact that our cost of salesfrom our Liquidmetal bulk alloy segment includes primarily fixed costs from ourlabor and equipment expenses.

 

Thesestatements should be read in conjunction with restatement Note 2 in the notes to the consolidated financial statementsincluded in this annual report on Form 10-K.

 

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**Consolidated Statements of Operations Data:**

 
| ** **                                                                                                              | ** ** | **For the Three Months Ended**             | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **12/31/05**                               | ** ** | **9/30/05** | ** ** | **6/30/05** | ** ** | **3/31/05** | ** ** |
| ** **                                                                                                              | ** ** | **(Restated)**                             | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                              | ** ** | **(In thousands, except per share  data)** | ** ** |
| ** **                                                                                                              | ** ** | **(Unaudited)**                            | ** ** |
| Revenue                                                                                                                 |       | $                                          | 5,453      |   | $ | 4,342 |   | $ | 3,727 |   | $ | 2,843 |   |
| Cost of  sales                                                                                                          |       | 4,576                                      |       | 3,756 |   | 3,962 |   | 2,835 |   |
| Gross (loss)  profit                                                                                                    |       | 877                                        |       | 586 |   | (235 | ) | 8 |   |
| Operating  expenses                                                                                                     |       |                                       |       |   |   |   |   |   |   |
| Selling,  general, and administrative                                                                                   |       | 2,013                                      |       | 2,364 |   | 1,567 |   | 2,590 |   |
| Research and  development                                                                                               |       | 314                                        |       | 196 |   | 213 |   | 397 |   |
| Impairment  of long lived assets                                                                                        |       | 260                                        |       | 833 |   | 3,394 |   | — |   |
| Total  operating expenses                                                                                               |       | 2,587                                      |       | 3,393 |   | 5,174 |   | 2,987 |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Loss from  operations                                                                                                   |       | (1,710                                     | )          | (2,807 | ) | (5,409 | ) | (2,979 | ) |
| Loss from  extinguishments of debt                                                                                      |       | —                                     |       | (1,247 | ) | — |   | — |   |
| Change in  value of warrants, gain (loss)                                                                               |       | 2,840                                      |       | 1,112 |   | (100 | ) | 133 |   |
| Change in  value of conversion feature, gain                                                                            |       | 4,621                                      |       | 2,215 |   | 1,167 |   | 1,115 |   |
| Interest  expense, net                                                                                                  |       | (1,641                                     | )          | (1,652 | ) | (1,180 | ) | (1,531 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Income  (loss) from operation before income taxes and discontinued operations                                           |       | 4,110                                      |       | (2,379 | ) | (5,522 | ) | (3,262 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Income taxes                                                                                                            |       | —                                     |       | — |   | — |   | — |   |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Net income  (loss)                                                                                                      |       | $                                          | 4,110      |   | $ | (2,379 | ) | $ | (5,522 | ) | $ | (3,262 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Income  (loss) per share from continuing operations - basic and diluted                                                 |       | $                                          | 0.10       |   | $ | (0.06 | ) | $ | (0.13 | ) | $ | (0.08 | ) |
|                                                                                                                    |       |                                       |       |   |   |   |   |   |   |
| Weighted  average common shares used to compute income (loss) per share from continuing  operations - basic and diluted |       | 42,180                                     |       | 41,933 |   | 41,610 |   | 41,610 |   |

 

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**Consolidated Statements of Operations Data:**

 
| ** **                                                                                                                   | ** ** | **For the Three Months Ended**             | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **12/31/04**                               | ** ** | **9/30/04** | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** |
| ** **                                                                                                                   | ** ** | **(Restated)**                             | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                                   | ** ** | **(In thousands, except per share  data)** | ** ** |
| ** **                                                                                                                   | ** ** | **(Unaudited)**                            | ** ** |
| Revenue                                                                                                                      |       | $                                          | 2,471      |   | $ | 4,615 |   | $ | 4,055 |   | $ | 6,288 |   |
| Cost of  sales                                                                                                               |       | 2,895                                      |       | 3,241 |   | 2,475 |   | 3,557 |   |
| Gross profit  (loss)                                                                                                         |       | (424                                       | )          | 1,374 |   | 1,580 |   | 2,731 |   |
| Operating  expense:                                                                                                          |       |                                       |       |   |   |   |   |   |   |
| Selling,  general, and administrative                                                                                        |       | 2,413                                      |       | 3,569 |   | 2,544 |   | 3,065 |   |
| Research and  development                                                                                                    |       | 407                                        |       | 374 |   | 345 |   | 341 |   |
| Total  operating expenses                                                                                                    |       | 2,820                                      |       | 3,943 |   | 2,889 |   | 3,406 |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Loss from  operations                                                                                                        |       | (3,244                                     | )          | (2,569 | ) | (1,309 | ) | (675 | ) |
| Loss on extinguishments  of debt                                                                                             |       | —                                     |       | (2,941 | ) | — |   | — |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Change in  value of warrants, (loss) gain                                                                                    |       | (99                                        | )          | (434 | ) | 694 |   | 586 |   |
| Change in  value of conversion feature, (loss) gain                                                                          |       | (1,183                                     | )          | (2,338 | ) | 3,904 |   | 1,710 |   |
| Other income  (expense), net                                                                                                 |       | —                                     |       | 302 |   | — |   | — |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Interest  income (expense), net                                                                                              |       | (640                                       | )          | (3,283 | ) | (2,233 | ) | (384 | ) |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| (Loss)  income from operation before income taxes and discontinued operations                                                |       | (5,166                                     | )          | (11,263 | ) | 1,056 |   | 1,237 |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Income taxes                                                                                                                 |       | —                                     |       | — |   | — |   | — |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| (Loss)  income from continuing operations                                                                               |       | (5,166                                     | )          | (11,263 | ) | 1,056 |   | 1,237 |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| (Loss) from  discontinued operations, net of tax                                                                             |       | —                                     |       | — |   | (356 | ) | (393 | ) |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Net (loss)  income                                                                                                           |       | $                                          | (5,166     | ) | $ | (11,263 | ) | $ | 700 |   | $ | 844 |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| (Loss)  income per share from continuing operations – basic and diluted                                                 |       | $                                          | (0.12      | ) | $ | (0.27 | ) | $ | 0.03 |   | $ | 0.03 |   |
|                                                                                                                         |       |                                       |       |   |   |   |   |   |   |
| Weighted  average common shares used to compute income (loss) per share from continuing  operations – basic and diluted |       | 41,610                                     |       | 41,610 |   | 41,610 |   | 41,610 |   |

 

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##### **LIQUIDITY AND CAPITAL RESOURCES**

 

Our cashused for operating activities was $6.5 million for the year ended December 31,2005. Our cash used for operating activities, including our discontinuedequipment manufacturing operations, was $6.3 million for the year ended December 31,2004. Our working deficit decreased to $11.0 million from $14.9 million at December 31,2005 and 2004. The decrease of approximately $3.9 million in working deficitwas primarily attributable to increase in cash and cash equivalents of $0.7million, increase in trade accounts receivable of $0.7 million, decrease incurrent portion of long term debt of $2.7 million, decrease in current portionof other liabilities of $0.6 million, decrease in conversion featureliabilities of $4.9 offset by an decrease in restricted cash of $0.8 million,decrease in inventories of $0.6 million, decrease in prepaid expenses and othercurrent assets of $0.3 million, increase in accounts payable and accruedliability of $1.6 million, increase in settlement payable of $0.1 million,increase in deferred revenue of $0.4 million, increase in short-term debt of$0.6 million, and increase in warrant liabilities of $1.2 million.

 

Our cashused in investing activities was $0.3 million for the year ended December 31,2005 for the acquisition of property and equipment and investments in patentsand trademarks.

 

Our cashprovided by financing activities was $7.1 million for the year ended December 31,2005, which consists of $0.8 million in proceeds from restricted cash, $13.1million in proceeds from convertible debt funded in June 2005 and seniorconvertible debt funded in August 2005, $0.2 million in proceeds fromborrowings from our short term debt executed in March 2005, $4.4 millionin proceeds from factoring agreement executed in April 2005, offset by$11.5 million on repayment of borrowings.

 

Weanticipate that our capital expenditures will be approximately less than $0.5million for the full year 2006 for the acquisition of furniture, fixtures, andother business equipment. This amount is subject to change, however, dependingupon the nature and the amount of the product orders that we actually receivefrom customers.

 

Ourcapital requirements during the next twelve months will depend on numerousfactors, including the success of existing products either in manufacturing ordevelopment, the development of new applications for Liquidmetal alloys, theresources we devote to develop and support our Liquidmetal alloy products, thesuccess of pursuing strategic licensing and funded product developmentrelationships with external partners. During the next twelve months, basedon our current business plan, we expect to have sufficient resources tocontinue to devote limited capital to our research and development activities,to further develop and strengthen our manufacturing technology, and to providefor working capital and other general corporate purposes. However, based on ourhistorical operating results and the continued development of our manufacturingcapabilities and alloy compositions, there exists the possibility that theseresources will not be adequate to operate at the proposed business plan levels.These expenses and capital expenditures could consume a material amount of ourcash resources, but the amount of these requirements will depend on the natureand amount of orders we receive for the purchase of our bulk Liquidmetal alloyproducts.

 

We have experienced significant operating losses since our inception.Our net loss for the fiscal years ended December 31, 2005 and 2004 was$7.1 million and $14.9 million, respectively. In the audit report on ourfinancial statements for our fiscal years ended December 31, 2005 and2004, our auditors included a going-concern qualification indicating that oursignificant operating losses and working capital deficit cause substantialdoubt about our ability to continue as a going concern. By issuing an opinionstating that there is substantial doubt about our ability to continue as agoing concern, our auditors have indicated that they are uncertain as towhether we have the capability to continue our operations without additionalfunding. Accordingly, we anticipate that we will need additional funding duringthe next 12 months and would seek to raise such funds through public or privateequity financing, bank debt financing, or from other sources. Adequate funds may notbe available when needed, and if we raise additional funds by issuing equity securities,existing stockholders may be diluted.

 

In March 1996,we entered into a distribution agreement whereby we granted to a third partyexclusive rights to market and sell golf products incorporating Liquidmetaltechnology to certain Japanese sporting equipment companies. The third partypaid us a $1.0 million distribution fee as part of this agreement, ofwhich a portion was refundable according to a formula based on the gross profitearned by the third party. The remaining unearned distribution fee of$0.8 million has not been refunded as of December 31, 2005, and we donot believe the third party is entitled to a refund. On March 28, 2003,the distribution agreement was terminated and we entered into a new agreementto pay to the same third party a commission on the net sales price of allLiquidmetal golf equipment that is shipped by our Company or its affiliates toJapanese golf companies for sale into the Japanese end-market. This commissionwill apply to golf equipment shipped by our Company or its affiliates duringthe period beginning on March 28, 2003 and ending on March 28, 2006.If, by March 28, 2006, we have not paid $0.4 million in commissionpayments, the balance between commissions paid and $0.4 million will bepaid by April 30, 2006, thereby guaranteeing the third party a $0.4million minimum payment during the term of the agreement. We will recognize theunearned distribution fee of $0.8 million as revenue proportionately withthe payment of commissions under the letter agreement.

 

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##### **USE OF PROCEEDS**

 

Pursuant toour Registration Statement on Form S-1 (Registration No. 333-73716),as amended, initially filed with the Securities and Exchange Commission on November 20,2001 and declared effective May 21, 2002, we closed an initial publicoffering of 5,000,000 shares of common stock on May 28, 2002, plus anadditional 229,000 shares on June 10, 2002 pursuant to an over allotmentoption, at a price of $15.00 per share (which sale is referred to herein as the“Offering”). The Offering generated aggregate cash proceeds during the secondquarter 2002 of $78.4 million. The net proceeds were $70.7 millionafter deducting underwriting commissions of $5.5 million and othertransaction fees of $2.2 million. The managing underwriters for theOffering were Merrill Lynch & Co., UBS Warburg, and Robert W. Baird &Co.

 

As of December 31,2003, we used $70.7 million of net proceeds from the Offering. In 2002, weused approximately $7.8 million of the net proceeds from the Offering torepay all outstanding promissory notes and accrued interest, $11.1 millionto fund the construction of our manufacturing facility in South Korea,$14.3 million to purchase equipment used to manufacture Liquidmetal parts,$0.4 million to purchase assets related to production and sale ofequipment used in the production process of Liquidmetal alloy products, and$0.3 million to purchase the 51% interest in our majority owned Dongyangsubsidiary. During the third quarter of 2002, we used $2.0 million toinvest in the common stock of Growell Metal, which supplied a portion of theLiquidmetal alloy ingots used in our manufacturing operations in Korea. We havesince sold such stock, realizing a gain on the sale. We used the remainingproceeds of $32.7 million for working capital in 2002 and 2003, excluding$2.1 million paid to Paul Azinger in 2002 and 2003 for amounts due underthe terms of his terminated endorsement agreement with our discontinued retailgolf operations.

 

**PrivatePlacements**

 

On March 3,2004, we sold $9.9 million of 6.0% senior convertible notes due 2007 (the “March Notes”)to investor groups in a transaction led by Michigan Venture Capital Co., Ltd, aSouth Korea-based institutional investment firm, and IndiGo Ventures LLC, a NewYork-based investment firm that served as a financial advisor to our companyfor the transaction. The notes were convertible at any time into our commonstock at a price of $3.00 per share. Investors in the private placementreceived warrants to purchase an aggregate amount of up to approximately 1.2million shares of common stock, originally exercisable at $3.00 per share forvarying periods but no later than 100 days following the effectiveness of aregistration statement covering the resale of shares issuable upon exercise ofthe warrants. In addition, the investors had the right to call for repayment ofthe notes prior to maturity at any time after the second anniversary of theclosing of the transaction.

 

On August 19,2004, we completed a private exchange offer for our March Notes. Underterms of the exchange offer, approximately $5.5 million in aggregate principalamount of the March Notes were exchanged for an aggregate of (i) $2.75million of 6% Senior Secured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.75million of 10% Senior Secured Notes Due 2005 (the “July 2005 Notes”),collectively referred to as “Exchange Notes”. In addition, we redeemedapproximately $4.5 million of the March Notes in cash. The Exchange Noteswere collateralized by certain patents owned by our company and a secondpriority mortgage interest in plant facilities and certain equipment at ourplant in South Korea. The July 2005 Notes had a maturity date of July 29,2005, and a conversion price of $2.00 per share (compared to a conversion priceof $3.00 per share under the March Notes). The July 2007 Notes have amaturity date of July 29, 2007, and a conversion price of $1.00 per share.Further, the exchange notes are convertible into Common Stock, at the option ofour company, if at any time after the issuance of the notes, the closing pershare price of the Common Stock exceeded $4.00 (as adjusted for stock splits,reverse splits, stock dividends, and recapitalizations) for 30 consecutivetrading days, and further provided that there has been effective registrationduring such period. Holders of the July 2007 Notes also have the right tocall for repayment of the July 2007 Notes prior to maturity at any timeafter the second anniversary of the completion of the exchange offer. A totalof 563,151 warrants to purchase our common stock at an exercise price of $3.00per share—all of which were previously issued in connection with the purchaseof the March Notes—were amended to provide for an extended expiration dateof March 1, 2006. The warrant exercise price is subject to priceadjustment for anti-dilution purposes. As of October 1, 2005, the warrantprice was determined to be exercisable at $2.73.

 

On June 13,2005, we completed a private placement (the “June 2005 Private Placement”)of 10% Convertible Unsecured Notes Due June 13, 2006 in the aggregateprincipal amount of $3,250 (the “June 2006 Notes”), together with warrantsto purchase up to an aggregate of 893,750 shares of our company’s common stock(the “Warrants”). The June 2006 Notes were unsecured and were due on theearlier of June 13, 2006 or the consummation of a follow-on equity or debtoffering or restructuring transaction pursuant to which our company receivesgross proceeds of at least $4,000. Prior to maturity, the June 2006 Noteswere interest-only, with interest payments due quarterly, at the rate of 10%per year. If, within 120 days following the issue date of the June 2006Notes, our company either failed to redeem the notes for the principal amountand accrued interest thereon or failed to close a “Qualified Financing,” thenthe June 2006 Notes would have been convertible at a conversion priceequal to seventy five percent (75%) of the closing price of our company’scommon stock on the first trading day immediately preceding the conversion date.A “Qualified Financing “ was defined in the June 2006 Notes as any debt orequity financing of our company resulting in aggregate gross proceeds to ourcompany of at least $5,000 and in which the holders of at least sixty percent(60%) of the aggregate principal amount of our company’s Long-Term Notes either(i) agree that the equity or debt securities to be issued in suchfinancing shall be pari passu in order of payment to the July 2007 Notesheld by them or (ii) exchange their July 2007 Notes for newsecurities in the financing transaction. We successfully completed a QualifiedFinancing on August 9, 2005, and the June 2006 Notes never becameconvertible.

 

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On August 9,2005, we completed a private placement (the “August 2005 Private Placement”)of $9,878 in principal amount of new 7% Convertible Secured Promissory Notesdue August 2007 (the “Senior Notes”). The issuance consisted of $5,000cash, exchange of $1,284 in principal amount of the July 2005 Notes, theexchange of $2,996 in principal amount of the June 2006 Notes,satisfaction of accrued interest and late registration fees in the amount of$589 on the July 2005 Notes, and satisfaction of accrued interest of $9 onthe previously issued June 2006 Notes. The Senior Notes were issuedpursuant to a Securities Purchase Agreement dated effective as of August 2,2005 among the our company, the purchasers of the Senior Notes, and the holdersof previously issued July 2005 Notes and June 2006 Notes. Interestpayments on the Senior Notes are due quarterly, and failure to make timelyinterest payments will result in increase in interest rates to 14% per annum onthe Senior Notes (“Default Rates”). As of September 30, 2005, we have madetimely interest payments. The Senior Notes are convertible into shares of ourcommon stock at $2.00 per share Pursuant to an Amended and Restated SecurityAgreement. The Senior Notes are secured by substantially all of our assets andrank senior to all other obligations of our company, other than the our loanwith Kookmin Bank of South Korea (or any refinancing of such loan), the July 2007Notes, purchase-money asset financing, trade creditors in the ordinary courseof business, and any inventory or receivables-based credit facility that we may obtainin the future, provided that the amount of the credit facility does not exceed50% of eligible inventory and 80% of eligible receivables. The Senior Noteswill automatically convert into shares of our common stock if the common stockhas an average closing price of more than $5.00 per share during 30 consecutivetrading days. We also issued warrants to the purchasers of the Senior Notes andplacement agents giving them the right to purchase up to 2,469,470 and 414,495shares of our common stock, respectively, with an exercise price of $2.00 pershare. The warrants will expire on August 2, 2010.

 

In connectionwith the August 2005 Private Placement, we entered into an amended andrestated registration rights agreement with the holders of the July 2007Notes, the holders of the August 2007 Notes, and the holders of theabove-described outstanding warrants. This amended and restated registrationrights agreement replaced all other registration rights agreements previouslyentered into by us in connection with the private sale by us of convertiblenotes and warrants. Under the amended and restated registration rightsagreement, we are required to file a resale registration statement for theshares underlying all of our outstanding convertible notes and warrants, asdescribed above, by October 31, 2005, to enable the resale of such sharesby the selling stockholders on a delayed or continuous basis under Rule 415of the Securities Act. We are then required to cause such registrationstatement to become effective within 60 days after we receive the first writtencomments on the registration statement from the SEC, or if the SEC notifies usthat it will not review the registration statement, within five days after suchnotification. We will be subject to certain monetary penalties, as set forth inthe registration rights agreement, if the registration statement is not filedor does not become effective on a timely basis. Specifically, if we do not filethe registration statement on a timely basis, we will be obligated to pay alate filing fee to the selling stockholders in the amount of 3% of the warrantexercise price on each of the warrants held by them plus 3% of the principalamount of the outstanding notes held by them. This fee will be payable for eachperiod of 30 business days that the filing of the registration statement ismade past the required filing date, and the payments will be due 10 businessdays following the end of each 30-day period. If the registration statement hasnot been declared effective by the required effective date, we will beobligated to pay a monthly late registration fee to the selling stockholders inthe amount of 2% of the aggregate warrant exercise prices and aggregate note principalamounts for the first 30 business days after the required effective date, and1% for each 30-business day period thereafter until the registration statementis declared effective. Notwithstanding the foregoing, the late filing fees andlate registration fees will not exceed 18% of the aggregate warrant exerciseprices and aggregate note principal amounts.

 

Ourconvertible notes and related documents contain restrictive covenants pursuantto which we generally may not (i) incur any indebtedness that wouldbe senior to, or on the same rank as, the convertible notes with respect topayment or security, (ii) grant any liens or security interests in any ofour assets which serve as collateral for the convertible notes (whichcollateral consists of substantially all of our assets), (iii) withcertain exceptions, sell any of the assets that constitute collateral for thenotes, (iv) become a guarantor for a third-party’s obligation (other thanguarantees in the ordinary course of business not in excess of $500,000 in theaggregate), (v) acquire any shares or securities of any other person orentity in excess of an aggregate of $1.0 million over any rolling 12-monthperiod, (vi) purchase or otherwise acquire any assets in excess of anaggregate of $3.0 million over any rolling 12-month period, (vii) engagein any transaction resulting in the issuance to any person of more than 40% ofthe equity of our company, or (viii) engage in any merger or sale of allor substantially all of our business assets. These covenants may curtailour ability to raise capital in the future or otherwise restrict our ability toenter into a transaction that we believe would be in the best interest of ourstockholders. We believe that we are currently in compliance with all suchcovenants. While there can be no assurances that we will be able to maintaincompliance with these restrictive covenants in the future, if we violate thesecovenants and do not cure such violations within 30 days of written notice fromthe noteholders, the noteholders may demand payment in full ourconvertible notes, collect penalty interest, and exercise other remedies thatare available under notes.

 

On December 6,2005, we received a letter from a representative of the holders of the August 2007Notes demanding the payment of a late filing fee by us for the period followingOctober 31, 2005, but under the terms of the amended and restatedregistration rights agreement, we do not believe that we are obligated to payany late filing fees unless and until we fail to file the registrationstatement by December 13, 2005, which is the last day of the first30-business day period following October 31, 2005. The letter also statedthat the letter was serving as a notice of default under the Senior Notes as aresult of our failure to file a registration statement by October 31,2005, although under the terms of the Senior Notes, we have thirty days after

 

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delivery ofthe letter in which to cure such default. On December 9, 2005, we filedthe registration statement and have cured the default notice received on December 6,2005.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

Anoff-balance sheet arrangement is any transaction, agreement or othercontractual arrangement involving an unconsolidated entity under which acompany has (1) made guarantees, (2) a retained or a contingentinterest in transferred assets, (3) an obligation under derivativeinstruments classified as equity, or (4) any obligation arising out of amaterial variable interest in an unconsolidated entity that provides financing,liquidity, market risk or credit risk support to the company, or that engagesin leasing, hedging, or research and development arrangements with the company.

 

We have made no arrangements of the types described in any of thecategories that may have a material current or future effect on ourfinancial condition, liquidity or results of operations. See Note 13 to theConsolidated Financial Statements contained in this Annual Report on Form 10-K.

 

##### **CONTRACTUAL OBLIGATIONS**

 

The followingtable summarizes our company’s obligations and commitments as of December 31,2005:

 
| ** **                      | ** ** | **Payments Due by Period (in  thousands)** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| **Contractual Obligations (1)** | ** ** | **Total**                                  | ** ** | **> 1 year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **After 5 years** | ** ** |
|                            |       |                                       |       |   |   |   |   |   |   |   |   |
| Long-term debt (2)              |       | $                                          | 15,036     |   | $ | 1,343 |   | $ | 13,693 |   | $ | — |   | $ | — |   |
| Short-term debt (3)             |       | 550                                        |       | 550 |   | — |   | — |   | — |   |
| Capital lease obligation (3)    |       | 69                                         |       | 62 |   | 7 |   | — |   | — |   |
| Operating leases and rents      |       | 1,223                                      |       | 706 |   | 439 |   | 78 |   | — |   |
| Growell settlement payable (4)  |       | 3,331                                      |       | 3,331 |   | — |   | — |   | — |   |
| Consulting services payable     |       | 78                                         |       | 78 |   | — |   | — |   | — |   |
| Dongyang payable                |       | 11                                         |       | 11 |   | — |   | — |   | — |   |
|                            |       |                                       |       |   |   |   |   |   |   |   |   |
|                            |       | $                                          | 20,298     |   | $ | 6,081 |   | $ | 14,139 |   | $ | 78 |   | $ | — |   |

 

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|   | (1)    |   | Contractual cash obligations include  Long-Term Debt comprised of $2,369 of Senior Convertible Notes issued in  2004, $9,878 of Convertible Notes issued in 2005, and $2,790 of Kookmin  Notes, Short-Term Debt comprised of $550 advances received under factoring,  loan, and security agreement, and future minimum lease payments under capital  and operating leases, liabilities incurred from settlement with a former  customer (Growell) and divesture of our equipment manufacturing business, and  purchase commitments from a consultant. |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (2)    |   | Does not include interest payments of  $1,623, un-amortized discounts for conversion feature and warrants of $8,259  of our convertible notes.                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | (3)    |   | Does not include minimum interest and fee  payments of $30.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   | (4)    |   | Includes imputed interest of $3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|   | (5)    |   | In January  2005 Growell was acquired by a third party, and we are currently in  negotiations to settle this balance with the third party.                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

##### **CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires us to makeestimates and assumptions that affect reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. These estimates and assumptions are based onhistorical experience and various other factors that are believed to bereasonable under the circumstances. Actual results could differ materially fromthese estimates under different assumptions or conditions.

 

We believe that the following accounting policies are the most criticalto our consolidated financial statements since these policies requiresignificant judgment or involve complex estimates that are important to theportrayal of our financial condition and operating results:

 

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•                  Ourearnings and cash flows are subject to fluctuations due to changes in non-U.S.currency exchange rates. We are exposed to non-U.S. exchange rate fluctuationsas the financial results of non-U.S. subsidiaries are translated into U.S.dollars. As exchange rates vary, those results, when translated, may varyfrom expectations and adversely impact overall expected profitability. The cumulativetranslation effects for subsidiaries using functional currencies other than theU.S. dollar are included in accumulated foreign exchange translation inshareholders’ equity. Movements in non-U.S. currency exchange rates may affectour competitive position, as exchange rate changes may affect businesspractices and/or pricing strategies of non-U.S. based competitors.

 

•                  Werecord an accrual for potential product warranty costs. Due to the lack ofhistorical information for warranty expense related to bulk alloy products,management estimates product warranties as a percentage of bulk alloy productsales earned during the period. In the event in future periods the actualproduct warranty costs consistently exceed the estimate for product warranty costs,an adjustment would be made and income would decrease in the period of suchdetermination. Likewise, in the event we determine that actual product warrantycosts are consistently lower than the estimate for product warranty costs, anadjustment would be made and income would increase in the period of suchdetermination.

 

•                  Werecord an allowance for doubtful accounts as a contra-asset to our tradereceivables for estimated uncollectible accounts. Management estimates theamount of potentially uncollectible accounts by reviewing significantly pastdue customer balances relative to historical information available for thosecustomers. In the event, in future periods, actual uncollectible accountsexceed the estimate for uncollectible accounts, an adjustment would be made andincome would decrease in the period of such determination. Likewise, in theevent, in future periods, actual uncollectible accounts are lower than theestimate for uncollectible accounts, an adjustment would be made and incomewould increase in the period of such determination.

 

•                  Wevalue inventories at lower of cost or net realizable value. Management hasdetermined net realizable value to be equal to the selling price of theproducts to be produced and sold less the cost of disposal. In the event, infuture periods, the actual selling prices exceed the estimate for sellingprices less cost to sell, an adjustment would be made and income would increasein the period of such determination. Likewise, in the event, in future periods,actual selling prices are lower than the estimate for selling prices, anadjustment would be made and income would decrease in the period of suchdetermination. During 2003 we reduced the carrying value of rawmaterials held by our subsidiary, Liquidmetal Korea, by the amounts consideredto be obsolete. During 2003 we reduced the carrying value of our inventories by$1.0 million as we determined that certain raw material and inventoriesexceeded their net realizable value as of December 31, 2003. Additionally,we recorded a write-down of $2.8 million of raw material and machine inventoryassociated with the settlement of a dispute with a customer, Growell, in December 2003.Such write-down adjustments are included within Cost of Sales. (see Note 7 tothe consolidated financial statements included in this annual report on Form 10-K)

 

•                  Werecord valuation allowances to reduce the deferred tax assets to the amountsestimated to be realized. While we consider taxable income in assessing theneed for a valuation allowance, in the event we determine we would be able torealize our deferred tax assets in the future in excess of the net recordedamount, an adjustment would be made and income increased in the period of suchdetermination. Likewise, in the event we determine we would not be able torealize all or part of our deferred tax assets in the future, anadjustment would be made and charged to income in the period of suchdetermination.

 

•                  We account for the warrants and embedded conversion feature of oursenior convertible notes as derivatives in accordance with Statement ofFinancial Accounting Standards No. 133, Accounting for DerivativeInstruments and Hedging Activities, and Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock. Fair values of warrants and embeddedconversion features are measured at each period end using Black-Scholes modelsand changes in fair value during the period are reported in our earnings.

 

##### **COMPLIANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACTOF 2002**

 

As directedby Section 404 of the Sarbanes-Oxley Act of 2002, or SOX, the SEC hasadopted rules requiring public companies to include a report of managementon the company’s internal controls over financial reporting in their annualreports on Form 10-K. In addition, the public accounting firm auditing apublic company’s financial statements must attest to and report on management’sassessment of the effectiveness of the company’s internal controls overfinancial reporting. Although these requirements were first applicable to ourannual report on Form 10-K for our fiscal year ending December 31,2004, we were unable to comply with these requirements for such fiscal year. Asdisclosed in our amended Form 10-K filed with the SEC on

 

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May 10,2005, the time and resources necessary to complete the restatement of priorperiods’ financial statements delayed our ability to complete the internaldocumentation, assessment and evaluation of internal control over financialreporting, all of which are required to be undertaken to comply with Section 404of SOX. This delay prevented our independent auditor from being able tosatisfactorily complete a timely audit of our internal control over financialreporting as of December 31, 2004.

 

Due to thesedelays, we and our independent auditor determined that it would not be possibleto complete the management’s assessment and auditor’s audit of our internalcontrols over financial reporting as of December 31, 2004, and accordinglyour independent auditor has issued a disclaimer of opinion with respect to ourinternal control over financial reporting as of December 31, 2004, andsuch disclaimer was filed with our amended Form 10-K filed on May 10,2005. The filing of this disclaimer does not comply with the SEC’s rules andregulations under Section 404, and this noncompliance has resulted in usbeing in violation of Section 13(a) under the Securities Exchange Actof 1934. Section 13(a) establishes the general requirement thatpublic companies must file with the SEC, in accordance with such rules andregulations as the SEC may prescribe, such information, documents, andreports as the SEC may from time to time require for the protection ofinvestors, including Form 10-Ks and 10-Qs.

 

In general,the SEC has broad authority under the Securities Exchange Act of 1934 toinstitute investigations, to seek injunctions, to seek monetary penalties, andto otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K. Therefore, a violation under Section 404of SOX or Section 13(a) of the Securities Exchange Act of 1934 couldpotentially subject an issuer to these same investigations and penalties. Section 404of SOX is a relatively new legal requirement, and there is very littleprecedent establishing the consequences or appropriate response to a publiccompany’s failure to comply with Section 404. Accordingly, we cannotpredict what action, if any, the SEC may take against our company as aresult of a failure to be compliant with our obligations under Section 404of SOX or Section 13(a) of the Securities Exchange Act of 1934.

 

Effective December 27,2005, the SEC announced final rulings on revisions to accelerated filerdefinition and deadlines for periodic reports. The ruling revised thedefinition of the term “accelerated filer” to permit an accelerated filer thathas voting and non-voting common equity held by non-affiliates of less than $50million to exit accelerated filer status at the end of the fiscal year in whichits equity falls below $50 million and to file its annual report for that yearand subsequent periodic reports on a non-accelerated basis. As of the fiscalyear ended December 31, 2005, we are considered an accelerated filer andare required to comply with SOX 404 requirements for the 2005 fiscal year.

 

In additionto the foregoing, although our common stock was admitted to the OTC BulletinBoard for quotation on June 15, 2005, as a result of our noncompliancewith Section 404 for our 2005 fiscal year, it may not have beenappropriate for the OTC Bulletin Board to admit our common stock for quotationon June 15, 2005. Consequently, there is no assurance that our commonstock will remain eligible for quotation on the OTC Bulletin Board.

 

****The Company has devotedsignificant amount of financial and internal resources during 2005 and early part of2006 to ensure compliance with SOX 404, and on January 16, 2006, Company’smanagement believes that the Company completed and concluded its documentation,assessment and evaluation of its internal controls over financial reporting asof December 31, 2005. However, our independent auditors, StonefieldJosephson Inc., resigned on December 1, 2005, and on January 20,2006, the Company hired Choi, Kim & Park LLP (“CKP”) as its newindependent registered public accounting firm. While the Company has advisedCKP of the foregoing weaknesses in internal controls, due to the untimelinessof the foregoing events, CKP was unable to satisfactorily complete their auditof the Company’s internal control over financial reporting pursuant to SOX 404,and thus, have issued a disclaimer of an opinion on the company’s internalcontrol over financial reporting as of December 31, 2005. The Company’smanagement will continue to monitor potential changes in the legal andregulatory requirements of SOX 404, particularly the requirements for smallpublic companies.****

 

##### **RECENT ACCOUNTING PRONOUNCEMENTS**

 

In June 2005,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-2“The Meaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19,‘Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.’” Issuers of convertible debt are requiredby Statement 133 to evaluate whether it is necessary to separate the “embedded”conversion feature from the debt contract and account for the conversionfeature as if it were a separate derivative instrument. If the issuerdetermines that the embedded conversion feature would be classified in equityif it were a freestanding instrument, the conversion feature is not separatedfrom the debt contract. EITF 00-19’s criteria must be applied to determinewhether a conversion feature qualifies for equity classification, but itexempts a conversion feature embedded in a “conventional convertible debtinstrument” from some of the criteria. EITF 05-2 requires convertibleinstruments that may be settled in a combination of cash or shares, e.g.,those referred to as “Instrument C” in EITF 90-19, and instruments that may beconvertible into a variable number of shares are not “conventional.”  As a result, nonconventional instrumentswould need to satisfy all requirements of EITF 00-19 to support a conclusionthat the conversion feature does not require accounting separate from that forthe debt contract. The adoption of this Issue resulted in recognition ofembedded conversion feature from the senior convertible notes issued in March 2004,which was exchanged in August 2004, and August 2005 as liabilities of$1.8 million and $6.7 million as of December 31, 2005 and 2004,respectively, and a gain of $9.1 million and $2.1

 

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million fromthe change in fair value of conversion feature liabilities for the year ended December 31,2005 and 2004, respectively.

 

In June 2005,the EITF reached a consensus on Issue 05-6, “Determining the AmortizationPeriod for Leasehold Improvements,” which requires that leasehold improvementsacquired in a business combination or purchased subsequent to the inception ofa lease be amortized over the lesser of the useful life of the assets or a termthat includes renewals that are reasonably assured at the date of the businesscombination or purchase. EITF 05-6 is effective for periods beginning after June 29,2005. Earlier application is permitted in periods for which financial statementshave not been issued. The adoption of this Issue did not have an impact on theCompany’s financial statements.

 

In September 2005,the EITF reached a consensus on Issue 05-7 “Accounting for Modifications toConversion Options Embedded in Debt Instruments and Related Issues,” whichrequires that a change in the fair value of a conversion option brought aboutby modifying the debt agreement be included in analyzing in accordance withEITF 96-19 “Debtor’s Accounting for a Modification or Exchange of DebtInstruments” whether a debt instrument is considered extinguished. Under EITF96-19’s requirements, an issuer who modifies a debt instrument must compare thepresent value of the original debt instrument’s cash flows to the present valueof the cash flows of the modified debt. If the present value of those cashflows varies by more than 10 percent, the modification is consideredsignificant and extinguishments accounting is applied to the original debt. Ifthe change in the present value of the cash flows is less than 10 percent, thedebt is considered to be modified and is subject to EITF 96-19’s modificationaccounting. EITF 05-7’s Consensus requires that in applying the 10 percent testthe change in the fair value of the conversion option be treated in the samemanner as a current period cash flow. The Consensus also requires that, if amodification does not result in an extinguishment, the change in fair value ofthe conversion option be accounted for as an adjustment to interest expenseover the remaining term of the debt. The issuer should not recognize abeneficial conversion feature or reassess an existing beneficial conversionfeature upon modification of the conversion option of a debt instrument thatdoes not result in an extinguishment. EITF 05-7 is effective for modificationsof debt instruments beginning in the first interim or annual reporting periodbeginning after December 15, 2005. The Company does not expect theadoption of the EITF to have material impact on the Company’s financial statements.

 

In September 2005,the EITF reached a consensus on Issue No. 05-8, “Income Tax Consequencesof Issuing Convertible Debt with a Beneficial Conversion Feature.”  Under EITF 05-8, the issuance of convertibledebt with a beneficial conversion feature results in a temporary difference forpurposes of applying Statement 109. The deferred taxes recognized for thetemporary difference should be recorded as an adjustment to paid-in capital.EITF 98-5 “Accounting for Convertible Securities with Beneficial ConversionFeatures or Contingently Adjustable Conversion Ratios” and EITF 00-27  “Application of Issue No. 98-5 toCertain Convertible Instruments” require that the nondetachable conversionfeature of a convertible debt security be accounted for separately if it is abeneficial conversion feature. A beneficial conversion feature is recognizedand measured by allocating to additional paid-in capital a portion of theproceeds equal to the conversion feature’s intrinsic value. A discount on theconvertible debt is recognized for the amount that is allocated to additionalpaid-in capital. The debt discount is accreted from the date of issuance to thestated redemption date of the convertible instrument or through the earliestconversion date if the instrument does not have a stated redemption date. TheU.S. Federal Income Tax Code includes the entire amount of proceeds received atissuance as the tax basis of the convertible debt security. The EITF 05-8Consensus should be applied retrospectively to all instruments with abeneficial conversion feature accounted for under EITF 98-5 and EITF 00-27 forperiods beginning after December 15, 2005. The Company does not expect theadoption of the EITF to have material impact on the Company’s financialstatements.

 

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections –a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes,” andFASB Statement No. 3, “Reporting Accounting Changes in Interim FinancialStatements” and changes the requirements for the accounting for and reportingof a change in accounting principle. This statement applies to all voluntarychanges in accounting principle. It also applies to changes required by anaccounting pronouncement in the unusual instance that the pronouncement doesnot include specific transition provisions. When a pronouncement includesspecific transition provisions, those provisions should be followed. SFAS No. 154is effective for accounting changes and corrections of errors made in fiscalyears beginning after December 31, 2005.  We do not believe the adoption of SFAS No. 154will have a material effect on its consolidated financial position, results ofoperations or cash flows.

 

On March 29,2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) regardingthe Staff’s interpretation of SFAS 123(R). This interpretation expresses theviews of the staff regarding the interaction between SFAS 123(R) and certainSEC rules and regulations and provides the staff’s views regarding thevaluation of share-based payment arrangements for public companies. Inparticular, this SAB provides guidance related to share-based paymenttransactions with no employees, the transition from nonpublic to public entitystatus, valuation methods, the accounting for certain redeemable financialinstruments issued under share-based payment arrangements, the classificationof compensation expense, non-GAAP financial measures, first-time adoption ofSFAS 123(R) in an interim period, capitalization of compensation cost relatedto share-based payment arrangements, the accounting for income tax effects ofshare-based payment arrangements upon adoption of SFAS 123(R), the modificationof employee share options prior to adoption of Statement 123(R) and disclosuresin Management’s Discussion and Analysis subsequent to adoption of SFAS 123(R). Ourcompany will adopt SAB 107 in connection with its adoption of SFAS 123(R).

 

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In December 2004,the FASB issued SFAS No. 123R, “Share-Based Payment”, which replaces SFAS No. 123.SFAS No. 123R requires public companies to recognize an expense forshare-based payment arrangements including stock options and employee stockpurchase plans. The statement eliminates a company’s ability to account forshare-based compensation transactions using APB 25, and generally requiresinstead that such transactions be accounted for using a fair value basedmethod. SFAS No. 123R requires an entity to measure the cost of employeeservices received in exchange for an award of equity instruments based on thefair value of the award on the date of grant, and to recognize the cost overthe period during which the employee is required to provide service in exchangefor the award. In April 2005, the SEC amended the compliance dates forSFAS 123(R), to allow companies to implement the standard at the beginning oftheir next fiscal year, instead of the next reporting period beginning after June 15,2005. SFAS No. 123R is effective for our company in the quarter ending March 31,2006. Upon adoption of SFAS 123R, companies are allowed to select one of threealternative transition methods, each of which has different financial reportingimplications. We are currently evaluating the transition methods, valuationmethodologies and other assumptions for employee stock options in light of SFASNo. 123R. Current estimates of option values using the Black-Scholesmethod may not be indicative of results from valuation methodologiesultimately implemented by our company upon adoption of SFAS No. 123R.Although we have not yet fully quantified the impact this standard will have onour financial statements, it is likely that the adoption of SFAS No. 123Rwill have a material impact on our company’s financial position and results ofoperations. Stock-based Compensation under Consolidated Financial Statementsprovides the pro forma net income and earnings per share as if the Company hadused a fair-value-based method similar to the methods required under SFAS123(R) to measure the compensation expense for employee stock awards during theyear ended December 31, 2005 and 2004.

 

In December 2004the Financial Accounting Standards Board issued two FASB Staff Positions—FSPFAS 109-1, *Application of FASBStatement 109 “Accounting for Income Taxes” to the Tax Deduction on QualifiedProduction Activities*Provided*bythe American Jobs Creation Act of 2004, and FSP FAS 109-2 Accounting andDisclosure Guidance for the Foreign Earnings Repatriation Provision within theAmerican Jobs Creation Act of 2004.* Neither of these affected theCompany as it does not participate in the related activities.

 

In December 2004,the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment ofAPB Opinion No. 29, Accounting for Nonmonetary Transactions.” Theamendments made by Statement 153 are based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. Further, the amendments eliminate the narrow exception fornonmonetary exchanges of similar productive assets and replace it with abroader exception for exchanges of nonmonetary assets that do not havecommercial substance. Previously, Opinion 29 required that the accounting foran exchange of a productive asset for a similar productive asset or anequivalent interest in the same or similar productive asset should be based onthe recorded amount of the asset relinquished. Opinion 29 provided an exceptionto its basic measurement principle (fair value) for exchanges of similarproductive assets. The Board believes that exception required that somenonmonetary exchanges, although commercially substantive, be recorded on acarryover basis. By focusing the exception on exchanges that lack commercialsubstance, the Board believes this Statement produces financial reporting thatmore faithfully represents the economics of the transactions. The Statement iseffective for nonmonetary asset exchanges occurring in fiscal periods beginningafter June 15, 2005. Earlier application is permitted for nonmonetaryasset exchanges occurring in fiscal periods beginning after the date ofissuance. The provisions of this Statement shall be applied prospectively. Wehave evaluated the impact of the adoption of SFAS 153, and do not believe theimpact will be significant to our company’s overall results of operations orfinancial position.

 

In November 2004,the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No. 43,Chapter 4. The amendments made by Statement 151 clarify that abnormal amountsof idle facility expense, freight, handling costs, and wasted materials(spoilage) should be recognized as current-period charges and require theallocation of fixed production overheads to inventory based on the normalcapacity of the production facilities. The guidance is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted for inventory costs incurred during fiscal yearsbeginning after November 23, 2004. We have evaluated the impact of theadoption of SFAS 151, and do not believe the impact will be significant to ourcompany’s overall results of operations or financial position.

 

In March 2004,the FASB approved the consensus reached on the Emerging Issues Task Force(EITF) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.” The objective of this Issue is toprovide guidance for identifying impaired investments. EITF 03-1 also providesnew disclosure requirements for investments that are deemed to be temporarilyimpaired. In September 2004, the FASB issued a FASB Staff Position (FSP)EITF 03-1-1 that delays the effective date of the measurement and recognitionguidance in EITF 03-1 until after further deliberations by the FASB. Thedisclosure requirements are effective only for annual periods ending after June 15,2004. We have evaluated the impact of the adoption of the disclosurerequirements of EITF 03-1 and do not believe the impact will be significant toour company’s overall results of operations or financial position. Once theFASB reaches a final decision on the measurement and recognition provisions, wewill evaluate the impact of the adoption of EITF 03-1.

 

In December 2003,the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin(“SAB”) No. 104, “Revenue Recognition.” SAB 104 supersedes SAB 101, “RevenueRecognition in Financial Statements.” SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superseded

 

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as a resultof the issuance of EITF 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s RevenueRecognition in Financial Statements Frequently Asked Questions and Answers (“theFAQ”) issued with SAB 101 that had been codified in SEC Topic 13, RevenueRecognition. Selected portions of the FAQ have been incorporated into SAB 104.While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21,the revenue recognition principles of SAB 101 remain largely unchanged by theissuance of SAB 104, which was effective upon issuance. The adoption of SAB 104did not impact the consolidated financial statements.

 

Other recentaccounting pronouncements issued by the FASB (including its Emerging Issues TaskForce), the AICPA and the SEC did not or are not believed by management to havea material impact on our company’s present or future consolidated financialstatements.

 

**Item 7A. Quantitative and Qualitative Disclosures AboutMarket Risks**

 

We are exposed tovarious market risks in conducting the business of the company, and weanticipate that this exposure will increase as a result of our planned growth.In an effort to mitigate losses associated with these risks, we may attimes enter into derivative financial instruments, although we have nothistorically done so. These may take the form of forward sales contracts,option contracts, foreign currency exchange contracts, and interest rate swaps.We have not, and do not intend to, engage in the practice of trading derivativesecurities for profit.

 

*InterestRates.*We are exposed to market risks relatingto changes in interest rates. Although we do not currently have any borrowingswith variable interest rates, fluctuations in interest rates may have anegative impact to any future borrowings.

 

*CommodityPrices.*We are exposed to price risk related toanticipated purchases of certain commodities used as raw materials by ourbusinesses, including titanium and zirconium. Although we do not currentlyenter into commodity future, forward, and option contracts to manage thefluctuations in prices of anticipated purchases, we may enter into suchcontacts in the future as our business grows and as our purchases of these rawmaterials increases.

 

*ForeignExchange Rates.*As a result ofour manufacturing presence in South Korea, a substantial portion of our costswill be denominated in South Korean won. Consequently, fluctuations in theexchange rates of the South Korean won to the U.S. dollar will affect our costsof goods sold and operating margins and could result in exchange losses.Although we do not currently enter into foreign exchange hedge transactions, wemay do so in the future as our business grows. Fluctuationsin exchange rates resulted in foreign currency translation gains of $0.3million, $1.7 million, and $0.2 million for the years ended December 31,2005, 2004, and 2003, respectively.

 

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**Item 8.Financial Statements and Supplementary Data**

 

The financial statements required by this itemare located in Consolidated Financial Statements in Item 15 of this report. Thesupplementary financial information required by this item is located under thecaption “QUARTERLY RESULTS” in Item 7 of this report.

 

**Item 9.Changes in and Disagreements with Accountants on Accounting and FinancialDisclosures**

 

On May 6, 2004, Deloitte & Touche LLP (“Deloitte”),the Company’s independent auditors, notified the Company that they wereresigning from the client-auditor relationship with the Company effective as ofthat date.

 

Deloitte was engaged by the Company to serve as theCompany’s independent auditors for the fiscal year ended December 31, 2003. Thereports of Deloitte with respect to the Company’s financial statements for thefiscal years ended December 31, 2002 and 2001 contained no adverse opinion ordisclaimer of opinion and were not qualified or modified as to uncertainty,audit scope or accounting principles. During the fiscal years ended December31, 2003 and 2002 and the period from December 31, 2003 through the date ofDeloitte’s resignation, there were no disagreements between the Company andDeloitte on any matter of accounting principles or practices, financialstatement disclosure, or auditing scope or procedure, which disagreements, ifnot resolved to the satisfaction of Deloitte, would have caused Deloitte tomake reference to the subject matter of the disagreements in connection withits report on the Company’s financial statements for such year.

 

The Company previously announced that it expected torestate revenues and results of operations for the third and fourth quarters of2002 and the first quarter of 2003 in connection with the Company’s sales ofalloy melting and casting equipment during such quarters to Growell Metal Co.,Ltd., a South Korea metals processing company (“Growell”). The Company’s AuditCommittee conducted an internal inquiry at the request of Deloitte into theCompany’s transactions with Growell and found that the original revenuerecognition on the Growell equipment sales did not take into account allrelevant documentation relating to the transactions. The Company announced inJanuary 2004 that it entered into a dispute settlement agreement with Growellto resolve various outstanding claims between the parties relating to theCompany’s transactions with Growell.

 

In connection with the Audit Committee’s inquiry into theGrowell equipment sales and dispute settlement, the Audit Committee alsoreviewed the facts and circumstances relating to a personal stock transactionbetween the Company’s CEO and Growell. In this transaction, as reported by theCEO, the CEO undertook a private sale of personal shares of the Company’scommon stock to Growell in February 2002, prior to the Company’s initial publicoffering. As part of the inquiry, the CEO reported that this sale included apreviously undisclosed personal agreement to ensure that the purchase price ofthe stock purchased by Growell would be at a thirty percent discount to theCompany’s initial public offering price, and he also provided informationregarding his fulfillment of this personal agreement.

 

As of May 6, 2004, certain details of the foregoingtransactions had not been resolved to Deloitte’s satisfaction. As a result ofthe expected restatements and these unresolved issues, the Company’s previouslyissued financial statements for the year ended December 31, 2002 and Deloitte’saudit report thereon, as well as the Company’s quarterly financial statementsfor the third quarter of 2002 and the first, second, and third quarters of 2003(and Deloitte’s related review reports thereon), should no longer be reliedupon.

 

Deloitte communicated to the Company that it wasunwilling to continue to rely on the representations of the Company’s CEO.Deloitte had also previously communicated to the Company that, in light of thefacts and circumstances surrounding the expected restatement, there werematerial weaknesses in the Company’s internal accounting controls relating tothe execution, administration, and accounting for contracts, particularly inthe Company’s South Korean operations. The Company has taken and is continuingto take steps to improve these internal controls.

 

Other than the foregoing, none of the reportable eventsdescribed under Item 304(a)(1)(v) of Regulation S-K occurred within the twomost recent fiscal years of the Company ended December 31, 2003 and 2002 orwithin the subsequent interim period through the date of Deloitte’sresignation.

 

The Company’s Audit Committee discussed with Deloitte thematters disclosed above regarding Deloitte’s resignation. The Companyauthorized Deloitte to respond fully to the inquiries of the Company’ssuccessor accountant concerning the matters disclosed above.

 

On May 21, 2004, the Company’s Audit Committee appointedStonefield Josephson, Inc. (“Stonefield”) as the Company’s independentauditors.   During the two fiscal yearsprior to the engagement of Stonefield and through the date of the commencementof their engagement, the Company did not consult Stonefield regarding (i) theapplication of accounting principles to a specific transaction, eithercompleted or proposed, or the type of audit opinion that may be rendered on theCompany’s financial statements, and neither a written report nor oral advicewas provided to the Company that Stonefield Josephson concluded was animportant factor considered by the Company in reaching a decision as to anyaccounting, auditing 

 

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or financial reporting issue; or (ii) any matter that waseither the subject of a “disagreement” (as defined in Item 304(a)(1)(iv) ofRegulation S-K and the related instructions thereto) or a “reportable event”(as defined in Item 304(a)(1)(v) of Regulation S-K). On November 23, 2005,Stonefield, the Company’s independent registered public accounting firm,notified the Company that Stonefield would resign as the Company’s independentregistered public accounting firm upon the completion of Stonefield’s review ofthe Company’s interim unaudited financial statements as of and for the threeand nine month periods ended September 30, 2005.  The Company’s interim unaudited financialstatements as of and for the three and nine month periods ended September 30,2005 were included in the Company’s report on Form 10-Q for the third quarterended September 30, 2005 filed with the SEC on December 1, 2005, and theCompany’s relationship with Stonefield was therefore effectively terminated asof December 1, 2005.

 

The reports of Stonefield with respect to the Company’sfinancial statements for the fiscal years ended December 31, 2003 and 2004contained no adverse opinion or disclaimer of opinion and were not qualified ormodified as to uncertainty, audit scope, or accounting principles, except foran explanatory paragraph regarding the Company’s ability to continue as a goingconcern contained in Stonefield’s report on the Company’s financial statementsand for a disclaimer of opinion made by Stonefield with respect to the Company’sinternal controls over financial reporting and the Company’s assessment ofthose controls as of December 31, 2004.

 

From May 21, 2004, the date Stonefield was appointed asthe Company’s independent auditors,  through the date of Stonefield’s resignation,there were no disagreements between the Company and Stonefield on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedure, which disagreements, if not resolved to the satisfaction ofStonefield, would have caused Stonefield to make reference to the subjectmatter of the disagreements in connection with its report on the Company’sfinancial statements for such years.

 

There were no “reportable events” as described under Item304(a)(1)(v) of Regulation S-K occurring within the two most recent fiscalyears of the Company ended December 31, 2004 and 2003 or within the subsequentinterim period through the date of Stonefield’s resignation, except as follows:

 

Stonefield has advised the Company that there arematerial weaknesses in its internal controls, mainly related to internalcontrols of its South Korean operations.  Therefore, Stonefield has expanded the scopeof its review of the interim unaudited financial statements as of and for thethree and nine month periods ended September 30, 2005.  The material deficiencies in the Company’sinternal controls over financial reporting include the following:

 

a)     Lack of adequate segregation of duties inthe Company’s South Korean operations in accounts receivable, involving cashreceipts, shipping, delivery of products, and customer invoice reconciliations;

 

b)    Lack of adequate segregation of duties inthe Company’s Coatings Division in Texas in order processing and invoicing;

 

c)     Lack of adequate controls anddocumentation in the Company’s South Korean operations to evidence propercustomer invoicing and revenue recognition in the proper period;

 

d)    Lack of progress in documenting, assessingand evaluating the Company’s internal controls in our South Korean Operationsevidenced by aforementioned deficiencies of which remediations will need to becompleted as of December 31, 2005.

 

e)     Lack of sufficient controls over internalaccess to the Company’s SAP system of reporting by unauthorized users; and

 

f)     The manual performance of numerousprocedures that could be automated using current reporting systems;

 

In connection with the foregoing, Stonefield has alsoadvised the Company that it believes that the Company has made insufficientprogress in documenting, assessing, and evaluating the Company’s internalcontrols over financial reporting for purposes of timely complying with Section404 of the Sarbanes-Oxley Act of 2002.

 

The Company’s Audit Committee has discussed with Stonefield the mattersdisclosed above regarding Stonefield’s resignation.  The Company has authorized Stonefield torespond fully to the inquiries of the Company’s successor accountant concerningthe matters disclosed above.

 

Upon Stonefield’s resignation, the Company’s Audit Committee commencedan immediate search and on January 20, 2006, hired Choi Kim & Park LLP (“CKP”)as its new registered independent public accounting firm.

 

**Item9A. Controls and Procedures**

 

Evaluation of disclosure controls and procedures.  During the courseof the re-audit of our financial statements of Liquidmetal Technologies, Inc.(the “Company”) for the fiscal years ended December 31, 2001, 2002, and 2003,it was determined that revenues from certain sales made by the Company to variouscustomers were either not recognized in the proper periods or 

 

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should not have been recognized as revenue.  It ****was also determined that compensation expenserelated to certain stock options granted in 2001 and 2002 were not calculatedin accordance with generally accepted accounting principles under APB OpinionNo. 25, SFAS No. 123, and EITF 00-23.**  **These determinations and theassociated restatement of previously issued financial statements in the Form10-K for the year ended December 31, 2003, filed on November 10, 2004, suggestthat, at the time of the subject transactions and the preparation of ourfinancial statements for the relevant periods, the Company’s disclosurecontrols and procedures (as defined in Rule 13a-15 under the SecuritiesExchange Act of 1934) were ineffective as of the end of the period covered bysuch Form 10-K.

 

Pursuant to Section 404 of the Sarbanes-OxleyAct of 2002 (“SOX 404”), the SEC has adopted rules requiring public companiesto include a report of management on the company’s internal controls overfinancial reporting in their annual reports on Form 10-K as of the Company’sfiscal year-ended December 31, 2004. SOX 404 also requires the publicaccounting firm auditing a public company’s financial statements to attest andreport on management’s assessment of the effectiveness of the company’sinternal controls over financial reporting. Although these requirements were first applicable to the Company’sannual report on Form 10-K for the fiscal year ended December 31, 2004, theCompany did not comply with these requirements for such fiscal year asdescribed in the following paragraphs. ****Therefore,****the Company’s former independent registered publicaccounting firm, Stonefield Josephson, Inc., issued a disclaimer of opinionwith respect to the Company’s internal control over financial reporting as ofDecember 31, 2004, and such disclaimer was filed with the Company’s amendedForm 10-K filed on May 10, 2005.

 

The Company carried out an evaluation underthe supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness, as of December 31, 2005, of the design and operation of theCompany’s disclosure controls and procedures pursuant to Rule 13a-15 under theSecurities Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive Officer and ChiefFinancial Officer have concluded that these disclosure controls and procedures,as of December 31, 2005, were not effective. This conclusion was based on the Company’s determination that it hadpreviously failed to properly account for the senior convertible notes issuedby the Company.  In particular, theCompany had previously failed to identify and properly account for thederivative feature of such convertible notes in accordance with applicableaccounting standards.  As a result ofthis failure, the Company restated its financial statements contained in its 2004and 2005 Form 10-Q’s and 10-K’s.

 

****Updateon Management’s Assessment of Internal Control Over Financial Reporting********.The time********and resources committed tothe restatement of prior periods’ financial statements as aforementioneddelayed management in commencing and completing its documentation, assessmentand evaluation of internal control over financial reporting.  Due to the issues described in the foregoingparagraph, as well as limitation on financial and internal resources,management’s assessment of the effectiveness of our internal control overfinancial reporting had been substantially delayed, which in turn prohibitedthe Company’s former independent registered public accounting firm, StonefieldJosephson, Inc., in performing its audit of management’s assessment of theeffectiveness of internal control over financial reporting pursuant to SOX 404as of December 31, 2004.****

 

****Thefiling of the above mentioned disclaimer does not comply with the SEC’s rulesand regulations under Section 404, and this noncompliance has resulted in theCompany being in violation of Section 13(a) under the Securities Exchange Actof 1934 Section 13(a) establishes the general requirement that public companiesmust file with the SEC, in accordance with such rules and regulations as the SECmay prescribe, such information, documents, and reports as the SEC may fromtime to time require for the protection of investors, including Form 10-Ks and10-Qs.****

 

****During2005, the Company has taken steps to comply with Section 404, including hiringindependent consulting firms, Assurance Consulting 3 in January 2005 and LoginFinancial in July 2005, to assist the Company with its Section 404 complianceand to identify and propose remedial actions to address and mitigatedeficiencies in internal controls over financial reporting.  In addition, beginning July 2005 the Companyhas devoted additional internal resources including having an executive managerlead the SOX 404 compliance effort on a full time basis.  Also, beginning August 2005, management allocateda consultant from Login Financial to our South Korean operations andre-evaluated our controls as well as implemented additional controlprocedures.  The Company’s evaluationincluded revising our documentation, re-performing walkthroughs and re-testingour internal controls.  In addition, onNovember 14, 2005 management hired an additional “Big 4” third party consultantwho is experienced in the SOX 404 effort for companies operating in South Koreato address and mitigate material deficiencies during the fourth quarter of 2005and into 2006.  Even though the Companydevoted these resources, considering the********nature of the Company’s operations having substantial presence in South Koreain addition to the Company’s US operations in Texas and California as well asthe amount of time, financial resources, complexity associated with Section 404compliance, limited financial resources of the Company and management’s latestart in identifying and documenting it’s internal controls, the Company’sauditors advised the Company and the Audit Committee of the Board of Directorsthat they believed it was highly unlikely that the Company’s management wouldbe able to finish its testing and assessment of the Company’s internal controlsin time for Stonefield to begin its testing of management’s assertions overinternal controls by the end of fiscal year 2005 in accordance with thestandards of Section 404.****

 

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****In theongoing process of making our assessment of internal control over financialreporting, management used the criteria established in “Internal Control -Integrated Framework” issued by the Committee of Sponsoring Organizations ofthe Treadway Commission (COSO). Of the various control procedures that we havedocumented, performed walkthroughs, and tested as of December 31, 2005,management has identified several control deficiencies, some of which have beendetermined to be material weaknesses in internal control over financialreporting as follows.****

 

****1.********   ********Lack of adequate segregation of dutiesin the Company’s South Korean Operations in accounts receivable involving cashreceipts, shipping, delivery of products and customer invoice reconciliations:****

 

****This deficiency resulted from the factthat the processes utilized at the Company’s Korean Operations were designed tomeet certain Korean business practices whereby invoices are created once amonth, the invoices are confirmed by the customer prior to being sent to andreceived by the customer, and payments of invoices are done only through wiretransfers.  As part of these Koreanbusiness practices,, “tax invoices” are generated by sellers of goods and areissued to customers as formal documents required by the Korean government toimmediately document and report sales for income tax purposes.****

 

****Previously, these processes were handledby the accounting and sales departments in the Korean Operations, and tomitigate the risk of fraud or error, the Company relied on the fact that allinvoices were confirmed with the customer prior to recognizing revenue, allcash receipts were received via wire transfer, and revenue accounts werereconciled by accounting on a monthly basis. Nevertheless, the Company’s formerauditor has informed the Company that these processes lacked certain formaldocumentation and segregation of duties. To remediate these weaknesses, the Company implemented the followingchanges in its Korean Operations during November 2005****

 

****•********     ********Segregationof Duties: The tax invoices are now being created by a sales accountant, anindividual who has dual duties in both Accounting and Sales in the KoreanOperations, whereas previously, tax invoices were created by the AssistantSales Manager responsible for delivery of the products to the customer.  This segregation of the tax invoicingfunction from product deliveries is an additional control procedure to mitigatethe risk of fraud or error.****

 

****•********     ********SequentialDocuments:  The Company has created aninternal, sequential invoice system tracked directly by the Company’s SAPsystem which summarizes the tax invoice created by the accounting department,delivery requisitions created by the production department, and the salestransaction report created by the sales department.  This three-way matching system is anadditional control to ensure that revenues are properly documented andreconciled at the end of each month.****

 

****•********     ********AdditionalResources:  In November 2005, the Companybegan devoting additional internal resources to the Korean accountingdepartment to segregate duties further. This included having (1) the sales accountant create all tax invoices asmentioned under “Segregation of Duties” above, (2) the Assistant Sales Managerreconcile the delivery requisitions maintained in the Production Department,and (3) the Accounting Department control vendor creation in the purchasingmodule of our SAP reporting system.  Inaddition, the Company is currently conducting a search for an accountant forthe Korean operations to further augment control procedures.****

 

****2.********    ********Lack of adequate segregation of dutiesin the Company’s Coatings Division in Texas in order processing and invoicing:****

**** ****

****The Company’s coatings business in Texas(the “Coatings Business”) is managed by two individuals, the Vice President ofCoatings and the General Accountant.  Theaccountant handles all of the “front end” processes, including purchase orders,sales orders, order fulfillment, and invoicing. To mitigate the risk of fraud or error, the Company previously relied onthe fact that the “back end” processes for all orders (such as cash receipts,vendor management, customer management, collections, and review of the resultsof operations) are all handled by the Company’s corporate office.  In addition, the Company also relied on thefact that all sales orders, inventory management, and order fulfillment arehandled through the Company’s SAP system, which provides real-time monitoringand review.****

**** ****

****Despite these measures, the Company’sformer auditor concluded that the lack of segregation of duties in the CoatingsBusiness constituted a material weakness in the Company’s internal controlsover financial reporting.  As a result,in September 2005, the Company instituted additional internal controlprocedures in its Coatings Business, including the following: (1) requiringthat all orders be supported by a written purchase order containing thecustomer’s letterhead and address, the part number and description, and thesignature of the purchaser with terms and conditions, (2) requiring that all3rd party vendor “drop shipments” be supported by shipping documents faxed ormailed to the Company by the vendor, (3) periodically performing on-site auditsof the accounting procedures at the Coating Business by the Company’s centralcorporate accounting group, the first of which has been performed in December2005 and (4) hiring an additional Accounting Manager in December 2005 in theCorporate Accounting Group to further monitor the Coatings Business and otheraccounting functions.****

 

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****3.********   ********Lack of adequate controls anddocumentation in the Company’s South Korean Operations to evidence propercustomer invoicing and revenue recognition in the proper period:****

 

****The measures taken to remedy thedeficiency described in number 1 above also served to remediate thisdeficiency.****

 

****4.********    ********Lack of progress in documenting,assessing and evaluating our internal controls in our South Korean Operationsevidenced by aforementioned deficiencies of which remediations will need to becompleted as of December 31, 2005:****

**** ****

****The Company’s overall assessment of itsinternal controls, including documentation, walkthroughs, and testwork,commenced in February of 2005. Management believes that the Company’s assessment of its controls in itsU.S. operations has been substantially completed in December 2005, although dueto limited financial resources, the Company was unable to begin its assessmentof its Korean Operations until mid-to late 2005.  The Company identified and, beginning inAugust of 2005, retained a bi-lingual consultant from Login Financial to workin the Company’s Korean Operations on a full time basis to help with the SOX404 compliance effort.  In addition, toexpedite the implementation process, the Company hired, in November 2005, anconsultant from Price Waterhouse Coopers-Korea who is familiar with SOX 404implementation for Korean companies. Nevertheless, the Company’s former auditor informed the Company thatthey believed that progress at the Korean Operations on the SOX 404 process hasnot been sufficient to enable the Company to complete the process in time forcompliance.  Although the disclosure inthis paragraph may not be characterized as a material weakness in internalcontrols per se (but instead constitutes an update on the Company’s effortsregarding SOX 404 compliance), the Company has disclosed this information basedon former auditor’s recommendation.****

 

****5.********    ********Lack of controls over internal access tothe Company’s SAP system of reporting by unauthorized users.****

**** ****

****SAP is the Company’s global enterpriseresource planning (ERP) software that handles the Company’s financial reportingon a real-time basis.  Historically,access to SAP was controlled on an ad hoc basis by the Controller and the VicePresident of Operations of the Company, and formal IT procedures for SAPadministration were lacking.  DuringSeptember 2005, the Company hired an independent IT consultant specializing inSOX implementations specifically for the Company’s global IT cycle.  The Company has substantially completed itsassessment of IT system controls, including improving the Company’s internalaccess controls to its SAP system.****

 

****6.********    ********Manual performance of numerousprocedures that could be automated using current reporting systems.****

**** ****

****Current manual procedures include (1) creating excelspreadsheet invoices to bill customers; (2) performing manual currencytranslations (“FX Translation”) for financial reporting in U.S. dollars; and(3) using a manual purchase requisition system. While these procedures may be automated through modules in the SAP system,due to the significant financial investment necessary to automate theseprocedures in SAP, the Company is not able to automate these procedures at thistime.  However, beginning in August 2005,the Company implemented control procedures to mitigate risks associated withmanual procedures including (1) requiring additional authorizations fro allpurchases, journal entries, and requisitions and (2) creating checklists formonth end, customer/vendor creation, human resource filing, and revenue supportto ensure propriety and completeness of the Company’s accounting records.****

 

****On January 16, 2006, the Company’s management completed and concludedits documentation, assessment and evaluation of its internal controls overfinancial reporting as of December 31, 2005. During the course of its assessment, management has identified thecontrol deficiencies described in the foregoing paragraphs and believes thatthese deficiencies were remediated as of December 31, 2005.  However, our independent auditors, StonefieldJosephson Inc., resigned on December 1, 2005, and on January 20, 2006, theCompany hired Choi, Kim & Park LLP (“CKP”) as its new independentregistered public accounting firm.  Whilethe Company has advised CKP of the foregoing weaknesses in internal controls,due to the untimeliness of the foregoing events, CKP was unable tosatisfactorily complete their audit of the Company’s internal control overfinancial reporting pursuant to SOX 404, and thus, have issued a disclaimer ofan opinion on the company’s internal control over financial reporting as ofDecember 31, 2005.  The Company’smanagement will continue to monitor potential changes in the legal andregulatory requirements of SOX 404, particularly the requirements for smallpublic companies.****

 

****Ingeneral, the SEC has broad authority under the Securities Exchange Act of 1934to institute investigations, to seek injunctions, to seek monetary penalties,and to otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K.  Therefore, aviolation under Section 404 could potentially subject a company to these sameinvestigations and penalties. Section 404 is a relatively new legalrequirement, and there is very little precedent establishing the consequencesor appropriate response to a public company’s failure to comply with Section404.  Accordingly, the Company cannotpredict what action, if any, the SEC may take against the Company as a resultof a failure to be compliant with its obligations under Section 404.****

 

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****Changes ininternal controls********. The Companyhas made significant changes to the internal controls over financial reportingduring 2005.  These material changes aredescribed in paragraph 2, 5, and 6 above under the caption “Update onManagement’s Assessment of Internal Control Over Financial Reporting.”  In addition, the company has previouslydisclosed as a material weakness a lack of adequate controls and monitoring ofpayroll process, as such function was outsourced to a third-party payrollprocessor that was not certified under SAS 70 (Type II).  In August 2005, the Company remediated thisweakness by retaining the services of ADP for payroll processing.  ADP is certified under SAS 70 (Type II).****

 

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****REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM****

 

Tothe Board of Directors and Shareholders of Liquidmetal Technologies, Inc.

 

Wewere engaged to audit management’s assessment included in the accompanyingManagement’s Report on Internal Control Over Financial Reporting, thatLiquidmetal Technologies, Inc. (the “Company”) maintained effective internalcontrol over financial reporting as of December 31, 2005, based on criteriaestablished in Internal Control - Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO).  Liquidmetal Technologies, Inc.’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting.

 

Amaterial weakness is a significant deficiency, or combination of significantdeficiencies, that results in more than a remote likelihood that a materialmisstatement of the annual or interim financial statements will not beprevented or detected.  Management hasnot completed its assessment of internal control over financial reporting,which has prevented us from being able to satisfactorily complete an audit ofthe Company’s internal control over financial reporting.   However, management has identified thefollowing material weaknesses during their assessment:  lack of adequate segregation of duties inaccounts receivable involving cash receipts, shipping, delivery of products,and invoice reconciliations, as well as in order processing and invoicing; lackof documentation of authorization of transactions; manual performance ofnumerous procedures that could be automated using current reporting systems;material adjustments to the accounting records and financial statements as ofand for the year ended December 31, 2005 that were not initially identified bythe Company’s internal control over financial reporting; and the Company hadinadequate controls related to timely performance of its assessment of internalcontrol over financial reporting.   Theexistence of one or more material weaknesses as of December 31, 2005 wouldpreclude a conclusion that the Company’s internal control over financialreporting was effective as of that date.  These material weaknesses were considered indetermining the nature, timing and extent of audit tests applied in our auditof the 2005 consolidated financial statements, and our disclaimer of opinionregarding the effectiveness of the Company’s internal control over financialreporting does not affect our opinion on those consolidated financialstatements.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Managementhas represented to us that they have completed their assessment of theirinternal control over financial reporting as of December 31, 2005, and we haveperformed a preliminary review of their assessment by reviewing the Company’sdocumentation of their internal control assessment and performing a limitedobservation of internal controls.  However, due to the timing of our engagement,we were unable to satisfactorily complete an audit of their internal controlover financial reporting, we were unable to apply other procedures to satisfyourselves as to the effectiveness of the Company’s internal control overfinancial reporting, and we were unable to conclude whether management’sassessment is fairly stated.  Therefore,the scope of our work was not sufficient to enable us to express, and we do notexpress, an opinion either on management’s assessment or on the effectivenessof the company’s internal control over financial reporting.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements of Liquidmetal Technologies, Inc. and our report dated February 23,2006 expressed an unqualified opinion including an explanatory paragraph on theCompany’s ability to continue as a going concern.

 

 

Choi,Kim & Park, LLP

 
| /s/  Choi, Kim & Park, LLP |   |
|--------------------------------|--------|

LosAngeles, California

CertifiedPublic Accountants

 

February23, 2006

 

57

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****Item 9B. Other Information****

**** ****

****None.****

**** ****

****58****

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**** ****

**PART III**

 

**Item 10.Directors and Executive Officers of the Registrant**

 

Set forth below is a table identifying our directors and executiveofficers as of December 31, 2005:

 
| **Name**               | ** ** | **Age** | ** ** | **Position**                                          |
|------------------------|------------|---------|------------|-------------------------------------------------------|
|                   |       |    |       |                                                  |
| John Kang              |       | 42      |       | Chairman of the Board                                 |
|                   |       |    |       |                                                  |
| Ricardo Salas          |       | 41      |       | President & Chief Executive Officer, and Director |
|                   |       |    |       |                                                  |
| James Kang             |       | 45      |       | Director and Founder                                  |
|                   |       |    |       |                                                  |
| William Johnson, Ph.D. |       | 56      |       | Director                                              |
|                   |       |    |       |                                                  |
| Dean Tanella           |       | 45      |       | Director (Audit Committee Chairman)                   |
|                   |       |    |       |                                                  |
| Robert Biehl           |       | 61      |       | Director                                              |
|                   |       |    |       |                                                  |
| CK Cho                 |       | 50      |       | Director                                              |
|                   |       |    |       |                                                  |
| Young Ham              |       | 36      |       | Chief Financial Officer                               |

 

*John Kang* was re-elected as Chairman of ourBoard of Directors in August 2003.   Mr.Kang**has been a director of ourCompany since 1994.  From December 1994to June 2001, he served as Chairman of our Board of Directors in variouscapacities.  From June 2001 until December30, 2005, Mr. Kang had served variously as our Chief Executive Officer andPresident.  From July 1996 to September2000, Mr. Kang served variously as Chief Executive Officer, President, and adirector of Medical Manager Corporation, a public company traded on the NasdaqNational Market until its sale in September 2000 to WebMD Corporation. From1988 to 1995, he was Chairman of the board of directors of Clayton Group, Inc.,a private company engaged in the distribution of waterworks equipment.  Mr. Kang received a B.A. degree in Economicsfrom Harvard College in 1985. Mr. Kang is the brother of James Kang, one of ourdirectors. On December 15, 2005, an indictment naming as defendants ten formerofficers and directs of Medical Manager Corporation, including Mr. Kang, wasfiled in the United States District Court for the District of South Carolina(Beaufort Division). The indictment includes counts for conspiracy, conspiracyto launder money instruments, and money laundering relating to a series ofacquisitions that were made by Medical Manager during the years the years 1996through 2003, the accounting practices of Medical Manager during that timeframe, and the filing of various financial statements during that timeframe.  The indictment is unrelated toMr. Kang’s service as a director and officer of our company.  Mr. Kang resigned as our President and ChiefExecutive Officer on December 30, 2005, although he continues to serves asChairman of the Board of our company and continues to work for our company on afull-time basis.

 

*Ricardo Salas* was elected as a director by the Boardof Directors on December 30, 2005 to fill the vacancy created by Mr. Addonisio’sresignation. Also on December 30, 2005, Mr. Salas was elected as President andChief Executive Officer of the Company. Mr. Salas previously served as a Boardmember of the Company from April 1995 to May 2003. From January 2000 throughJune 2005, Mr. Salas served as Chief Executive Officer of iLIANT Corporation,an information technology and outsourcing service firm in the health careindustry, and he continues to serve as Chairman of iLIANT. From 1987 through2004, he was Vice President of J. Holdsworth Capital Ltd., a private investmentfirm. As an officer of J. Holdsworth Capital Ltd., Mr. Salas held positions invarious investments including Medical Manager Corporation as a vice presidentbetween June 1999 and January 2000, National Medical Systems, Inc. as vicepresident between April 1994 and February 1997, and Uni Flange Corporation asvice president between June 1989 and June 1994. He currently serves as adirector of VillageEDOCS, a provider of business information delivery servicesand products. Mr. Salas received a B.A. degree in Economics from HarvardCollege in 1986.

 

*James Kang*has served as a director sinceDecember 1994 and as executive Founder of our company since August 2003.  From December 1994 to June 2001, he servedvariously as our Chief Executive Officer, President, and Chairman.  Mr. Kang received a B.A. degree in Marketingfrom the University of Illinois in 1983, and an M.B.A. degree from the KelloggSchool of Management at Northwestern University in 1985.  Mr. Kang is the brother of John Kang, ourChairman of the Board of Directors, who was also our Chief Executive Officerand President during 2004.

 

*William Johnson, Ph.D*.*,*hasserved as a director since June 2000. From October 2001 to September 2003, he was employed as our executiveVice Chairman of Technology.  Since 1997,Professor Johnson has been the Mettler Professor of 

 

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Engineering and Applied Physics at Caltech.  He held a Visiting Professor appointment atthe Metal Physics Institute in Gottingen, Germany (1983) and received a VonHumbolt Distinguished Scientist Fellowship in Gottingen (1988).  He is the 1995 recipient of the TMS/AIME HumeRothery Award for his experimental work. He received a B.A. degree in Physics from Hamilton College and a Ph.D.degree in Applied Physics from Caltech. He spent two years at IBM’s Research Center (1975-1977).  At Caltech, Professor Johnson directed theresearch that led to the discovery of our bulk Liquidmetal alloy.  Professor Johnson is currently a consultantto the Company.

 

*Dean Tanella* waselected as a director in February 2004. Mr. Tanella is a 20-year veteran of the institutional investmentbusiness and has worked for such leading firms as Raymond James &Associates, CS First Boston Corp., Adams Harkness & Hill, Drexel BurnhamLanbert, Inc., Kidder Peabody & Co. and the Vanguard Group.  Since 1999, Mr. Tanella has served asPresident of Safe Harbor Capital, LLC and, since 2003, as President ofHarborLight Capital, LLC, both of which are private investment firms.  Mr. Tanella received his bachelors degreefrom Princeton University and his MBA from the Harvard Graduate School ofBusiness Administration.  In December2004, Mr. Tanella was also named Executive Vice President – Capital MarketsGroup and a member of the Board of Directors at GunnAllen Financial Inc., aleading independent brokerage firm headquartered in Tampa, Florida.

 

*Robert Biehl* hasserved as a director since January 2005. Mr. Biehl founded the Masterplanning Group International and asPresident, personally consulted over 400 clients and mentored over 2,500executives and world leaders.  Prior tostarting Masterplanning Group, Mr. Biehl was an executive staff of World VisionInternational where he designed and developed the Love Loaf Program, which hasraised millions of dollars worldwide.  Hehas also published many books in the area of personal and organizationaldevelopment.  Mr. Biehl received his B.A.degree in psychology and a Masters Degree in Counseling from Michigan StateUniversity.

 

*CK Cho* was electedas a director in January 2005.  Mr. Chohas over 18 years of experience with Samsung Electronics and managed over $700million annual procurement budget responsible for semi-conductor andtelecommunication equipment and other electronic components.  He also served as CEO and President ofWinvest Venture Partners Inc. and is currently serving as President and CEO ofATIC, an IT Venture Capital Company based in Korea.  Mr. Cho received his bachelors degreemajoring in Business Administration and Material Sciences from the KoreaUniversity of Seoul.

 

*Young Ham* has been our Chief Financial Officer since April 2005, prior to which heserved as the CFO of the Asian operation in 2004.  Prior to joining Liquidmetal, he served asPresident and Chief Consultant of Dime Financial Advisory based in Seoul, Koreafrom November 1999 through July 2003.  Inaddition, Mr. Ham was a founding partner for Hanmi Accounting Corporation inSouth Korea since July 2003 where he provided accounting and consultingservices to multi-national corporations. Mr. Ham was also the Chief Internal Auditor and Financial Advisor toAnswer International Asia Inc. and Director of Dongyang Economy ResearchInstitute.  Financial advisory andmanagement consulting clients have included, Nextel Co., Ltd, KoreaMasterbuilders, Korea Spoland Co., Ltd.. Tax and legal service clients range from Hyundai Merchant Marine to theKorea National Oil Company. An M.B.A. graduate student of Seoul NationalUniversity in 1994, Young Ham is a CPA in both the United States and Seoul,South Korea.

 

**Change in Principal FinancialOfficer**

 

On April 15, 2005, Tony Chung resigned as our VicePresident of Finance and ceased to be our principal financial officer.  On the same day, our board elected Young Hamto serve as our Chief Financial Officer and become our company’s principalfinancial officer.  Mr. Chung continuesto serve our company as Vice President of Legal and Administration.  Additional information regarding Mr. Ham isset forth above in this Item 10.

 

###### **BOARD OF DIRECTORS**

 

**Terms of Directors**

 

**Ourboard of directors is divided into three classes (designated “CLASS I,” “CLASSII,” and “CLASS III”), as nearly equal in number as possible, with each classserving three-year terms expiring at the third annual meeting of stockholdersafter their elections or until their respective successors have been electedand qualified.  CLASS I currently consistof the following directors whose term is scheduled to expire at the 2005 annualmeeting of stockholders: John Kang, William Johnson, and Robert Biehl.  CLASS II currently consists of the followingdirectors whose term is scheduled to expire at the 2006 annual meeting ofstockholders:  Dean Tanella and CKCho.  CLASS III currently consists of thefollowing directors whose term will expire at the 2007 annual meeting ofstockholders:  James Kang and Rick Salas.**

** **

**Audit Committee**

 

Our board of directors has an Audit Committee that is currently comprisedof Mr. Tanella, who has assumed the role of Audit Committee Chairman since Mr.Addonisio’s resignation, and Mr. Biehl.  The Audit Committee is responsible forreviewing the 

 

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independence, qualifications, and activities of our independent certifiedaccountants and our financial policies, control procedures, and accountingstaff.  The Audit Committee is alsoresponsible for the review of transactions between us and any officer,director, or entity in which an officer or director of our company has amaterial interest.  Our board ofdirectors has determined that Mr. Tanella qualifies as “audit committeefinancial expert” as defined by the regulations of the Securities and ExchangeCommission.   In addition, our board ofdirectors has determined that Mr. Tanella is an “independent” director withinthe meaning of Rule 10A-3(b)(i) under the Securities Exchange Act of 1934.  The Audit Committee is governed by a writtencharter approved by the board of directors.

 

**CompensationCommittee**

 

The Compensation Committee is comprised of Mr. Cho and Mr. Biehl. All ofthe members of the Compensation Committee are “independent directors,” asdefined by the rules applicable to members of the Compensation Committee. TheCompensation Committee is responsible for establishing the compensation of oursenior management, including salaries, bonuses, termination arrangements, andother executive officer benefits. The Compensation Committee also administersour equity incentive plans.

 

**Corporate Governance and Nominating Committee**

 

A Corporate Governance and Nominating Committee (“the Committee”) wasformed on February 18, 2003, and is comprised of Mr. Tanella and Mr. Biehl.  All members of the Committee are “independentdirectors,” as defined by the rules applicable to members of the Committee. TheCommittee is generally responsible for adopting policies, procedures, andpractices designed to help ensure that our corporate governance policies,procedures, and practices continue to assist the board and our management ineffectively and efficiently promoting the best interests of our stockholders.The Committee is also responsible for selecting and recommending for approvalby the Board and the Company’s stockholders a slate of director nominees forelection at each of the Company’s annual meetings of stockholders, andotherwise for determining the Board committee members and chairmen, subject toBoard ratification, as well as recommending to the Board director nominees tofill vacancies or new positions on the Board or its committees that may occuror be created from time to time, all in accordance with the Company’s Bylawsand applicable law.

 

The Corporate Governance Committee’s principal functions include:

 
| •     |       | developing and maintaining our corporate governance policy  guidelines;                                                                                                                                                                                                                      |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                         |
| •     |       | developing and maintaining our codes of conduct and ethics;                                                                                                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                         |
| •     |       | overseeing the interpretation and enforcement of our Code of Conduct  and our Code of Ethics for Chief Executive Officer and Senior Financial and  Accounting Officers; and                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                         |
| •     |       | evaluating the performance of our board, its committees, and  committee chairmen and our directors.                                                                                                                                                                                          |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                   |
| •     |       | selecting and recommending a slate of director nominees for election  at each of the Company’s annual meeting of the shareholders and recommending  to the Board director nominees to fill vacancies or new positions on the  Board or its committees that may occur from time to time. |

 

**Code of Ethics**

 

Our board of directors has adopted a Code of Ethics that is applicable toits principal executive officer, principal financial officer, principalaccounting officer or controller, and persons performing similarfunctions.  The Code of Ethics isattached as Exhibit 14 to our Annual Report on Form 10-K filed on November 10,2004.  In addition, we intend to promptlydisclose (1) the nature of any amendment to our Code that applies to ourprincipal executive officer, principal financial officer, principal accountingofficer or controller, or persons performing similar functions and (2) thenature of any waiver, including an implicit waiver, from a provision of ourCode that is granted to one of these specified officers, the name of suchperson who is granted the waiver and the date of the waiver on our website inthe future. You may also request a copy of the Code by sending the request toinformation@liquidmetal.com.

 

###### **BENEFICIALOWNERSHIP REPORTING REQUIREMENTS**

 

During the years ended December 31, 2004 and2005, our executive officers and directors filed with the Securities andExchange Commission on a timely basis all required reports relating totransactions involving shares of our common stock beneficially owned by them,except that John Kang, Chairman, disposed of 188,700 shares during variousdates in 2004 and 207,520 during various dates in 2005 as gifts to variousindividuals and organizations and James Kang, Director and Founder, disposed of67,320 shares on January 5, 2004 and 200,000 shares on November 23, 2005 asgifts to various individuals and organization. These disposals were reported inJohn Kang’s Form 5 filed of February 17, 2005 and February 14, 2006 and JamesKang’s Form 4 filed on January 28, 2005 and Form 5 filed on February 17, 2006.

 

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**Item 11.Executive Compensation**

 

The following table sets forth certain informationregarding compensation paid by us for each of our last three years to our ChiefExecutive Officer and each of our other executive officers as of December 31,2005 (collectively, the “named executive officers”).

 
| ** **              | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Long-Term  Compensation** | ** ** | ** **                      | ** ** |
|-------------------------|------------|------------|------------|-------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **Name  and Positions** | ** ** | **Year**   | ** ** | **Salary**              | ** ** | **Bonus**                   | ** ** | **Other  Annual  Compensation** | ** ** | **Shares  Underlying  Options  Granted** | ** ** | **All Other  Compensation** | ** ** |
| John Kang (1)           |       | 2005       |       | $                       | 200,005    |                        | —     |                            | —     |   | 50,000 |   | — |   |
| Chairman of the Board   |       | 2004       |       | $                       | 208,586    |                        | —     |                            | —     |   | — |   | — |   |
|                    |       | 2003       |       | $                       | 300,007    |                        | —     |                            | —     |   | — |   | — |   |
|                    |       |       |       |                    |       |                        |       |                            |       |   |   |   |   |
| Ricardo Salas (2)       |       | 2005       |       | —                  |       | —                      |       | —                          |       | — |   | — |   |
| Chief Executive Officer |       | 2004       |       | —                  |       | —                      |       | —                          |       | — |   | — |   |
| and President           |       | 2003       |       | —                  |       | —                      |       | —                          |       | — |   | — |   |
|                    |       |       |       |                    |       |                        |       |                            |       |   |   |   |   |
| James Kang (3)          |       | 2005       |       | $                       | 300,008    |                        | —     |                            | —     |   | — |   | — |   |
| Founder and Director    |       | 2004       |       | $                       | 300,004    |                        | —     |                            | —     |   | — |   | — |   |
|                    |       | 2003       |       | $                       | 280,011    |                        | —     |                            | —     |   | 2,877,420 |   | — |   |
|                    |       |       |       |                    |       |                        |       |                            |       |   |   |   |   |
| Young Ham (4)           |       | 2005       |       | $                       | 150,000    |                        | —     |                            | —     |   | 87,500 |   | — |   |
| Chief Financial Officer |       | 2004       |       | $                       | 64,052     |                        | —     |                            | —     |   | 50,000 |   | — |   |
|                    |       | 2003       |       | —                  |       | —                      |       | —                          |       | — |   | — |   |

 

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| **(1)** | ** ** | **As of  August 22, 2003, John Kang was named Chairman of our board of directors. Mr. Kang  resigned from his position as President and Chief Executive Officer of our  company on December 30, 2005.  However,  he will continue to serve as Chairman of the board and will continue to work  for the Company on a full-time basis.** |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **(2)** | ** ** | **On  December 30, 2005, Ricardo Salas was named Chief Executive Officer and  President of the Company.  Previously  during 2005, Mr. Salas served as a consultant, and has accrued $20,000 in  unpaid service fees as of December 31, 2005.**                                                                                         |
| **(3)** | ** ** | **As of  August 22, 2003, James Kang became the executive Founder of the Company and  ceased to be the Chairman of our board of directors.**                                                                                                                                                                                                |
| (4)     |       | On April 15, 2005, Young Ham became the Chief Financial Officer of the  Company.  Previously during 2005 and  2004, Mr. Ham Served as the Chief Financial Officer at Liquidmetal Korea.                                                                                                                                                |

 

 

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The following table sets forth information with respect tothe aggregate stock option exercises by the executive officers named in theSummary Compensation Table during 2005 and the year-end value of unexercisedoptions held by such executive officers.

 

**Aggregate Option Exercises inLast Year and Year-End Values**

 
| ** **    | ** ** | **Shares  Acquired on** | ** ** | **Value**        | ** ** | **Number of Unexercised  Options at Year End** | ** ** | **Value of Unexercised  In-The-Money Options   at Year End (2)** | ** ** |
|---------------|------------|-------------------------|------------|------------------|------------|------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **    | ** ** | **Exercise**            | ** ** | **Realized (1)** | ** ** | **Exercisable**                                | ** ** | **Unexercisable**                                                | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
|          |       |                    |       |             |       |                                           |       |                                                             |       |   |   |   |   |
| John Kang     |       | —                  |       | —           |       | 1,622,904                                      |       | 40,000                                                           |       | — |   | — |   |
|          |       |                    |       |             |       |                                           |       |                                                             |       |   |   |   |   |
| Ricardo Salas |       | —                  |       | —           |       | —                                         |       | —                                                           |       | — |   | — |   |
|          |       |                    |       |             |       |                                           |       |                                                             |       |   |   |   |   |
| James Kang    |       | —                  |       | —           |       | 2,861,291                                      |       | 16,129                                                           |       | — |   | — |   |
|          |       |                    |       |             |       |                                           |       |                                                             |       |   |   |   |   |
| Young Ham     |       | —                  |       | —           |       | 17,500                                         |       | 120,000                                                          |       | — |   | — |   |

 

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**(1)**   Represents the differencebetween the fair market value of the underlying shares at the time of exerciseand the exercise price of the options exercised.

** **

**(2)**   Based upon a value of $0.88per share as of December 31, 2005.

** **

**EMPLOYMENT AGREEMENTS**

 

We have entered into employment agreements with the executive officersidentified in Item 11 above, as follows:

 

We have entered into the following employment agreements with theexecutive officers identified above. Ricardo Salas, who was elected as ourPresident and Chief Executive Officer on December 30, 2005, will receive aninitial base salary of $250,000 for serving as President and Chief ExecutiveOfficer of our company. We and Mr. Salas have not yet entered into anemployment agreement relating to Mr. Salas’ employment with us, but we maydetermine to do so in the future.

 

*John Kang.* On December 31, 2000, we entered into an employment agreement with JohnKang that, as amended, provides for his employment as our Chief ExecutiveOfficer and President, and on August 22, 2003, Mr. Kang was named Chairman ofour Board of Directors. On December 30, 2005, Mr. Kang ceased to serve as ourPresident and Chief Executive Officer, and Mr. Kang’s employment agreement hasan expiration date of December 31, 2005, although the agreement automaticallyrenews on a year-to-year basis until Mr. Kang resigns or his employment isterminated by us with or without cause. Mr. Kang receives an annual base salaryequal to $200,000 per year, and his employment will terminate upon the earlierof his death, resignation, disability, or termination by the board of directorsfor any reason. If we terminate Mr. Kang’s employment without cause, or if Mr.Kang terminates his own employment upon a change of control of our company orfor other good reason, as defined in the agreement, we are responsible forpaying Mr. Kang a lump-sum cash payment equal to 200% of Mr. Kang’s annual basesalary plus the average cash bonus during the two full fiscal years immediatelypreceding the termination. Pursuant to the agreement, Mr. Kang was issuedoptions to purchase 1,612,904 shares of our common stock at an exercise priceof $4.65 per share. The options expire on December 31, 2010 and vestedimmediately upon grant. In addition, Mr. Kang is prohibited, during hisemployment with us and for one year after he is no longer employed by us, fromsoliciting any of our employees or competing with us in any manner. Starting inMay 2003, Mr. Kang and other members of senior management took a 10% voluntarydecrease in their base salary and returned to full salary in June 2004.

 

*James Kang.** ***On May 1,2001, we entered into an employment agreement with James Kang that, as amended,provides for his employment as the named executive Founder of our company.  Mr. Kang’s employment agreement expires onMay 1, 2006.  Mr. Kang receives an annualbase salary equal to $300,000 per year, and his employment will terminate uponthe earlier of his death, resignation, disability, or termination by the boardof directors for any reason.  If weterminate Mr. Kang’s employment without cause, or if Mr. Kang terminates hisown employment upon a change of control of our company or for other goodreason, as defined in the agreement, we are responsible for paying Mr. Kang aseverance benefit equal to a lump-sum cash payment equal to 200% of Mr. Kang’sannual base salary plus the average cash bonus during the two full fiscal yearsimmediately preceding the termination. Pursuant to the agreement, Mr. Kang was issued options to purchase2,580,646 shares of our common stock at an exercise price of $6.20 pershare.  The options expire on April 30,2011 and vest at a rate of 33% per year for three years, with the first 33%vesting on May 21, 2002 and an additional 33% on May 21, 2003 and 2004.  In addition, Mr. Kang is prohibited, duringhis employment with us and for two years after he is 

 

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no longer employed by us, from soliciting any of our employees orcustomers.  Starting in May 2003, Mr.Kang and other members of senior management took a 10% voluntary decrease intheir base salary and returned to full salary in June 2004.

 

*Young Ham.*  On April 15, 2005, we entered into anemployment agreement with Young Ham, which provides for his employment as thenamed Chief Financial Officer.  Mr. Ham’semployment agreement expires April 15, 2008, and his term may continuesubsequent to the expiration date on a month-to-month basis at the samesalary.  His annual salary is $150,000,and he received 50,000 stock options as part of the employment agreement.

 

###### **REPORT ON EXECUTIVECOMPENSATION**

 

**General**

 

The Compensation Committee of our Board of Directors wasestablished in 2002 and currently consists of CK Cho and Robert Biehl.  The Compensation Committee is comprisedentirely of non-employee directors and is responsible for establishing thecompensation of our senior management, including salaries, bonuses, terminationarrangements, and other executive officer benefits.  The Compensation Committee also administersour equity incentive plans.  TheCompensation Committee also annually reviews and approves the compensation ofRicardo Salas, our Chief Executive Officer and President.

 

**Compensation Philosophy**

 

**TheCompensation Committee’s goal is to establish and maintain compensationpolicies that will enable us to attract, motivate, and retain high-qualityexecutives and to ensure that their individual interests are aligned with ourlong-term interests and our stockholders. The committee places heavy emphasis on paying for performance andbelieves that a significant portion of an executive’s total compensationopportunity should be at risk and tied to company performance.  Our compensation package consists of threeprincipal components:**

 

•      Basesalaries, subject to minimums set forth in individual employment agreements;

 

•      Annualincentive bonus eligibility; and

 

•      Stockoption grants and other forms of equity-based compensation.

 

**Base Salary***. *Base salary is thelargest portion of the cash compensation package received by each of ourexecutive officers.  The base salary ofeach of our executive officers is governed by employment agreements that wereentered into during 2000 through 2005. Subject to the minimum amounts set forthin their respective employment agreements, we generally establish the basesalary of each executive officer based, among other factors, on theCompensation Committee’s assessment of that executive officer’s position,responsibilities, experience, and performance. Our philosophy is to pay base salaries sufficient to attract and retainhighly qualified executives.  Anexecutive officer’s level of responsibility is the primary factor used indetermining base salary.  Individualperformance also is considered in determining any salary adjustment.

 

The Compensation Committee reviews and approves allexecutive officer salary adjustments as recommended by the Chief ExecutiveOfficer and determines whether to increase the base salary above the amount setforth in their employment agreements. The Compensation Committee reviews annually the performance of the ChiefExecutive Officer and establishes his base salary, subject to the minimum$250,000 annual base salary.   In 2005and 2004, the Compensation Committee did not increase the base salary of any ofthe executive officers.

 

**AnnualBonus***. *Our executive officers areeligible for an annual cash bonus under our Performance Bonus Plan.

The plan is designed to:

 

•      puta significant portion of an executive officer’s total cash compensationopportunity at risk based on the performance of the Company;

 

•      bealigned with our mission, values and culture;

 

•      becost-effective and appropriately budgeted to allow for growth of our revenue aswell as growth of individual compensation plans;

 

•      be externallycompetitive by matching or leading competitors; and

 

•      be internallyequitable through alignment with level of contribution, performance-basedrewards, and administrative capabilities.

 

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Awards of incentive bonuses generally are based onachieving corporate goals and a subjective evaluation of the contributions ofindividual executives toward the achievement of our business goals.  Eligibility for the bonus will be contingentupon the Company meeting or exceeding company-wide financial goals andsuccessful attainment of individual goals for the position.  Both elements must be successfully met inorder to be eligible for the bonus.  Noneof our executive officers received bonuses for 2004 and 2005 because thecompany-wide financial goals were not satisfied.

 

**Equity-Based Compensation***.*

** **

**Ourequity-based awards to our executive officers consist principally of stockoptions granted from time to time under our 2002 Equity Incentive Plan and our1996 Stock Option Plan.  Stock optiongrants are based on various factors, including the executive officer’sposition, responsibility and tenure, each executive officer’s ability to contributeto our future success, and the other elements of such executive officer’scompensation. Generally, we use equity-based compensation to better align theinterests of our executive officers with those of our stockholders.  For 2005, the Compensation Committee approvedawards of options to executive officers and certain members of seniormanagement, with the sizes of the awards determined with reference to the scopeof the position and the employees’ relative contributions to the Company.  In addition, three of our executive officers,John Kang, our Chairman of the Board, James Kang, our executive Founder, andWilliam Johnson, our Director, own a significant amount of our common stock.**

 

**CEO Compensation**

 

Ricardo Salas, who was elected as our President and ChiefExecutive Officer on December 30, 2005, will receive an initial base salary of$250,000 for serving as President and Chief Executive Officer of our company.Mr. Salas did not receive any salary or stock options as our President andChief Executive Officer during 2005.

 

Prior to John Kang’s resignation as our President and Chief ExecutiveOfficer on December 30, 2005, Mr. Kang’s base salary was $200,000.  Mr. Kang’s compensation reflects his statusas a significant stockholder of the Company. Accordingly, his base salary is lower than the base salary of CEOs ofcomparable companies.  Mr. Kangvoluntarily waived his base salary from January 2004 through May 2004 insupport of the Company’s strategic cash objectives.  In June 2004, Mr. Kang returned to his basesalary of $200,000 and received his differential retroactive pay in equalinstallments over the remaining months of 2004. As a significant stockholder in the Company, his overall compensation istied directly to sustained increases in the Company’s value. During 2005, Mr.Kang participated in a voluntary salary deferral plan, which resulted in 50%deferral of his base salary from January through June 2005, which was appliedto his Section 16(b) liability from 2002 stock transactions with Growell MetalCo., Ltd.  In June 2005, Mr. Kangreturned to his base salary of $200,000.

 

No bonus payments were made to Mr. Kang for 2004 and 2005because the Compensation Committee determined not to pay any bonuses to any ofour executive officers due to the Company missing its financial goals.  During 2005, Mr. Kang was granted 50,000 shares of stock options.  No options were granted to Mr. Kang in 2004.As of December 31, 2005, Mr. Kang held options and warrants to purchase1,985,485 shares of our common stock, of which 1,945,485 were fully vested.

 

**TheInternal Revenue Code imposes a limitation on the deduction under Section162(m) for certain executive officers’ compensation unless certain requirementsare met. Our policy is to have all compensation fully deductible; however, wereserve the right to pay compensation that is not deductible if it is in ourbest interests.**

 

Compensation Committee of the Board of Directors

 

CK Cho

Robert Biehl

 

December 31, 2005

 

**Thereport of the Compensation Committee shall not be deemed incorporated byreference by any general statement incorporating by reference this AnnualReport on Form 10-K into any filing under the Securities Act of 1933 or underthe Securities Exchange Act of 1934, except to the extent that we specificallyincorporate this information by reference, and shall not otherwise be deemedfiled under such acts.**

** **

**65**

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** **

**DIRECTOR COMPENSATION**

 

Our non-employee directors receive an annual fee of $10,000for their service to our board and are reimbursed for expenses incurred inattending board and committee meetings. Non-employee directors are also entitled to receive a $10,000 annualcash stipend for each standing board committee (excluding the Audit Committee)on which the director serves.  For AuditCommittee service, the Audit Committee chairman is entitled to a $35,000 annualstipend, and the other members of the Audit Committee are entitled to a $27,500annual stipend.  In addition to theannual stipends, each non-employee director is entitled to receive aper-meeting fee of $1,000 for each meeting of the board of directors or anyboard committee attended in person. Effective December 30, 2005, Dean Tanella was elected as the leadindependent director of the Company.  Thelead independent director is entitled to a $30,000 annual stipend.

 

We also have a 2002 Non-employee Director Stock Option Plan pursuant towhich our non-employee directors are entitled to receive stock options.  Under this plan, when a director is firstelected or appointed to our board of directors, the non-employee director isentitled to receive an initial stock option grant to purchase 50,000 shares ofour common stock.  Thereafter, on thefirst business day of January of each year in which the director continues toserve as a member of our board, the director is entitled to an annual stockoption grant to purchase 10,000 shares of our common stock.  All options granted under the plan have anexercise price equal to the fair market value of our common stock on the dateof the grant.  These stock options have a10-year term, vest, and are exercisable pursuant to an equal 5-year vestingschedule, and remain exercisable for certain periods of time after a person isno longer a director.

 

No director who is an employee will receive separatecompensation for services rendered as a director.  However, our employee directors are eligibleto participate in our 2002 Equity Incentive Plan

 

**Item 12.Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

The following table sets forth certain information regarding thebeneficial ownership of our common stock as of January 13, 2006 by:

 

each person known by usto be a beneficial owner of more than 5.0% of our outstanding common stock; 

 

each of our directors;

 

each of our namedexecutive officers; and

 

all directors andexecutive officers as a group.

 

**Theamounts and percentage of common stock beneficially owned are reported on thebasis of the regulations of the SEC governing the determination of beneficialownership of securities. Under the rules of the SEC, a person is deemed to be a“beneficial owner” of a security if that person has or shares “voting power,”which includes the power to vote or to direct the voting of such security, or “investmentpower,” which includes the power to dispose of or to direct the disposition ofsuch security. A person is also deemed to be a beneficial owner of anysecurities of which that person has a right to acquire beneficial ownership within60 days. Under these rules, more than one person may be deemed a beneficialowner of the same securities and a person may be deemed a beneficial owner ofsecurities as to which he has no economic interest. The number of shares ofcommon stock outstanding used in calculating the percentage for each listedperson includes the shares of common stock underlying options or warrants heldby such person that are, or within 60 days after January 13, 2006, exercisable,but excludes shares of common stock underlying options or warrants held by anyother person (whether or not exercisable within 60 days).  The percentage of common stock beneficiallyowned is based on 42,246,621 shares of common stock outstanding on January 13,2006.**

 

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| **Name of Beneficial Owner**                                                        | ** ** | **Shares** | ** ** | **Percent of Class** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|
| ** **                                                                          | ** ** | ** ** | ** ** | ** **           | ** ** |
| **5% Stockholders**                                                                 | ** ** | ** ** | ** ** | ** **           | ** ** |
|                                                                                | ** ** | ** ** | ** ** | ** **           | ** ** |
| Tjoa Thian Song(7)   16 Raffles Quay #B1-14A   Hong Leong Building   Singapore 0101 |       | 4,008,523  |       | 10                   | %          |
|                                                                                |       |       |       |                 |       |
| Jack Chitayat(10)   1133 Park Avenue, Suite 1W   New York, NY 10128                 |       | 2,544,289  |       | 6                    | %          |
|                                                                                |       |       |       |                 |       |
| **Directors  and Named Executive Officers**                                         | ** ** | ** ** | ** ** | ** **           | ** ** |
|                                                                                |       |       |       |                 |       |
| Ricardo A. Salas(9)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630   |       | 1,221,812  |       | 3                    | %          |
|                                                                                |       |       |       |                 |       |
| John Kang(1)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630          |       | 5,104,973  |       | 12                   | %          |
|                                                                                |       |       |       |                 |       |
| James Kang(2)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630         |       | 6,066,033  |       | 14                   | %          |
|                                                                                |       |       |       |                 |       |
| William Johnson(3)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630    |       | 1,207,650  |       | 3                    | %          |
|                                                                                |       |       |       |                 |       |
| Dean Tanella(4)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630       |       | 38,120     |       |                 | *          |
|                                                                                |       |       |       |                 |       |
| Bobb Biehl(5)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630         |       | 37,929     |       |                 | *          |
|                                                                                |       |       |       |                 |       |
| CK Cho(6)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630             |       | 287,686    |       |                 | *          |
|                                                                                |       |       |       |                 |       |
| Young Ham(8)   25800 Commercentre Drive, Suite 100   Lake Forest, CA 92630          |       | 17,500     |       |                 | *          |
|                                                                                |       |       |       |                 |       |
| All directors and executive officers as a  group (8 persons)                        |       | 13,981,703 |       | 33                   | %          |

 

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*  Less than one percent.

 

(1)           Asof August 22, 2003, John Kang was named Chairman of our board of directors. Mr.Kang resigned from his position as President and Chief Executive Officer of ourcompany on December 30, 2005.  However,he will continue to serve as Chairman of the board and will continue to workfor the Company on a full-time basis.** **The beneficial shares include:

 

(a)           1,622,904shares that are issuable pursuant to outstanding stock options that areexercisable currently or within 60 days of January 13, 2006.  Does not include 40,000 shares that areissuable pursuant to outstanding stock options that are not exercisable within60 days; and

 

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(b)           132,400shares held by Mr. Kang’s minor children.

 

(2)           Includes2,861,291 shares issuable pursuant to outstanding stock options that areexercisable currently or within 60 days of January 13, 2006.  Also includes 969 shares held by James Kang’sminor children. Does not include 16,129 shares issuable pursuant to outstandingstock options that are not exercisable currently or within 60 days of January13, 2006.

 

(3)           Includes12,000 shares issuable pursuant to outstanding stock options that areexercisable currently or within 60 days of January 13, 2006.  Does not include 58,000 shares that areissuable pursuant to outstanding stock options that are not exercisable within60 days.

 

 (4)          Includes16,130 shares held by Mr. Tanella’s investment firm, HarborLight DiversifiedFund, LP.  Also, includes 1,390 sharesheld by Mr. Tanella’s family.  Does notinclude 78,000 shares that are issuable pursuant to outstanding stock optionsthat are not exercisable within 60 days. Includes 12,000 shares that are issuable pursuant to outstanding stockoptions that are exercisable within 60 days of January 13, 2006.

 

(5)           Doesnot include 10,000 shares issuable pursuant to outstanding stock options thatare exercisable currently within 60 days of January 13, 2006. Does not include50,000 shares that are issuable pursuant to outstanding stock options that arenot exercisable within 60 days of January 13, 2006.

 

(6)           Includes92,584 shares issuable pursuant to currently exercisable warrants and 435,167shares issuable pursuant to currently convertible notes.  Also, includes 10,000 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of January 13, 2006.  Does notinclude 50,000 shares that are issuable pursuant to outstanding stock optionsthat are not exercisable within 60 days of January 13, 2006.

 

(7)           3,874,585of these shares are held of record by a revocable grantor trust established byMr. Tjoa for himself and his family members. Mr. Tjoa continues to beneficially own all such shares.

 

(8)           Includes17,500 shares issuable pursuant to outstanding stock options exercisable currentlyor within 60 days of January 13, 2006. Does not include 120,000 shares that are issuable pursuant tooutstanding stock options that are not exercisable within 60 days of January13, 2006.

 

(9)           Includes67,126 shares issuable pursuant to currently exercisable warrants and 217,584shares issuable pursuant to currently convertible notes.

 

(10)         91,792of these shares are held of record by a trust established by Mr. Chitayat forhis family members.  Mr. Chitayatcontinues to beneficially own all such shares.

 

**Equity IncentivePlans/Equity Compensation Plans**

 

Securities authorized for issuance under equity compensation plans as ofDecember 31, 2005 were as follows:

 
| **Plan Category**                                       | ** ** | **Number of securities   to be issued upon   exercise of   outstanding options,   warrants, and rights  [a]** | ** ** | **Weighted-average   exercise price of   outstanding options,  warrants, and rights  [b]** | ** ** | **Number of securities   remaining available for   future issuance under equity   compensation plans   (excluding securities   reflected in column [a])  [c]** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                                                                                    | ** ** | ** **                                                                                 | ** ** | ** **                                                                                                                                                     | ** ** |
| Equity compensation plans approved by  stockholders     |       | 7,993,555                                                                                                     |       | $                                                                                          | 4.45       |                                                                                                                                                           | 6,790,585  |   |
| Equity compensation plans not approved by  stockholders |       | 5,362,373                                                                                                     |       | $                                                                                          | 2.36       |                                                                                                                                                           | —     |   |
| Total                                                   |       | 13,355,928                                                                                                    |       |                                                                                       |       | 6,790,585                                                                                                                                                      |       |

 

Equity compensation plans not approved by stockholders consist of:

 

Warrants to purchase upto 563,151 shares issued on March 1, 2004 with an original exercise price of$3.00 per share and an expiration date of March 1, 2006;

 

Warrants to purchase upto 893,750 shares issued on June 13, 2005 with an exercise price of $2.00 pershare and an expiration date of June 13, 2010;

 

Warrants to purchase upto 2,883,965 shares issued on August 2, 2005 with an exercise price of $2.00per share and an expiration date of August 2, 2010;

 

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Warrants to purchase upto 322,581 shares issued to John Kang and Ricardo Salas on February 21, 2001with an exercise price of $4.65 per share and an expiration date of December 31,2005;

 

Warrants to purchase upto 322,581 shares issued to Tjoa Thian Song on February 21, 2001 with anexercise price of $4.65 per share and an expiration date of December 31, 2005;and

 

Warrants to purchase upto 376,345 shares issued to Paul Azinger on January 1, 2001 with an exerciseprice of $1.16 per share and an expiration date of January 1, 2008.

 

The number of securities and type of plans available for future issuanceof stock options as of December 31, 2005 were as follows:

 
| ** **                                    | ** ** | **Options and Warrants for Common Shares** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| **Plan  Name**                                | ** ** | **Authorized**                             | ** ** | **Exercised** | ** ** | **Outstanding** | ** ** | **Available** | ** ** |
| ** **                                    | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 1996 Stock Option Plan                        |       | 12,903,226                                 |       | 1,974,365 |   | 3,386,297 |   | — |   |
| 2002 Equity Incentive Plan                    |       | 10,000,000                                 |       | — |   | 2,151,950 |   | 6,420,585 |   |
| 2002 Non-employee Director Stock Option  Plan |       | 1,000,000                                  |       | — |   | 234,000 |   | 370,000 |   |
| Total Stock Options                           |       | 23,903,226                                 |       | 1,974,365 |   | 5,772,247 |   | 6,790,585 |   |

 

***1996 Stock Option Plan***

 

Our 1996 Stock Option Plan provides for the grant of stock options toemployees, directors, and consultants of our company and its affiliates. Thepurpose of the plan is to retain the services of existing employees, directors,and consultants; to secure and retain the services of new employees, directors,and consultants; and to provide incentives for such persons to exert maximumefforts for our success. The plan provides for the granting to employees ofincentive stock options within the meaning of Section 422 of the InternalRevenue Code of 1986, as amended, and for the granting to employees andconsultants of nonstatutory stock options. Our board of directors terminatedthe 1996 Stock Option Plan on April 4, 2002. The termination will not affectany outstanding options under the plan, and all such options will continue toremain outstanding and be governed by the plan.

 

Options granted under the 1996 Stock Option Plan are generally nottransferable by the optionee except by will or the laws of descent anddistribution, and each option is exercisable, during the lifetime of theoptionee, only by the optionee. Options generally must be exercised within 90days after the optionee’s termination for cause, three months following the endof the optionee’s status as an employee or consultant, other than for cause orfor death or disability, or within six months after the optionee’s terminationby disability or twelve months following the optionee’s termination by death.However, in no event may an option be exercised later than the earlier of theexpiration of the term of the option or ten years from the date of the grant ofthe option or, where an optionee owns stock representing more than 10% of thevoting power, five years from the date of the grant of the option in the caseof incentive stock options.

 

As of December 31, 2005, options to purchase 3,386,297 shares of commonstock were outstanding and exercisable at a weighted average price of $6.14 pershare under the 1996 Stock Option Plan. As of December 31, 2005, 1,974,365shares had been issued upon exercise of options under the plan.

 

***2002 Equity Incentive Plan***

 

Our 2002 Equity Incentive Plan, which was adopted by our board ofdirectors and approved by our stockholders in April 2002, provides for thegrant of stock options to officers, employees, consultants, and directors ofour company and its subsidiaries. The purpose of the plan is to advance theinterests of our stockholders by enhancing our ability to attract, retain, andmotivate persons who make or are expected to make important contributions toour company and its subsidiaries by providing such persons with equityownership opportunities and performance-based incentives, thereby betteraligning their interests with those of our stockholders. The plan provides forthe granting to employees of incentive stock options within the meaning ofSection 422 of the Internal Revenue Code of 1986, as amended, and for thegranting to employees and consultants of nonstatutory stock options. Inaddition, the plan permits the granting of stock appreciation rights, or SARs,with or independently of options, as 

 

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well as stock bonuses and rights to purchase restricted stock. A total often million shares of our common stock may be granted under the plan.

 

The plan is administered by our board of directors or a committeeappointed by our board of directors. All members of such a committee must be anon-employee director and an outside director, as defined in the plan. Subjectto the limitations set forth in the plan, the administrator has the authorityto select the persons to whom grants are to be made, to designate the number ofshares to be covered by each stock award, to determine whether an option is tobe an incentive stock option or a nonstatutory stock option, to establishvesting schedules, to specify the option exercise price and the type ofconsideration to be paid upon exercise, and, subject to some restrictions, tospecify other terms of stock awards.

 

The administrator establishes the option exercise price, which in the caseof incentive stock options, must be at least the fair market value of the commonstock on the date of the grant or, with respect to optionees who own at least10% of our outstanding common stock, 110% of fair market value. If our commonstock is listed and traded on a registered national or regional securitiesexchange, or quoted on the National Association of Securities Dealers’Automated Quotation System, fair market value is the average closing price of ashare of our common stock on such exchange or quotation system for the fivetrading days prior to the date of grant. If our common stock is not traded on aregistered securities exchange or quoted in such a quotation system, fairmarket value is determined in good faith by the administrator.

 

Options granted under the plan are generally not transferable by theoptionee except by will or the laws of descent and distribution, and to certainrelated individuals with the consent of the administrator. Options generallymust be exercised within three months after the optionee’s termination ofemployment for any reason other than disability or death, or within 12 monthsafter the optionee’s termination by disability. Options granted under the planvest at the rate specified in the option agreement. However, in no event may anoption be exercised later than the earlier of the expiration of the term of theoption or 10 years from the date of the grant of the option, or when anoptionee owns stock representing more than 10% of the voting power, five yearsfrom the date of the grant of the option in the case of incentive stockoptions.

 

Any incentive stock options granted to an optionee which, when combinedwith all other incentive stock options becoming exercisable for the first timein any calendar year that are held by that person, would have an aggregate fairmarket value in excess of $100,000, shall automatically be treated asnonstatutory stock options.

 

The plan may be amended, altered, suspended or terminated by our board ofdirectors at any time, but no such amendment, alteration, suspension ortermination may adversely affect the terms of any option previously grantedwithout the consent of the affected optionee. Unless terminated sooner, theplan will terminate automatically in April 2012.  As of December 31, 2005, there were 2,151,950outstanding options or stock awards at a weighted average price of $2.66 underthe plan.

 

In September 2005, the non-employee directors of our company were giventhe opportunity to receive shares of stock under the plan in lieu of past-duedirector and committee fees that were due to them for periods through September30, 2005.  Such shares were issuable tosuch directors at an average price of $1.89 per share.  As of December 31, 2005, a total of 92,219shares were issued to non-employee directors in lieu of these past-due fees.

 

***2002 Non-employee Director Stock Option Plan***

 

Our 2002 Non-employee Director Stock Option Plan was adopted by our boardof directors and by our stockholders in April 2002. We have reserved a total ofone million shares of our common stock for issuance under the plan. The optiongrants under the plan are automatic and nondiscretionary, and the exerciseprice of the options is equal to 100% of the fair market value of our commonstock on the grant date.

 

Only non-employee directors are eligible for grants under the plan. Theplan will provide for an initial grant to a new non-employee director of anoption to purchase 50,000 shares of our common stock. Subsequent to the initialgrants, each non-employee director will be automatically granted on the firstbusiness day of January commencing January 1, 2003, an option to purchase10,000 shares of our common stock.

 

The term of the options granted under the plan is 10 years, but theoptions expire 12 months after the termination of the optionee’s status as adirector or three months if the termination is due to the voluntary resignationof the optionee. The option grants will vest and become exercisable as toone-fifth of the shares on the date that is one year after the date of grantand an additional one-fifth of the shares subject to the option on a cumulativebasis will vest and become exercisable annually thereafter.

 

As of December 31, 2005, options to purchase 234,000 shares of commonstock were outstanding at a weighted average price of $2.55 per share under the2002 Non-employee Director Stock Option Plan. There were 24,000 optionsexercisable under the 2002 Non-employee Director Stock Option Plan as ofDecember 31, 2005.

 

The plan will terminate in March 2012, unless our board of directorsterminates it sooner.

 

70

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**Item 13.Certain Relationships and Related Transactions**

 

In June 2003, we entered into an exclusive, ten-year license agreementwith LLPG, Inc. (“LLPG”), a corporation primarily owned and led by JackChitayat, a former director of our company.  Under the terms of the agreement, LLPG has theright to commercialize Liquidmetal alloys, particularly precious-metal basedcompositions, in jewelry and high-end luxury product markets.  In turn, we will receive royalty payments overthe life of the contract on all Liquidmetal products produced and sold by LLPG. In conjunction with its technologylicensing contract, LLPG purchased two proprietary Liquidmetal alloy meltingmachines and three proprietary Liquidmetal alloy casting machines for a totalpurchase price of $2,000,000.  We havenot received any royalties to date under this agreement.

 

We are a party to a license agreement with California Institute ofTechnology (“Caltech”) under which we exclusively license from Caltech certain inventionsand technology relating to amorphous alloys.  Professor William Johnson, a member of ourboard of directors, is a professor at Caltech, and substantially all of theamorphous alloy technology licensed to us under the Caltech license agreementwas developed in Professor Johnson’s Caltech laboratory.   Additionally, we reimburse Caltech forlaboratory expenses incurred by Professor Johnson’s Caltech laboratory, whichduring the years ended December 31, 2005 and 2004, amounted to $20,000 and $0,respectively.

 

We are a party to a consulting agreement with WilliamJohnson, a board member.  Under thisagreement, Mr. Johnson provides consulting services on an as-needed basisthrough 2004 as it relates to marketing and development Liquidmetal alloy.  The agreement currently continues on amonth-to-month basis.  During the yearsended December 31, 2005 and 2004, we incurred approximately $15,000 andapproximately $90,000 in consulting fees from Mr. Johnson, respectively.

 

We are a party to a consulting agreement with Chitnis Consulting, Inc.,which is owned 100% by Shekhar Chitnis, a former director and executive officerof our company.  Under this agreement, wehave engaged Chitnis Consulting to provide consulting services on an as-neededbasis through December 31, 2005.  Duringthe years ended December 31, 2005 and 2004, we incurred approximately $53,000and $54,000 in consulting fees from Chitnis Consulting, respectively.

 

Soo Buchanan, the sister of John Kang and James Kang, was employed by ourcompany and was paid aggregate compensation of approximately $104,000 and$43,000 as of December 31, 2005 and 2004.  Effective, July 31, 2005, our Ms. Buchanan wasterminated as an employee and began providing services to the company as aconsultant.  During 2005, the companyincurred $18,000 for her services as a consultant. Additionally, Otis Buchanan,the husband of Ms. Buchanan, was employed by the Company and was paid aggregatecompensation of approximately $103,000 and $54,000 as of December 31, 2005 and2004, respectively.

 

In November 2004, we entered into an agreement with John Kang, ourChairman, President, and Chief Executive Officer, in which Mr. Kang agreed thatcertain stock transactions by him in 2002 involving our common stock shouldhave resulted in a liability under Section 16(b) of the Securities Exchange Actof 1934, as amended (“Section 16(b)”). These transactions include Mr. Kang’s private sale of 285,715 shares ofhis personal Liquidmetal Technologies common stock to Growell Metal Co., Ltd.in February 2002, prior to our initial public offering.  They also include Mr. Kang’s subsequentindirect purchase and disposition of Liquidmetal Technologies common stock inorder to satisfy a personal agreement Mr. Kang made to Growell Metal inFebruary 2002 regarding the guaranteed minimum value of the stock purchased byGrowell Metal in February 2002 (the purchases and dispositions incident to thisagreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-market purchasesof an aggregate of 89,300 shares of our common stock made by Mr. Kang in August2002.

 

The Audit Committee of our Board of Directors conducted an independentinquiry into the above-described transactions with the aid of independent legalcounsel and, as a result of such inquiry, the Audit Committee concluded thatthe transactions should have resulted in a liability to the Company underSection 16(b) in the amount of $0.3 million. Mr. Kang has acknowledged this liability, and in an agreement negotiatedbetween Mr. Kang and the Audit Committee and approved by the full Board, Mr.Kang will pay this liability through periodic installments in 2005 and2006.  As a result, the Company accruedfor the $0.3 million receivable in other assets and other income as of December31, 2004.  The above-describedtransactions involving Growell Metal was reported on a new Form 4 filed by Mr.Kang on November 15, 2004, and the open-market purchases were previouslyreported on a timely basis in August 2002. As of December 31, 2005, the outstanding amount of the receivable was$0.2 million, which is included in other assets.  Mr. Kang has paid $0.1 million during2005.  The Company has agreed to deferMr. Kang’s payment schedule until 2006 as Mr. Kang has agreed accept reducedcompensation for the remainder of 2005. The remaining outstanding balance of$0.2 million will be due before the end of 2006.

 

During the year ended December 31, 2005, the Company executed a $0.2million promissory note with CK Cho, member of our Board of Directors, forworking capital purposes. The note was due and paid in full as of June 30,2005.  The note has an annual rate ofinterest of 6% resulting in the Company paying approximately $2 thousand ininterest.  Mr. Cho also holds $0.6million of Senior Convertible Notes and holds 92,584 exercisable warrants as ofDecember 31, 2005.  Further, during theyear ended December 31, 2005, Mr. Cho advanced approximately $1.3 million tocover short-term liquidity needs.  Theadvances were made without interest and were repaid as of December 31, 2005.

 

71

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During the year ended December 31, 2005, Ricardo Salas, our President andChief Executive Officer, and Young Ham, our Chief Financial Officer, eachadvanced the company approximately $0.1 million to cover short-term liquidityneeds.  The advances were made withoutinterest and were repaid as of December 31, 2005.

 

We believe that each of the foregoing transactions was consummated onterms at least as favorable to us as we would expect to negotiate withunrelated third parties.

 

**Item14. Principal Accounting Fees and Services**

 

Prior to December 2005, Stonefield Josephson, Inc. was ourindependent public accountant; however, effective December 1 2005, StonefieldJosephson, Inc. resigned as our independent accountant.  Liquidmetal Technologies subsequently engagedChoi, Kim & Park, LLP.  Item 14includes the principal accounting fees and services for our auditors.

 

Choi, Kim & Park, LLP

 

Choi, Kim & Park, LLP was engaged in January 2006 and has served asour independent public accountants since that date.

 

Thefollowing table summarizes the aggregate fees billed to the Company by Choi,Kim & Park, LLP for professional services:

 
| **Fees**       | ** ** | **2005** | ** ** |
|----------------|------------|----------|------------|
| Audit Fees (1) |       | $        | 150,000    |   |
|                |            |          |            |  |

 

----

(1) *Audit Fees.* Fees for audit servicesbilled in 2005 consisted of audit of the Company’s annual financial statementsfor 2005;

 

Stonefield Josephson, Inc.

 

Stonefield Josephson, Inc. was engaged in May 2004 and hasserved as our independent public accountants during the year ended December 31,2003 and 2004, and through December 1, 2005.

 

Thefollowing table summarizes the aggregate fees billed to the Company byStonefield for professional services:

 
| **Fees**       | ** ** | **2003, 2002, and 2001** | ** ** | **2004** | ** ** | **2005** | ** ** |
|----------------|------------|--------------------------|------------|----------|------------|----------|------------|
| Audit Fees (1) |       | $                        | 760,000    |     | $          | 150,000  |       | $ | 420,000 |   |
|                |            |                          |            |          |            |          |            |  |  |  |

 

----

(1) *Audit Fees.* Fees for audit servicesbilled in 2004 consisted of:

•      Auditof the Company’s annual financial statements for 2003, 2002, and 2001;

•      Reviewand audit of the Company’s quarterly and annual financial statements for 2004,respectively.

 

Fees for audit services billed in 2005 consisted of:

•      Reviewof the Company’s quarterly financial statements for 2005;

•      Reviewof the Company’s internal controls in accordance with Section 404 of theSarbanes-Oxley Act of 2002 for 2005.

 

The Audit Committee pre-approves all audit and permissible non-auditservices provided by the independent directors on a case-by-case basis.  The Audit Committee approved 100% of theservices performed by Choi, Kim & Park, LLP and Stonefield Josephson, Inc.in 2005, 2004, and 2003 as identified above.

 

**PART IV**

 

**Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K**

 

(a)   The followingdocuments are filed as a part of this report:

 

1.*Financial Statements*.

 

72

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2.*Financial Statement Schedules*.See the last page of Consolidated Financial Statements.

 

3.*Exhibits*. See Item 15(c) below.

 
| (b)    | * * | *Exhibits.*                                               |   | The exhibits listed on the Exhibit Index,  which appears at the end of this Item 15, are filed as part of, or  incorporated by reference into, this report. |
|--------|----------|-----------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |     |                                                      |   |                                                                                                                                                        |
| (c)    | * * | *Financial Statement Schedules*. See Item 15(a)(2) above. |
|        |          |                                                           |        |                                                                                                                                                             |  |  |

 

73

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | ** ** | ** ** | **Description of Document**                                                                                                                                                                                                                                                                                                                 |
|---------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |       | —     |       | Agreement and Plan of Merger, dated May 21, 2003, between Liquidmetal  Technologies, Inc. and Liquidmetal Technologies (incorporated by reference to  Exhibit 2.1 to the Form 10-Q filed on August 14, 2003).                                                                                                                               |
| 3.1                 |       | —     |       | Certificate of Incorporation (incorporated  by reference to Exhibit 3.1 to the Form 10-Q filed on August 14, 2003)                                                                                                                                                                                                                          |
| 3.2                 |       | —     |       | Bylaws (incorporated by reference to  Exhibit 3.2 to the Form 10-Q filed on August 14, 2003)                                                                                                                                                                                                                                                |
| 4.1                 |       | —     |       | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                                                                  |
| 4.2                 |       | —     |       | Form of Common Stock Certificate  (incorporated by reference to Exhibit 4.2 to the Form 10-Q filed on August  14, 2003)                                                                                                                                                                                                                     |
| 10.1                |       | —     |       | Amended and Restated License Agreement, dated September 1, 2001,  between Liquidmetal Technologies, Inc. and California Institute of Technology  (incorporated by reference to Exhibit 10.1 to the Registration Statement on  Form S-1 filed on November 20, 2001 (Registration No. 333-73716)).                                            |
| 10.2                |       | —     |       | Improved Property Commercial Lease, dated  September 11, 2002, between Liquidmetal Technologies, Inc. and P & S  Properties (incorporated by reference to Exhibit 10.2 of Form 10-K filed on  March 31, 2003).                                                                                                                          |
| 10.3                |       | —     |       | Lease, dated October 4, 2001, between Plaza IV Associates, Ltd. and  Liquidmetal Technologies, Inc. (incorporated by reference to Exhibit 10.1 to  the Registration Statement on Form S-1 filed on November 20, 2001  (Registration No. 333-73716)).                                                                                        |
| 10.4                |       | —     |       | Second Amendment of Lease, dated October 3, 2003, between Liquidmetal  Technologies, Inc. and Plaza Associates IV, Ltd. (incorporated by reference  to Exhibit 10.1 of Form 10-Q filed on November 14, 2003).                                                                                                                               |
| 10.5                |       | —     |       | Standard Lease, dated May 27, 2001, between Investors Equity Fund,  Inc. and Amorphous Technologies International (now known as Liquidmetal  Technologies, Inc.) (incorporated by reference to Exhibit 10.1 to the  Registration Statement on Form S-1 on November 20, 2001 (Registration No.  333-73716)).                                 |
| 10.6*               |       | —     |       | 1996 Stock Option Plan, as amended, together with form of Stock  Option Agreement (incorporated by reference to Exhibit 10.7 to the  Registration Statement on Form S-1 filed on November 20, 2001 (Registration  No. 333-73716)).                                                                                                          |
| 10.7*               |       | —     |       | 2002 Equity Incentive Plan (incorporated by  reference to Exhibit 10.23 to the Registration Statement on Form S-1  (Amendment No. 2) filed on April 5, 2002 (Registration No. 333-73716)).                                                                                                                                                  |
| 10.8*               |       | —     |       | 2002 Non-Employee Director Stock Option  Plan (incorporated by reference to Exhibit 10.24 to the Registration  Statement on Form S-1 (Amendment No. 2) filed on April 5, 2002 (Registration  No.  333-73716)).                                                                                                                              |
| 10.9*               |       | —     |       | Employment Agreement, dated December 31,  2000, between Liquidmetal Technologies, Inc. and John Kang, as amended by  Amendment No. 1 to Employment Agreement, dated June 28, 2001 (incorporated by  reference to Exhibit 10.8 to the Registration Statement on Form S-1 filed on  November 20, 2001 (Registration No.  333-73716)).         |
| 10.10*              |       | —     |       | Employment Agreement, dated May 1, 2001,  between Liquidmetal Technologies, Inc. and James Kang, as amended by  Amendment No. 1 to Employment Agreement, dated June 28, 2001 (incorporated by  reference to Exhibit 10.9 to the Registration Statement on Form S-1  (Amendment No. 2) filed on April 5, 2002 (Registration No. 333-73716)). |
| 10.11*              |       | —     |       | Amendment No. 2 to Employment Agreement, dated September 1, 2003,  between James Kang and Liquidmetal Technologies, Inc. (incorporated by  reference to Exhibit 10.2 of Form 10-Q filed on November 14, 2003).                                                                                                                              |
| 10.12*              |       | —     |       | Employment Agreement, dated October 1, 2001, between Liquidmetal  Technologies, Inc. and William Johnson, Ph.D. (incorporated by reference to  Exhibit 10.10 to the Registration Statement on Form S-1 filed on November 20,  2001 (Registration No. 333-73716))                                                                            |
| 10.13*              |       | —     |       | Employment Agreement, dated October 1,  2001, between Liquidmetal Technologies, Inc., and David Binnie. (incorporated  by reference to Exhibit 10.13 to the Form 10-K filed on November 10, 2004)                                                                                                                                           |
| 10.14*              |       | —     |       | Employment Agreement, dated November 3,  2004, between Liquidmetal Technologies, Inc. and Tony Chung. (incorporated by  reference to Exhibit 10.14 to the Form 10-K filed on November 10, 2004)                                                                                                                                             |

 

74

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| 10.15* |   | — |   | Employment Agreement, dated December 31, 2000, between Liquidmetal  Technologies, Inc. and T. Scott Wiggins (incorporated by reference to Exhibit  10.11 to the Registration Statement on Form S-1 filed on November 20, 2001  (Registration No. 333-73716)).                                                                                        |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.16* |   | — |   | Employment Agreement, dated May 21, 2001, between Liquidmetal  Technologies, Inc. and Brian McDougall (incorporated by reference to Exhibit  10.12 to the Registration Statement on Form S-1 filed on November 20, 2001  (Registration No. 333-73716)).                                                                                              |
| 10.17* |   | — |   | Employment Separation Agreement, dated December 31, 2003, between  Liquidmetal Technologies, Inc. and Brian McDougall. (incorporated by  reference to Exhibit 10.17 to the Form 10-K filed on November 10, 2004)                                                                                                                                     |
| 10.18* |   | — |   | Letter Agreement, dated February 26, 2004,  between Brian McDougall and Liquidmetal Technologies, Inc. (incorporated by  reference to Exhibit 10.18 to the Form 10-K filed on November 10, 2004)                                                                                                                                                     |
| 10.19* |   | — |   | Employment Agreement, December 1, 2002, between Liquidmetal  Technologies, Inc. and Thomas Trotter. (incorporated by reference to Exhibit  10.19 to the Form 10-K filed on November 10, 2004)                                                                                                                                                        |
| 10.20* |   | — |   | Employment Separation Agreement, dated November 6, 2003, between  Liquidmetal Technologies, Inc. and Thomas Trotter. (incorporated by reference  to Exhibit 10.20 to the Form 10-K filed on November 10, 2004)                                                                                                                                       |
| 10.21* |   | — |   | Separation and Consulting Agreement, dated November 15, 2001, between  Liquidmetal Technologies, Inc. and Shekhar Chitnis, together with Consulting  Agreement attached as Exhibit A (incorporated by reference to Exhibit 10.14  to the Registration Statement on Form S-1 (Amendment No. 2) filed on April 5,  2002 (Registration No. 333-73716)). |
| 10.22  |   | — |   | Warrant for Purchase of Shares of Common Stock, dated February 21,  2001, granted by Liquidmetal Technologies, Inc. to John Kang and Ricardo  Salas (incorporated by reference to Exhibit 10.18 to the Registration  Statement on Form S-1 filed on November 20, 2001 (Registration No.  333-73716)).                                                |
| 10.23  |   | — |   | Warrant for Purchase of Shares of Common Stock, dated February 21,  2001, granted by Liquidmetal Technologies, Inc. to Tjoa Thian Song  (incorporated by reference to Exhibit 10.19 to the Registration Statement on  Form S-1 filed on November 20, 2001 (Registration No. 333-73716)).                                                             |
| 10.24  |   | — |   | Non-Qualified Stock Option Agreement, dated January 1, 2001, between  Liquidmetal Technologies, Inc. and Paul Azinger (incorporated by reference to  Exhibit 10.19 to the Registration Statement on Form S-1 filed on November 20,  2001 (Registration No. 333-73716)).                                                                              |
| 10.25  |   | — |   | Foreign Corporation Lease Zone Occupancy  (Lease) Agreement, dated March 5, 2002, between Kyonggi Local Corporation and  Liquidmetal Korea Co., Ltd. (incorporated by reference to Exhibit 10.22 to  the Registration Statement on Form S-1 (Amendment No. 2) filed by Liquidmetal  Technologies on April 5, 2002 (Registration No. 333-73716)).     |
| 10.26  |   | — |   | Credit Service Agreement, dated February  2003, between Liquidmetal Korea Co., Ltd. and Kookmin Bank (incorporated by  reference to Exhibit 10.20 to the Form 10-K filed on March 31, 2003).                                                                                                                                                         |
| 10.27  |   | — |   | Agreement for Rent dated February, 2003,  between Liquidmetal Korea Co., Ltd. and Dong Myung Seo Bank (incorporated by  reference to Exhibit 10.21 to the Form 10-K filed on March 31, 2003).                                                                                                                                                        |
| 10.28  |   | — |   | Share Transfer Agreement, dated February 28, 2004, among Liquidmetal  Korea Co. Ltd., Sun Joo Ho, and Dongyang Induction Co. Ltd. (incorporated by  reference to Exhibit 10.28 to the Form 10-K filed on November 10, 2004)                                                                                                                          |
| 10.29  |   | — |   | Settlement Agreement, dated January 10, 2004, between Liquidmetal  Korea Co., Ltd. and Growell Metal Co., Ltd. (incorporated by reference to  Exhibit 10.29 to the Form 10-K filed on November 10, 2004)                                                                                                                                             |
| 10.30  |   | — |   | Amended and Restated Securities Purchase Agreement, dated March 1,  2004, among Liquidmetal Technologies, Inc., Michigan Venture Capital Co.,  Ltd., and the investors identified as “Purchasers” therein (incorporated by  reference to Exhibit 10.1 to the Form 8-K filed on July 2, 2004).                                              |
| 10.31  |   | — |   | Form of 6% Senior Convertible Note issued under Amended and Restated  Securities Purchase Agreement (incorporated by reference to Exhibit 10.2 to  the Form 8-K filed on July 2, 2004).                                                                                                                                                              |
| 10.32  |   | — |   | Registration Rights Agreement, dated March 1, 2004, among Liquidmetal  Technologies, Inc. and the purchasers under Amended and Restated Securities  Purchase Agreement (incorporated by reference to Exhibit 10.3 to the Form 8-K  filed on July 2, 2004).                                                                                           |
| 10.33  |   | — |   | Common Stock Purchase Warrant, dated March 1, 2004, granted by  Liquidmetal Technologies, Inc. to Michigan Venture Capital Co., Ltd.  (incorporated by reference to Exhibit 10.4 to the Form 8-K filed on July 2,  2004).                                                                                                                            |
| 10.34  |   | — |   | Factory Mortgage Agreement, dated March 1, 2004, among Liquidmetal  Korea Co., Ltd.,                                                                                                                                                                                                                                                                 |

 

75

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|   |   |   |   | Michigan Venture Capital Co., Ltd., and the other parties identified  therein (incorporated by reference to Exhibit 10.5 to the Form 8-K filed on  July 2, 2004).                                                                                                                                         |
|--------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.35  |   | — |   | Securities Purchase Agreement, dated March 1, 2004, among Liquidmetal  Technologies, Inc. and the investors identified as “Purchasers” therein  (incorporated by reference to Exhibit 10.6 to the Form 8-K filed on July 2,  2004).                                                             |
| 10.36  |   | — |   | Form of 6% Senior Convertible Note issued under Securities Purchase  Agreement (incorporated by reference to Exhibit 10.7 to the Form 8-K filed on  July 2, 2004).                                                                                                                                        |
| 10.37  |   | — |   | Registration Rights Agreement, dated March 1, 2004, among Liquidmetal  Technologies, Inc. and the purchasers under Securities Purchase Agreement  (incorporated by reference to Exhibit 10.8 to the Form 8-K filed on July 2,  2004).                                                                     |
| 10.38  |   | — |   | Form of Common Stock Purchase Warrant granted to purchasers under  Securities Purchase Agreement (incorporated by reference to Exhibit 10.9 to  the Form 8-K filed on July 2, 2004).                                                                                                                      |
| 10.39  |   | — |   | Form of Placement Agent Common Stock Purchase Warrant, dated March 1,  2004 (incorporated by reference to Exhibit 10.10 to the Form 8-K filed on  July 2, 2004).                                                                                                                                          |
| 10.40  |   | — |   | Security Agreement, dated March 1, 2004, between Liquidmetal  Technologies, Inc. and Middlebury Capital LLC, as agent (incorporated by  reference to Exhibit 10.11 to the Form 8-K filed on July 2, 2004).                                                                                                |
| 10.41  |   | — |   | Note Exchange Agreement, dated July 29, 2004, among Liquidmetal  Technologies, Inc. and certain individuals identified as “Noteholders”  therein (incorporated by reference to Exhibit 10.1 to the Form 8-K filed on  August 20, 2004).                                                         |
| 10.42  |   | — |   | Form of 10% Senior Secured Notes Due 2005 of Liquidmetal Technologies,  Inc. issued pursuant to Note Exchange Agreement filed as Exhibit 10.2 hereto  (incorporated by reference to Exhibit 10.2 to the Form 8-K filed on August  20, 2004).                                                              |
| 10.43  |   | — |   | Form of 6% Senior Security Note Due 2007 of Liquidmetal Technologies,  Inc. issued pursuant to Note Exchange Agreement filed as Exhibit 10.3 hereto  (incorporated by reference to Exhibit 10.3 to the Form 8-K filed on August  20, 2004).                                                               |
| 10.44  |   | — |   | Note Exchange Agreement, dated July 29, 2004, among Liquidmetal  Technologies, Inc and Winvest Venture Partners Inc. (incorporated by  reference to Exhibit 10.4 to the Form 8-K filed on August 20, 2004).                                                                                               |
| 10.45  |   | — |   | 10% Senior Secured Notes Due 2005 of Liquidmetal Technologies, Inc.  issued to Winvest Venture Partners Inc. (incorporated by reference to Exhibit  10.5 to the Form 8-K filed on August 20, 2004).                                                                                                       |
| 10.46  |   | — |   | Form of 6% Senior Security Note Due 2007 of Liquidmetal Technologies,  Inc. issued to Winvest Venture Partners Inc. (incorporated by reference to  Exhibit 10.6 to the Form 8-K filed on August 20, 2004).                                                                                                |
| 10.47  |   | — |   | Employment Agreement, dated January 14, 2005, between Liquidmetal  Technologies, Inc. and John Thorne (incorporated by reference to Exhibit  10.47 to the Form 10-K filed on March 30, 2005).                                                                                                             |
| 10.48  |   |   |   | Securities Purchase Agreement dated August 2, 2005, among  Liquidmetal Technologies, Inc. and the parties identified as “Purchasers”  therein (incorporated by reference from Exhibit 10.1 of the Registrant’s  10-Q/A filed on August 30, 3005)                       |
| 10.49  |   |   |   | Form of 7% Senior Secured Convertible Note of Liquidmetal  Technologies, Inc., dated August 2, 2005 (incorporated by reference  from Exhibit 10.2 of the Registrant’s 10-Q/A filed on August 30,  3005)                                                                     |
| 10.50  |   |   |   | Form of Common Stock Purchase Warrant, dated August 2, 2005  (incorporated by reference from Exhibit 10.3 of the Registrant’s 10-Q/A  filed on August 30, 3005)                                                                                                                  |
| 10.51  |   |   |   | Amended and Restated Registration Rights Agreement, dated August 2,  2005, among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein (incorporated by reference from Exhibit 10.4 of the  Registrant’s 10-Q/A filed on August 30, 3005) |
| 10.52  |   |   |   | Amended and Restated Security Agreement, dated August 2, 2005,  among Liquidmetal Technologies, Inc. and the parties identified as the “Secured  Parties” therein (incorporated by reference from Exhibit 10.5 of  Registrant’s 10-Q/A filed on August 30, 3005)       |
| 10.53* |   |   |   | Employment Separation Agreement, dated September 30, 2005,  between Liquidmetal Technologies, Inc. and David G. Binnie (incorporated  by reference from Exhibit 10.53 of the Registration Statement on Form S-1  filed on December 9, 2005 (Registration No.333-130251)).        |
| 10.54  |   |   |   | Securities Purchase Agreement, dated June 13, 2005, among  Liquidmetal Technologies, Inc. and the parties identified as “Purchasers”  therein (incorporated by reference from Exhibit 99.1 of the Registrant’s  8-K filed on 06/16/05)                                      |
| 10.55  |   |   |   | Form of 10% Convertible Unsecured Note of Liquidmetal  Technologies, Inc. due June 2006 (incorporated by reference from Exhibit 99.2  of the Registrant’s 8-K filed on 06/16/05)                                                                                                 |
| 10.56  |   |   |   | Form of Common Stock Purchase Warrant, dated June 13, 2005  (incorporated by reference                                                                                                                                                                                                          |

 

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|      |   |   |   | from Exhibit 99.3 of the Registrant’s 8-K filed on 06/16/05)                                                                                                                                                                                               |
|-----------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.57     |   |   |   | Registration Rights Agreement, dated June 13, 2005, among  Liquidmetal Technologies, Inc. and the parties identified as “Purchasers”  therein (incorporated by reference from Exhibit 99.4 of the Registrant’s  8-K filed on 06/16/05) |
| 10.58 (1) |   |   |   | Agreement, dated November 3, 2004, between Liquidmetal  Technologies, Inc. and John Kang relating to liability under Section 16(b).                                                                                                                   |
| 10.59 (1) |   |   |   | Form of Indemnity Agreement between Liquidmetal Technologies, Inc.  and directors and executive officers.                                                                                                                                                  |
| 10.60 (1) |   |   |   | Factoring, Loan, and Security Agreement, dated April 21, 2005,  between Liquidmetal Technologies, Inc. and Hana Financial, Inc.                                                                                                                       |
| 14        |   | — |   | Code of Ethics for Chief Executive Officer and Senior Financial and  Accounting Officers. (incorporated by reference to Exhibit 14 to the Form  10-K filed on November 10, 2004)                                                                                     |
| 21        |   | — |   | Subsidiaries of the Registrant. (incorporated by reference to Exhibit  21 to the Form 10-K filed on November 10, 2004)                                                                                                                                               |
| 23.1      |   | — |   | Consent of Choi, Kim & Park, LLP                                                                                                                                                                                                                            |
| 23.2      |   |   |   | Consent of Stonefield Josephson, Inc.                                                                                                                                                                                                                           |
| 24.1      |   | — |   | Power of Attorney relating to subsequent amendments (included on the  signature page(s) of this report).                                                                                                                                                             |
| 31.1      |   | — |   | Certification of Principal Executive Officer pursuant to Rule 13a-15(e) or  15d-15(e) of the Securities Exchange Act of 1934, as amended.                                                                                                             |
| 31.2      |   | — |   | Certification of Principal Financial Officer pursuant to Rule 13a-15(e) or  15d-15(e) of the Securities Exchange Act of 1934, as amended.                                                                                                             |
| 32.1      |   | — |   | Certification pursuant to 18 U.S.C. 1350.                                                                                                                                                                                                                            |

 

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*                 Denotes a management contract or compensatoryplan or arrangement required to be filed as an exhibit this Form 10-K.

 

(1)          Previously filed

 

77

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
|                     |   | Liquidmetal Technologies, Inc.   |
|--------------------------|--------|---------------------------------------|
|                     |   |                                  |
|                     |   |                                  |
|                     | By:    | /s/ Ricardo A. Salas                  |   |
|                     |   | Ricardo A. Salas                      |   |
|                     |   | President and Chief Executive Officer |   |
|                     |   |                                  |   |
| Date: July 20, 2006 |   |                                  |   |
|                     |   |                                  |   |
|                     | By:    | /s/ Young Ham                         |   |
|                     |   | Young Ham                             |   |
|                     |   | Chief Financial Officer               |   |
|                     |   |                                  |   |
| Date: July 20, 2006 |   |                                  |   |

 

78

----

 

**POWER OF ATTORNEY**

 

KNOW ALL THESE PERSONS BY THESE PRESENTS, that each personwhose signature appears below constitutes and appoints Ricardo Salas and YoungHam and each of them, jointly and severally, his attorneys-in-fact, each withfull power of substitution, for him in any and all capacities, to sign any andall amendments to this Report on Form 10-K, and to file the same, withexhibits thereto and other documents in connection therewith, with theSecurities and Exchange Commission, hereby ratifying and confirming all thateach said attorneys-in-fact or his substitute or substitutes, may do orcause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Actof 1934, this Report on Form 10-K has been signed below by the followingpersons on behalf of the Registrant and in the capacities and on the datesindicated:

 
| **Signature**       | ** ** | **Title**             | ** ** | **Date**           |
|---------------------|------------|-----------------------|------------|--------------------|
|                |       |                  |       |               |
| /s/ John Kang       |       | Chairman of the Board |       | July 20, 2006 |
| John Kang           |       | and Director          |       |               |
|                |       |                  |       |               |
| /s/ James Kang      |       | Founder and Director  |       | July 20, 2006 |
| James Kang          |       |                  |       |               |
|                |       |                  |       |               |
| /s/ William Johnson |       | Director              |       | July 20, 2006 |
| William Johnson     |       |                  |       |               |
|                |       |                  |       |               |
| /s/ Robert Biehl    |       | Director              |       | July 20, 2006 |
| Robert Biehl        |       |                  |       |               |
|                |       |                  |       |               |
| /s/ Dean Tanella    |       | Director              |       | July 20, 2006 |
| Dean Tanella        |       |                  |       |               |
|                |       |                  |       |               |
| /s/ CK Cho          |       | Director              |       | July 20, 2006 |
| CK Cho              |       |                  |       |               |

 

Certificationsprovided as Exhibits.

 

79

----

 

**INDEX TO CONSOLIDATEDFINANCIAL STATEMENTS**

 
| Report of Independent  Registered Public Accounting Firm           |   |
|--------------------------------------------------------------------|--------|
| Consolidated Financial Statements:                                 |   |
| Consolidated Balance Sheet                                         |   |
| Consolidated Statements of  Operations and Comprehensive Loss      |   |
| Consolidated Statements of  Shareholders’ Equity (Deficiency) |   |
| Consolidated Statements of  Cash Flows                             |   |
| Notes to Consolidated  Financial Statements                        |   |

 

80

----

 

**REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

** **

To the Board of Directors and Shareholders of

Liquidmetal Technologies, Inc.

 

We have audited the accompanying consolidated balance sheet ofLiquidmetal Technologies, Inc. and subsidiaries (the “Company”) as of December 31,2005, and the related consolidated statements of operations and comprehensiveloss, shareholders’ equity (deficiency), and cash flows for the year ended December 31,2005 as well as the effects of the adjustments for the correction of the errordescribed in Note 2 as of and for the year ended December 31, 2004. Ouraudit also included the financial statement schedule listed at index inItem 15(a) as of and for the year ended December 31, 2005. Ourresponsibility is to express an opinion on the financial statements andfinancial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of Liquidmetal Technologies, Inc.and subsidiaries as of December 31, 2005, and the results of theiroperations and cash flows for the year ended December 31, 2005, as well asthe effects of the adjustments for the correction of the error described inNote 2 as of and for the year ended December 31, 2004, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, such financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly in all material respects the information set forth therein.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 3 tothe consolidated financial statements, the Company’s significant operatinglosses and working capital deficit raise substantial doubt about its ability tocontinue as a going concern. Management’s plans regarding those matters alsoare described in Note 3. The consolidated financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

 
| /s/ Choi, Kim & Park LLP |   |   |
|-----------------------------------|--------|--------|
|                              |   |
| Los Angeles, California           |   |
| Certified Public Accountants      |   |

 

February 23, 2006, except for Note 2, as to which the date is July 17,2006

 

81

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Shareholders of Liquidmetal Technologies, Inc.

 

We have audited, before the effects of the adjustments for thecorrection of the error described in Note 2, the accompanying consolidatedbalance sheet of Liquidmetal Technologies, Inc. and subsidiaries (the “Company”)as of December 31, 2004 , and the related consolidated statements ofoperations and comprehensive loss, shareholders’ equity (deficiency), and cashflows for each of the two years in the period ended December 31, 2004 (the2004 financial statements before the effects of the adjustments discussed inNote 2 are not presented herein). . Our audit also included the financialstatement schedule listed at index in Item 15(a), except for the correctionof the error described in Note 2, as of and for the years ended December 31,2004 and 2003. Our responsibility is to express an opinion on the financialstatements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

 

In our opinion, except for the error described in Note 2, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Liquidmetal Technologies, Inc. and subsidiaries asof December 31, 2004, and the results of their operations and cash flowsfor each of the two years in the period ended December 31, 2004, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, such financial statement schedule, except forthe error described in Note 2, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly in allmaterial respects the information set forth therein.

 

We were not engaged to audit, review, or apply any procedures to theadjustments for the correction of the error described in Note 2, andaccordingly, we do not express an opinion or any other form of assuranceabout whether such adjustments are appropriate and have been properly applied. Thoseadjustments were audited by Choi, Kim & Park LLP.

 

The accompanying consolidated financial statements have been preparedassuming that the Company will continue as a going concern. As discussed inNote 3 to the consolidated financial statements, the Company’s significantoperating losses and working capital deficit raise substantial doubt about itsability to continue as a going concern. Management’s plans regarding thosematters also are described in Note 3. The consolidated financial statements donot include any adjustments that might result from the outcome of this uncertainty.

 

 
| /s/ Stonefield Josephson, Inc. |   |   |
|-------------------------------------|--------|--------|
|                                |   |
| Irvine, California                  |   |
| Certified Public Accountants        |   |
|                                |   |
| March 3, 2005                  |   |

 

82

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share data)**

 
| ** **                                                                                                                                                            | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                            | ** ** | **(Restated)**        | ** ** | **(Restated)** | ** ** |
| **ASSETS**                                                                                                                                                            |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Current Assets:                                                                                                                                                       |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                             |       | $                     | 1,392      |   | $ | 742 |   |
| Restricted cash                                                                                                                                                       |       | —                |       | 754 |   |
| Trade accounts receivables, net of allowance for doubtful accounts of  $61 and $108                                                                                   |       | 2,360                 |       | 1,668 |   |
| Inventories                                                                                                                                                           |       | 1,748                 |       | 2,353 |   |
| Prepaid expenses and other current assets                                                                                                                             |       | 609                   |       | 930 |   |
| Total current assets                                                                                                                                                  |       | 6,109                 |       | 6,447 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Property, plant and equipment, net                                                                                                                                    |       | 13,437                |       | 16,434 |   |
| Idle equipment                                                                                                                                                        |       | 193                   |       | 1,906 |   |
| Long-term inventory                                                                                                                                                   |       | —                |       | 1,810 |   |
| Other intangibles, net                                                                                                                                                |       | 1,185                 |       | 1,143 |   |
| Other assets                                                                                                                                                          |       | 639                   |       | 768 |   |
| Total assets                                                                                                                                                          |       | $                     | 21,563     |   | $ | 28,508 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                         |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                  |       |                  |       |   |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Accounts payable and accrued expenses                                                                                                                                 |       | $                     | 6,530      |   | $ | 4,969 |   |
| Settlement payable                                                                                                                                                    |       | 3,331                 |       | 3,246 |   |
| Deferred revenue                                                                                                                                                      |       | 1,275                 |       | 900 |   |
| Short-term debt                                                                                                                                                       |       | 550                   |       | — |   |
| Long-term debt, current portion, net of debt discount of $0 and  $2,831                                                                                               |       | 1,343                 |       | 4,010 |   |
| Other liabilities, current portion                                                                                                                                    |       | 483                   |       | 1,032 |   |
| Warrant liabilities                                                                                                                                                   |       | 1,792                 |       | 550 |   |
| Conversion feature liabilities                                                                                                                                        |       | 1,798                 |       | 6,650 |   |
| Total current liabilities                                                                                                                                             |       | 17,102                |       | 21,357 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Long-term debt, net of current portion and debt discount of $8,259  and $0                                                                                            |       | 5,433                 |       | 2,618 |   |
| Other long-term liabilities, net of current portion                                                                                                                   |       | 348                   |       | 342 |   |
| Total liabilities                                                                                                                                                     |       | 22,883                |       | 24,317 |   |
|                                                                                                                                                                  |       |                  |       |   |   |
| Shareholder’s equity (deficiency):                                                                                                                               |       |                  |       |   |   |
| Common stock, $0.001 par value; 100,000,000 shares authorized and  42,187,621 and 41,609,652 issued and outstanding at December 31, 2005  and 2004, respectively |       | 42                    |       | 42 |   |
| Additional paid-in capital                                                                                                                                            |       | 130,893               |       | 129,650 |   |
| Accumulated deficit                                                                                                                                                   |       | (134,525              | )          | (127,472 | ) |
| Accumulated other comprehensive income                                                                                                                                |       | 2,270                 |       | 1,971 |   |
| Total shareholder’ equity (deficiency)                                                                                                                           |       | (1,320                | )          | 4,191 |   |
| Total liabilities and shareholders’ equity (deficiency)                                                                                                          |       | $                     | 21,563     |   | $ | 28,508 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

83

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

**(inthousands, except per share data)**

 
| ** **                                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                          | ** ** | **(Restated)**                              | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                                                                |       |                                        |       |   |   |   |   |
| Revenue                                                                                             |       | $                                           | 16,365     |   | $ | 17,429 |   | $ | 13,658 |   |
| Cost of sales                                                                                       |       | 15,129                                      |       | 12,168 |   | 18,162 |   |
|                                                                                                |       |                                        |       |   |   |   |   |
| Gross profit (loss)                                                                                 |       | 1,236                                       |       | 5,261 |   | (4,504 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Operating expenses                                                                                  |       |                                        |       |   |   |   |   |
| Selling, general, and administrative                                                                |       | 8,534                                       |       | 11,591 |   | 17,729 |   |
| Research and development                                                                            |       | 1,120                                       |       | 1,467 |   | 8,780 |   |
| Impairment of goodwill                                                                              |       | —                                      |       | — |   | 184 |   |
| Impairment of long lived assets                                                                     |       | 4,487                                       |       | — |   | 2,684 |   |
| Total operating expenses                                                                            |       | 14,141                                      |       | 13,058 |   | 29,377 |   |
|                                                                                                |       |                                        |       |   |   |   |   |
| (Loss) before interest, other income, income taxes, minority  interest, and discontinued operations |       | (12,905                                     | )          | (7,797 | ) | (33,881 | ) |
| (Loss) from extinguishments of debt                                                                 |       | (1,247                                      | )          | (2,941 | ) | — |   |
| Change in value of warrants, gain                                                                   |       | 3,985                                       |       | 747 |   | — |   |
| Change in value of conversion feature, gain                                                         |       | 9,118                                       |       | 2,093 |   | — |   |
| Other income                                                                                        |       | —                                      |       | 302 |   | — |   |
| Interest expense                                                                                    |       | (6,021                                      | )          | (6,577 | ) | (390 | ) |
| Interest income                                                                                     |       | 17                                          |       | 37 |   | 304 |   |
| Gain on sale of marketable securities held-for-sale                                                 |       | —                                      |       | — |   | 1,178 |   |
| (Loss) before income taxes, minority interest and discontinued  operations                          |       | (7,053                                      | )          | (14,136 | ) | (32,789 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Income taxes                                                                                        |       | —                                      |       | — |   | — |   |
|                                                                                                |       |                                        |       |   |   |   |   |
| (Loss) before minority interest and discontinued operations                                         |       | (7,053                                      | )          | (14,136 | ) | (32,789 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Minority interest in loss of consolidated subsidiary                                                |       | —                                      |       | — |   | 21 |   |
|                                                                                                |       |                                        |       |   |   |   |   |
| (Loss) from continuing operations                                                                   |       | (7,053                                      | )          | (14,136 | ) | (32,768 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Discontinued operations:                                                                            |       |                                        |       |   |   |   |   |
| (Loss) from operations of discontinued operations, net                                              |       | —                                      |       | (749 | ) | (964 | ) |
| Gain from disposal of discontinued operations, net                                                  |       | —                                      |       | — |   | 127 |   |
| Net (Loss)                                                                                          |       | (7,053                                      | )          | (14,885 | ) | (33,605 | ) |
| Other comprehensive gain (loss):                                                                    |       |                                        |       |   |   |   |   |
| Foreign exchange translation gain during the period                                                 |       | 299                                         |       | 1,716 |   | 211 |   |
| Net unrealized (loss) on marketable securities available-for-sale                                   |       | —                                      |       | — |   | (1,668 | ) |
| Comprehensive (loss)                                                                                |       | $                                           | (6,754     | ) | $ | (13,169 | ) | $ | (35,062 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Per common share basic and diluted:                                                                 |       |                                        |       |   |   |   |   |
| Loss per share - continuing operations                                                              |       | (0.17                                       | )          | (0.34 | ) | (0.79 | ) |
| Loss per share - discontinuing operations                                                           |       | —                                      |       | (0.02 | ) | (0.02 | ) |
| Loss per share basic and diluted                                                                    |       | (0.17                                       | )          | (0.36 | ) | (0.81 | ) |
|                                                                                                |       |                                        |       |   |   |   |   |
| Number of weighted average shares - basic and diluted                                               |       | 41,833                                      |       | 41,610 |   | 41,505 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

84

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)**

**(inthousands, except share data)**

 
| ** **                                        | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Unamortized  Stock-based  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (loss)** | ** ** | **Total**  | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                        | ** ** | ** **         | ** ** | ** **        | ** ** | **(Restated)**                   | ** ** | **(Restated)**                             | ** ** | **(Restated)**           | ** ** | ** **                                           | ** ** | ** ** | ** ** |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| **Balance, December 31, 2002 (As Restated)** |       | 41,009,245         |       | $                 | 106,554    |                             | $          | 21,575                                     |       | $                        | (260       | )                                                    | $          | (78,982    | )          | $ | 1,712 |   | $ | 50,599 |   |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| Stock options exercised                           |       | 684,165            |       | 1,149             |       | —                           |       | —                                     |       | —                   |       | —                                               |       | 1,149      |       |
| Repurchase of shares                              |       | (93,758            | )          | (653              | )          | —                           |       | —                                     |       | —                   |       | —                                               |       | (653       | )          |
| Change in par value due to reincorporation        |       | —             |       | (107,008          | )          | 107,008                          |       | —                                     |       | —                   |       | —                                               |       | —     |       |
| Stock-based compensation                          |       | 10,000             |       | —            |       | 100                              |       | 25                                         |       | —                   |       | —                                               |       | 125        |       |
| Unamortized stock option-based compensation       |       | —             |       | —            |       | (107                             | )          | 107                                        |       | —                   |       | —                                               |       | —     |       |
| Purchase of common stock of subsidiaries          |       | —             |       | —            |       | 5                                |       | —                                     |       | —                   |       | —                                               |       | 5          |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                           |       | —                                     |       | —                   |       | 211                                                  |       | 211        |       |
| Reclassification for net realized gain            |       | —             |       | —            |       | —                           |       | —                                     |       | —                   |       | (1,668                                               | )          | (1,668     | )          |
| Net loss                                          |       | —             |       | —            |       | —                           |       | —                                     |       | (33,605                  | )          | —                                               |       | (33,605    | )          |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| **Balance December 31, 2003**                |       | 41,609,652         |       | $                 | 42         |                             | $          | 128,581                                    |       | $                        | (128       | )                                                    | $          | (112,587   | )          | $ | 255 |   | $ | 16,163 |   |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| Stock-based compensation                          |       | —             |       | —            |       | 261                              |       | 15                                         |       | —                   |       | —                                               |       | 276        |       |
| Unamortized stock option-based compensation       |       | —             |       | —            |       | (113                             | )          | 113                                        |       | —                   |       | —                                               |       | —     |       |
| Redemption of convertible notes payable           |       | —             |       | —            |       | 914                              |       | —                                     |       | —                   |       | —                                               |       | 914        |       |
| Warrants cancelled                                |       | —             |       | —            |       | 7                                |       | —                                     |       | —                   |       | —                                               |       | 7          |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                           |       | —                                     |       | —                   |       | 1,716                                                |       | 1,716      |       |
| Net loss                                          |       | —             |       | —            |       | —                           |       | —                                     |       | (14,885                  | )          | —                                               |       | (14,885    | )          |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| **Balance, December 31, 2004 (As Restated)** |       | 41,609,652         |       | $                 | 42         |                             | $          | 129,650                                    |       | $                        | —     |                                                 | $          | (127,472   | )          | $ | 1,971 |   | $ | 4,191 |   |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| Stock based compensation                          |       | —             |       | —            |       | 41                               |       | —                                     |       | —                   |       | —                                               |       | 41         |       |
| Conversion of notes payable                       |       | 485,750            |       | —            |       | 1,026                            |       | —                                     |       | —                   |       | —                                               |       | 1,026      |       |
| Redemption of convertible notes payable           |       | —             |       | —            |       | 1                                |       | —                                     |       | —                   |       | —                                               |       | 1          |       |
| Common stock issued as director’s fees       |       | 92,219             |       | —            |       | 175                              |       | —                                     |       | —                   |       | —                                               |       | 175        |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                           |       | —                                     |       | —                   |       | 299                                                  |       | 299        |       |
| Net loss                                          |       | —             |       | —            |       | —                           |       | —                                     |       | (7,053                   | )          | —                                               |       | (7,053     | )          |
|                                              |       |               |       |              |       |                             |       |                                       |       |                     |       |                                                 |       |       |       |
| **Balance, December 31, 2005 (As Restated)** |       | 42,187,621         |       | $                 | 42         |                             | $          | 130,893                                    |       | $                        | —     |                                                 | $          | (134,525   | )          | $ | 2,270 |   | $ | (1,320 | ) |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

85

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands, exceptshare data)**

 
| ** **                                                                                    | ** ** | **Years  Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                    | ** ** | **(Restated)**                     | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| **Operating activities:**                                                                     | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net (loss)                                                                                    |       | $                                  | (7,053     | ) | (14,885 | ) | (33,605 | ) |
| Add (gain) loss from operations and loss on disposition of  discontinued operations           |       | —                             |       | 749 |   | 837 |   |
|                                                                                          |       | (7,053                             | )          | (14,136 | ) | (32,768 | ) |
| Adjustments to reconcile net loss from operations to net cash used  for operating activities: |       |                               |       |   |   |   |   |
| Impairment of long lived assets                                                               |       | 4,307                              |       | — |   | 2,684 |   |
| Impairment of goodwill                                                                        |       | —                             |       | — |   | 184 |   |
| Loss from growell settlement                                                                  |       | —                             |       | — |   | 2,765 |   |
| Gain on sale of marketable securities held-for-sale                                           |       | —                             |       | — |   | (1,178 | ) |
| (Gain) loss on disposal of asset                                                              |       | (14                                | )          | 4 |   | — |   |
| Depreciation and amortization                                                                 |       | 3,401                              |       | 3,444 |   | 4,354 |   |
| Loss on extinguishments of debt                                                               |       | 1,247                              |       | 2,941 |   | — |   |
| Amortization of debt discount                                                                 |       | 3,869                              |       | 5,834 |   | — |   |
| Stock-based compensation                                                                      |       | 41                                 |       | 276 |   | 123 |   |
| Bad debt (recovery) expense                                                                   |       | (6                                 | )          | 84 |   | (28 | ) |
| Warranty expense                                                                              |       | 101                                |       | 288 |   | (297 | ) |
| Minority interest                                                                             |       | —                             |       | — |   | (21 | ) |
| (Gain) loss from change in value of warrants                                                  |       | (3,985                             | )          | (747 | ) | — |   |
| (Gain) loss from change in value of conversion feature                                        |       | (9,118                             | )          | (2,093 | ) | — |   |
| Changes in operating assets and liabilities:                                                  |       |                               |       |   |   |   |   |
| Trade accounts receivable                                                                     |       | (686                               | )          | 1,996 |   | 1,660 |   |
| Inventories                                                                                   |       | (151                               | )          | (2,103 | ) | (100 | ) |
| Prepaid expenses and other current assets                                                     |       | 350                                |       | (535 | ) | 1,689 |   |
| Other assets                                                                                  |       | (378                               | )          | (869 | ) | 83 |   |
| Accounts payable and accrued expenses                                                         |       | 1,606                              |       | 998 |   | (5,969 | ) |
| Deferred revenue                                                                              |       | 375                                |       | (535 | ) | 38 |   |
| Other liabilities                                                                             |       | (412                               | )          | (1,244 | ) | 2,661 |   |
| Net cash used for continuing operations                                                       |       | (6,506                             | )          | (6,397 | ) | (24,120 | ) |
|                                                                                          |       |                               |       |   |   |   |   |
| Net cash provided by (used for) discontinued operations                                       |       | —                             |       | 73 |   | (2,429 | ) |
| Net cash used for operating activities                                                        |       | (6,506                             | )          | (6,324 | ) | (26,549 | ) |
| **Investing Activities:**                                                                     | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                           |       | (169                               | )          | (73 | ) | (2,329 | ) |
| Proceeds from sale of property and equipment                                                  |       | 69                                 |       | 38 |   | — |   |
| Proceeds from sale of marketable securities held-for-sale                                     |       | —                             |       | — |   | 2,578 |   |
| Investment in patents and trademarks                                                          |       | (159                               | )          | (273 | ) | (298 | ) |
| Net cash used for investing activities                                                        |       | (259                               | )          | (308 | ) | (49 | ) |
| **Financing Activities:**                                                                     | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from borrowings                                                                      |       | 17,774                             |       | 9,924 |   | 5,488 |   |
| Repayment of borrowings                                                                       |       | (11,333                            | )          | (5,184 | ) | (1,441 | ) |
| Repayment of other liabilities                                                                |       | (133                               | )          | (135 | ) | (72 | ) |
| Proceeds from restricted cash                                                                 |       | 754                                |       | (754 | ) | — |   |
| Stock options exercised                                                                       |       | —                             |       | — |   | 899 |   |
| Proceeds from issuance of common stock by subsidiaries, net                                   |       | —                             |       | — |   | 5 |   |
| Net cash provided by financing activities                                                     |       | 7,062                              |       | 3,851 |   | 4,879 |   |
| Effect of foreign exchange translation                                                        |       | 353                                |       | 396 |   | (212 | ) |
| Net increase (decrease) in cash and cash equivalents                                          |       | 650                                |       | (2,385 | ) | (21,931 | ) |
| Cash and cash equivalents at beginning of period                                              |       | 742                                |       | 3,127 |   | 25,058 |   |
| Cash and cash equivalents at end of period                                                    |       | 1,392                              |       | 742 |   | 3,127 |   |
|                                                                                          |       |                               |       |   |   |   |   |
| Supplemental cash flow information                                                            |       |                               |       |   |   |   |   |
| Interest paid                                                                                 |       | $                                  | 1,472      |   | $ | 640 |   | $ | 443 |   |
| Taxes paid                                                                                    |       | $                                  | —     |   | $ | — |   | $ | — |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

86

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In 2005, theCompany’s 6% senior convertible notes due July 2007 was converted into485,750 of the Company’s common stock at a conversion price of $1.00 per share.

 

In 2004, theCompany sold its 51% ownership interest in Dongyang to the 49% minorityshareholder, which resulted in a loss of $46 from disposal of discontinuedoperations.

 

In 2004, the Company sold assets and liability of its Taesung equipmentmanufacturing division in Korea to a third party which resulted in a loss ofapproximately $184.

 

In 2003, an option holder surrendered 93,758 shares of theCompany’s common stock in lieu of cash payment for the option exercise price of$250 and income taxes payable by the option holder of $403. The Companyimmediately canceled the common shares received in lieu of cash payment uponreceipt of the shares.

 

In 2003 the Company reclassified $1,477 of machines fromproperty, plant and equipment to machines held by customer.

 

In 2003, the Company entered into a lease agreement for$291 of laboratory equipment that was recorded as a capital lease obligation.

 

The accompanying notes are an integralpart of the consolidated financial statements.

 

87

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**LIQUIDMETALTECHNOLOGIES, INC AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**Forthe Years Ended December 31, 2005, 2004, and 2003**

**(inthousands, except share data)**

 

**1. Description of Business**

 

Liquidmetal Technologies, Inc. (“LiquidmetalTechnologies”) and its subsidiaries (collectively “the Company”) are in thebusiness of developing, manufacturing, and marketing products made fromamorphous alloys. Liquidmetal Technologies markets and sells Liquidmetal® alloyindustrial coatings and also manufactures, markets and sells products andcomponents from bulk Liquidmetal alloys that can be incorporated into thefinished goods of its customers across a variety of industries. The Companyalso partners with third-party licensees and distributors to develop andcommercialize Liquidmetal alloy products.

 

The Company classifies operations into two reportablesegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys.Liquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal-burning power plants. BulkLiquidmetal alloys include potential market opportunities to manufacture andsell products and components for electronic devices, medical devices, defenseapplications, and sporting goods. In addition, the bulk Liquidmetal alloyssegment includes tooling and prototype sampling, and the manufacture and saleof die casting and VIM equipment (see Note 4 for disclosure regarding thedisposal of this segment). In addition, such alloys are used to generateresearch and development services revenue for developing uses related primarilyto defense and medical applications as well as potential license fees,royalties, and other compensation from strategic partnering transactions.

 

On August 4, 2004, the Company established a post-processingplant in the city of Weihai in Shandong province of China under WeihaiLiquidmetal Company Limited, which is 100 percent owned by Liquidmetal Korea,to facilitate our bulk alloy manufacturing business. Weihai Liquidmetal isconsolidated into Liquidmetal Technologies with all intercompany transactionseliminated.

 

**2. Restatement**

 

Asa part of the accompanying consolidated financial statements and the notesthereto, the Company has restated certain previously issued financialstatements due to an error related to the Company’s accounting for embeddedconvertible feature of senior convertible notes issued in March 2004,which was exchanged in August 2004, in accordance with Statement ofFinancial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” (SFAS 133).

 

The Company previously had incorrectly accounted for the conversionfeature of senior convertible notes during 2004 and 2005 in additional paid incapital for the beneficial conversion feature of the notes under EmergingIssues Task Force (EITF) 00-19, “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, andEITF 00-27 “Application of Issue No. 98-5, ‘Accounting for ConvertibleSecurities with Beneficial Conversion Features or Contingently AdjustableConversion Ratios,’ to Certain Convertible Instruments.”  The Company had failed to identify andaccount for the conversion feature as an embedded derivative in accordance withSFAS 133.

 

Thecorrection of the error to properly state the fair value of the embeddedconversion feature of senior convertible notes in accordance with SFAS 133resulted in recognition of $7,595 as a conversion feature liability as of theissuance of the senior convertible note in March 2004 as the convertiblenotes are considered non-conventional convertible debt instrument. The correctionresulted in recognition of the change in fair value of the embedded conversionfeature in the Company’s earnings as a gain of $2,093 and $5,269 for the yearsended December 31, 2004 and 2005, respectively, as well as adjustments toamortization of debt discount as interest expense of $2,974 and $1,076 for theyears ended December 31, 2004 and 2005, respectively, and an additionalloss on extinguishment of debt of $1,278 for the year ended December 31,2004. Additionally, the Company recognized $914 and $542 in additional paid incapital from redemption and conversion of convertible notes as of December 31,2004 and 2005, respectively (see Note 15). As part of the restatement,reclassifications to prior period consolidated financial statements have beenmade for consistent presentation of our warrant liabilities, settlementpayable, and change in value of warrant liabilities.

 

88

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Theeffects of the restatements are as follows:

 
| ** **                                                                                                                                                            | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2005**                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                                            | ** ** | **Previously  Reported**    | ** ** | **Restated** | ** ** | **Previously  Reported** | ** ** | **Restated** | ** ** |
| **ASSETS**                                                                                                                                                            | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current Assets:                                                                                                                                                       |       |                        |       |   |   |   |   |   |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                             |       | $                           | 1,392      |   | $ | 1,392 |   | $ | 742 |   | $ | 742 |   |
| Restricted cash                                                                                                                                                       |       | —                      |       | — |   | 754 |   | 754 |   |
| Trade accounts receivables, net of allowance for doubtful accounts                                                                                                    |       | 2,360                       |       | 2,360 |   | 1,668 |   | 1,668 |   |
| Inventories                                                                                                                                                           |       | 1,748                       |       | 1,748 |   | 2,353 |   | 2,353 |   |
| Prepaid expenses and other current assets                                                                                                                             |       | 609                         |       | 609 |   | 930 |   | 930 |   |
| Total current assets                                                                                                                                                  |       | 6,109                       |       | 6,109 |   | 6,447 |   | 6,447 |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Property, plant and equipment, net                                                                                                                                    |       | 13,437                      |       | 13,437 |   | 16,434 |   | 16,434 |   |
| Idle equipment                                                                                                                                                        |       | 193                         |       | 193 |   | 1,906 |   | 1,906 |   |
| Long-term inventory                                                                                                                                                   |       | —                      |       | — |   | 1,810 |   | 1,810 |   |
| Other intangibles, net                                                                                                                                                |       | 1,185                       |       | 1,185 |   | 1,143 |   | 1,143 |   |
| Other assets                                                                                                                                                          |       | 639                         |       | 639 |   | 768 |   | 768 |   |
| Total assets                                                                                                                                                          |       | $                           | 21,563     |   | $ | 21,563 |   | $ | 28,508 |   | $ | 28,508 |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                         | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                            | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current liabilities:                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Accounts payable and accrued expenses                                                                                                                                 |       | $                           | 6,530      |   | $ | 6,530 |   | $ | 4,969 |   | $ | 4,969 |   |
| Settlement payable                                                                                                                                                    |       | 3,331                       |       | 3,331 |   | 3,246 |   | 3,246 |   |
| Deferred revenue                                                                                                                                                      |       | 1,275                       |       | 1,275 |   | 900 |   | 900 |   |
| Short-term debt                                                                                                                                                       |       | 550                         |       | 550 |   | — |   | — |   |
| Long-term debt, current portion, net of debt discount                                                                                                                 |       | 1,343                       |       | 1,343 |   | 5,991 |   | 4,010 |   |
| Other liabilities, current portion                                                                                                                                    |       | 483                         |       | 483 |   | 1,032 |   | 1,032 |   |
| Warrant liabilities                                                                                                                                                   |       | 1,792                       |       | 1,792 |   | 550 |   | 550 |   |
| Conversion feature liabilities                                                                                                                                        |       | 959                         |       | 1,798 |   | — |   | 6,650 |   |
| Total current liabilities                                                                                                                                             |       | 16,263                      |       | 17,102 |   | 16,688 |   | 21,357 |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Long-term debt, net of current portion and debt discount March 31,  2006, December 31, 2005 and 2004, respectively                                          |       | 6,338                       |       | 5,433 |   | 2,618 |   | 2,618 |   |
| Other long-term liabilities, net of current portion                                                                                                                   |       | 348                         |       | 348 |   | 342 |   | 342 |   |
| Total liabilities                                                                                                                                                     |       | 22,949                      |       | 22,883 |   | 19,648 |   | 24,317 |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Shareholder’s equity (deficiency):                                                                                                                               |       |                        |       |   |   |   |   |   |   |
| Common stock, $0.001 par value; 100,000,000 shares authorized and  42,187,621 and 41,609,652 issued and outstanding at December 31, 2005  and 2004, respectively |       | 42                          |       | 42 |   | 42 |   | 42 |   |
| Additional paid-in capital                                                                                                                                            |       | 132,861                     |       | 130,893 |   | 132,160 |   | 129,650 |   |
| Accumulated deficit                                                                                                                                                   |       | (136,559                    | )          | (134,525 | ) | (125,313 | ) | (127,472 | ) |
| Accumulated other comprehensive income                                                                                                                                |       | 2,270                       |       | 2,270 |   | 1,971 |   | 1,971 |   |
| Total shareholder’ equity (deficiency)                                                                                                                           |       | (1,386                      | )          | (1,320 | ) | 8,860 |   | 4,191 |   |
|                                                                                                                                                                  |       |                        |       |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity (deficiency)                                                                                                          |       | $                           | 21,563     |   | $ | 21,563 |   | $ | 28,508 |   | $ | 28,508 |   |

 

89

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| ** **                                                                                        | ** ** | **Years  Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2004** | ** ** |
| ** **                                                                                        | ** ** | **Previously  Reported**           | ** ** | **Restated** | ** ** | **Previously  Reported** | ** ** | **Restated** | ** ** |
| ** **                                                                                        | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                           |       | $                                  | 16,365     |   | $ | 16,365 |   | $ | 17,429 |   | $ | 17,429 |   |
| Cost of sales                                                                                     |       | 15,129                             |       | 15,129 |   | 12,168 |   | 12,168 |   |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Gross (loss) profit                                                                               |       | 1,236                              |       | 1,236 |   | 5,261 |   | 5,261 |   |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Operating expenses                                                                                |       |                               |       |   |   |   |   |   |   |
| Selling, general, and administrative                                                              |       | 8,534                              |       | 8,534 |   | 11,591 |   | 11,591 |   |
| Research and development                                                                          |       | 1,120                              |       | 1,120 |   | 1,467 |   | 1,467 |   |
| Impairment of goodwill                                                                            |       | —                             |       | — |   | — |   | — |   |
| Impairment of long lived assets                                                                   |       | 4,487                              |       | 4,487 |   | — |   | — |   |
| Total operating expenses                                                                          |       | 14,141                             |       | 14,141 |   | 13,058 |   | 13,058 |   |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Loss before interest, other income, income taxes, minority interest,  and discontinued operations |       | (12,905                            | )          | (12,905 | ) | (7,797 | ) | (7,797 | ) |
| Loss from extinguishments of debt                                                                 |       | (1,247                             | )          | (1,247 | ) | (1,663 | ) | (2,941 | ) |
| Change in value of warrants, (loss) gain                                                          |       | 3,985                              |       | 3,985 |   | 747 |   | 747 |   |
| Change in value of conversion feature, (loss) gain                                                |       | 3,849                              |       | 9,118 |   | — |   | 2,093 |   |
| Other income                                                                                      |       | —                             |       | — |   | 302 |   | 302 |   |
| Interest expense                                                                                  |       | (4,945                             | )          | (6,021 | ) | (3,603 | ) | (6,577 | ) |
| Interest income                                                                                   |       | 17                                 |       | 17 |   | 37 |   | 37 |   |
| Gain on sale of marketable securities held-for-sale                                               |       | —                             |       | — |   | — |   | — |   |
| Loss before income taxes, minority interest and discontinued  operations                          |       | (11,246                            | )          | (7,053 | ) | (11,977 | ) | (14,136 | ) |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Income taxes                                                                                      |       | —                             |       | — |   | — |   | — |   |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Loss before minority interest and discontinued operations                                         |       | (11,246                            | )          | (7,053 | ) | (11,977 | ) | (14,136 | ) |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Minority interest in loss of consolidated subsidiary                                              |       | —                             |       | — |   | — |   | — |   |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Loss from continuing operations                                                                   |       | (11,246                            | )          | (7,053 | ) | (11,977 | ) | (14,136 | ) |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Discontinued operations:                                                                          |       |                               |       |   |   |   |   |   |   |
| Income (loss) from operations of discontinued operations, net                                     |       | —                             |       | — |   | (749 | ) | (749 | ) |
| Gain (loss) from disposal of discontinued operations, net                                         |       | —                             |       | — |   | — |   | — |   |
| Net Loss                                                                                          |       | (11,246                            | )          | (7,053 | ) | (12,726 | ) | (14,885 | ) |
| Other comprehensive gain (loss):                                                                  |       |                               |       |   |   |   |   |   |   |
| Foreign exchange translation gain during the period                                               |       | 299                                |       | 299 |   | 1,716 |   | 1,716 |   |
| Net unrealized gain (loss) on marketable securities  available-for-sale                           |       | —                             |       | — |   | — |   | — |   |
| Comprehensive loss                                                                                |       | $                                  | (10,947    | ) | $ | (6,754 | ) | $ | (11,010 | ) | $ | (13,169 | ) |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Per common share basic and diluted:                                                               |       |                               |       |   |   |   |   |   |   |
| Loss per share - continuing operations                                                            |       | (0.27                              | )          | (0.17 | ) | (0.29 | ) | (0.34 | ) |
| Loss per share - discontinuing operations                                                         |       | —                             |       | — |   | (0.02 | ) | (0.02 | ) |
| Loss per share basic and diluted                                                                  |       | (0.27                              | )          | (0.17 | ) | (0.31 | ) | (0.36 | ) |
|                                                                                              |       |                               |       |   |   |   |   |   |   |
| Number of weighted average shares - basic and diluted                                             |       | 41,833                             |       | 41,833 |   | 41,610 |   | 41,610 |   |

 

90

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**3. Liquidity**

 

The Company has experienced losses from continuingoperations during the last two fiscal years and has an accumulated deficit of$134,525 as of December 31, 2005. Cash used for continuing operations forthe year ended December 31, 2005 was $6,506. At December 31, 2005,working deficit was $10,993. As of December 31, 2005, the Company’sprincipal source of liquidity is $1,392 of cash and $2,360 of trade accountsreceivable. Such conditions raise substantial doubt that the Company will beable to continue as a going concern. These operating results occurred while theCompany was developing and continues to develop and to commercialize andmanufacture products from an entirely new and unique technology. These factorshave placed a significant strain on the financial resources of the Company. Theability of the Company to overcome these challenges depends on its ability tocorrect its production inefficiencies, continue to reduce its operating costs,generate higher revenue, and achieve positive cash flow from continuingoperations and profitability and continued sources of debt and equity financing.The consolidated financial statements do not include any adjustments that mightresult from the outcome of the uncertainty.

 

Capital requirements during the next 12 months willdepend on numerous factors, including the success of existing products, thedevelopment of new applications for Liquidmetal alloys, the resources devotedto develop and support Liquidmetal alloy products. If the available funds andcash generated from operations are insufficient to satisfy liquidityrequirements, the Company will need additional funds in the future to supportworking capital requirements and for other purposes, and will need to raiseadditional funds through public or private equity financing, bank debtfinancing, or from other sources. Subsequent to the close of the second quarterof 2005, the Company completed a private placement of $9,878 of 7% convertibledebt in consideration for $5,000 aggregate cash received, $4,280 exchange ofpreviously issued notes, and satisfaction of accrued interest and fees of $598from the previously issued notes (see Note 15). Adequate funds may not beavailable when needed or may not be available on favorable terms. TheCompany expects to continue to devote limited capital to our research anddevelopment activities, to further develop and strengthen our manufacturingcapabilities, and for working capital and other general corporate purposes.

 

Pursuant to Section 404 of the Sarbanes-OxleyAct of 2002 (“SOX 404”), the SEC has adopted rules requiring publiccompanies to include a report of management on the company’s internal controlsover financial reporting in their annual reports on Form 10-K. Inaddition, the public accounting firm auditing a public company’s financialstatements must attest to and report on management’s assessment of theeffectiveness of the company’s internal controls over financial reporting. Althoughthese requirements were first applicable to the Company’s annual report on Form 10-Kfor the fiscal year ended December 31, 2004, the Company did not complywith these requirements for such fiscal year as described in the followingparagraphs.

 

EffectiveDecember 27, 2005, the SEC announced final rulings on revisions toaccelerated filer definition and deadlines for periodic reports. The rulingrevised the definition of the term “accelerated filer” to permit an acceleratedfiler that has voting and non-voting common equity held by non-affiliates ofless than $50 million to exit accelerated filer status at the end of the fiscalyear in which its equity falls below $50 million and to file its annual reportfor that year and subsequent periodic reports on a non-accelerated basis. As ofthe fiscal year ended December 31, 2005, we are considered an acceleratedfiler and are required to comply with SOX 404 requirements for the 2005 fiscalyear.

 

****The time********and resources committed to the restatement of prior periods’ financial statementsas aforementioned delayed our internal timetable with respect to ourdocumentation, assessment and evaluation of internal control over financialreporting. Due to the issues described in the foregoing paragraph, as well aslimitation on financial and internal resources, management’s assessment of theeffectiveness of our internal control over financial reporting had beensubstantially delayed, which in turn had delayed the Company’s independentregistered public accounting firm, Stonefield Josephson, Inc. inperforming its audit of management’s assessment of the effectiveness ofinternal control over financial reporting pursuant to SOX 404. Therefore, theCompany’s independent registered public accounting firm issued a disclaimer ofopinion with respect to the Company’s internal control over financial reportingas of December 31, 2004, and such disclaimer was filed with the Company’samended Form 10-K filed on May 10, 2005.****

 

****The Companyhas devoted significant amount of financial and internal resources during 2005and early part of 2006 to ensure compliance with SOX 404, and on January 16,2006, Company’s management has completed and concluded its documentation,assessment and evaluation of its internal controls over financial reporting asof December 31, 2005. However, our independent auditors, StonefieldJosephson Inc., resigned on December 1, 2005, and on January 20,2006, the Company hired Choi, Kim & Park LLP (“CKP”) as its newindependent registered public accounting firm. While the Company has advisedCKP of the foregoing weaknesses in internal controls, due to the untimelinessof the foregoing events, CKP was unable to satisfactorily complete their auditof the Company’s internal control over financial reporting pursuant to SOX 404,and thus, have issued a disclaimer of an opinion on the company’s internalcontrol over financial reporting as of December 31, 2005. The Company’smanagement will continue to monitor potential changes in the legal andregulatory requirements of SOX 404, particularly the requirements for smallpublic companies.****

 

91

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****The filing of a disclaimer does not comply with theSEC’s rules and regulations under Section 404, and this noncompliancehas resulted in the Company being in violation of Section 13(a) underthe Securities Exchange Act of 1934. Section 13(a) establishes thegeneral requirement that public companies must file with the SEC, in accordancewith such rules and regulations as the SEC may prescribe, suchinformation, documents, and reports as the SEC may from time to timerequire for the protection of investors, including Form 10-Ks and 10-Qs.****

 

****In addition to the foregoing, although the Company’scommon stock was admitted to the OTC Bulletin Board for quotation on June 15,2005, as a result of our noncompliance with Section 404 for the 2005fiscal year, it may not have been appropriate for the OTC Bulletin Boardto admit our common stock for quotation on June 15, 2005. Consequently,there is no assurance that the Company’s common stock will remain eligible forquotation on the OTC Bulletin Board.****

 

**4. Summary of Significant AccountingPolicies**

 

*Principles of Consolidation.*The consolidated financial statementsinclude the accounts of Liquidmetal Technologies, Inc. and its wholly-ownedsubsidiaries, Liquidmetal Korea Co., Ltd. (“LMT Korea”), located in SouthKorea, Chusik Hoesa Dongyang Yudoro (“Dongyang”), now accounted for as adiscontinued operations, and Liquidmetal Golf and its subsidiaries, whichincluded the retail golf segment, now accounted for as a discontinuedoperations. The Company acquired its 51% interest in Dongyang in 2002. Theaggregate purchase price was $333 in cash. As of March 2004, the Companydivested of its 51% ownership in Dongyang to the minority shareholder.InJune 2004, the Company sold assets and liability of its Taesung equipmentmanufacturing division in Korea to a third party.Accordingly, the results of Dongyang and Taesung’soperations have been reclassified in the consolidated financial statements asdiscontinued operations (see Note 18). Previously, the results of Donyang andTaesung’s operations have been included in the consolidated financialstatements from the acquisition date. All intercompany balances andtransactions have been eliminated. A minority interest in Liquidmetal Golf isincluded in the consolidated financial statements as a component of the lossfrom operations of the discontinued retail golf segment (see Note 18). Effectivein 2003, management closed the Japan operations and the Seoul office, which didnot result in a significant impact on the financial position or results ofoperations for any of the periods presented. Also, effective in December 2003,management closed the Tampa office (see Note 12). In August 2004, the Companyestablished a post-processing plant in the city of Weihai in Shandong provinceof China under Weihai Liquidmetal Company Limited, which is 100 percent ownedby Liquidmetal Korea, to facilitate our bulk alloy manufacturing business.

 

*Sales of Stock by Subsidiaries.*Gains on sales of stock by LiquidmetalGolf are recognized as components of the Company’s shareholders’ equity(deficiency).

 

*Revenue Recognition.*Revenue is recognized pursuant toapplicable accounting standards including Securities and Exchange Commission (“SEC”)Staff Accounting Bulletin (“SAB”) No. 101 (SAB 101), *“Revenue Recognition in Financial Statements”*,and *SAB 104, Revenue Recognition*.SAB 101 as amended and SAB 104 summarize certain points of the SEC staff’sviews in applying generally accepted accounting principles to revenuerecognition in financial statements and provides guidance on revenuerecognition issues in the absence of authoritative literature addressing aspecific arrangement or a specific industry. The Company’s revenue recognitionpolicy complies with the requirements of SAB 101 and SAB 104. Revenue isrecognized at the time the Company ships its products, as this is when titlepasses to the customer and all other incidences of a sale have occurred.Revenue is deferred and included in liabilities when the Company receives cashin advance for services not yet performed or goods not yet delivered.

 

The Company applies the percentage of completion method torecognize revenue earned from government contracts that have cost-plus-fixed-feearrangements. These arrangements provide the Company with full reimbursement onthe actual cost incurred, plus a fixed fee that the Company is entitled to. Thesearrangements are covered by the American Institute of Certified Public AccountantsStatement of Position 81-1, *Accounting forPerformance of Construction-Type and Certain Production-Type Contracts*(SOP 81-1) and Accounting Research Bulletin No. 45, *Long-term Construction-Type Contracts* (ARB45). In addition, cost-reimbursable contracts are also specifically covered byAccounting Research Bulletin No. 43, Chapter 11, Section A, *Government Contracts, Cost-Plus-Fixed Fee Contracts*(ARB43). Substantially all of our cost-reimbursable and time and material contractsare with the U.S. Government, primarily with the Department of Defense. Revenuesrecognized under cost-plus-fixed fee are consistent with percentage ofcompletion method and are consistent with ARB 43.

 

Sales on cost-reimbursable plus fixedfee type contracts are recognized as allowable costs are incurred on thecontract and become billable to the customer, at an amount equal to theallowable costs plus the estimated profit on those costs. The estimated profiton a cost-reimbursable contract is generally fixed or variable based on thecontract fee arrangement.

 

*Cash and Cash Equivalents.*The Company considers all highlyliquid investments with maturity dates of three months or less when purchasedto be cash equivalents. The Company limits the amount of credit exposure toeach individual financial institution and

 

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places its temporary cash into investments of high creditquality. There are no significant concentrations of credit risk to the Companyassociated with cash and cash equivalents.

 

*Restricted Cash.* The Company considers all cash and cash equivalents heldunder restrictive accounts as restricted cash.

 

*Marketable Securities.*The Company follows Statement ofFinancial Accounting Standards (“SFAS”) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, and classifies all of its investment securities asavailable -for-sale. Available-for-sale securities are carried at fair value,with the unrealized gains and losses reported in Shareholders’ Equity (Deficiency)under the caption “Accumulated Other Comprehensive Income.”

 

*Trade Accounts Receivables.*The Company grants credit to itscustomers generally in the form of short-term trade accounts receivable.The creditworthiness of customers is evaluated prior to the sale of inventory. Asof December 31, 2005, one customer represented 12%, or $288, of the totaloutstanding trade accounts receivable. Two customers represent 30%, or $497, oftotal outstanding trade accounts receivable as of December 31, 2004.

 

The allowance for doubtful accounts reflects management’sbest estimate of probable losses inherent in the trade accounts receivable. Managementprimarily determines the allowance based on the aging of accounts receivablebalances, historical write-off experience, customer concentrations, customercreditworthiness and current industry and economic trends. The Company’sprovisions for uncollectible receivables are included in selling, general andadministrative expense in the accompanying consolidated statements ofoperations and comprehensive loss.

 

*Inventories.*Inventories are accounted for usingthe moving average basis and reported at the lower of cost or market.Inventories consist of raw materials, work in process, and finished goods. TheCompany records write-offs for inventory obsolescence when it is deemed thatthere is impairment of the value of the inventories on hand.

 

*Property, Plant and Equipment.*Property, plant and equipment arestated at cost less accumulated depreciation and amortization. Additions andmajor renewals are capitalized. Repairs and maintenance are charged to expenseas incurred. Upon disposal, the related cost and accumulated depreciation areremoved from the accounts, with the resulting gain or loss included inoperating income. Depreciation is provided principally on the straight-linemethod over the estimated useful lives of the assets, which range from two totwenty years.

 

Leased property meeting certain criteria is capitalized andthe present value of the related lease payments is recorded as a liability.Amortization of capitalized leased assets is provided on the straight-linemethod over the estimated useful lives of the assets, which is five years.

 

*Intangible Assets.*Intangible assets consist of the costsincurred to purchase patent rights and costs incurred to internally developpatents and trademarks. Intangible assets are reported net of accumulatedamortization. Patents and trademarks are amortized using the straight-linemethod over a period based on their contractual lives ranging from ten toseventeen years.

 

*Goodwill.*Beginning January 1, 2002, the Company adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*(See “NewAccounting Pronouncements”). According to this statement, goodwill and otherintangible assets are no longer subject to amortization, but instead must bereviewed annually for impairment by applying a fair value-based test.

 

*Impairment of Long-lived Assets.*The Company reviews long-lived assetsto be held and used in operations for impairment whenever events or changes incircumstances indicate that the carrying value of an asset may beimpaired. An impairment loss is recognized when the estimated fair value of theassets is less than the carrying value of the assets. The Company recognized animpairment of long-lived assets in the amount of $4,512 during the year ended December 31,2005 (see Notes 6 and 8), $0 during the year ended December 31, 2004, and$2,684 during the year ended December 31, 2003 (see Note 7).

 

*Fair Value of Financial Instruments.*The estimated fair value of amountsreported in the consolidated financial statements have been determined usingavailable market information and valuation methodologies, as applicable. Thecarrying amount of cash and cash equivalents, accounts receivable, accountspayable, and all other current assets and liabilities approximate their fairvalue because of their short term maturities at December 31, 2005 and2004, unless otherwise stated. The fair value of non-current assets andliabilities approximate their carrying value unless otherwise stated. The fairvalue of the Company’s long-term debt is based on interest rates that would beavailable to the Company for the issuance of debt with similar terms.

 

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*Research and Development Expenses.*Research and development expensesrepresent salaries, related benefits expense, expenses incurred for the designand testing of new processing methods and other expenses related to theresearch and development of Liquidmetal alloys. Development costs incurred inresearch and development activities are expensed as incurred.

 

*Advertising and Promotion Expenses.*Advertising and promotion expenses areexpensed when incurred. Advertising and promotion expenses were $2, $239, and$136, for the years ended December 31, 2005, 2004, and 2003 respectively.

 

*Debt Discount Amortization.*Debt discounts for notes payable areamortized to interest expense, using a method that approximates the interestmethod over the term of the related debt instruments.

 

*Stock-Based Compensation.*The Company applies AccountingPrinciples Board (“APB”) Opinion No. 25 for options when the exerciseprice of options granted to employees is less than the fair value of theunderlying stock on the date of grant. The Company applies Statement ofFinancial Accounting Standards (“SFAS”) No. 123 for options granted to non-employeeswho perform services for the Company.

 

Had the Company determined employee stock-based compensationcost based on the fair value at the grant date for stock options consistentwith the method of SFAS No. 123, the Company’s net loss and basic anddiluted net loss per share would have been as follows:

 
| ** **                                                                                                                                                                                                                                 | ** ** | **For the  years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                                                                                 | ** ** | **(Restated)**                             | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net loss from continuing  operations:                                                                                                                                                                                                      |       |                                       |       |   |   |   |   |
| As reported                                                                                                                                                                                                                                |       | $                                          | (7,053     | ) | $ | (14,136 | ) | $ | (32,768 | ) |
| Add:                     stock-based employee compensation expense included included in reported  net loss, net of related tax effects |       | 41                                         |       | 276 |   | 123 |   |
| Deduct:      total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax                                                                    |       | (2,861                                     | )          | (4,201 | ) | (5,427 | ) |
| Proforma net loss from continuing operations                                                                                                                                                                                               |       | $                                          | (9,873     | ) | $ | (18,061 | ) | $ | (38,072 | ) |
|                                                                                                                                                                                                                                       |       |                                       |       |   |   |   |   |
| Basic and diluted net loss per  share:                                                                                                                                                                                                     |       |                                       |       |   |   |   |   |
| As reported                                                                                                                                                                                                                                |       | (0.17                                      | )          | (0.34 | ) | (0.79 | ) |
| Proforma                                                                                                                                                                                                                                   |       | (0.24                                      | )          | (0.43 | ) | (0.92 | ) |

 

*Income Taxes.*Income taxes are provided under theasset and liability method as required by SFAS No. 109, *Accounting for Income Taxes*. Under thismethod, deferred income taxes are recognized for the tax consequences of “temporarydifferences” by applying enacted statutory tax rates applicable to future yearsto differences between the financial statement carrying amounts and the taxbasis of existing assets and liabilities. The effect of a tax rate change ondeferred taxes is recognized in operations in the period that the change in therate is enacted. Valuation allowances are established when necessary to reducenet deferred tax assets to the amount expected to be realized.

 

*Translation of Foreign Currency.*Upon consolidation of the Company’sforeign subsidiaries into the Company’s consolidated financial statements, anybalances with the subsidiaries denominated in the foreign currency aretranslated at the exchange rate at year end. The financial statements of LMTKorea have been translated based upon Korean Won as the functional currency. LMTSingapore’s and LMT Korea’s assets and liabilities were translated using theexchange rate at year end and income and expense items were translated at theaverage exchange rate for the year. The resulting translation adjustment wasincluded in other comprehensive income (loss).

 

The Companyapplies *FASB No. 52,Foreign Currency Translation*, fortranslating foreign currency into US dollars in our consolidation ofthe financial statements. Due to our restatement of 2002 financial statements,certain footnote disclosures and previously reported financial statements wereadjusted to conform to retroactive applications of FASB No. 52. Theseadjustments did not have a material impact in the financialstatements. See Note 2 in the notes to consolidated financial statementsin the fiscal 2003 annual report on Form 10-K filed on November 10,2004, which reflects the restatements of prior year transactions.

 

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*Earnings Per Share.*Basic earnings per share (“EPS”) iscomputed by dividing earnings (losses) attributable to common shareholdersby the weighted average number of common shares outstanding for the periods.Diluted EPS reflects the potential dilution that could occur if securities orother contracts to issue common stock were exercised or converted into commonstock.

 

*Use of Estimates.*The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reported periods.Actual results could differ from those estimates. These management estimatesare primarily related to impairment of long-lived assets, inventory valuation,product warranty, and the allowance for bad debt account balances.

 

*Reclassifications.*Certain amounts from prior years havebeen reclassified to conform to the current year’s presentation.

 

*New Accounting Pronouncements.*

 

In June 2005, the Emerging Issues Task Force (“EITF”)reached a consensus on Issue No. 05-2 “The Meaning of ‘ConventionalConvertible Debt Instrument’ in EITF Issue No. 00-19, ‘Accounting forDerivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.’” Issuers of convertible debt are required by Statement133 to evaluate whether it is necessary to separate the “embedded” conversionfeature from the debt contract and account for the conversion feature as if itwere a separate derivative instrument. If the issuer determines that theembedded conversion feature would be classified in equity if it were afreestanding instrument, the conversion feature is not separated from the debtcontract. EITF 00-19’s criteria must be applied to determine whether aconversion feature qualifies for equity classification, but it exempts aconversion feature embedded in a “conventional convertible debt instrument”from some of the criteria. EITF 05-2 requires convertible instruments that may besettled in a combination of cash or shares, e.g., those referred to as “InstrumentC” in EITF 90-19, and instruments that may be convertible into a variablenumber of shares are not “conventional.” As a result, nonconventional instrumentswould need to satisfy all requirements of EITF 00-19 to support a conclusionthat the conversion feature does not require accounting separate from that forthe debt contract. The adoption of this Issue resulted in recognition of the embeddedconversion feature from the senior convertible notes issued in March 2004,which was exchanged in August 2004, and August 2005 as liabilities of$1,792 and $6,650 as of December 31, 2005 and 2004, respectively, and again of $9,118 and $2,093 from the change in fair value of beneficialconversion feature liabilities for the year ended December 31, 2005 and2004, respectively (see Note 15).

 

In June 2005, the EITF reached a consensus onIssue 05-6, “Determining the Amortization Period for Leasehold Improvements,”which requires that leasehold improvements acquired in a business combinationor purchased subsequent to the inception of a lease be amortized over thelesser of the useful life of the assets or a term that includes renewals thatare reasonably assured at the date of the business combination or purchase.EITF 05-6 is effective for periods beginning after June 29, 2005. Earlierapplication is permitted in periods for which financial statements have notbeen issued. The adoption of this Issue did not have an impact on the Company’sfinancial statements.

 

In September 2005, the EITF reached a consensuson Issue 05-7 “Accounting for Modifications to Conversion Options Embedded inDebt Instruments and Related Issues,” which requires that a change in the fairvalue of a conversion option brought about by modifying the debt agreement beincluded in analyzing in accordance with EITF 96-19 “Debtor’s Accounting for aModification or Exchange of Debt Instruments” whether a debt instrument isconsidered extinguished. Under EITF 96-19’s requirements, an issuer whomodifies a debt instrument must compare the present value of the original debtinstrument’s cash flows to the present value of the cash flows of the modifieddebt. If the present value of those cash flows varies by more than 10 percent,the modification is considered significant and extinguishments accounting isapplied to the original debt. If the change in the present value of the cashflows is less than 10 percent, the debt is considered to be modified and issubject to EITF 96-19’s modification accounting. EITF 05-7’s Consensus requiresthat in applying the 10 percent test the change in the fair value of theconversion option be treated in the same manner as a current period cash flow.The Consensus also requires that, if a modification does not result in anextinguishment, the change in fair value of the conversion option be accountedfor as an adjustment to interest expense over the remaining term of the debt.The issuer should not recognize a beneficial conversion feature or reassess anexisting beneficial conversion feature upon modification of the conversionoption of a debt instrument that does not result in an extinguishment. EITF 05-7is effective for modifications of debt instruments beginning in the firstinterim or annual reporting period beginning after December 15, 2005. TheCompany does not expect the adoption of the EITF to have material impact on theCompany’s financial statements.

 

In September 2005, the EITF reached a consensuson Issue No. 05-8, “Income Tax Consequences of Issuing Convertible Debtwith a Beneficial Conversion Feature.” Under EITF 05-8, the issuance of convertible debt with a beneficialconversion feature results in a temporary difference for purposes of applyingStatement 109. The deferred taxes recognized for the temporary differenceshould be recorded as an adjustment to paid-in capital. EITF 98-5 “Accountingfor Convertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios” and EITF 00-27 “Application of Issue No. 98-5 toCertain Convertible Instruments”

 

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require that the nondetachable conversion feature ofa convertible debt security be accounted for separately if it is a beneficialconversion feature. A beneficial conversion feature is recognized and measuredby allocating to additional paid-in capital a portion of the proceeds equal tothe conversion feature’s intrinsic value. A discount on the convertible debt isrecognized for the amount that is allocated to additional paid-in capital. Thedebt discount is accreted from the date of issuance to the stated redemptiondate of the convertible instrument or through the earliest conversion date ifthe instrument does not have a stated redemption date. The U.S. Federal IncomeTax Code includes the entire amount of proceeds received at issuance as the taxbasis of the convertible debt security. The EITF 05-8 Consensus should beapplied retrospectively to all instruments with a beneficial conversion featureaccounted for under EITF 98-5 and EITF 00-27 for periods beginning after December 15,2005. The Company does not expect the adoption of the EITF to have materialimpact on the Company’s financial statements.

 

In May 2005, the FASB issued SFAS No. 154,“Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20and FASB Statement No. 3.”  SFAS No. 154 replaces APB Opinion No. 20,“Accounting Changes,” and FASB Statement No. 3, “Reporting AccountingChanges in Interim Financial Statements” and changes the requirements for theaccounting for and reporting of a change in accounting principle. Thisstatement applies to all voluntary changes in accounting principle. It alsoapplies to changes required by an accounting pronouncement in the unusualinstance that the pronouncement does not include specific transition provisions.When a pronouncement includes specific transition provisions, those provisionsshould be followed. SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 31,2005.  We do not believe the adoption ofSFAS No. 154 will have a material effect on its consolidated financialposition, results of operations or cash flows.

 

On March 29, 2005, the SEC issued StaffAccounting Bulletin No. 107 (SAB 107) regarding the Staff’s interpretationof SFAS123(R). This interpretation expresses the views of the staff regarding theinteraction between SFAS 123(R) and certain SEC rules and regulations andprovides the staff’s views regarding the valuation of share-based paymentarrangements for public companies. In particular, this SAB provides guidancerelated to share-based payment transactions with no employees, the transitionfrom nonpublic to public entity status, valuation methods, the accounting forcertain redeemable financial instruments issued under share-based paymentarrangements, the classification of compensation expense, non-GAAP financialmeasures, first-time adoption of SFAS123(R) in an interim period, capitalization of compensation cost related toshare-based payment arrangements, the accounting for income tax effects ofshare-based payment arrangements upon adoption of SFAS 123(R), the modificationof employee share options prior to adoption of Statement 123(R) and disclosuresin Management’s Discussion and Analysis subsequent to adoption of SFAS123(R). Our company will adopt SAB 107 in connection with its adoption of SFAS123(R).

 

In December 2004, the FASB issued SFAS No. 123R,“Share-Based Payment”, which replaces SFAS No. 123. SFAS No. 123Rrequires public companies to recognize an expense for share-based paymentarrangements including stock options and employee stock purchase plans. Thestatement eliminates a company’s ability to account for share-basedcompensation transactions using APB 25, and generally requires instead thatsuch transactions be accounted for using a fair value based method. SFAS No. 123Rrequires an entity to measure the cost of employee services received inexchange for an award of equity instruments based on the fair value of theaward on the date of grant, and to recognize the cost over the period duringwhich the employee is required to provide service in exchange for the award. InApril 2005, the SEC amended the compliance dates for SFAS 123(R), to allowcompanies to implement the standard at the beginning of their next fiscal year,instead of the next reporting period beginning after June 15, 2005. SFAS No. 123Ris effective for our company in the quarter ending March 31, 2006. Uponadoption of SFAS 123R, companies are allowed to select one of three alternativetransition methods, each of which has different financial reportingimplications. We are currently evaluating the transition methods, valuationmethodologies and other assumptions for employee stock options in light of SFASNo. 123R. Current estimates of option values using the Black-Scholesmethod may not be indicative of results from valuation methodologiesultimately implemented by our company upon adoption of SFAS No. 123R.Although we have not yet fully quantified the impact this standard will have onour financial statements, it is likely that the adoption of SFAS No. 123Rwill have a material impact on our company’s financial position and results ofoperations. Stock-based Compensation under Consolidated Financial Statementsprovides the pro forma net income and earnings per share as if the Company hadused a fair-value-based method similar to the methods required under SFAS123(R) to measure the compensation expense for employee stock awards during theyear ended December 31, 2005 and 2004.

 

In December 2004 the Financial AccountingStandards Board issued two FASB Staff Positions—FSP FAS 109-1, *Application of FASB Statement 109 “Accounting forIncome Taxes” to the Tax Deduction on Qualified Production Activities*Provided*by the American Jobs Creation Act of 2004, and FSPFAS 109-2 Accounting and Disclosure Guidance for the Foreign EarningsRepatriation Provision within the American Jobs Creation Act of 2004.*Neither of these affected the Company as it does not participate in the relatedactivities.

 

In December 2004, the FASB issued SFAS No.153, “Exchangesof Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting forNonmonetary Transactions.” The amendments made by Statement 153 are based onthe principle that exchanges of nonmonetary assets should be measured based onthe fair value of the assets exchanged. Further, the amendments eliminate thenarrow exception for nonmonetary exchanges of similar productive assets andreplace it with a broader exception for exchanges of nonmonetary assets that donot have commercial substance. Previously, Opinion 29 required that theaccounting for an exchange of a productive asset for a similar productive assetor an equivalent interest in the same or similar productive asset should bebased on the recorded amount of

 

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the asset relinquished. Opinion 29 provided anexception to its basic measurement principle (fair value) for exchanges ofsimilar productive assets. The Board believes that exception required that somenonmonetary exchanges, although commercially substantive, be recorded on acarryover basis. By focusing the exception on exchanges that lack commercial substance,the Board believes this Statement produces financial reporting that morefaithfully represents the economics of the transactions. The Statement iseffective for nonmonetary asset exchanges occurring in fiscal periods beginningafter June 15, 2005. Earlier application is permitted for nonmonetaryasset exchanges occurring in fiscal periods beginning after the date ofissuance. The provisions of this Statement shall be applied prospectively. Wehave evaluated the impact of the adoption of SFAS 153, and do not believe theimpact will be significant to our company’s overall results of operations orfinancial position.

 

In November 2004, the FASB issued SFAS No. 151“Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendmentsmade by Statement 151 clarify that abnormal amounts of idle facility expense,freight, handling costs, and wasted materials (spoilage) should be recognizedas current-period charges and require the allocation of fixed productionoverheads to inventory based on the normal capacity of the productionfacilities. The guidance is effective for inventory costs incurred duringfiscal years beginning after June 15, 2005. Earlier application ispermitted for inventory costs incurred during fiscal years beginning after November 23,2004. We have evaluated the impact of the adoption of SFAS 151, and do notbelieve the impact will be significant to our company’s overall results ofoperations or financial position.

 

In March 2004, the FASB approved the consensusreached on the Emerging Issues Task Force (EITF) Issue No. 03-1, “TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments.” The objective of this Issue is to provide guidance foridentifying impaired investments. EITF 03-1 also provides new disclosurerequirements for investments that are deemed to be temporarily impaired. In September 2004,the FASB issued a FASB Staff Position (FSP) EITF 03-1-1 that delays theeffective date of the measurement and recognition guidance in EITF 03-1 untilafter further deliberations by the FASB. The disclosure requirements areeffective only for annual periods ending after June 15, 2004. We haveevaluated the impact of the adoption of the disclosure requirements of EITF 03-1and do not believe the impact will be significant to our company’s overallresults of operations or financial position. Once the FASB reaches a finaldecision on the measurement and recognition provisions, we will evaluate theimpact of the adoption of EITF 03-1.

 

In December 2003, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition.” SAB 104 supersedes SAB 101, “Revenue Recognition in FinancialStatements.” SAB 104’s primary purpose is to rescind accounting guidancecontained in SAB 101 related to multiple element revenue arrangements,superseded as a result of the issuance of EITF 00-21, “Accounting for RevenueArrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds theSEC’s Revenue Recognition in Financial Statements Frequently Asked Questionsand Answers (“the FAQ”) issued with SAB 101 that had been codified in SEC Topic13, Revenue Recognition. Selected portions of the FAQ have been incorporatedinto SAB 104. While the wording of SAB 104 has changed to reflect the issuanceof EITF 00-21, the revenue recognition principles of SAB 101 remain largelyunchanged by the issuance of SAB 104, which was effective upon issuance. Theadoption of SAB 104 did not impact the consolidated financial statements.

 

Other recent accounting pronouncements issued by theFASB (including its Emerging Issues Task Force), the AICPA and the SEC did notor are not believed by management to have a material impact on our company’spresent or future consolidated financial statements.

 

**5. Marketable Securities**

 

On July 29, 2002, the Company invested $2,000 inGrowell Metal, Inc. (“Growell”), a metals processing company located inSouth Korea and publicly traded on South Korea’s KOSDAQ stock market. TheCompany acquired 891,100 shares (or approximately 5%) of Growell’soutstanding common stock in this transaction. During the fourth quarter of2002, Growell’s spin-off of its electronics division resulted in the creationof a new company named Growell Electronics, Inc. (“Growell Electronics”).As a result of the spin-off, 30% of the Company’s 891,100 common shares ofGrowell were exchanged for an equal number of shares in the common stock ofGrowell Electronics. During the year ended December 31, 2002, the Companysold its shares in Growell Electronics for approximately $1,432, which wasbased on the market price of the stock on the KOSDAQ stock market on the dateof sale. This sale resulted in a realized gain of $832. At December 31,2002, the change in fair value of the remaining investment in Growell resultedin an unrealized gain of $1,668, which is reported as other comprehensiveincome in the accompanying consolidated financial statements. In April 2003,the Company sold the stock owned in Growell, which resulted in a realized gainof $1,178. A reclassification adjustment of ($1,668) for net realized gainsincluded in net loss is included in “Other comprehensive loss” on theaccompanying Statement of Operations and Comprehensive Loss for the year ended December 31,2003.

 

**6. Trade accounts receivable**

 

Trade accounts receivables from continuing operations werecomprised of the following:

 

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| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                  |       |                  |       |   |   |
| Trade accounts receivable             |       | $                     | 2,421      |   | $ | 1,776 |   |
| Less: Allowance for doubtful accounts |       | (61                   | )          | (108 | ) |
| Trade accounts receivable, net        |       | $                     | 2,360      |   | $ | 1,668 |   |

 

**7. Inventories**

 

Inventories were comprised of the following:

 
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                       |       |                  |       |   |   |
| Raw materials              |       | $                     | 565        |   | $ | 1,688 |   |
| Work in process            |       | 763                   |       | 352 |   |
| Finished goods             |       | 420                   |       | 313 |   |
| Machines held by customer  |       | —                |       | — |   |
| Total  current inventories |       | 1,748                 |       | 2,353 |   |
| Long-term inventories      |       | —                |       | 1,810 |   |
| Total  inventories         |       | $                     | 1,748      |   | $ | 4,163 |   |

 

The Company maintains certain of its rawmaterial inventories in amounts in excess of our operating cycle of one yeardue to the nature of our manufacturing process, production lead time, and therecyclability of our raw material. These inventories were classified as long-terminventory as of December 31, 2005 and 2004. The Company determined thatits current and projected raw material requirements are not sufficient enoughto warrant the use of such raw materials in the foreseeable future.Accordingly, the Company reduced the carrying value of raw materials held byits subsidiary, Liquidmetal Korea, by the amounts considered to be excessiveduring the year ended 2005. The write-down during the year ended December 31,2005 amounted to $2,746 and is included in “Impairment of long lived assets” inthe accompanying Consolidated Statement of Operations and Comprehensive Lossfor the year ended December 31, 2005. The total amount of long terminventory was $0 and $1,810 as of December 31, 2005 and 2004,respectively.

 

The Company analyzes inventory held for any excess or obsolescence issues.Any amounts considered excess or obsolete are written off. Further, assignificant amount of sales of Liquidmetal bulk alloy parts are used primarilyin consumer electronics components, our inventory is subject to fluctuations indemand for those consumer electronics goods. Accordingly, the Company reducesthe carrying value of raw materials held by its subsidiary, Liquidmetal Korea,by the amounts considered to be excess or obsolete. The write-downs amounted to$1,644 and are included in “Cost of Sales” in the accompanying Statement ofOperations and Comprehensive Loss for the year ended December 31, 2005. Asof December 31, 2004, the write-downs included in “Cost of Sales” in theaccompanying Statement of Operations and Comprehensive Loss amounted to $605,which includes a $406 charge incurred during the fourth quarter of 2004 relatedto certain hinge finished goods used in our customer’s cell phone modelswhich were nearing its end of life.

 

Machines held by customer represent machines conditionally sold toGrowell in 2002 and 2003. These machines are subject to put options wherebyGrowell has the right to require the Company to buy back the machines ifcertain conditions are not met. The Company recorded a write-down of $2,765 ofraw material and machine inventory associated with the settlement of a disputewith Growell in December 2003 (see Note 12). These amounts are included in“Cost of Sales” in the accompanying Statement of Operations and ComprehensiveLoss for the years ended December 31, 2003 and 2002.

 

**8. Property, Plant and Equipment**

 

Property,plant and equipment consists of the following:

 

98

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| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                            |       |                  |       |   |   |
| Machinery and equipment                         |       | $                     | 11,365     |   | $ | 12,600 |   |
| Computer equipment                              |       | 1,354                 |       | 1,357 |   |
| Office equipment, furnishings, and improvements |       | 1,824                 |       | 1,910 |   |
| Buildings                                       |       | 11,892                |       | 9,719 |   |
| Construction in progress                        |       | 6                     |       | — |   |
| Total                                           |       | 26,441                |       | 25,586 |   |
| Accumulated depreciation                        |       | (13,004               | )          | (9,152 | ) |
| Total property, plant and equipment, net        |       | $                     | 13,437     |   | $ | 16,434 |   |

 

Depreciation expense is classified as follows:

 
| ** **                          | ** ** | **For the  years ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                |       |                                       |       |   |   |   |   |
| Cost of Sales                       |       | $                                          | 2,744      |   | $ | 2,623 |   | $ | 2,908 |   |
| Selling, general and administrative |       | 542                                        |       | 700 |   | 627 |   |
| Research and development            |       | —                                     |       | 8 |   | 730 |   |
| Total depreciation expense          |       | $                                          | 3,286      |   | $ | 3,331 |   | $ | 4,265 |   |

 

During 2003,the Company experienced significant operational difficulties as a result ofproblems and delays encountered in manufacturing bulk amorphous parts. Theseevents, along with the Company’s history of operating or cash flow losses anduncertainty surrounding its future cash flows, led the Company to evaluate itslong-lived assets for recoverability as of December 31, 2003. As a result,the Company determined that the carrying value of its manufacturing plant inPyongtaek, South Korea exceeded its fair value as of December 31, 2003 inthe amount of $2,684. The fair value of the building was based on the averageof two independent appraisals of the building. This impairment loss is recordedin operating expenses as “Impairment of long lived assets” in the accompanyingConsolidated Statement of Operations and Comprehensive Loss for the year ended December 31,2003.

 

**9. Idle Equipment**

 

Idle equipment consists of certain equipment held by theCompany for use in expansion of bulk alloy parts manufacturing. Due to excessmanufacturing capacity, the Company classified the equipment as idleequipment at December 31, 2004. While the equipment may be usedinternally to meet future capacity requirements, considering our currentrevenue and foreseeable production requirements, the Company does notanticipate utilizing this equipment internally in the near future. For thesereasons, during the second quarter of 2005, the Company determined to writedown the carrying value of the idle equipment held by its subsidiary,Liquidmetal Korea, to its net realizable value. The write-down during thequarter ended June 30, 2005 amounted to $1,741 and is included inoperating expenses as “Impairment of long lived assets” in the accompanyingConsolidated Statement of Operations and Comprehensive Loss for the year ended December 31,2005. Total amount of idle equipment remaining was $193, and $1,906 as of December 31,2005 and 2004, respectively.

 

99

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**10.Other Intangible Assets**

 

Intangibleassets consist of the following: 

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                  |       |                  |       |   |   |
| Purchased  and licensed patent rights |       | $                     | 559        |   | $ | 555 |   |
| Internally  developed patents         |       | 1,212                 |       | 1,056 |   |
| Trademarks                            |       | 85                    |       | 85 |   |
| Total                                 |       | 1,856                 |       | 1,696 |   |
| Accumulated  amortization             |       | (670                  | )          | (553 | ) |
| Total intangible assets, net          |       | $                     | 1,186      |   | $ | 1,143 |   |

 

Amortization expensewas $117, $113, and $100, for the years ended December 31, 2005, 2004, and2003, respectively.   The estimatedaggregate amortization expense for each of the five succeeding years is asfollows:

 
| **December 31,** | ** ** | **Aggregate Amortization Expense** | ** ** |
|-----------------------|------------|------------------------------------|------------|
| 2006                  |       | $                                  | 114        |   |
| 2007                  |       | 112                                |       |
| 2008                  |       | 110                                |       |
| 2009                  |       | 108                                |       |
|                       |            |                                    |            |  |

 

Accumulated Amortization for the years ended December 31, 2005 and 2004 is as follows:

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                  |       |                  |       |   |   |
| Purchased  and licensed patent rights |       | $                     | (211       | ) | $ | (181 | ) |
| Internally  developed patents         |       | (430                  | )          | (352 | ) |
| Trademarks                            |       | (28                   | )          | (20 | ) |
| Total                                 |       | $                     | (670       | ) | $ | (553 | ) |

 

Theweighted average amortization periods for each of the years ended December 31,2005, 2004, and 2003 is as follows:

 
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                 |       |                  |       |   |   |   |   |
| Purchased  and licensed patent right |       | 17.0                  |       | 17.0 |   | 17.0 |   |
| Internally  developed patents        |       | 17.0                  |       | 17.0 |   | 17.0 |   |
| Trademarks                           |       | 10.0                  |       | 10.0 |   | 10.0 |   |

 

Purchasedpatent rights represent the exclusive right to commercialize the bulk amorphousalloy and other amorphous alloy technology acquired from California Instituteof Technology (“Caltech”), a shareholder, through a license agreement withCaltech (“License Agreement”). Under the License Agreement, the Company has theexclusive right to make, use, and sell products from all of Caltech’sinventions, proprietary information, know-how, and other technology relating toamorphous alloys in existence as of September 1, 2001. The Company alsohas an exclusive license to eleven issued patents and two patent applicationsheld by Caltech relating to amorphous alloy technology, as well as all relatedforeign counterpart patents and patent applications. Of the patents currentlyissued to Caltech and licensed by the Company, the earliest expiration date is2013 and the latest expiration date is 2021. Furthermore, the license agreementgives the Company the exclusive right to make, use, and sell products from substantiallyall amorphous alloy technology that is developed in Professor William Johnson’sCaltech laboratory during the period September 1,

 

100

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2001 through August 31, 2005. All fees andother amounts payable by the Company for these rights and licenses have beenpaid or accrued in full, and no further royalties, license fees or otheramounts will be payable in the future under the License Agreements.

 

In addition to the patents and patentapplications under the License Agreement with Caltech, the Company hasinternally developed patents. Internally developed patents include legal andregistration costs incurred to obtain the respective patents. The Companycurrently holds various patents and numerous pending patent applications in theUnited States, as well as numerous foreign counterparts to these patentsoutside of the United States.

 

**11. Goodwill**

 

During 2002, the Company completed animpairment review and did not recognize any impairment of goodwill.  Accordingly, for 2002, the Company hasforgone all related goodwill amortization expense.   During 2003, Dongyang experienced net lossesas a result of a continuing economic downturn in markets for its machineryproducts. These events, along with Dongyang’s operating loss, cash flow lossesand uncertainty surrounding its future cash flows, led the Company to evaluateits investment for recoverability as of December 31, 2003.  As a result, the Company determined that thecarrying value of its investment in Dongyang exceeded its fair value as ofDecember 31, 2003 in the amount of $184. This impairment loss is recorded in operating expenses as “Impairment ofGoodwill” in the accompanying Statement of Operations and Comprehensive Lossfor the year ended December 31, 2003.

 

InMarch 2004, the Company sold its 51% investment in Dongyang to the 49% minorityshareholder (see Note 18).

 

**12. Settlement Payable**

 

The settlement payable balanceconsists of payables to Growell Metal Co., Ltd., a South Korean metals processingcompany (“Growell”), as a result of a settlement agreement executed in January2004.  Under terms of the January 2004settlement of the dispute over certain sales transactions from 2003 and 2002between Liquidmetal Korea and Growell, Liquidmetal Korea agreed to pay Growell$4,895 to purchase Growell’s investment in alloy inventories, proprietaryalloying equipment purchased from Liquidmetal Korea, and supporting equipmentpurchased from other suppliers.  Also aspart of the settlement, Growell satisfied in full a balance of $2,058 owed toLiquidmetal Korea for the die casting machines Growell purchased fromLiquidmetal Korea in the first quarter of 2003 as part of a license agreementto manufacture Liquidmetal alloy parts for the South Korean automotiveindustry.  The remaining settlementpayable of $2,837 were to be paid to Growell (in cash or stock at the Company’sdiscretion) by December 31, 2004.  As ofDecember 31, 2005, the settlement payable was not paid to Growell due toGrowell’s breach of warranty on equipment repurchased by LiquidmetalKorea.  The outstanding balance ofpayables to Growell from the settlement was $3,331 and $3,246 as of December31, 2005 and 2004, respectively, net of foreign exchange translation loss.   In January 2005, Growell was acquired by athird party and the Company is currently in negotiations to settle this balancewith the third party.

 

**TheCompany recorded a loss on the settlement at December 31, 2003 of $2,765 whichis included in “Cost of Sales” in the December 31, 2003 Consolidated Statementsof Operations and Comprehensive Loss. The loss on settlement reflects the write-down of the assets received inthe settlement to their fair market value. The sale of the die casting machines to Growell was reflected in thefirst quarter of 2004.  Under thesettlement agreement between the parties, the Company and Growell granted tothe other party (and the other party’s affiliates) a release of all known andunknown claims of any nature arising between the parties through the date ofsettlement, as well as a release against future claims under agreements betweenthe parties that were terminated as a part of the settlement.  The settlement agreement provided that allagreements of any nature between the parties and their respective affiliateswere terminated as of the date of settlement, with the exception of certainconfidentiality agreements, a Liquidmetal coatings distribution agreement, andfuture rights under the die casting agreement pursuant to which Growellpurchased the die casting machines and obtained a license to make auto partsfrom Liquidmetal alloys.  The settlementagreement also includes**, as anaccommodation to Growell, if the Company becomes aware of any prospectivecustomer that desires to purchase a proprietary Company casting machine at atime when Growell desires to sell any of its Liquidmetal die casting machines,then the Company will not sell such die casting machine to the prospectivecustomer unless the Company first directs the prospective customer to Growelland encourages the prospective customer to purchase the machine from Growell.

 

**13. Other Liabilities**

 

The other liabilities balance consists ofaccrued severance and operating lease costs associated with the Company’s costreduction measures for the Tampa, Florida executive offices, a capital leaseobligation for office furniture and furnishings and capital lease obligationsfor a SEM Microscope and a JSM Electron Microscope used in the laboratory inLake Forest, California.

 

101

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| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|------------------|------------|
| ** **                                         | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                               |       |             |       |   |   |
| Accrued  severance                                 |       | $                | 550        |   | $ | 579 |   |
| Accrued  operating lease costs                     |       | 215              |       | 596 |   |
| Accrued  capital lease costs                       |       | 69               |       | 213 |   |
| Total                                              |       | 833              |       | 1,388 |   |
|                                               |       |             |       |   |   |
| Imputed  interest                                  |       | (3               | )          | (14 | ) |
| Total                                              |       | 831              |       | 1,374 |   |
| Less current  portion                              |       | (483             | )          | (1,032 | ) |
| Other long term liabilities, less current  portion |       | $                | 348        |   | $ | 342 |   |
|                                                    |            |                  |            |  |  |  |  |  |

 

During 2003, the Company initiated activities to substantially reducethe number of employees and consolidate manufacturing and administrativefacilities to improve operational effectiveness and efficiency and reduceexpenses.  During the year ended December31, 2003, there was a total of 225 employees terminated.  The total amount of severance granted to theterminated employees is $2,718 which is included in Cost of Sales in the amountof $199, Selling, general and administrative in the amount of $2,253, andResearch and Development in the amount of $266 in the accompanying ConsolidatedStatement of Operations for the year ended December 31, 2003.  The amount of severance paid was $174 and$1,104 as of December 31, 2005 and 2004, respectively.  The remaining severance owed to the terminatedemployees is $48 and $579 as of December 31, 2005 and 2004, respectively.  The total severance granted to terminatedemployees of $2,718 is separated into the following reportable segments as ofDecember 31, 2003: Coatings at $75 and Bulk alloy at $2,643.  The categories of employees that wereeliminated include the following:  Productmanagement positions at various levels, including Vice President; entry leveltechnicians; accounting and finance positions from entry level throughexecutive; marketing mid to senior level positions; engineering mid to seniorlevels positions; information technology support; administrative, legal andexecutive support; senior internal legal counsel; human resources and seniorexecutives.  Also, there were otherrelocation expenses associated with relocating the Tampa, Florida office toLake Forest, California totaling $759, which included the accrual of allremaining facility and telecommunication lease payments for the Tampa, Floridaoffice.  Total liability accrued from therelocation and terminations in 2003, including the severance and lease accruals,were $276 and $1,175 as of December 31, 2005 and 2004, respectively.  The Company has substantially concluded allcost reduction and restructuring activities as of March 31, 2004. The remainingportion of the 2003 termination and relocation liability, all classified ascurrent liability, is $416 at December 31, 2005.  At December 31, 2004, the current portion ofthe 2003 termination and relocation liability was $909 and the long-termportion of the liability was $266.

 

All leases with an initial term greater than oneyear are accounted for under SFAS No. 13 *Accountingfor Leases.*These leases are classified as either capital leases oroperating leases, as appropriate.  Assetsunder capital leases are capitalized using interest rates appropriate at the inceptionof each lease. At December 31, 2005, the cost recorded for the office furnitureand furnishings, the SEM Microscope and the JSM 6360 Electron Microscope underthe capital lease was $107, $47 and $289, respectively, and the accumulatedamortization was $79, $27 and $147, respectively.  At December 31, 2004, the cost recordedfor the office furniture and furnishings, the SEM Microscope and the JSM 6360Electron Microscope under the capital lease was $107, $47 and $289,respectively and the accumulated amortization $57, $22 and $89,respectively.  Future minimum leasepayments for the above assets under capital leases during subsequent years areas follows:

 
| ** **                                        | ** ** | **Minimum**  | ** ** |
|---------------------------------------------------|------------|--------------|------------|
| **December 31,**                                  | ** ** | **Payments** | ** ** |
|                                              |       |         |       |
| 2006                                              |       | $            | 62         |   |
| 2007                                              |       | 7            |       |
| Total                                             |       | 69           |       |
| Imputed interest                                  |       | (3           | )          |
| Total                                             |       | 66           |       |
| Less current portion                              |       | (60          | )          |
| Capital lease obligation, net of current  portion |       | $            | 6          |   |

 

102

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**14. Product Warranty**

 

Management estimates product warranties as apercentage of bulk alloy product revenues. As of December 31, 2005 and 2004,the Company used five percent of bulk alloy product sales as an estimate ofwarranties to be claimed.  During theyears ended December 31, 2004 and 2005, the Company’s product warrantyaccrual balance had the following activity:

 
| Balance, December 31, 2003  |   | $   | 303    |   |
|-----------------------------|--------|-----|--------|--------|
| Expense  accrual            |   | 288 |   |
| Warranty  charges           |   | (72 | )      |
| Balance,  December 31, 2004 |   | $   | 519    |   |
| Expense  accrual            |   | 101 |   |
| Warranty  charges           |   | 14  |   |
| Balance,  December 31, 2005 |   | $   | 634    |   |

 

The product warranty accrual balance wasincluded in accounts payable and accrued expenses at December 31, 2005 andDecember 31, 2004.

 

**15. Notes Payable**

 

Senior ConvertibleNote

 

On March 3, 2004, the Company issued $9.9million of 6% senior convertible notes due 2007 (the “March Notes”) to investorgroups in a transaction led by Michigan Venture Capital Co., Ltd, a SouthKorea-based institutional investment firm, and IndiGo Ventures LLC, a NewYork-based investment firm (the “Placement Agents”) that served as a financialadvisor to the Company for the transaction. The notes were collateralized by the patents held by the Company andsecond priority mortgage interest in plant facilities and certain equipment inSouth Korea.  The notes were convertibleat any time into common stock at a price of $3.00 per share.  Investors in the private placement and thePlacement Agents received warrants to purchase an aggregate amount of up toapproximately 1.2 million shares of common stock, exercisable at $3.00 pershare for varying periods but no later than 100 days following theeffectiveness of a registration statement covering the resale of sharesissuable upon exercise of the warrants. The conversion and warrant exerciseprice are subject to price adjustments for anti-dilution purposes. In addition,the investors had the right to call for repayment of the notes prior tomaturity at any time after the second anniversary of the closing of thetransaction.

 

Pursuant to Statement of Financial AccountingStandards No. 133, “Accounting for Derivative Instruments and HedgingActivities,” EITF 00-19, “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock,” EITF 00-27, “Applicationof Issue No. 98-5 to Certain Convertible Instruments,” and EITF 05-2 “TheMeaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19,”the original fair value of the embedded conversion feature of $7,595 have beenrecorded as conversion feature liabilities as the debt is considered non-conventionalconvertible debt. The original fair value was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 3 years; (2)volatility of 82%; (3) risk free interest of 2.15% and dividend rate of 0%.  The fair value of the conversion feature onthe date of issuance has been recorded as debt discount to be amortized overthe life the debt.

 

Pursuant to EITF 00-19, “Accounting forDerivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”, the original fair value of the 1.2 million warrants of $1,302has been recorded as warrant liabilities as the shares issuable under thewarrants have not been registered.  Theoriginal fair value was computed using the Black-Scholes pricing model under thefollowing assumptions: (1) expected life of 3 years; (2) volatility of 82%, (3)risk free interest of 0.95% and dividend rate of 0%.

 

In March 2004, the original fair value of theembedded conversion feature of $7,595 and the original fair value of the 0.6million warrants issued to investors of $584, and the original fair value of0.6 million warrants issued to Placement Agents of $718 were recorded asdiscounts of the convertible note.  Inaddition, $581 direct costs incurred relating to issuance of the convertiblenote were recorded as debt issuance cost in other assets.

 

During 2004, the Company redeemed $4,465 ofthe outstanding note balance in cash. The redemption resulted in a write down of debt issuance costs and debtdiscount of $3,571 to interest expense and a reduction in conversion featureliabilities of $914 from cancellation of the embedded conversion feature of theredeemed notes to additional paid in capital during the year ended December 

 

103

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31, 2004. Further, 500,000 of warrants originally issued to a financial advisorfor the transaction expired during June 2004 and 163,748 of unexercisedwarrants originally issued to investors were cancelled as a result of theCompany’s redemption of the note balances during the year ended December 31,2004.  The 663,748 total expired andcanceled warrants immediately prior to the expiration and cancellation resultedin a reduction of warrant liability of $7 and $279 to additional paid incapital and change in value of warrants, respectively, during the year endedDecember 31, 2004.

 

On August 19, 2004, the Company completed aprivate exchange offer for its March Notes with the remaining holders after theredemption.  Under terms of the exchangeoffer, approximately $5.5 million in aggregate principal amount of the MarchNotes have been exchanged for an aggregate of (i) $2.75 million of 6% SeniorSecured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.75 million of 10%Senior Secured Notes Due 2005 (the “July 2005 Notes”), collectively referred toas “Exchange Notes”.  The Exchange Notesare collateralized by certain patents owned by the Company and second prioritymortgage interest in plant facilities and certain equipment at our South Koreaplant.  The July 2005 Notes had amaturity date of July 29, 2005, and a conversion price of $2.00 per share(compared to a conversion price of $3.00 per share under the March Notes).  The July 2005 Notes have been exchanged andredeemed subsequent to the close of the second quarter of 2005 (see 2005 SeniorConvertible Notes below). The July 2007 Notes have a maturity date of July 29,2007, and a conversion price of $1.00 per share.   The conversion prices of the July 2007 Notesand July 2005 Notes are subject to price adjustments for anti-dilutionpurposes.  Further, the exchange notesare convertible into Common Stock, at the option of the Company, if at any timeafter the issuance of the notes, the closing per share price of the CommonStock exceeds $4.00 (as adjusted for stock splits, reverse splits, stockdividends, and recapitalizations) for 30 consecutive trading days, and furtherprovided that there has been effective registration during such period.  Holders of the July 2007 Notes also have theright to call for repayment of the July 2007 Notes prior to maturity at anytime after the second anniversary of the closing of the exchange offer.  The July 2007 Notes have been amendedsubsequent to the close of the second quarter of 2005 to provide for an AmendedRegistration Rights Agreement, and Amended and Restated Security Agreement (see2005 Senior Convertible Notes below).

 

A total of 563,151 warrants to purchase ourcommon stock at an exercise price of $3.00 per share—all of which werepreviously issued in connection with the purchase of the March Notes—have beenamended to provide for an extended expiration date of March 1, 2006.  The warrant exercise price is subject toprice adjustment for anti-dilution purposes. As of December 31, 2005, the warrant price was determined to beexercisable at $2.73.

 

The exchange offer was treated as anextinguishment of the March Notes in accordance with Emerging Issues Task ForceNo. 96-19, “Debtors Accounting for a Modification or Exchange of DebtInstruments.”  The exchange resulted in a$2,941 loss from extinguishment of the March Notes, which consisted of writedown of $352 of deferred issue costs in other assets, $670 of debt discount,and an increase of $1,919 in conversion feature liability as a result of thechange in carrying value of exchanged notes.

 

In connection with the private exchangeoffer, the Company issued $250 of private placement notes to certain PlacementAgents as issuance costs.  Of the $250notes issued, $125 was paid in the form of long-term notes which is due in 2007with interest rate of 6% per annum (July 2007 Notes) and $125 was paid in theform of short-term notes which is due in 2005 with interest rate of 10% perannum (July 2005 Notes).  The July 2005and July 2007 Notes are convertible into Common Stock at $2.00 and $1.00,respectively, and have the same terms as the Exchange Notes issued to theinvestors.  Further, $143 of originalfair value of the embedded conversion feature of $250 notes issued to PlacementAgents was recorded as conversion feature liabilities during August 2004.

 

The Company was obligated, pursuant to aRegistration Rights Agreement, as amended by the Exchange Notes, between theCompany, the Placement Agents and the note holders to file a registrationstatement with the Securities and Exchange Commission (“SEC”) to register theshares of Common Stock issuable upon conversion of the notes payable and therelated warrants within 90 days following the effective closing date of theexchange notes (July 29, 2004), and to use best efforts to cause suchregistration statement to become effective within 60 days following the SEC’sfirst written comments on the registration statement.  Further, if the Company is not in compliancewith the registration or listing requirements, the holders have rights to lateregistration payments equal to between 2 and 3 percent of the purchase pricepaid for the unconverted notes for the first 30 business days of lateregistration, and 1 and 3 percent for each 30 business days thereafter, but nomore than 18 percent of the purchase price of the unconverted notebalance.  Late registration fee of $1,028has been recorded as interest expense during the year ended December 31, 2005.

 

Interest payments are due quarterly, andfailure to make timely interest payments will result in increase in interestrate to 10% and 14% on the 6% and 10% senior convertible notes (“Default Rates”).  The Default Rates became effective on April1, 2005 from non-payment of a scheduled interest payment.  As of December 31, 2005, the Company hascomplied with all scheduled interest payments.

 

104

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On August 9, 2005, the July 2005 Notes,accrued interest and late registration fees were redeemed in cash and exchangedfor 7% Convertible Secured Promissory Notes due August 2007  (see 2005 Senior Convertible Notes below).

 

During the year ended December 31, 2005, $485of the July 2007 Notes were converted into 485,750 of the Company’s commonstock at a conversion price of $1.00 per share. The conversionresulted in reduction of conversion feature liabilities of $541 to additionalpaid in capital for the year ended December 31, 2005.

 

As of December 31, 2005 our gross outstandingloan balance of the July 2005 and July 2007 Notes totaled $0 and $2,369,respectively.  As of December 31, 2004,our gross outstanding loan balance of the July 2005 and July 2007 Notes totaled$2,854 and $2,855, respectively.  As ofDecember 31, 2005 and December 31, 2004, un-amortized discounts for conversionfeature and warrants totaled $1,207 and $2,831, and other asset debt issuancecosts totaled $43 and $183, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $1,765 and $3,763 for the year ended December 31, 2005 and 2004,respectively.  As of December 31, 2005,the effective interest rates for the July 2007 Notes were 37%.  As of December 31, 2004, the effectiveinterest rates for the July 2005 and July 2007 Notes were 40% and 37%respectively.

 

Pursuant to Statement of Financial AccountingStandards No. 133, “Accounting for Derivative Instruments and HedgingActivities,” the Company is required to report a value of the conversion liabilityas a fair value and record the fluctuation to the fair value of the conversionfeature liability to current operations. The change in the fair value of the conversionfeature liability resulted in a gain of $5,269 and $2,093 for the year endedDecember 31, 2005 and 2004, respectively. The fair value of conversion feature liability outstanding at December31, 2005 and 2004 was $840 and $6,650, respectively.  The fair value of conversion featuresoutstanding at December 31, 2005 was computed using the Black-Scholes modelunder the following assumptions: (1) 1.57 years; (2) volatility of 88%, (3)risk free interest of 4.41%and dividend rate of 0%.

 

Pursuant to EITF 00-19, “Accounting forDerivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”, the original relative fair values of the warrants of $1,302have been recorded as other liability as the Company has not yet filed theregistration statement.  In addition, theCompany is required to report a value of the warrant as a fair value and recordthe fluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a net gain of $550 and $747 for the year endedDecember 31, 2005 and 2004, respectively. The fair value of warrants outstanding was $0 at December 31, 2005.  The fair value was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 0.16years; (2) volatility of 88%, (3) risk free interest of 4.08%and dividend rateof 0%.

 

**The following is a repayment schedule of the July 2005 andJuly 2007 Notes based on maturity date of the notes:**

 
| **July 2005 and 2007 Notes** | ** ** | ** **   | ** ** |
|------------------------------|------------|--------------|------------|
| **Repayment Schedule**       | ** ** | **Minimum**  | ** ** |
| **December 31,**             | ** ** | **Payments** | ** ** |
|                         |       |         |       |
| 2005                         |       | $            | —     |   |
| 2006                         |       | —       |       |
| 2007                         |       | 2,369        |       |
| Total                        |       | $            | 2,369      |   |

 

Convertible Notes

 

On June 13,2005, the Company completed a private placement (the “June 2005 PrivatePlacement”) of 10% Convertible Unsecured Notes Due June 13, 2006 in theaggregate principal amount of $3,250 (the “June 2006 Notes”), together withwarrants to purchase up to an aggregate of 893,750 shares of the Company’scommon stock (the “Warrants”).

 

The June 2006 Notesissued by the Company in the June 2005 Private Placement are unsecured and wasdue on the earlier of June 13, 2006 or the consummation of a follow-onequity or debt offering or restructuring transaction pursuant to which theCompany receives gross proceeds of at least $4,000.  Prior to maturity,the June 2006 Notes are interest-only, with interest payments due quarterly, atthe rate of 10% per year.  The June 2006 Notes can be prepaid by theCompany at any time without penalty.  If, within 120 days following theissue date of the June 2006 Notes, the Company either fails to redeem the notesfor the principal amount and accrued interest thereon or fails to close a “QualifiedFinancing,” then the June 2006 Notes will thereafter be convertible at aconversion price equal to seventy five percent (75%) of the closing price ofthe Company’s common stock on the first trading day immediately preceding theconversion date.  A “Qualified Financing “ is defined in the June 2006Notes as any debt or equity financing of the Company resulting in aggregategross proceeds to the Company of at least $5,000 and in which the holders of atleast sixty percent 

 

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(60%) of theaggregate principal amount of the Company’s July 2007 Notes either(i) agree that the equity or debt securities to be issued in suchfinancing shall be *pari passu* inorder of payment to the July 2007 Notes held by them or (ii) exchange theirJuly 2007 Notes for new securities in the financing transaction.  On August 9, 2005, the Company successfullycompleted Qualified Financing, which resulted in exchange and redemption of theConvertible Notes (see 2005 Senior Convertible Notes below).  As a result, the June 2006 Notes never becameconvertible.

 

As a part of theJune 2005 Private Placement, the Company issued warrants to the purchasers ofthe June 2006 Notes giving them the right to purchase up to an aggregate of812,500 shares of the Company’s common stock. In addition, warrants to purchase 81,250 shares of the Company’s commonstock were issued to the placement agent in the transaction.  The warrants have an exercise price of $2.00per share, provided that upon the consummation of the first ensuing public orprivate equity or debt offering or restructuring transaction in which theCompany receives gross proceeds of at least $3,250 (including withoutlimitation any restructuring of the Company’s July 2005 Notes), the exerciseprice will be automatically adjusted downward (but not upward) as of theclosing date of such offering or restructuring transaction so that it is equalto the lowest effective common stock purchase price paid for any securitiesissued by the Company to the investors in such offering or restructuringtransaction.  The warrants will expire onJune 13, 2010 and are subject to exercise price adjustment for anti-dilutionpurposes.

 

**The fair value of the 893,750 warrantstotaled $1,160 and was computed using the Black-Scholes pricing model under thefollowing assumptions: (1) expected life of 5 years; (2) volatility of 118%,(3) risk free interest of 3.87% and dividend rate of 0%.  In accordance with Emerging Issues Task ForceNo. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments”the embedded beneficial conversion feature of the debt was not recorded as thedebt is considered contingently convertible at the time of issuance, and as aresult of the completion of the Qualified Financing the debt subsequent to theclose of the second quarter, the debt was determined to be not convertible. InJune 2005, the fair value of the 812,500 warrants issued to investors of $1,055was recorded as discounts of the convertible note.  In addition $105 relating to the fair valueof the 81,250 warrants issued to the Placement Agents and $278 direct costsincurred relating to issuance of the convertible note were recorded as debtissuance cost as a contra liability account in debt discount and other assets,respectively, and will be amortized using the effective interest rate methodover the life of the loan.**

 

**On August 9, 2005, the June 2006 Noteswere redeemed in cash and exchanged for 7% Convertible Secured Promissory Notesdue August 2007 (see 2005 Senior Convertible Notes below).  The exchange offer was treated as anextinguishment of the June 2006 Notes in accordance with Emerging Issues TaskForce No. 96-19, “Debtors Accounting for a Modification or Exchange of DebtInstruments.”  The exchange resulted in a$1,247 loss from extinguishment of the June 2006 Notes as of December 31, 2005,which consists of write down of $240 of deferred issue costs in other assets,$92 of contra liability deferred issuance costs, and $915 of debt discount as aresult of the change in carrying value of exchanged notes.**

 

Pursuant to EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original fair values of thewarrants of $1,160 have been recorded as other liability as the Company has notyet filed the registration statement.  Inaddition, the Company is required to report a value of the warrant as a fairvalue and record the fluctuation to the fair value of the warrant liability tocurrent operations.  The change in thefair value of the warrants resulted in a net gain of $743 for the year endedDecember 31, 2005.  The fair value ofwarrants outstanding at December 31, 2005 of $418 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 4.45years; (2) volatility of 88%, (3) risk free interest of 4.35%and dividend rateof 0%.

 

2005 Senior Convertible Notes

 

On August 9, 2005, the Company completed aprivate placement (the “August 2005 Private Placement”) of $9,878 in principalamount of new 7% Convertible Secured Promissory Notes due August 2007 (the “August2007 Notes”).  The issuance consisted of$5,000 cash, exchange of $1,284 in principal amount of the July 2005 Notes, theexchange of $2,996 in principal amount of the June 2006 Notes, satisfaction ofaccrued interest and late registration fees in the amount of $589 on the July2005 Notes, and satisfaction of accrued interest of $9 on the June 2006Notes.  The August 2007 Notes were issuedpursuant to a Securities Purchase Agreement dated effective as of August 2,2005 among the Company, the purchasers of the August 2007 Notes, and theholders of July 2005 Notes and June 2006 Notes of the Company.

 

Interest payments are due quarterly, andfailure to make timely interest payments will result in increase in interestrates to 14% per annum on the August 2007 Notes (“Default Rates”).  As of December 31, 2005, the Company has madetimely interest payments.

 

The August 2007 Notes are convertible intoshares of the Company’s common stock at $2.00 per share Pursuant to an Amendedand Restated Security Agreement.  Theconvertible price of the August 2007 Notes is subject price adjustment foranti-dilution purposes.  As of December31, 2005, the convertible price of the August 2007 Notes remained unchanged at$2.00 per share.

 

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Further, pursuant to Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities,” EITF 00-19, “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock,”EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,”and EITF 05-2 “The Meaning of ‘Conventional Convertible Debt Instrument’ in EITFIssue No. 00-19,” the original fair value of the embedded conversion feature of$4,808 have been recorded as conversion feature liability as the debt isconsidered nonconventional convertible debt. The original fair value wascomputed using the Black-Scholes model under the following assumptions: (1)expected life of 2 years; (2) volatility of 93%; (3) risk free interest of4.06% and dividend rate of 0%.  Inaddition, the Company is required to report a value of the conversion liabilityas a fair value and record the fluctuation to the fair value of the conversionfeature liability to current operations. The change in the fair value of the conversion feature liabilityresulted in a gain of $3,849 for the year ended December 31, 2005.  The fair value of conversion featuresoutstanding at December 31, 2005 of $959 was computed using the Black-Scholesmodel under the following assumptions: (1) 1.59 years; (2) volatility of 88%,(3) risk free interest of 4.41%and dividend rate of 0%.

 

The August 2007 Notes are secured bysubstantially all assets of the Company and rank senior to all otherobligations of the Company, other than the Company’s loan with Kookmin Bank ofSouth Korea (or any refinancing of such loan), the July 2007 Notes, purchasemoney asset financing, trade creditors in the ordinary course of business, andany inventory or receivables-based credit facility that the Company may obtainin the future, provided that the amount of the credit facility does not exceed50% of eligible inventory and 80% of eligible receivables. The August 2007Notes will automatically convert into common stock if the Company’s commonstock has an average closing price of more than $5.00 per share during 30consecutive trading days.

 

The Company also issued warrants to the purchasersof the August 2007 Notes and placement agents giving them the right to purchaseup to 2,469,470 and 414,495 shares of Company common stock, respectively, withan exercise price of  $2.00 per share,which is subject to price adjustment for anti-dilution purposes .  The warrants will expire on August 2, 2010.

 

**Pursuantto EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original fair values of thewarrants of $4,068 have been recorded as warrant liability as the Company hasnot yet filed the registration statement, which was computed using theBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 5 years; (2) volatility of 93%; (3) risk free interest of 4.17% and dividendrate of 0%.  In addition, the Company isrequired to report a value of the warrant as a fair value and record thefluctuation to the fair value of the warrant liability to current operations.  The change in the fair value of the warrantsresulted in a net gain of $2,693 for the year ended December 31, 2005.  The fair value of warrants outstanding atDecember 31, 2005 of $1,375 was computed using the Black-Scholes model underthe following assumptions: (1) expected life of 4.59 years; (2) volatility of88%, (3) risk free interest of 4.35% and dividend rate of 0%.**

** **

In connection with the August 2005 Private Placement, the Company enteredinto an amended and restated registration rights agreement with the holders ofthe July 2007 Notes, the holders of the August 2007 Notes, and the holders ofthe above-described outstanding warrants. This amended and restated registration rights agreement replaced allother registration rights agreements previously entered into by us inconnection with the private sale by us of convertible notes and warrants.  Under the amended and restated registrationrights agreement, the Company is required to file a resale registrationstatement for the shares underlying all of our outstanding convertible notes andwarrants, as described above, by October 31, 2005, to enable the resale of suchshares by the selling stockholders on a delayed or continuous basis under Rule415 of the Securities Act.  The Companyis then required to cause such registration statement to become effectivewithin 60 days after we receive the first written comments on the registrationstatement from the SEC, or if the SEC notifies us that it will not review theregistration statement, within five days after such notification.  The Company will be subject to certainmonetary penalties, as set forth in the registration rights agreement, if theregistration statement is not filed or does not become effective on a timelybasis.  Specifically, if the Company doesnot file the registration statement on a timely basis, we will be obligated topay a late filing fee to the selling stockholders in the amount of 3% of thewarrant exercise price on each of the warrants held by them plus 3% of theprincipal amount of the outstanding notes held by them.  This fee will be payable for each period of30 business days that the filing of the registration statement is made past therequired filing date, and the payments will be due 10 business days followingthe end of each 30-day period.  If theregistration statement has not been declared effective by the requiredeffective date, the Company will be obligated to pay a monthly lateregistration fee to the selling stockholders in the amount of 2% of theaggregate warrant exercise prices and aggregate note principal amounts for thefirst 30 business days after the required effective date, and 1% for each30-business day period thereafter until the registration statement is declaredeffective.  Notwithstanding theforegoing, the late filing fees and late registration fees will not exceed 18%of the aggregate warrant exercise prices and aggregate note principal amounts.

 

On December 6, 2005, the Company received a letter from a representativeof the holders of the August 2007 Notes demanding the payment of a late filingfee by us for the period following October 31, 2005, but under the terms of theamended and restated registration rights agreement, the Company does notbelieve that it is obligated to pay any late filing fees unless and until theCompany fails to file the registration statement by December 13, 2005, which isthe last day of the first 30-business day period following October 31,2005.  The letter also stated that theletter was serving as a notice of default under the Senior Notes as a result ofour failure to file a registration statement by October 31, 2005, althoughunder the terms of the Senior Notes, the Company has thirty days after deliveryof the letter in 

 

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which to cure such default.  OnDecember 9, 2005 the Company filed the registration statement, which was withinthe 30-day period and has cured the default notice.

 

The Company has received first writtencomments in January 2006.  However, theregistration statement has not been made effective within the 60 day periodcalled for by the registration rights agreement and the Company may be subjectto default notices by the holders of the convertible notes and warrants.  As of the filing of this report, the Company’smanagement is not aware of any outstanding default notices.

 

As of December 31, 2005, our grossoutstanding loan balance of the August 2007 Notes totaled $9,878.  As of December 31, 2005, un-amortizeddiscounts for beneficial conversion feature and warrants totaled $5,663, andother asset debt issuance costs totaled $384, and contra liability debtissuance cost totaled $464.  Interestexpense for the amortization of debt issuance cost and discount on note was$1,913 and for the year ended December 31, 2005.  As of December 31, 2005, the effectiveinterest rate for the August 2007 Notes was 54%.

 

**The following is a repayment schedule of the August 2007Notes based on maturity date of the notes:**

 
| **August 2007 Notes**  | ** ** | ** **   | ** ** |
|------------------------|------------|--------------|------------|
| **Repayment Schedule** | ** ** | **Minimum**  | ** ** |
| **December 31,**       | ** ** | **Payments** | ** ** |
|                   |       |         |       |
| 2005                   |       | $            | —     |   |
| 2006                   |       | —       |       |
| 2007                   |       | 9,878        |       |
| Total                  |       | $            | 9,878      |   |

 

Factoring Agreement

 

The Company enteredinto a Factoring, Loan, and Security Agreement (the “Agreement”) with afinancing company on April 21, 2005, which allows for borrowings of up to$1,500.  The Agreement expires on April21, 2006, and automatically renews annually thereafter. All borrowings aresecured by outstanding receivables specifically assigned to the financingcompany.  Assigned receivables areconsidered “Approved” or “Non-Approved” by the financing company.  Advances are made on 80% of Approvedreceivables assigned and 30% of Non-Approved receivables assigned.  Payments on assigned receivables are receiveddirectly by the financing company, and applied to outstanding advances.  All outstanding advances and uncollectedassigned receivables are subject to fees and interest charges ranging from 0.65percent to 2 percent plus prime rate as published by the Wall Street Journal,with a minimum annual fee of $30. All receivables assigned and advances madeare subject to return and recall by the financing company, respectively.  As such, the advances have been classified asshort-term secured borrowings in accordance with FAS 140 “Accounting forTransfer and Servicing of Financial Assets and Extinguishments of Liabilities.”  As of December 31, 2005, the Company hasborrowed $4,449 and repaid $3,899.  Thetotal outstanding advance made under the agreement is $550 as of December 31,2005, which is presented as short-term debt.  The weighted average rate of interest for borrowings made under theAgreement was 8.5% for the year ended December 31, 2005. The Company has $950available for future borrowings under the Agreement as of December 31, 2005,which is contingent on approval of eligible receivables by the financingcompany.

 

Kookmin Note

 

On February 4, 2003, our Korean subsidiaryreceived 6,500,000 in South Korean Won, or approximately $5,488, under a loanfrom Kookmin Bank of South Korea.  Theloan bears interest at an annual rate of 7.1%. In the event of delayed repayment, the interest increases to a maximumof 21%, depending on the length of time the repayment is delayed.  As of December 31, 2005, the interest ratewas increased to 9.2% from delayed interest payments made.  This loan is collateralized by the plantfacilities and certain equipment in South Korea.  During the first eighteen months from theorigination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873 ofprincipal at the request of Kookmin Bank due to the sale of machines that hadbeen part of the collateral on the loan. Subsequent to October 31, 2003, Kookmin Bank requested that the Companypay an additional $866 of principal by February 2004 due to the Company’scurrent credit rating.  The Company made twopayments on the requested additional loan pay down in November and December2003 of $320 and $205, respectively.  Theremaining payment of $341 was subsequently made in February 2004.  Beginning in September 2004, the Company isrequired to make equal monthly installments of principal and interest to repaythe remaining balance of the loan over a 36-month period.  For the year ended December 31, 2004,principal payments made to Kookmin Bank totaled $296, which includes $422 offoreign exchange translation loss. Principal payments made to Kookmin Bank totaled $1,036 for the yearended December 31, 2005, which includes $95 of foreign exchange

 

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translation gain.  The outstanding loan balance totaled $2,790,of which $1,343 is included in current portion of long-term debt, as ofDecember 31, 2005.

 

The notes payable from Kookmin Loan as ofDecember 31, 2005 and 2004 and the activity for the year ended December 31,2005 is shown in the following table:

 
| ** **                           | ** ** | **December 31,** | ** ** | ** **     | ** ** | ** **     | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------|------------|----------------|------------|----------------|------------|------------------|------------|
| ** **                           | ** ** | **2004**         | ** ** | **Borrowings** | ** ** | **Repayments** | ** ** | **2005**         | ** ** |
| Kookmin Loan  9.2%, principal $5,488 |       | $                | 3,751      |           | $          | —         |       | $                | (1,036     | ) | $ | 2,790 |   |
|                                      |            |                  |            |                |            |                |            |                  |            |  |  |  |  |

 
| **Kookmin Repayment Schedule** | ** ** | **Minimum**  | ** ** |
|--------------------------------|------------|--------------|------------|
| **December 31,**               | ** ** | **Payments** | ** ** |
|                           |       |         |       |
| 2006                           |       | $            | 1,343      |   |
| 2007                           |       | 1,240        |       |
| 2008                           |       | 207          |       |
| Total                          |       | $            | 2,790      |   |

 

**16. Shareholders’ Equity(Deficiency)**

 

*Initial PublicOffering.*Pursuant to theCompany’s Registration Statement (Registration No. 333-73716) onForm S-1, as amended, initially filed with the Securities and ExchangeCommission on November 20, 2001 and declared effective May 21, 2002,the Company closed an initial public offering of 5,000,000 registered shares ofcommon stock on May 28, 2002, plus an additional 229,000 shares onJune 10, 2002 pursuant to an over allotment option, at a price of $15.00per share (which sale is referred to herein as the “Offering”). The Offeringgenerated net cash proceeds for the Company during the second quarter 2002 ofapproximately $70,721, net of underwriting commissions of $5,490 and other transactionfees of approximately $2,224.

 

*Stock Split.*OnJune 29, 2001 the Company declared a ten-for-one stock split to its commonshareholders of record on June 29, 2001. This stock split was effected inthe form of a stock dividend. On April 4, 2002, the Company declared aone-for-3.1 reverse stock split to its common shareholders of record onApril 4, 2002. The consolidated financial statements and accompanyingnotes have been retroactively adjusted to reflect the effects of the split andreverse split.

 

*Reincorporation*.  On May 21, 2003, the Company completed areincorporation by transitioning from a California corporation to a Delawarecorporation. The reincorporation was effected though the merger of the formerCalifornia entity into its newly created wholly owned Delaware subsidiary. Inconnection with the reincorporation, the number of authorized common shares wasreduced from 200,000,000 to 100,000,000. Additionally, the par value of thecommon stock was changed from no par value common stock to common stock with apar value of $0.001 per share. For purposes of these notes, the term “Company”refers to the former California entity with respect to periods prior toMay 21, 2003.

 

*Preferred Stock.*Asof December 31, 2001, the Company received net proceeds of $5,577 from thesale of the preferred stock at a per share price of $12.40, as adjusted for therevised stock split. Upon the completion of the Offering, each share ofpreferred stock was converted automatically into one share of Class Acommon stock pursuant to the terms of the preferred stock issued.

 

Warrants

 

As of December 31, 2005, outstanding warrants toacquire shares of the Company’s common stock are as follows:

 
| **Number of Shares** | ** ** | **Exercise Price** | ** ** | **Expiration Date** | ** **         |
|----------------------|------------|--------------------|------------|---------------------|--------------------|
|                 |       |               |       |                |               |
| 645,162              |       | $                  | 4.60       |                | December 31,  2005 |   |
| 563,151              |       | 2.73               |       | March 1,  2006      |               |
| 893,750              |       | 2.00               |       | June 13,  2010      |               |
| 2,883,965            |       | 2.00               |       | August 2,  2010     |               |
| 4,986,028            |       |               |       |                |               |
|                      |            |                    |            |                     |                    |  |

 

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**17. Stock CompensationPlan**

 

Under the Company’s 1996 Stock Option Plan (“1996Company Plan”) the Company could grant to employees, directors or consultantsoptions to purchase up to 12,903,226 shares of common stock as adjusted for thereverse stock split. The stock options are exercisable over a period determinedby the Board of Directors or the Compensation Committee, but no longer than10 years.

 

On April 4, 2002, our shareholders andboard of directors adopted the 2002 Equity Incentive Plan (“2002 Equity Plan”).The 2002 Equity Plan provides for the grant of stock options to officers,employees, consultants and directors of the Company and its subsidiaries. Inaddition, the plan permits the granting of stock appreciation rights with, orindependently of, options, as well as stock bonuses and rights to purchaserestricted stock. A total of 10,000,000 shares of our common stock may begranted under the 2002 Equity Plan.  Asof December 31, 2005, there are 2,151,950 options outstanding under the 2002Equity Plan.

 

Prior to the approval of the 2002 Equity Plan,options were primarily granted under the Company’s 1996 Stock Option Plan (“1996Company Plan”). On April 4, 2002, our board of directors terminated the1996 Company Plan. The termination will not affect any outstanding optionsunder the 1996 Company Plan and all such options will continue to remainoutstanding and be governed by the Plan. No additional options may be grantedunder the 1996 Company Plan. As of December 31, 2005, there were 3,386,297options outstanding under the 1996 Company Plan.

 

On April 4, 2002, our shareholders andboard of directors adopted the 2002 Non-employee Director Stock Option Plan (“2002Director Plan”). Only non-employee directors are eligible for grants under the2002 Director Plan. A total of 1,000,000 shares of the Company’s Common Stockmay be granted under the 2002 Director Plan. There are 234,000 optionsoutstanding under the 2002 Director Plan as of December 31, 2005.

 

In September 2005, the non-employee directors ofour Company were given the opportunity to receive shares of stock under theplan in lieu of past-due director and committee fees that were due to them fromperiods through September 2005.  Suchshares were issuable to such directors in lieu of these past-due fees.

 

Additionally, the Company has 2,221,508 optionsoutstanding at December 31, 2004 which were granted outside the 1996

Company Plan, 2002 Equity Plan and 2002 DirectorPlan.

 

The Company applies APB Opinion No. 25 foroptions when the exercise price of options granted to employees is less thanthe fair value of the underlying stock on the date of grant. The Companyapplies SFAS No. 123 for options granted to non-employees who performservices for the Company. Stock-based compensation expense was recognized asfollows for the year ended December 31, 2005:

 
| ** **                  | ** ** | **In accordance with** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **APB Opinion**        | ** ** | **SFAS** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **No. 25**             | ** ** | **No. 123** | ** ** | **Total** | ** ** |
|                        |       |                   |       |   |   |   |   |
| General and  administrative |       | $                      | —     |   | $ | 41 |   | $ | 41 |   |
| Research and  development   |       | —                 |       | — |   | — |   |
| Total                       |       | $                      | —     |   | $ | 41 |   | $ | 41 |   |

 

Stock-basedcompensation expense was recognized as follows for the year endedDecember 31, 2004:

 
| ** **                  | ** ** | **In accordance with** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **APB Opinion**        | ** ** | **SFAS** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **No. 25**             | ** ** | **No. 123** | ** ** | **Total** | ** ** |
|                        |       |                   |       |   |   |   |   |
| General and  administrative |       | $                      | —     |   | $ | 240 |   | $ | 240 |   |
| Research and  development   |       | —                 |       | 36 |   | 36 |   |
| Total                       |       | $                      | —     |   | $ | 276 |   | $ | 276 |   |

 

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Stock-basedcompensation expense was recognized as follows for the year endedDecember 31, 2003:

 
| ** **                 | ** ** | **In accordance with** | ** ** |
|----------------------------|------------|------------------------|------------|
| ** **                 | ** ** | **APB Opinion**        | ** ** | **SFAS** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **No. 25**             | ** ** | **No. 123** | ** ** | **Total** | ** ** |
|                       |       |                   |       |   |   |   |   |
| General and administrative |       | $                      | 50         |   | $ | 5 |   | $ | 55 |   |
| Research and  development  |       | 6                      |       | 62 |   | 68 |   |
| Total                      |       | $                      | 56         |   | $ | 67 |   | $ | 123 |   |

 

The fair value of each option grant is estimatedon the date of the grant using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions used for grants for the years endedDecember 31, 2005, 2004, and 2003, respectively: expected volatility of100% for all periods; dividend yield of 0.0% for all periods; expected optionlife of approximately 5 years; and risk-free interest rate ranging from 2.57% and 4.16%, as appropriate.

 

The following table summarizes the Company’sstock option transactions for the three years ended December 31, 2005:

 
| ** **                                | ** ** | ** **    | ** ** | **Weighted** | ** ** |
|-------------------------------------------|------------|---------------|------------|--------------|------------|
| ** **                                | ** ** | ** **    | ** ** | **Average**  | ** ** |
| ** **                                | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| ** **                                | ** ** | **Shares**    | ** ** | **Price**    | ** ** |
| Options outstanding  at December 31, 2002 |       | 8,317,187     |       | $            | 5.33       |   |
| Granted                                   |       | 1,810,920     |       | 3.07         |       |
| Exercised                                 |       | (684,165      | )          | 1.68         |       |
| Forfeited                                 |       | (1,272,481    | )          | 5.43         |       |
| Options  outstanding at December 31, 2003 |       | 8,171,461     |       | 5.11         |       |
| Granted                                   |       | 795,843       |       | 1.89         |       |
| Exercised                                 |       | —        |       | —       |       |
| Forfeited                                 |       | (1,591,795    | )          | 5.34         |       |
| Options  outstanding at December 31, 2004 |       | 7,375,509     |       | 4.72         |       |
| Granted                                   |       | 1,048,165     |       | 2.18         |       |
| Exercised                                 |       | —        |       | —       |       |
| Forfeited                                 |       | (429,919      | )          | 3.43         |       |
| Options  outstanding at December 31, 2005 |       | 7,993,755     |       | $            | 4.45       |   |

 

The weighted average fair value of optionsgranted during the years ended December 31, 2005, 2004, and 2003 was$1.74, $1.29, and $2.41, respectively. There were 6,451,364 options with aweighted average exercise price of $4.87 exercisable at December 31, 2005, 5,752,412options with a weighted average exercise price of $5.22 exercisable at December31, 2004, and 5,080,557 options with a weighted average exercise price of $5.12exercisable at December 31, 2003.

 

Includedin the above tables are certain options granted where their exercise priceswere below the fair market value of the common stock at the grant date(measurement date).  Such options totaled358,582 with a weighted average fair value of $11.22 were outstanding atDecember 31, 2005 and December 31, 2004; and 1,327,314 with a weighted averagefair value of $4.96 were outstanding at December 31, 2003.

 

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The following table summarizes theCompany’s stock options outstanding and exercisable by ranges of option pricesas of December 31, 2005:

 
| **Options Outstanding** | ** **          | **Options Exercisable** | ** ** |
|-------------------------|---------------------|-------------------------|------------|
| ** **              | ** **          | **Numbers of**          | ** ** | **Weighted Average** | ** ** | ** ** | ** ** | **Number of** | ** ** | **Weighted** | ** ** |
| **Range of**            | ** **          | **options**             | ** ** | **Remaining Contractual** | ** ** | **Weighted Average** | ** ** | **Options** | ** ** | **Average** | ** ** |
| **Exercise Prices**     | ** **          | **Outstanding**         | ** ** | **Life (Years)** | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
|                    |                |                    |       |   |   |   |   |   |   |   |   |
| $0.00 -  $1.55          |                | 711,575                 |       | 6.70 |   | $ | 1.26 |   | 456,095 |   | $ | 1.19 |   |
|                    |  1.56 -  3.10  |                    | 2,542,943  |   | 5.80 |   | 2.41 |   | 1,401,856 |   | 2.53 |   |
|                    |  3.11 -  4.65  |                    | 1,843,195  |   | 4.80 |   | 4.61 |   | 1,781,195 |   | 4.64 |   |
|                    |  4.66 -  6.20  |                    | 2,581,519  |   | 5.40 |   | 6.20 |   | 2,564,866 |   | 6.20 |   |
|                    |  6.21 -  7.75  |                    | —     |   | 0.00 |   | — |   | — |   | — |   |
|                    |  7.76 -  9.30  |                    | 10,000     |   | 7.00 |   | 8.95 |   | 6,000 |   | 8.95 |   |
|                    |  9.31 -  10.85 |                    | 10,000     |   | 7.00 |   | 9.81 |   | 4,000 |   | 9.81 |   |
|                    | 10.86 -  12.40      |                    | 222,585    |   | 5.60 |   | 12.40 |   | 194,193 |   | 12.40 |   |
|                    | 12.41 -  13.95      |                    | —     |   | 0.00 |   | — |   | — |   | — |   |
|                    | 13.96 -  15.50      |                    | 71,938     |   | 6.30 |   | 15.00 |   | 43,159 |   | 15.00 |   |
| Total                   |                | 7,993,755               |       |   |   |   |   | 6,451,364 |   |   |   |
|                         |                     |                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**18. DiscontinuedOperations**

 

*Dongyang*

 

On June 28, 2002, the Company acquired a51% interest in Chusik Hoesa Dongyang Yudoro (“Dongyang”).   During 2003, Dongyang experienced net lossesas a result of a continuing economic downturn in markets for its machineryproducts. These events, along with Dongyang’s operating loss, cash flow lossesand uncertainty surrounding its future cash flows, led the Company to evaluateits investment for recoverability as of December 31, 2003.  As a result, the Company determined that thecarrying value of its investment in Dongyang exceeded its fair value as ofDecember 31, 2003 in the amount of $184. This impairment loss was recorded in operating expenses for the yearended December 31, 2003.

 

In March 2004, the Company sold its 51%investment in Dongyang to the 49% minority shareholder.  The selling price of the Company’s 51% interestin Dongyang was $80, which was equal to the Company’s net carrying value forthe 51% ownership held.  Further, theCompany agreed to pay Dongyang $155 for the purchase of a receivable balancefrom Growell.  The transaction resultedin net payable to Dongyang of $75 and a loss of $46 from transfer of theCompany’s interest in Donyang to the minority shareholder.  The net payable balance of $75 is to be paidin quarterly installments throughout 2004, with $25 to be paid subsequent to 2004. The outstanding amount payable to Dongyang is $25 as of December 31,2004 and is included in accounts payable and accrued liabilities.

 

The Company has adopted SFAS 144 and as a resultthe 2003 balances have been reclassified in order to conform with thepresentation of 2004 financial statements.

 

Summarized operating results of Dongyang’sdiscontinued operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended  December 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                             | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                   |       |                         |       |   |   |   |   |
| Revenue                                                                |       | —                       |       | $ | 22 |   | $ | 1,019 |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | —                       |       | (96 | ) | (268 | ) |
|                                                                        |            |                              |            |  |  |  |  |  |  |

 

*Taesung*

 

On June 14, 2004, the Company entered into anAsset Purchase Agreement whereby all the assets and liabilities of its Taesungequipment manufacturing division in Korea were sold to a third party for $345which is payable by the third party in four equal installments with the lastinstallment being due on June 30, 2005. The sale resulted in a loss of $184 and is included in the loss fromdiscontinued equipment manufacturing operations as of December 31, 2004.  The loss from operations for the year endedDecember 31, 2004 totaled $653 and is included in the loss from discontinuedequipment manufacturing operations for the period.

 

112

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The Company has adopted SFAS 144 and as a resultthe 2003 balances have been reclassified in order to conform with thepresentation of 2004 financial statements.

 

Summarized operating results of Taesung’s operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended  Ended December,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **2005**                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                   |       |                            |       |   |   |   |   |
| Revenue                                                                |       | —                          |       | $ | 172 |   | $ | 2,177 |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | —                          |       | (653 | ) | (696 | ) |
|                                                                        |            |                                 |            |  |  |  |  |  |  |

 

*Liquidmetal Golf*

 

On April 30, 2002, management terminatedthe operations of the retail golf segment by means of liquidating substantiallyall of the retail golf assets and liabilities. The disposition of the retailgolf operations represents the disposal of a business segment. Accordingly, theaccompanying consolidated financial statements reflect the retail golf segmentas a discontinued operation for all periods presented.

 

For the year ended December 31, 2003, there wasa net gain of $127 in the estimate of expenses associated with the disposal ofthe discontinued retail golf operations. The change resulted from reducing the net liabilities of thediscontinued operations to $0 as there are no additional expendituresassociated with the discontinued retail golf operations.  There were no assets associated withdiscontinued retail golf operations at December 31, 2004 and 2005.

 

The results of operations for all periodspresented have been restated for discontinued operations. The operating resultsof the discontinued operations are as follows:

 
| ** **                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                  | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                        |       |                         |       |   |   |   |   |
| Net gain  (loss on disposal)                                |       | $                            | —     |   | $ | — |   | $ | 127 |   |
| Foreign  exchange translation gain (loss during the period) |       | —                       |       | — |   | — |   |
| Comprehensive gain (loss)                                   |       | $                            | —     |   | $ | — |   | $ | 127 |   |

 

*Stock CompensationPlan.*Historically, Liquidmetal Golf grantedits own options to employees, directors and consultants under a stock optionplan (“1997 Golf Plan”) approved by Liquidmetal Golf’s Board of Directorspursuant to which Liquidmetal Golf could have granted stock options exercisableover a period determined by the Board of Directors to purchase up to 500,000shares of common stock of Liquidmetal Golf. In connection with the Company’splan to discontinue the retail golf operations, the Company does not intend toissue additional options under the 1997 Golf Plan.

 

Liquidmetal Golf applies APB Opinion No. 25and related interpretations in accounting for its plans. Accordingly,Liquidmetal Golf recognized compensation when the exercise price of the optionswas less than the fair value of the underlying stock on the date of grant.  There was no compensation expense recordedduring the years ended December 31, 2005, 2004, and 2003.

 

Had compensation cost been determined based onthe fair value at the grant dates for awards under those plans consistent withthe method of SFAS No. 123, Liquidmetal Golf’s net loss would havebeen as follows:

 
| ** **  | ** ** | **Years e****nded December 31,** | ** ** |
|-------------|------------|----------------------------------|------------|
| ** **  | ** ** | **2005**                         | ** ** | **2004** | ** ** | **2003** | ** ** |
|        |       |                             |       |   |   |   |   |
| As reported |       | $                                | —     |   | $ | — |   | $ | 127 |   |
| Pro forma   |       | $                                | —     |   | $ | — |   | $ | 15 |   |

 

The fair value of each option grant is estimatedon the date of the grant using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions used for grants for the fiscal yearsended December 31, 2005, 2004, and 2003: expected volatility of 100% forall periods; dividend yield of 0.0% for all periods; expected option life ofapproximately 5 years; and a risk-free interest rate ranging from 5.2% to 6.2%,as appropriate.

 

113

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The following table summarizes Liquidmetal Golf’sstock option transactions for the three years ended December 31, 2005:

 
| ** **                                | ** ** | ** **    | ** ** | **Weighted** | ** ** |
|-------------------------------------------|------------|---------------|------------|--------------|------------|
| ** **                                | ** ** | **Number of** | ** ** | **Average**  | ** ** |
| ** **                                | ** ** | **Shares**    | ** ** | **Price**    | ** ** |
|                                      |       |          |       |         |       |
| Options  outstanding at December 31, 2002 |       | 115,500       |       | $            | 8.31       |   |
| Granted                                   |       | —        |       | —       |       |
| Exercised                                 |       | (300          | )          | 16.00        |       |
| Forfeited                                 |       | (16,500       | )          | 5.73         |       |
| Options  outstanding at December 31, 2003 |       | 98,700        |       | 8.72         |       |
| Granted                                   |       | —        |       | —       |       |
| Exercised                                 |       | —        |       | —       |       |
| Forfeited                                 |       | (10,000       | )          | 8.00         |       |
| Options  outstanding at December 31, 2004 |       | 88,700        |       | 8.80         |       |
| Granted                                   |       | —        |       | —       |       |
| Exercised                                 |       | —        |       | —       |       |
| Forfeited                                 |       | (10,500       | )          | 13.71        |       |
| Options  outstanding at December 31, 2005 |       | 78,200        |       | $            | 8.14       |   |

 

There were 78,200 options with a weightedaverage exercise price of $8.14 exercisable at December 31, 2005.  There were 88,700 options with a weightedaverage exercise price of $8.80 exercisable at December 31, 2004 and there were98,700 options with a weighted average exercise price of $8.72 exercisable atDecember 31, 2003.

 

Included in the above tables are certain optionsgranted where their exercise prices were below the fair market value of thecommon stock at the grant date. Such options totaled 10,000, 10,000, and131,250 with weighted average fair values of $5.74, $5.74 and $5.74 wereoutstanding at December 31, 2005, 2004 and 2003, respectively.

 

The following summarizes Liquidmetal Golf’sstock options outstanding and exercisable by the different exercise prices atDecember 31, 2005:

 
| ** **         | ** ** | **Number of Options** | ** ** | **Weighted Average**   | ** ** | **Number of Options** | ** ** |
|--------------------|------------|-----------------------|------------|------------------------|------------|-----------------------|------------|
| ** **         | ** ** | **Outstanding at**    | ** ** | **Remaining Contract** | ** ** | **Exercisable at**    | ** ** |
| **Exercise Price** | ** ** | **December 31, 2005** | ** ** | **Life (Years)**       | ** ** | **December 31, 2005** | ** ** |
|               | $          | 0.50                  |       |                   | 10,000     |                  | 1.33       |   | 10,000 |   |
|               | $          | 8.00                  |       |                   | 60,000     |                  | 3.83       |   | 60,000 |   |
|               | $          | 16.00                 |       |                   | 5,700      |                  | 2.33       |   | 5,700 |   |
|               | $          | 24.00                 |       |                   | 2,500      |                  | 2.58       |   | 2,500 |   |
|               |       | 88,700                |       |                   |       | 78,200                |       |

 

**19. Income Taxes**

 

For all financial statement periods presented,there was no provision for domestic income taxes.  However, there was approximately $8 of taxexpense during the twelve months ended December 31, 2003, related to foreigntaxes incurred by Dongyang, a 51% owned subsidiary, which is included as partof loss from discontinued operations on the consolidated statements ofoperations and comprehensive loss (see Note 18).

 

TheCompany has restated certain previously issued financial statements for due toan error related to the Company’s accounting for embedded convertible featureof senior convertible notes (see Note 2).

 

114

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The significant components of deferred taxassets were as follows:

 
| ** **                       | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |                         |       |   |   |   |   |
| Non-employee  stock compensation |       | $                            | —     |   | $ | 109 |   | $ | 51 |   |
| Allowance  for bad debt          |       | 9                            |       | 37 |   | 44 |   |
| Loss carry  forwards             |       | 31,623                       |       | 32,087 |   | 27,202 |   |
| Other                            |       | 1,139                        |       | 1,244 |   | 1,569 |   |
| Total deferred tax asset         |       | 32,771                       |       | 33,477 |   | 28,866 |   |
| Valuation allowance              |       | (32,771                      | )          | (33,477 | ) | (28,866 | ) |
| Total deferred tax asset, net    |       | $                            | —     |   | $ | — |   | $ | — |   |

 

The following table accounts for the differencesbetween the actual tax provision and the amounts obtained by applying thestatutory U.S. Federal income tax rate of 34% to income (loss) beforeincome taxes:

 
| ** **                               | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------|------------|------------------------------|------------|
| ** **                               | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                         |       |   |   |   |   |
| Federal tax expense                      |       | (34.00                       | )%         | (34.00 | )% | (34.00 | )% |
|                                     |       |                         |       |   |   |   |   |
| State tax expense, net                   |       | (0.00                        | )%         | (4.91 | )% | (1.62 | )% |
| Foreign income not subject to income tax |       | 42,27                        | %          | 4.24 | % | 24.16 | % |
|                                     |       |                         |       |   |   |   |   |
| Other                                    |       | 0.17                         | %          | 0.68 | % | 0.36 | % |
| Increase in valuation allowance          |       | (8.44                        | )%         | 33.99 | % | 11.13 | % |
|                                     |       |                         |       |   |   |   |   |
| Total tax  provision                     |       | 0.0                          | %          | 0.00 | % | 0.03 | % |

 

As of December 31, 2005, the Company hadapproximately $88,000 of net operating loss (“NOL”) carry forwards for U.S.federal income tax purposes expiring in 2006 through 2025. In addition, theCompany has state NOL carryforwards of approximately $32,000 expiring in 2010through 2015. The Company and Liquidmetal Golf filed on a separate companybasis for federal income tax purposes. Accordingly, the federal NOLcarryforwards of one legal entity are not available to offset federal taxableincome of the other. As of December 31, 2005, Liquidmetal Technologies,Inc. had approximately $50,000 in federal NOL carryforwards, expiring in 2006through 2025 and approximately $23,000 in state NOL carryforwards, expiring in2011 through 2015. Liquidmetal Golf, Inc. had approximately $38,000 of federalNOL carryforwards, expiring in 2012 through 2025 and approximately $9,000 instate NOL carryforwards expiring in 2010 through 2015.

 

As of December 31, 2005, the Company hadapproximately $199 of Research & Development (“R&D”) creditcarryforwards for U.S. federal income tax purposes expiring in 2021 through2025.  In addition, the Company hasCalifornia R&D credit carryforwards of approximately $269, which do notexpire under current California law.

 

Section 382 of the Internal Revenue Code (“IRC”)imposes limitations on the use of NOL’s and credits following changes inownership as defined in the IRC. The limitation could reduce the amount ofbenefits that would be available to offset future taxable income each year,starting with the year of an ownership change. The Company has not completedthe complex analysis required by the IRC to determine if an ownership changehas occurred.

 

The ability to realize the tax benefitsassociated with deferred tax assets, which includes benefits related to NOL’s,is principally dependent upon the Company’s ability to generate future taxableincome from operations.  The Company hasprovided a full valuation allowance for its net deferred tax assets due to theCompany’s net operating losses.

 

**20. Segment Reportingand Geographic Information**

 

SFAS No. 131,*Disclosures about Segments of an Enterprise and Related Information,*requirescompanies to provide certain information about their operating segments.  In April 2002, the Company began classifyingoperations into two reportable segments: Liquidmetal alloy industrial coatingsand bulk Liquidmetal alloys.  TheLiquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal burning power plants.  Bulk Liquidmetal alloys include marketopportunities to manufacture and sell casing components for electronic devices,medical devices, sporting goods, tooling, prototype sampling, defenseapplications and metal processing 

 

115

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equipment. The expenses incurred by the bulk Liquidmetal alloy segment aremanufacturing, research and development costs, and selling expenses associatedwith identifying and developing market opportunities.  Bulk Liquidmetal alloy products can bedistinguished from Liquidmetal alloy coatings in that the bulk Liquidmetalalloy can have significant thickness, up to approximately one inch, whichallows for their use in a wider variety of applications other than a thinprotective coating applied to machinery and equipment.   Revenue and expenses associated withresearch and development services are included in the bulk Liquidmetal alloysegment.  The accounting policies of thereportable segments are the same as those described in Note 4 above.

 

TheCompany has restated certain previously issued financial statements for due toan error related to the Company’s accounting for embedded convertible featureof senior convertible notes (see Note 2).

 

Summarized financial information concerning theCompany’s reportable segments is shown in the following tables:

 
| ** **                                 | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|--------------------------------------------|------------|--------------|------------|----------------|------------|--------------------|------------|
| Year ended  December 31, 2005:             |       |         |       |           |       |               |       |
| Revenue to external customers              |       | $            | 5,894      |           | $          | 10,471             |       | $ | 16,365 |   |
| Gross profit                               |       | 2,505        |       | (1,270         | )          | 1,236              |       |
| Total segment income                       |       | 1,746        |       | (7,747         | )          | (6,001             | )          |
| Total identifiable assets at end of period |       | 1,199        |       | 16,473         |       | 17,672             |       |
|                                       |       |         |       |           |       |               |       |
| Year ended  December 31, 2004:             |       |         |       |           |       |               |       |
| Revenue to external customers              |       | $            | 3,956      |           | $          | 13,473             |       | $ | 17,429 |   |
| Gross profit                               |       | 1,807        |       | 3,454          |       | 5,261              |       |
| Total segment income                       |       | 1,227        |       | 2,330          |       | 3,557              |       |
| Total identifiable assets at end of period |       | 842          |       | 22,635         |       | 23,477             |       |
|                                       |       |         |       |           |       |               |       |
| Year ended  December 31, 2003:             |       |         |       |           |       |               |       |
| Revenue to external customers              |       | $            | 2,997      |           | $          | 10,661             |       | $ | 13,658 |   |
| Gross profit                               |       | 1,466        |       | (5,970         | )          | (4,504             | )          |
| Total segment income                       |       | 369          |       | (21,140        | )          | (20,771            | )          |
| Total identifiable assets at end of period |       | 959          |       | 23,832         |       | 24,791             |       |

 

116

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Reconciling information for the statements ofoperations between reportable segments and the Company’s consolidated totals isshown in the following table:

 
| ** **                                                                                                    | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                    | ** ** | **(Restated)**                       | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                                                                          |       |                                 |       |   |   |   |   |
| Total segment income (loss) before minority  interest, interest expense and discontinued operations           |       | $                                    | (6,001     | ) | $ | 3,557 |   | $ | (20,771 | ) |
| General and administrative expenses,  excluded                                                                |       | (6,904                               | )          | (11,354 | ) | (13,110 | ) |
| Consolidated loss before interest, other  income, income taxes, minority interest and discontinued operations |       | (12,905                              | )          | (7,797 | ) | (33,881 | ) |
| Loss from extinguishment of debt                                                                              |       | (1,247                               | )          | (2,941 | ) | — |   |
| Change in value of warrants, gain                                                                             |       | 3,985                                |       | 747 |   | — |   |
| Change in value of conversion feature, gain                                                                   |       | 9,118                                |       | 2,093 |   | — |   |
| Other income                                                                                                  |       | —                               |       | 302 |   | — |   |
| Interest expense                                                                                              |       | (6,021                               | )          | (6,577 | ) | (390 | ) |
| Interest income                                                                                               |       | 17                                   |       | 37 |   | 304 |   |
| Gain on sale of marketable securities  held-for-sale                                                          |       | —                               |       | — |   | 1,178 |   |
| Income taxes                                                                                                  |       | —                               |       | — |   | — |   |
| Minority interest in loss of consolidated  subsidiary                                                         |       | —                               |       | — |   | 21 |   |
| Gain (loss) from discontinued operations,  net                                                                |       | —                               |       | (749 | ) | (837 | ) |
| Consolidated net loss                                                                                         |       | $                                    | (7,053     | ) | $ | (14,885 | ) | $ | (33,605 | ) |

 

Excluded general and administrative expensesare attributable to the Company’s corporate headquarters.  These expenses primarily include corporatesalaries, consulting, professional fees and facility costs.  Research and development expenses areincluded in the operating costs of the segment that performed the research anddevelopment.

 

Included in our bulk alloy revenue to externalcustomers are equipment sales from our Dongyang subsidiary and Taesungequipment division in Korea, both of which were divested in March and June 2004respectively.  External revenue from ourdiscontinued equipment manufacturing operations includes  $0.2 million for the years ended December 31,2004.

 

Reconciling information for the balance sheetsbetween reportable segments and the Company’s consolidated totals is shown inthe following table:

 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|------------------|------------|
| ** **                                | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                      |       |             |       |   |   |
| Total  segment assets                     |       | $                | 17,672     |   | $ | 23,477 |   |
| Cash and cash equivalents                 |       | 1,392            |       | 742 |   |
| Restricted cash                           |       | —           |       | 754 |   |
| Prepaid expenses and other current assets |       | 340              |       | 801 |   |
| Other property, plant and equipment       |       | 473              |       | 975 |   |
| Intangibles, net                          |       | 1,186            |       | 1,143 |   |
| Other assets                              |       | 500              |       | 616 |   |
| Total  Consolidated Assets                |       | $                | 21,563     |   | $ | 28,508 |   |

 

Assetsexcluded from segments include assets attributable to the Company’s corporateheadquarters. The largest asset represents the Company’s intangible assets,consisting primarily of the Company’s patents and trademarks.

 

117

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Certain customers accounted for more than 10% ofrevenues from continuing operations as follows:

 
| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                      |       |                        |       |   |   |   |   |
| Samsung                   |       | 10                          | %          | 5 | % | 10 | % |
| Charm Tech                |       | —                      |       | 32 | % | — |   |
| Pntel                     |       | 8                           | %          | 30 | % | 2 | % |
| United  States Government |       | 9                           | %          | 10 | % | 16 | % |
| Growell  Metal            |       | —                      |       | 12 | % | — |   |
| LLPG                      |       | —                      |       | — |   | 12 | % |

 

Revenues from sales to companies in the UnitedStates of America were $8,523, $5,546 and $6,050 during the years endedDecember 31, 2005, 2004 and 2003, respectively. The revenue related to the United States of America was earned underthree defense-related research and development contracts and sales of coatingsproducts.

 

During the year ended December 31, 2005,the Company had revenue on sales to companies outside of the United States of$7,829 of which $5,047 represented sales to companies located in SouthKorea.  During the year ended December31, 2004, the Company had revenue on sales to outside of the United States of$11,883 of which $9,545 represented sales to companies located in SouthKorea.  During the year endedDecember 31, 2003, the Company had revenue on sales to companies outsideof the United States of $7,608, of which $4,559 represented sales to companieslocated in South Korea.

 

Long-lived assets include net property, plant,and equipment and net intangible assets. The Company had long-lived assets of$2,107 and $1,594 located in the United States at December 31, 2005 and2004, respectively. The Company had long-lived assets of  $12,846 and $15,422 located in South Korea atDecember 31, 2005 and December 31, 2004, respectively.   Further, the Companyhas long lived assets located in China of $ 106 and $47 at December 31, 2005and 2004 respectively, as a result of a new plant that opened during August2004 (see Note 1).

 

**21. Income (Loss) PerCommon Share**

 

Basic EPS is computed by dividing earnings(loss) attributable to common shareholders by the weighted average numberof common shares outstanding for the periods. Diluted EPS reflects thepotential dilution of securities that could share in the earnings. Areconciliation of the number of common shares used in calculation of basic anddiluted EPS is presented below:

 
| ** **                       | ** ** | **For the Years ended December 31,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2005**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                             |       |                                 |       |   |   |   |   |
| Weighted  average basic shares   |       | 41,833,058                           |       | 41,609,652 |   | 41,505,218 |   |
| Effect of  dilutive securities:  |       |                                 |       |   |   |   |   |
| Stock options                    |       | —                               |       | — |   | — |   |
| Conversion of notes payable      |       | —                               |       | — |   | — |   |
| Weighted  average diluted shares |       | 41,833,058                           |       | 41,609,652 |   | 41,505,218 |   |

 

Options to purchase 7,993,755 shares of commonstock at prices ranging from $0.88to $15.00 per share were outstanding atDecember 31, 2005, but were not included in the computation of diluted EPS forthe same period because the inclusion would have been antidilutive. Options topurchase approximately 6,899,164 shares of common stock at prices ranging from$1.18 to $15.00 per share were outstanding at December 31, 2004, but werenot included in the computation of diluted EPS for the same period because theinclusion would have been antidilutive. Options to purchase approximately 8,171,461 shares of common stock atprices ranging from $1.16 to $15.50 per share were outstanding atDecember 31, 2003, but were not included in the computation of diluted EPSfor the same period because the inclusion would have been antidilutive.

 

Warrants to purchase 4,986,028 shares of commonstock between $2.00 and $4.65 per share outstanding at December 31, 2005 werenot included in the computation of diluted EPS for the same period because theinclusion would have been antidilutive. Warrants to 

 

118

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purchase 1,208,313 shares of common stockbetween $3.00 and $4.65 per share were outstanding at December 31, 2004but were not included in the computation of diluted EPS for the same periodbecause the inclusion would have been antidilutive.  Warrants to purchase 645,162 shares of commonstock at $4.65 per share were outstanding at December 31, 2003.

 

**22. Commitments and Contingencies**

** **

The Company is from time to time a party tocertain legal proceedings arising in the ordinary course of business. Althoughoutcomes cannot be predicted with certainty, the Company does not believe thatany legal proceeding to which it is a party will have a material adverse effecton the Company’s financial position, results of operations, and cash flows.

 

The Company and certain of the present and former officers anddirectors were named as defendants in nine purported class action complaintsfiled in the United States District Court for the Middle District of Florida,Tampa Division, and the Central District of California, Southern Division,alleging violations of Sections 11 and 15 of the Securities Act of 1933 andSections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder.  In August 2004,four complaints were consolidated in the Middle District of Florida under thecaption*Primavera Investors v. LiquidmetalTechnologies, Inc., et al.*, Case No. 8:04-CV-919-T-23EAJ. John Lee,Chris Cowley, Dwight Mamanteo, Scott Purcell and Mark Rabold were appointedco-lead plaintiffs (the “Lead Plaintiffs”), but Mr. Mamanteo laterwithdrew.  In September 2004, the fivecomplaints filed in the Central District of California were transferred to theMiddle District of Florida for consolidation with the*Primavera Investors* action. The Lead Plaintiffs served their Consolidated Amended Class ActionComplaint on January 12, 2005.  TheAmended Complaint alleges that the Prospectus issued in connection with ourinitial public offering in May 2002 contained material misrepresentations andomissions regarding our historical financial condition and regarding a personalstock transaction by our former chief executive officer.  The Lead Plaintiffs further generally allegethat during the proposed Class Period of May 21, 2002, through May 13, 2004,the defendants engaged in improper revenue recognition with respect to certainof our business transactions, failed to maintain adequate internal controls,and knowingly disclosed unrealistic but favorable information about marketdemand for and commercial viability of our products to artificially inflate thevalue of our stock. The Amended Complaint seeks unspecified compensatory damagesand other relief.  The Company, alongwith other defendants, filed a Motion to Dismiss Plaintiffs’ ConsolidatedAmended Class Action Complaint in March 2005.  TheMotion to Dismiss was denied in December 2005, and the defendants servedtheir Answer and Affirmative Defenses to the Consolidated Amended Class ActionComplaint on December 16, 2005.  The Lead Plaintiffs Motion for ClassCertification is presently due in April 2006. The Company intends to vigorouslydefend against the class action.  TheCompany cannot currently predict the impact or resolution of this litigation orreasonably estimate a range of possible loss, which could be material.  The resolution of this lawsuit may harm theCompany’s business and have a material adverse impact on the Company’sfinancial condition.

 

In addition to the above, certain of present and former officers anddirectors, as well as the Company as a nominal defendant, have beennamed in three shareholder derivative actions. Two shareholder derivative complaints were filed in California statecourt styled*Brian Clair, Derivatively onBehalf of Liquidmetal Technologies, Inc. v. John Kang, et al.*, CaseNo. 04CC00551, and*Joseph Durgin,Derivatively on Behalf of Liquidmetal Technologies, Inc. v. John Kang, et al.*,Case No. 04CC00553, both commenced in the Superior Court of Orange County,California.   A third shareholder derivative complaint was filedin the United States District Court for the Middle District of Florida,Tampa Division, styled*Robert Story v.John Kang, et al.*, Case No. 8:04-CV-1587-T-23TBM.  These shareholder derivative lawsuits allegethat the defendants breached various fiduciary duties and otherwise violatedstate law based primarily upon the same underlying facts and circumstances asalleged in the federal shareholder class action.  The plaintiffs seek unspecified compensatorydamages, restitution and disgorgement of profits, equitable and/or injunctiverelief as permitted by law and other relief.

 

The two shareholder derivative complaints in California state courthave been consolidated.  The Company,along with other defendants, have thrice succeeded in having the Plaintiffs’complaints dismissed for their failure to adequately pleaddemand futility.  Most recently, on September 15, 2005, we, alongwith other defendants, filed a demurrer to the Plaintiffs’ ConsolidatedSecond Amended Shareholder Derivative Complaint dated August 16,2005.  In hearings on October 19, 2005, and January 20, 2006,the presiding judge sustained the demurrer, dismissing the second amendedcomplaint but giving the plaintiffs until February 3, 2006, within whichto serve a third amended complaint.  The plaintiffs filed theirConsolidated Third Amended Shareholder Derivative Complaint on February 3,2006.  The Company anticipates filing ademurer, seeking dismissal of the third amended complaint.

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004.  The Company,along with other defendants, filed a Motion to Dismiss inDecember 2004, to which the Plaintiff responded in opposition inFebruary 2005.  On January 20, 2006, the presiding judge granted ourMotion to Dismiss, dismissing the complaint based upon the plaintiff’s failureto adequately plead futility.  On February17, 2006, the plaintiff filed its Notice of Appeal of the Court’s Ordergranting the Motion to Dismiss.  The plaintiff’s initial brief ispresently due  on April 4, 2006.  A mediation of the class and 

 

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derivative actions is scheduled for early April 2006.  We intend to vigorously defend against thederivative actions.  The Company cannotcurrently predict the impact or resolution of this litigation or reasonablyestimate a range of possible loss, which could be material.  The resolution of this lawsuit may harm theCompany’s business and have a material adverse impact on our financialcondition.

 

In March 1996, the Company entered into adistribution agreement whereby it granted to a third party exclusive rights tomarket and sell golf products incorporating Liquidmetal Technology to certainJapanese sporting equipment companies. The third party paid the Company a $1.0 million distribution fee as partof this agreement, of which a portion was refundable according to a formulabased on the gross profit earned by the third party.  The remaining unearned distribution fee of$830 has not been refunded as of December 31, 2004.  On March 28, 2003, the distribution agreementwas terminated and the Company entered into a new agreement to pay to the samethird party a commission on the net sales price of all Liquidmetal golfequipment that is shipped by the Company or its affiliates to Japanese golfcompanies for sale into the Japanese end-market.  This commission will apply to golf equipmentshipped by the Company or its affiliates during the period beginning on March28, 2003 and ending on March 28, 2006. If, by March 28, 2006, the Company has not paid $350 in commissionpayments, the balance between commission paid and $350 will be paid by April30, 2006, thereby guaranteeing the third party a $350 minimum payment duringthe term of the agreement.  The Companywill recognize the unearned distribution fee of $830 as revenue proportionatelywith the payment of commissions under the new agreement.  As of December 31, 2005, the unearneddistribution fee remained unchanged at $830.

 

In August 2004, the Company entered into aconsulting agreement whereby the Company was to receive services from a thirdparty to improve the Company’s bulk alloy manufacturing process.  The service is to be provided from 2004through February 2006.  The total amountof service fees is $172, of which $78 and $15 was included in trade accountspayable as of December 31, 2005 and 2004, respectively.

 

***OperatingLeases***

 

The Company leases its offices and warehousefacilities under various lease agreements, certain of which are subject toescalations based upon increases in specified operating expenses or increasesin the Consumer Price Index. Future minimum lease payments under non-cancelableoperating leases during subsequent years are as follows:

 
| ** **       | ** ** | **Minimum**  | ** ** |
|------------------|------------|--------------|------------|
| **December 31,** | ** ** | **Payments** | ** ** |
|             |       |         |       |
| 2006             |       | $            | 706        |   |
| 2007             |       | 322          |       |
| 2008             |       | 117          |       |
| 2009             |       | 77           |       |
| 2010             |       | 1            |       |
| Total            |       | $            | 1,223      |   |

 

Rent expense was $508, $479, and $1,419 for theyears ended December 31, 2005, 2004, and 2003, respectively.

 

**23.  401(k)Savings Plan**

 

The Company has a tax-qualified employee savingsand retirement plan, or 401(k) plan, which covers all of its United States-based employees. Our Korean employees are covered under a government sponsoredpension program and do not participate in the U.S. based 401(k) program.

 

Under the U.S. based 401 (k) plan, participantsmay elect to reduce their current compensation, on a pre-tax basis, by up to15% of their taxable compensation or of the statutorily prescribed annuallimit, whichever is lower, and have the amount of the reduction contributed tothe 401(k) plan. The 401(k) plan permits the Company, in its sole discretion,to make additional employer contributions to the 401(k) plan. However, theCompany did not make employer contributions to the 401(k) plan during any ofthe periods presented in the accompanying consolidated financial statements.

 

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**24. Related PartyTransactions**

 

In June 2003, the Company entered into an exclusive, ten-year licenseagreement with LLPG, Inc. (“LLPG”), a corporation primarily owned and led byJack Chitayat, a former director.  Under the terms of the agreement, LLPGhas the right to commercialize Liquidmetal alloys, particularly precious-metalbased compositions, in jewelry and high-end luxury product markets.  Inturn, the Company will receive royalty payments over the life of the contracton all Liquidmetal products produced and sold by LLPG.  In conjunctionwith its technology licensing contract, LLPG purchased two proprietaryLiquidmetal alloy melting machines and three proprietary Liquidmetal alloycasting machines for a total purchase price of $2,000.  No royalty payments were received to dateunder this agreement.

 

The Company has a license agreement with California Institute ofTechnology (“Caltech”) under which we exclusively license from Caltech certaininventions and technology relating to amorphous alloys.  Professor WilliamJohnson, a member of the Company’s board of directors, is a professor atCaltech, and substantially all of the amorphous alloy technology licensed to usunder the Caltech license agreement was developed in Professor Johnson’s Caltechlaboratory.   Additionally, the Company reimburses Caltech forlaboratory expenses incurred by Professor Johnson’s Caltech laboratory, whichduring the years ended December 31, 2005 and 2004, amounted to $20 and $0,respectively.

 

The Company is a party to a consulting agreement withWilliam Johnson, a board member.  Underthis agreement, Mr. Johnson provides consulting services on an as-needed basisthrough 2004 as it relates to marketing and development Liquidmetal alloy.  The agreement currently continues on amonth-to-month basis.  During the yearsended December 31, 2005 and 2004, the Company incurred 15 and $90 in consultingfees from Mr. Johnson, respectively.

 

The Company is a party to a consulting agreement with Chitnis Consulting,Inc., which is owned 100% by Shekhar Chitnis, a former director and executiveofficer of the Company.  Under this agreement, Chitnis Consulting has beenengaged to provide consulting services on an as-needed basis through December31, 2005.  During the years ended December 31, 2005 and 2004, the Companyincurred $53 and $54 in consulting fees from Chitnis Consulting, respectively.

 

Soo Buchanan, the sister of John Kang and James Kang, was employed by theCompany and was paid aggregate compensation of approximately $104 and $43 as ofDecember 31, 2005 and 2004.  Effective, July 31, 2005, Ms. Buchanan wasterminated as an employee and began providing services to the Company as aconsultant.  During 2005, the Companyincurred $24 for her services as a consultant. Additionally, Otis Buchanan, thehusband of Ms. Buchanan, was employed by the Company and was paid aggregatecompensation of approximately $103 and $54 as of December 31, 2005 and 2004,respectively.

 

In November 2004, the Company entered into an agreement with John Kang,our Chairman, President, and Chief Executive Officer, in which Mr. Kang agreedthat certain stock transactions by him in 2002 involving the Company’s commonstock should have resulted in a liability under Section 16(b) of the SecuritiesExchange Act of 1934, as amended (“Section 16(b)”).  These transactions include Mr. Kang’s privatesale of 285,715 shares of his personal Liquidmetal Technologies common stock toGrowell Metal Co., Ltd. in February 2002, prior to our initial publicoffering.  They also include Mr. Kang’ssubsequent indirect purchase and disposition of Liquidmetal Technologies commonstock in order to satisfy a personal agreement Mr. Kang made to Growell Metalin February 2002 regarding the guaranteed minimum value of the stock purchasedby Growell Metal in February 2002 (the purchases and dispositions incident tothis agreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-marketpurchases of an aggregate of 89,300 shares of the Company’s common stock madeby Mr. Kang in August 2002.

 

The Audit Committee of our Board of Directors conducted an independentinquiry into the above-described transactions with the aid of independent legalcounsel and, as a result of such inquiry, the Audit Committee concluded thatthe transactions should have resulted in a liability to the Company underSection 16(b) in the amount of $302.  Mr.Kang has acknowledged this liability, and in an agreement negotiated betweenMr. Kang and the Audit Committee and approved by the full Board, Mr. Kang willpay this liability through periodic installments in 2005 and 2006.  As a result, the Company accrued for the $302receivable in other assets and other income as of December 31, 2004.  The above-described transactions involvingGrowell Metal was reported on a new Form 4 filed by Mr. Kang onNovember 15, 2004, and the open-market purchases were previously reported on atimely basis in August 2002.  As ofDecember 31, 2005, the outstanding amount of the receivable was $235, which isincluded in other assets.  Mr. Kang haspaid $67 during 2005.  The Company hasagreed to defer Mr. Kang’s payment schedule until 2006 as Mr. Kang has agreedaccept reduced compensation for the remainder of 2005. The remainingoutstanding balance of $235 will be due before the end of 2006.

 

During the year ended December 31, 2005, the Company executed a $198promissory note with CK Cho, member of our Board of Directors, for workingcapital purposes. The note was due and paid in full as of June 30, 2005.  The note has an annual rate of interest of 6%resulting in the Company paying approximately $2 in interest.  Mr. Cho also holds $620 of Senior ConvertibleNotes and holds 92,584 exercisable warrants as of December 31, 2005.  Further, during the year ended December 31,2005, Mr. Cho advanced approximately $1,260 to cover short-term liquidityneeds.  The advances were made withoutinterest and were repaid as of December 31, 2005.

 

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During the year ended December 31, 2005, Ricardo Salas, our President andChief Executive Officer, and Young Ham, our Chief Financial Officer, advancedthe company $75 and $133 to cover short-term liquidity needs,respectively.  The advances were madewithout interest and were repaid as of December 31, 2005.

 

**25. Fourth QuarterAdjustments and Transactions**

 

During the fourth quarter of 2005, the Company wrote-down$260 of primarily raw material inventory considered to be long term as thecarrying value of the inventory held as an “Impairment of long-lived assets” inthe accompanying Statement of Operations and Comprehensive Loss. While wemay use the excess raw materials beyond one year to fulfill future demand, wedid not foresee use of this inventory in the foreseeable future as of December31, 2005 (see Note 6).

 

Further, the Company amended its quarterlyfinancial statements originally filed on Form 10-Q for fiscal year 2005, toproperly account for the conversionfeature of the senior convertible notes issued in March 2004, which wereexchanged in August 2004, and August 2005 (see Note 15).  In addition, includedin the amended quarterly financial statements for the third quarter was a write-down $833 of primarily raw material inventory considered to be long term asthe carrying value of the inventory held as an impairment charge. While wemay use the excess raw materials beyond one year to fulfill future demand, wedid not foresee use of this inventory in the foreseeable future.

 

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**Schedule II – Valuation and Qualifying Accounts**

 
| ** **                                | ** ** | **Balance at**   | ** ** | **Additions**  | ** ** | **Write-offs** | ** ** | **Balance at** | ** ** |
|-------------------------------------------|------------|------------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                                | ** ** | **Beginning of** | ** ** | **Charged to** | ** ** | **and**        | ** ** | **End of**     | ** ** |
| ** **                                | ** ** | **Period**       | ** ** | **Expenses**   | ** ** | **Payments**   | ** ** | **Period**     | ** ** |
| Allowance  for doubtful accounts          |       |             |       |           |       |           |       |           |       |
| Year ended December 31, 2005              |       | $                | 108        |           | $          | (6             | )          | $              | (41        | ) | $ | 61 |   |
| Year ended December 31, 2004              |       | 127              |       | 84             |       | (103           | )          | 108            |       |
| Year ended December 31, 2003              |       | 450              |       | (28            | )          | (295           | )          | 127            |       |
|                                      |       |             |       |           |       |           |       |           |       |
| Product  warranty accrual                 |       |             |       |           |       |           |       |           |       |
| Year ended December 31, 2005              |       | $                | 519        |           | $          | 101            |       | $              | 14         |   | $ | 634 |   |
| Year ended December 31, 2004              |       | 303              |       | 288            |       | (72            | )          | 519            |       |
| Year ended December 31, 2003              |       | 237              |       | (297           | )          | 363            |       | 303            |       |
|                                      |       |             |       |           |       |           |       |           |       |
| Deferred tax  asset valuation allowance * |       |             |       |           |       |           |       |           |       |
| Year ended December 31, 2005              |       | $                | 33,477     |           | $          | —         |       | $              | (706       | ) | $ | 32,771 |   |
| Year ended December 31, 2004              |       | 28,866           |       | 4,611          |       | —         |       | 33,477         |       |
| Year ended December 31, 2003              |       | 25,401           |       | 3,465          |       | —         |       | 28,866         |       |

 

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*      Thedeferred tax asset valuation allowance represents a 100% reserve against thedeferred tax asset accounts at December 31, 2005, 2004, and 2003,respectively.

 

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