**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM10-K**

 
| ý                                               | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                 |       |                                                                                          |
| **For the fiscal year ended December 31, 2004** |
|                                                 |       |                                                                                          |
| o                                                    | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from              to             **

 

**Commission File No**.**000-31332**

 

----

 

**LIQUIDMETAL TECHNOLOGIES, INC.****(**Exact name of Registrant as specified in itscharter**)**

 
| **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 executiveoffice, zip code)

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for at least the past90 days.    Yes   o   No   ý

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K   o

 

Indicate by check mark whether the registrant isan accelerated filer (as defined in Exchange Act Rule 12b-2).   Yes   ý   No   o

 

The aggregate market value of the registrant’sCommon Stock held by non-affiliates of the registrant as of June 30, 2004 wasapproximately $34,793,699. For purposes of this calculation only, (i) shares ofCommon Stock are deemed to have a market value of $1.42 per share, the closingprice of the Common Stock as reported on the Nasdaq National Market on June 30,2004, and (ii) each of the executive officers, directors and persons holdingmore than 10% of the outstanding Common Stock as of June 30, 2004 is deemed tobe an affiliate.

 

 

----

 

**TABLE OF CONTENTS**

 
| PART I   |   |
|----------|--------|
|     |   | Item 1.  Business |   |
|     |   | 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 |   |
| 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 |   |

 

2

----

 

**PART I**

 

**Forward-Looking Statements**

 

This annual report on Form 10-K of LiquidmetalTechnologies, Inc. contains “forward-looking statements” that may state ourmanagement’s current expectations, estimates, forecasts, and projections aboutthe company and its business. Any statement in this report that is not astatement of historical fact is a forward-looking statement, and in some cases,words such as “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.  It is important to note that LiquidmetalTechnologies, Inc.’s actual results could differ materially from what isexpressed in our forward-looking statements due to the risk factors describedin the section of this report entitled “Factors Affecting Future Results,” aswell as the following 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 and unpredictablecustomer 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

 

Liquidmetal Technologies, Inc. undertakes noobligation to update publicly any forward-looking statements, whether as aresult of new information, future events or otherwise.

 

**Item 1. Business**

 

**Overview**

 

We are a materials technology company thatdevelops and commercializes products made from amorphous alloys.  Our Liquidmetal® family of alloys consists ofa variety of proprietary coatings, powders, bulk alloys, and composites thatutilize the advantages offered by amorphous alloy technology. We develop,manufacture, and sell products and components from bulk amorphous alloys tocustomers in various industries, and we also partner with third-party licenseesand distributors to develop and commercialize bulk Liquidmetal alloy products.We believe that our proprietary bulk alloys are the only commercially viablebulk amorphous alloys currently available in the marketplace.  In addition to our bulk alloys, we market andsell a line of proprietary amorphous alloy-based industrial coatings under theLiquidmetal® ArmacorTM Coatings brand.

 

Amorphous alloys are unique materials that aredistinguished by their ability to retain a random atomic structure when theysolidify, in contrast to the crystalline atomic structure that forms in othermetals and alloys when they solidify. Liquidmetal alloys possess a combinationof performance, processing, and potential cost advantages that we believe willmake them preferable to other materials in a variety of applications. Theamorphous atomic structure of our alloys enables them to overcome certainperformance limitations caused by inherent weaknesses in crystalline atomicstructures, 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.

 

**General CorporateInformation**

 

We were originally incorporated in California in1987, and we reincorporated in Delaware in May 2003.  Our principal executive offices are locatedat 25800 Commercentre Dr., Suite 100, Lake Forest, California 92630. Ourtelephone number at that address is (949) 206-8000. Previously, ourprincipal executive offices were located in Tampa, Florida. In December 2003,we consolidated all corporate functions into our Lake Forest facility, whichhad previously served as our principal research and development office. OurInternet website address is www.liquidmetal.com and all of our filings with theSecurities and Exchange Commission are available free of charge on our website.

 

3

----

 

**Our Technology**

 

The performance, processing, and potential costadvantages of Liquidmetal alloys are a function of their unique atomicstructure and their proprietary material composition.

 

***UniqueAtomic Structure***

 

The atomic structure of Liquidmetal alloys isthe fundamental feature that differentiates them from other alloys and metals.In the molten state, the atomic particles of all alloys and metals have anamorphous atomic structure, which means that the atomic particles appear in acompletely random structure with no discernible patterns. However, whennon-amorphous alloys and metals are cooled to a solid state, their atoms bondtogether in a repeating pattern of regular and predictable shapes, orcrystalline grains. This process is analogous to the way ice forms when waterfreezes and crystallizes. In non-amorphous metals and alloys, the individualcrystalline grains contain naturally occurring structural defects that limitthe potential strength and performance characteristics of the material. Thesedefects, known as dislocations, consist of discontinuities or inconsistenciesin the patterned atomic structure of each grain. Unlike other alloys andmetals, bulk Liquidmetal alloys can retain their amorphous atomic structurethroughout the solidification process and therefore do not develop crystallinegrains and the associated dislocations. Consequently, bulk Liquidmetal alloysexhibit superior strength and other superior performance characteristicscompared to their crystalline counterparts. Our Liquidmetal alloy coatings, incontrast to our bulk alloys, have a crystalline atomic structure when initiallyapplied, but their atomic structure becomes amorphous as the coatings rubagainst surfaces under force, thus improving their performance over time.

 

 

Prior to 1993, commercially viable amorphousalloys could be created only in thin forms, such as coatings, films, orribbons. However, in 1993, researchers at the California Institute ofTechnology (Caltech) developed the first commercially viable amorphous alloy ina bulk form. Today, bulk Liquidmetal alloys can be formed into objects that areup to 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.

 

***ProprietaryMaterial Composition***

 

The constituent elements and percentagecomposition of Liquidmetal alloys are critical to their ability to solidifyinto an amorphous atomic structure. We have several different alloycompositions that have different constituent elements in varying percentages.These compositions are protected by various patents that we own or exclusivelylicense from third parties, including Caltech. The raw materials that we use inLiquidmetal alloys are readily available and can be purchased from multiplesuppliers.

 

**Advantages ofLiquidmetal Alloys**

 

Liquidmetal alloys possess a unique combinationof performance, processing and cost advantages that we believe makes themsuperior in many ways to other commercially available materials for a varietyof existing and potential future product applications.

 

4

----

 

***PerformanceAdvantages***

 

Our bulk Liquidmetal alloys provide severaldistinct performance advantages over other materials, and we believe that theseadvantages make the alloys desirable in applications that require high yieldstrength, strength-to-weight ratio, elasticity and hardness.

 

The high yield strength of bulk Liquidmetalalloys means that a high amount of stress must be exerted to create permanentdeformation. However, because the yield strength is so high, the yield strengthof many of our bulk Liquidmetal alloy compositions is very near their ultimatestrength, which is the measure of stress at which total breakage occurs.Therefore, very little additional stress may be required to break an objectmade of bulk Liquidmetal alloys once the yield strength is exceeded. Althoughwe believe that the yield strength of many of our bulk alloys exceeds theultimate strength of most other commonly used alloys and metals, our bulkalloys may not be suitable for certain applications, such as pressurized tanks,in which the ability of the material to yield significantly before it breaks ismore important than its strength advantage. Additionally, although our bulkalloys show a high resistance to crack initiation because of their very highstrength and hardness, certain of our bulk alloys are sensitive to crackpropagation under certain long-term, cyclical loading conditions. Crackpropagation is the tendency of a crack to grow after it forms. We are currently developing new alloy compositionsthat have improved material properties to overcome these limitations.

 

***ProcessingAdvantages***

 

The processing of a material generally refers tohow a material is shaped, formed, or combined with other materials to create afinished product. Bulk Liquidmetal alloys possess processing characteristicsthat we believe make them preferable to other materials in a wide variety ofapplications. In particular, our alloys are amenable to processing options thatare similar in many respects to those associated with plastics. For example, webelieve that bulk Liquidmetal alloys have superior net-shape castingcapabilities as compared to high-strength crystalline metals and alloys.  “Net-shape casting” is a type of casting thatpermits the creation of near-to-net shaped products that do not require much 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 formnear-to-net shaped products. Accordingly, thermoplastic molding can be beneficial and economical fornet shape fabrication of high-strength products.

 

Bulk Liquidmetal alloys also permit the creationof composite materials that cannot be created with most non-amorphous metalsand alloys. A composite is a material that is made from two or more differenttypes of materials. In general, the ability to create composites is beneficialbecause constituent materials can be combined with one another to optimize thecomposite’s performance characteristics for different applications. In othermetals and alloys, the high temperatures required for processing could damagesome of the composite’s constituent materials and therefore limit theirutility. However, the relatively low melting temperatures of bulk Liquidmetalalloys allow mild processing conditions that eliminate or limit damage to theconstituent materials when creating composites. In addition to composites, webelieve that the processing advantages of Liquidmetal alloys will ultimatelyallow for a variety of other finished forms, including a coating or a spray.Most high-strength metals and alloys cannot be processed into these forms.

 

Notwithstanding the foregoing advantages, ourbulk Liquidmetal alloys possess certain limitations relative to processing. Thebeneficial processing features of our bulk alloys are made possible in part bythe alloys’ relatively low melting temperatures. Although a lower meltingtemperature is a beneficial characteristic for processing purposes, it renderscertain bulk alloy compositions unsuitable for certain high-temperatureapplications, such as jet engine exhaust components. Additionally, the currentone-inch thickness limitation of our zirconium-titanium bulk alloy renders ouralloys currently unsuitable for use as structural materials in large-scaleapplications, such as load-bearing beams in building construction. We arecurrently engaged in research and development with the goal of developingprocessing technology and new alloy compositions that will enable our bulkalloys to be formed into thicker objects.

 

***CostAdvantages***

 

Liquidmetal alloys have the potential toprovide cost advantages over other high-strength metals and alloys in certainapplications. Because bulk Liquidmetal alloy has processing characteristicssimilar in some respects to plastics, which 

 

5

----

 

lends itself to near-to-net shape castingand molding, Liquidmetal alloys can in many cases be shaped efficiently intointricate, engineered products. This capability can eliminate or reduce certainpost-casting steps, such as machining and re-forming, and therefore has thepotential to significantly reduce processing costs associated with making partsin high volume.

 

Additionally, because the near-to-net shapeprocessing of Liquidmetal alloys reduces the need for capital-intensive heavyindustrial equipment such as that found in foundry and forging operations,Liquidmetal alloys can be processed with a smaller machinery footprint, whichallows for more efficient development of facilities and reduced permitting andregulatory costs. We believe that these advantages may allow our customers anopportunity to maintain or improve the performance of their products without acommensurate increase in cost.

 

**Our Strategy**

 

As a result of the experience and knowledge thatwe have gained through our activities to date, and recognizing that developingand commercializing a revolutionary new technology is an evolutionary process,we are continually modifying our business strategy to enable us to bettercapitalize on our evolving core strengths and more effectively pursue revenuegrowth and profitability.  The keyelements 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*.  We intend to focus our marketing and internalmanufacturing activities on select products with anticipated higher grossmargins.  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 onhigher-margin products that possess design features that take optimal advantageof our existing and developing manufacturing technology and that command aprice commensurate with the performance 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 actively pursue and support strategicpartnerships that will enable us to leverage the resources, strength, andtechnologies of other companies in order to more rapidly develop andcommercialize products.  These partnershipsmay include licensing transactions in which we license full commercial rightsto our technology 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 that utilizing such a partneringstrategy will enable us to reduce our working capital burden, better fundproduct development efforts, better understand customer adoption practices,leverage the technical and financial resources of our partners, and moreeffectively handle product design and process challenges.  As this partnering strategy evolves, agrowing portion of our revenue mix may be comprised of revenue from theprovision of product development services, technical support, and engineeringservices, as well as revenues from royalties on the sale of Liquidmetal alloyproducts 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.

 

6

----

 

**Initial Applications**

 

We have focused our commercialization efforts forLiquidmetal alloys on five identified product areas.  We believe that these areas are consistentwith our strategy in terms of market size, building brand recognition, andproviding an opportunity to develop and refine our processing capabilities.Although we believe that strategic partnering transactions could createvaluable opportunities beyond the parameters of these target markets, weanticipate continuing to pursue these markets both internally and inconjunction with partners.

 

***Casingsfor Electronic Products***

 

We produce casing components for electronicdevices using our bulk Liquidmetal alloys and believe that our alloys offerenhanced performance and design benefits for these casings in certainapplications.  Bulk Liquidmetal alloyscan be used for various structural components of a cellular phone, includingthe shield, faceplate, hinge, hinge housings, back plate, side plates,brackets, and the cover on the phones. We initially targeted the electroniccasings market because of its potential for high product volumes and brandingopportunities; however, unpredictable customer adoption practices, shortproduct model lives, processing limitations, and intense pricing pressures makeit very challenging to compete in this high-volume market.  Accordingly, we are currently limiting ourfocus in this market to higher-margin applications that have the potential tobenefit from the unique performance characteristics of bulk Liquidmetalalloys.  We continue to believe that thehigh strength-to-weight ratio and elastic limit of bulk Liquidmetal alloysenable the production of stronger and thinner electronic devices as compared toplastic, zinc, and magnesium, and we intend to focus on products that requirethese design and performance benefits.

 

Through our shipments to date, we havedemonstrated that bulk Liquidmetal alloys can be used for structural componentsof cellular phones and other electronic devices.  During 2003 and 2004, we shipped productionquantities of cell phone components to Samsung Electronics Company and VertuLimited, the luxury communication products subsidiary of Nokia, for inclusionin various cellular phone models.

 

***SportingGoods and Leisure Products***

 

We are developing a variety of applications forLiquidmetal alloys in the sporting goods and leisure products area.

 

In the sporting goods industry, we believe thatthe high strength, hardness, and elasticity of our bulk alloys have thepotential to enhance performance in a variety of products, and we furtherbelieve that many sporting goods products are conducive to our internalmanufacturing strategy of focusing on high-margin products that meet our designcriteria.  Substantial opportunities alsoexist for our amorphous alloy coatings, powders and composites. In 2003,Rawlings Sporting Goods Company launched a new line of baseball and softballbats that utilize a Liquidmetal alloy coating, and HEAD NV Sport launched a newline of HEAD® Liquidmetal® tennis racquets thatincorporates Liquidmetal alloy in composite form in their racquet design. In2005, we will also be launching goods that utilize Liquidmetal alloy includingskis, lacrosse sticks and other sporting goods. We are continuing to work with golf companies for the development ofgolf club components made from bulk Liquidmetal alloys. Other potentialapplications for our alloys in this industry include eyewear, fishing, hunting,diving, bicycle, skate and winter sport products.

 

In the leisure products category, we believethat bulk Liquidmetal alloys can be used to efficiently produce intricatelyengineered designs with high-quality finishes, such as premium watchcases, andwe further believe that Liquidmetal alloy technology can be used to makehigh-quality, high-strength jewelry from precious metals.  We have successfully produced prototype ringsmade from an amorphous Liquidmetal platinum alloy that is harder (and hencemore scratch resistant) than conventional platinum jewelry.  In 2003, aspecial-edition concept chronograph timepiece featuring our titanium-zirconiumLiquidmetal alloy was showcased by luxury watchmaker TAG Heuer at the renownedBasel Watch and Jewelry Show in Basel, Switzerland.  In 2004, we have begun prototyping variouswatch pieces with TAG Heuer and we expect to be ready to move into productionin 2005.

 

In order to accelerate the commercialization ofLiquidmetal alloys in the jewelry and high-end luxury products market, in June2003 we entered into a strategic licensing transaction with LLPG, Inc., acorporation headed by a former director of our company with ties to the Swissjewelry and luxury goods market.  Underthis agreement, LLPG was granted a 10-year exclusive worldwide license tomanufacture and sell a variety of luxury goods, including watchcases andprecious-metal jewelry, utilizing Liquidmetal alloys.  Under the agreement, we are entitled toroyalties over the life of the contract on all products produced and sold byLLPG.

 

7

----

 

***MedicalDevices***

 

We are engaged in product development effortsrelating to various medical devices that could be made from Liquidmetal alloys.We believe that the unique properties of bulk Liquidmetal alloys provide acombination of performance and cost benefits that could make them a desirablereplacement to incumbent materials, such as stainless steel and titanium,currently used in various medical device applications.  Our greatest emphasis in 2003 and ongoing in2004 has been on surgical instrument applications for Liquidmetal alloys. Theseinclude, but are not limited to, specialized blades, orthopedic instrumentsutilized for implant surgery procedures, ultrasonic devices, dental devices,external fixation devices and general surgery devices. The potential valueoffered by our alloys is high performance in some cases and cost reduction inothers, the latter stemming from the ability of Liquidmetal alloys to be netshape cast into components, thus reducing costs of secondary processing. Thestatus of most components in the prototyping phase is subject to non-disclosureagreements with our customers.

 

We believe that our future success in themedical device market will be driven largely by strategically aligningourselves with well-established companies that are uniquely positioned tofacilitate the introduction of Liquidmetal alloys into this market, especiallyas it relates to the unique processing challenges and stringent materialqualification requirements that are prevalent in this industry.  We also believe that our prospects forsuccess in this market will be enhanced through our focus on optimizingexisting alloy compositions and developing new alloy compositions to satisfythe industry’s rigorous material qualification standards. For example, we havebeen working with DePuy Orthopaedics, Inc., a Johnson & Johnson company, todevelop an alloy for orthopedic implants and instruments in the kneereplacement device market.  Our agreementwith DePuy gives them the exclusive worldwide right and license to market andsell knee replacement devices that incorporate Liquidmetal alloys.  We are also in the early stages of workingwith other orthopedic companies to identify surgical instrument or deviceapplications that would benefit from utilizing Liquidmetal alloys.

 

***IndustrialCoatings and Powders***

 

We continue to market and sell amorphous alloyindustrial coatings and powders under the Liquidmetal® ArmacorTMCoatings brand name. Liquidmetal alloy coatings are used primarily as aprotective coating for industrial machinery and equipment. Since the inceptionof this business in the late 1980s, our proprietary coatings have demonstrateda high degree of hardness and low coefficient of friction which, when combinedwith their strong adhesion properties, reduce the wear and consequent failureof the machinery and equipment on which they are used. In contrast to our bulkalloys, we sell Liquidmetal coatings primarily in the form of a wire or powderfeedstock that is melted and applied to machinery or equipment through weldingor thermal spray processes.

 

Our Liquidmetal coatings are widely used in theoil drilling industry as a protective coating on drill pipe and casings, and weestimate that our coatings represent a dominant share of annual worldwide salesof hard band coatings for new oil drill pipe. Drilling often places tremendousstress on pipes and casings, especially whenever the drill changes direction.Both the drill pipe and casing experience excessive wear, which leads to higherreplacement costs and greater failure rates. Liquidmetal coatings are used toprovide a protective coating, or hard band, around the outside of the drillpipe and the inside of casings to reduce wear and failure rates and accordinglyreduce operating costs. Our principal coatings customers currently includeGrant Prideco, Inc., and TAFA, Inc. among other distributors and applicators.

 

Liquidmetal coatings have also been sold intothe power generation industry specifically for the purpose of coating boilertubes in coal-burning power plants in order to extend the lives of theseboilers. Boiler tubes are subject to high heat, erosion, and corrosion andoften require costly replacement, both in terms of replacement parts and lengthof downtime for installation. Additionally, residue build-up in boiler tubes ofcoal burning power plants creates operating inefficiencies. Historicperformance and testing of Liquidmetal coatings have demonstrated that ourcoatings extend the life of these boiler tubes meaningfully beyond theircurrent average life depending on the specific environment. In addition, ourcoatings have demonstrated the ability to reduce build-up of residue on boilertubes, helping to improve the efficiencies of the boilers. Historically, wehave not concentrated sales efforts on the boiler tube market in a substantialway. However, given the size of the market and potential opportunities for ourcoatings, we have recently dedicated greater effort to this area by, amongother initial steps, establishing a team of independent industrial salesrepresentatives who are now including our coatings in their product portfolios.  In addition to boiler tubes, these salesrepresentatives are soliciting other OEM product applications for Liquidmetalcoatings.

 

***DefenseApplications***

 

We are working with the U.S. Department ofDefense, as well as a variety of defense-related research and developmentagencies and large defense contractors, to develop various defense-relatedapplications for Liquidmetal alloys. For example, we are currentlydeveloping prototype kinetic energy penetrator rods for use in armor-piercingammunition

 

8

----

 

systems. Kinetic energy penetrators, or KEPs,are armor piercing munitions that are currently made primarily from depleteduranium or tungsten. Initial live-fire ballistic tests underthe Liquidmetal KEP program have demonstrated that tungsten KEPs perform betterwhenever Liquidmetal alloy is combined with the tungsten to create a compositematerial.   In August 2003, we signed anew $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.

 

In addition to funding the Army KEP program in2005, the Department of Defense Spending Bill for 2005 contains money tosupport the development of an advanced Liquidmetal alloy for use in aerospaceapplications.  Lockheed Martin has joinedLiquidmetal Technologies for this new program that will be managed by the U.S.Navy.

 

Liquidmetal is also working with NASA to conductan experiment to use Liquidmetal alloys as the optical surface for spaced-basedtelescopes.

 

We also continue to work with a number ofdefense-related research and development agencies and large defense companiesto identify additional military applications that may benefit from usingLiquidmetal alloys. We believe that our alloys are well-positioned tocapitalize on the trend toward lighter but stronger weapon systems in the U.S.military, and our strategy is to align ourselves with the largest and mostsignificant players in this industry.  Productdevelopment programs for defense applications are currently underway withseveral leading defense contractors, including Alliant Techsystems and LockheedMartin.

 

**Liquidmetal Golf**

 

From 1997 until September 2001, we engaged inthe retail marketing and sale of golf clubs through a majority ownedsubsidiary, Liquidmetal Golf. The retail business of Liquidmetal Golf wasdiscontinued in September 2001 and is now treated as a discontinued operationin our consolidated financial statements. Although the retail golf clubbusiness has been discontinued, Liquidmetal Golf will be engaged in thebusiness of manufacturing and selling golf club components to golf originalequipment manufacturers that will integrate these components into their ownclubs and then sell them under their respective brand names. LiquidmetalTechnologies owns 79% of the outstanding common stock in Liquidmetal Golf.

 

Our Liquidmetal Golf subsidiary has theexclusive right and license to utilize our Liquidmetal alloy technology forpurposes of golf equipment applications. This right and license is set forth inan intercompany license agreement between Liquidmetal Technologies andLiquidmetal Golf. This license agreement provides that Liquidmetal Golf has aperpetual and exclusive license to use Liquidmetal alloy technology for thepurpose of manufacturing, marketing, and selling golf club components and otherproducts used in the sport of golf. In consideration of this license,Liquidmetal Golf has issued 4,500,000 shares of Liquidmetal Golf common stockto Liquidmetal Technologies.

 

**Our IntellectualProperty**

 

Our intellectual property consists of patents,trade secrets, know-how, and trademarks. Protection of our intellectual propertyis a strategic priority for our business, and we intend to vigorously protectour patents and other intellectual property. Our intellectual propertyportfolio includes 24 owned or licensed U.S. patents and numerous patentapplications relating to the composition, processing, and application of ouralloys, as well as various foreign counterpart patents and patent applications.

 

Our initial bulk amorphous alloy technology wasdeveloped by researchers at the California Institute of Technology (“Caltech”).We have purchased patent rights that provide us with the exclusive right tocommercialize the amorphous alloy and other amorphous alloy technology acquiredfrom Caltech through a license agreement (“Caltech License Agreement”) withCaltech. Under the Caltech license agreement, we have the exclusive worldwideright to make, use, and sell products from all of Caltech’s inventions,proprietary information, know-how, and other technology relating to amorphousalloys existing as of September 1, 2001. We also have an exclusiveworldwide license to nine issued patents and four patent applications held byCaltech relating to amorphous alloy technology, as well as all related foreigncounterpart patents and patent applications. Of the patents currently issued toCaltech and licensed by us, the earliest expiration date is 2013 and the latestexpiration 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 periodSeptember 1, 2001 through August 31, 2005. All fees and other 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 rights under the license agreement areperpetual in duration. However, Caltech has the right to convert the license toa non-exclusive license if we fail to utilize the licensed technology for aperiod of 18 or more consecutive months, 

 

9

----

 

provided that Caltech must give us 180-daysadvance written notice of the conversion and we may cure the failure at anytime during the 180-day notice period. If we cure the failure, then the licensewill not be converted into a non-exclusive license.

 

Under the license agreement, we have the rightto sublicense any of the licensed technology or patents. The license agreementalso provides that Caltech reserves the right to use the licensed technologyand patents for noncommercial educational and research purposes. The patentsand patent applications that we license from Caltech relate primarily to thecomposition and processing of our alloys. The currently issued U.S. patentscovered by the license agreement will expire between 2013 and 2021.

 

Under the Caltech license agreement, the partiesare obligated to provide reasonable cooperation to each other in connectionwith any threatened or actual infringement of the licensed technology by thirdparties. We have the right to commence an action for infringement of any of thelicensed technology, and although Caltech is not obligated to bring suit ortake action against infringers, Caltech is obligated to join in any suchlawsuit upon our request.

 

In addition to the patents and patentapplications that we license from Caltech, we are building a portfolio of ourown patents to expand and enhance our technology position. These patents andpatent applications primarily relate to various applications of our bulkamorphous alloys, the composition of our coatings and powders, and theprocessing of our alloys. The patents relating to our coatings expire onvarious dates between 2005 and 2017, and the patents relating to our bulkamorphous alloys expire on various dates between 2013 and 2021. Our policy isto seek patent protection for all technology, inventions, and improvements thatare of commercial importance to the development of our business, except to theextent that we believe it is advisable to maintain such technology or inventionas a trade secret.

 

In order to protect the confidentiality of ourtechnology, including trade secrets, know-how, and other proprietary technicaland business information, we require that all of our employees, consultants,advisors and collaborators enter into confidentiality agreements that prohibitthe use or disclosure of information that is deemed confidential. Theagreements also obligate our employees, consultants, advisors and collaboratorsto assign to us developments, discoveries and inventions made by such personsin connection with their work with us.

 

**Research and Development**

 

We are engaged in ongoing research anddevelopment programs that are driven by the following key objectives:

 

•                       *Enhance Material Processingand Manufacturing Efficiencies.*We plan to continue research and development of processes andcompositions that will decrease our cost of making products from Liquidmetalalloys.

 

•                       *Optimize Existing Alloys and Develop New Compositions*.  We believe that the primary technology driverof our business will continue to be our proprietary alloy compositions.**We plan to continue research and developmenton new alloy compositions to generate a broader class of amorphous alloys witha wider range of specialized performance characteristics. During 2003 andcontinuing into 2004, we have successfully expanded our portfolio ofbulk amorphous alloys to include additional zirconium-titanium alloys, as wellas alloys based on other metals, such as iron 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 incumbentmaterials and, in certain cases, drive down product costs.  We also believe that our ability to optimizeour existing alloy compositions will enable us to better tailor our alloys toour customers’ specific application requirements.

 

•                       *Develop New Applications.*We will continue research and development ofnew applications for Liquidmetal alloys. We believe the range of potentialapplications will broaden by expanding the forms, compositions, and methods ofprocessing of our alloys.

 

We conduct our research anddevelopment programs internally and also through strategic relationships thatwe enter into with third parties. Our internal research and development effortsare currently focused on product and process development. Our internal researchand development efforts are conducted by a team of 21 scientists, engineers andresearchers whom we either employ directly or engage as consultants. Includedamong this team are Professor William Johnson, who discovered our initial bulkamorphous alloy at Caltech in 1993, and his graduate student at the time,Atakan Peker, who is employed as our Vice President of Technology.  Professor Johnson was an employee of ourcompany from October 2001 through December 2003 and then became a consultant tothe Company.  Professor Johnson continuesto be a member of our board of directors.

 

In addition to our internal research anddevelopment efforts, we enter into cooperative research and developmentrelationships with leading academic institutions. Professor Johnson continuesto supervise a laboratory at Caltech, and through our license agreement withCaltech, we have a continuing relationship with the other researchers inProfessor 

 

10

----

 

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 have entered into development relationshipswith other companies for the purpose of identifying new applications for ouralloys and establishing customer relationships with such companies. Some of ourproduct development programs are partially funded by our customers. We are alsoengaged in negotiations with other potential customers regarding possibleproduct development relationships. Our research and development expenses forthe years ended December 31, 2004, 2003, and 2002 were $1.5 million,$8.8 million, and $11.8 million, respectively.

 

**Manufacturing**

 

We currently own and operate a 166,000 squarefeet manufacturing facility in Pyongtaek, South Korea, which became operationalin the third quarter of 2002.  We openeda 14,400 square feet facility in Weihai, China in August 2004 to facilitate ourbulk alloy manufacturing business.  Webelieve that these facilities will meet our anticipated manufacturing needs forthe foreseeable future, although these needs may change depending upon theactual and forecasted orders we receive for our products. We currently intendto develop supplemental research and development, prototyping and manufacturingcapabilities elsewhere, including the United States, for purposes of meetingour long-term manufacturing needs and our customers’ requirements.  In December 2003, we entered into a licenseagreement with Florida Custom Mold, Inc., a Clearwater, Florida-based companythat specializes in high-quality mold design and injection molding services,under which Florida Custom Mold is currently acting as a contract manufacturerto our company for purposes of producing prototypes of certain defense andmedical products in the US.

 

**Raw Materials**

 

Liquidmetal alloy compositions are comprised ofmany elements, all of which are available commodity products. We believe thateach of these raw materials is readily available in sufficient quantities frommultiple sources on commercially acceptable terms. However, any substantialincrease in the price or interruption in the supply of these materials couldhave an adverse effect on our profitability.

 

**Customers**

 

During 2004, four customers accounted for 10% ormore of our revenue from continuing operations. Revenues from Charm Tech and Pntel, both of which are direct suppliersto Samsung, represented 62% of revenue from continuing operations for the yearended 2004.  Also, revenues from defenserelated contracts with the Unites States of America represented 10% and GrowellMetal represented 12% of revenue from continuing operations for the year ended2004.  During 2003, three customersaccounted for 10% or more of our revenue from continuing operations. Revenuefrom Samsung represented 10% of revenue, revenue from LLPG, Inc. represented12% and defense-related contracts with three departments of the United Statesof America represented 16% of revenue from continuing operations for the yearended December 31, 2003. During the year ended December 31, 2002, revenuefrom Samsung represented 15% of revenue while revenue earned on contracts withthe government represented 16% of revenue from continuing operations.  We expect that a significant portion of ourrevenue may continue to be concentrated in a limited number of customers, evenas our bulk Liquidmetal alloy business grows.

 

**Competition**

 

We are not aware of any other company orbusiness that manufactures, markets, distributes, or sells bulk amorphousalloys or products made from bulk amorphous alloys. We believe it would bedifficult to develop a competitive bulk amorphous alloy without infringing ourpatents. However, we expect that our bulk Liquidmetal alloys will facecompetition from other materials, including metals, alloys, plastics andcomposites, which are currently used in the commercial applications that wepursue. Our alloys could also face competition from new materials that may bedeveloped in the future, including new materials that could render our alloysobsolete.

 

Our Liquidmetal alloy coatings face competitionfrom industrial coatings currently manufactured or sold by other companies. Atpresent, the primary competitors of our coatings business are VarcoInternational, Inc. and Arnco Technology Trust, Limited. Although we believe,based on market data gathered by us, that our coatings compete favorably withthese companies’ products and that we continue to maintain the dominant marketshare with respect to protective coatings for oil drill pipe and casings, thesecompetitors are larger well-established businesses that have substantiallygreater financial, marketing, and other resources than we do.

 

11

----

 

We will also experience indirect competitionfrom the competitors of our customers. Because we will rely on our customers tomarket and sell finished goods that incorporate our components or products, oursuccess will depend in part on the ability of our customers to effectivelymarket and sell their own products and compete in their respective markets.

 

**Backlog**

 

In our bulk alloy segment, because of theminimal lead-time associated with orders of bulk alloy parts, we generally donot carry a significant backlog. In our coatings segment, we typically ship ourcoating products shortly after receipt of an order, and our coatings backlog istherefore also insignificant. In both our bulk alloy segment and coatingssegment, the backlog as of any particular date gives no indication of actualsales for any succeeding period.

 

**Sales and Marketing**

 

We direct our marketing efforts towardscustomers that will incorporate our components and products into their finishedgoods. To that end, we will continue to hire business development personnelwho, in conjunction with engineers and scientists, will actively identifypotential customers that may be able to benefit from the introduction ofLiquidmetal alloys to their products. In some cases, we will developapplications in conjunction with existing or potential customers. By adoptingthis strategy, we intend to take advantage of the sales and marketing forcesand distribution channels of our customers to facilitate the commercialization ofour 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, 2004, we had 158 full-timeemployees. As of December 31, 2004, 55 of our Korean operation employees wererepresented by a labor union.  We havenot experienced any work stoppages and we consider our employee relations to befavorable.

 

**Governmental Regulation**

 

Medical instruments incorporating ourLiquidmetal alloys will be subject to regulation in the United States by theFDA and corresponding state and foreign regulatory agencies. Any orthopedicdevices that we develop will be regulated in a similar manner. Medical devicemanufacturers to whom we intend to sell our products may need to obtain FDAapproval before marketing their medical devices that incorporate our products.Medical device manufacturers may need to obtain similar approvals beforemarketing these medical device products in foreign countries.

 

Because we intend to sell our medical deviceproducts to medical device manufacturers, we do not believe that we will needto obtain FDA approval or similar foreign approvals before selling products tomedical 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 process of obtaining and maintainingrequired FDA and foreign regulatory approvals for medical devices thatincorporate our products could be lengthy, expensive, and uncertain for ourcustomers. Additionally, regulatory agencies can delay or prevent productintroductions. Generally, before a medical device manufacturer can market aproduct incorporating one of our products, our customer must obtain for theirfinished product marketing clearance through a 510(k) premarket notification orapproval of a pre-market approval application, or PMA. The FDA will typicallygrant a 510(k) clearance if the applicant can establish that the device issubstantially equivalent to a predicate device. It generally takes a number ofmonths from the date of a 510(k) submission to obtain clearance, but it maytake longer, particularly if a clinical trial is required.

 

The FDA may find that a 510(k) is notappropriate for a medical device that incorporates our product or that substantialequivalence has not been shown and as a result will require a PMA. A PMAapplication must be submitted if a proposed medical device does not qualify fora 510(k) pre-market clearance procedure. PMA applications must besupported 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.

 

12

----

 

Similar regulations in foreign countries varysignificantly from country to country and with respect to the nature of theparticular medical device. The time required to obtain these foreign approvalsto market our products may be longer or shorter than that required in theUnited States, and requirements for such approval may differ from FDArequirements.

 

**Factors Affecting FutureResults**

 

This report contains forward-looking statements(within the meaning of the Private Securities Litigation Reform Act of 1995)that are based on management’s current expectations, estimates, forecasts, andprojections about the Company and its business. In addition, other written ororal statements which constitute forward-looking statements may be made fromtime to time by or on behalf of Liquidmetal Technologies, Inc. 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. Liquidmetal Technologies, Inc. undertakes no obligation toupdate publicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

Factors that could cause actual results to differmaterially from what is expressed or forecasted in our forward-lookingstatements include, but are not limited to, the following:

 

**We have not sustainedprofitability and may incur losses in the future.**

 

We had an accumulated deficit of approximately $125.3million at December 31, 2004. Of this accumulated deficit, $44.5 millionwas attributable to losses generated by our discontinued equipmentmanufacturing and retail golf businesses through December 31, 2004.  We may incur additional operating losses inthe future. Consequently, it is possible that we may not achieve positiveearnings and, if we do achieve positive earnings, we may not be able to achievethem on a sustainable basis.

 

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

 

We have marketed and sold industrial coatings todistributors in the coatings industry since 1987. Prior to the third quarter of2002, our experience selling products made from bulk amorphous alloys has beenlimited to our discontinued retail golf business, which had a differentmarketing strategy than the one we are currently employing. Therefore, we havea relatively limited history of producing bulk amorphous alloy components andproducts on a mass-production basis. Many of our relationships with potentialcustomers for bulk alloy products are at an early stage, and there can be noassurance that these customers will enter into purchase commitments with us.

 

**We rely on assumptionsabout the markets for our products and components that, if incorrect, mayadversely affect our profitability.**

 

We have a relatively short history producingbulk amorphous alloy components on a mass-production basis. We have madeassumptions regarding the market size for, and the manufacturing requirementsof, our products and components based in part on information we received fromthird parties and also from our limited history. If these assumptions prove tobe incorrect, we may not achieve anticipated revenue targets or profitability.

 

**If we cannot establishand maintain relationships with customers that incorporate our components andproducts into their finished goods, we will not be able to increase our revenueand commercialize our products.**

 

To increase our revenue, we must establish andmaintain relationships with customers that will incorporate our components andproducts into their finished goods. We expect to rely on the marketing,distribution, and, in some cases, the manufacturing, research, and developmentabilities of our customers to assist us in developing, commercializing, andmarketing our products in different markets. Our future growth and success willdepend in large part on our ability to enter into these relationships and thesubsequent success of these relationships. If our products are selected for usein a customer’s products, we still may not realize significant revenue fromthat customer if that customer’s products are not commercially successful.

 

13

----

 

**It may take significanttime and cost for us to develop new customer relationships, which may delay ourability to generate additional revenue or achieve profitability.**

 

Our ability to generate revenue from newcustomers will be affected by the amount of time it takes for us to, amongother things:

 

•                                          identify a potential customer and introducethe customer to Liquidmetal alloys;

 

•                                          work with the customer to select and designthe parts to be fabricated from Liquidmetal alloys;

 

•                                          make the molds and tooling to be used toproduce the selected part;

 

•                                          make prototypes and samples for customertesting;

 

•                                          work with our customers to test and analyzeprototypes and samples; and

 

•                                          with respect to some types of products, suchas medical devices, to obtain regulatory approval.

 

We currently do not have a sufficient history ofselling products made from our bulk amorphous alloys to predict accurately thelength of our average sales cycle. We believe that our average sales cycle fromthe time we deliver an active proposal to a customer until the time ourcustomer fully integrates our bulk amorphous alloys into its product could be asignificant period of time. Our history to date has demonstrated that the salescycle could extend significantly longer than we anticipate. The time it takesto transition a customer from limited production to full-scale production runswill depend upon the nature of the processes and products into which our alloysare integrated.  Moreover, we have foundthat customers often proceed very cautiously and slowly before incorporating afundamentally new and unique type of material into their products.

 

**After we develop acustomer relationship, it may take a significant amount of time for thatcustomer to develop, manufacture, and sell finished goods that incorporate ourcomponents and products.**

 

Our experience has shown that our customers willperform numerous tests and extensively evaluate our components and productsbefore incorporating them into their finished products. The time required fortesting, evaluating, and designing our components and products into a customer’sproducts, and in some cases, obtaining regulatory approval, can take asignificant amount of time, with an additional period of time before a customercommences volume production of products incorporating our components andproducts, if ever. Moreover, because of this lengthy development cycle, we mayexperience a delay between the time we accrue expenses for research anddevelopment and sales and marketing efforts and the time when we generaterevenue, if any. We may incur substantial costs in an attempt to transition acustomer from initial testing to prototype and from prototype to final product.If we are unable to minimize these transition costs, or to recover the costs ofthese transitions from our customers, our operating results will be adverselyaffected.

 

**A limited number of ourcustomers generate a significant portion of our revenue.**

 

For the near future, we expect that asignificant portion of our revenue will be concentrated in a limited number ofcustomers. For example, for the year ended December 31, 2004, revenue from twocustomers represented approximately 62% of total revenue from continuingoperations and for the year ended December 31, 2003, revenue from twocustomers represented approximately 26% of total revenue from continuingoperations. A reduction, delay, or cancellation of orders from one or more ofthese 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 ourcustomers to market and sell finished goods that incorporate our products andcomponents, a process over which we will have little control.**

 

Our future revenue growth and ultimateprofitability will depend in part on the ability of our customers tosuccessfully market and sell their finished goods that incorporate ourproducts. We will have little control over our customers’ marketing and salesefforts. These marketing and sales efforts may be unsuccessful for variousreasons, any of which could hinder our ability to increase revenue or achieveprofitability. For example, our customers may not have or devote sufficientresources to develop, market, and sell their finished goods that incorporateour products. Because we 

 

14

----

 

typically will not have exclusive salesarrangements with our customers, they will not be precluded from exploring andadopting competing technologies. Also, products incorporating competingtechnologies may be more successful for reasons unrelated to the performance ofour customers’ products or the marketing efforts of our customers.

 

**Our growth depends onour ability to identify, develop, and commercialize new applications for ourtechnology.**

 

Our future growth and success will depend inpart on our ability to identify, develop, and commercialize, either alone or inconjunction with our customers, new applications and uses for Liquidmetalalloys. If we are unable to identify and develop new applications, we may beunable to develop new products or generate additional revenue. Successfuldevelopment of new applications for our products may require additionalinvestment, including costs associated with research and development and theidentification of new customers. In addition, difficulties in developing andachieving market acceptance of new products would harm our business.

 

**We may not be able toeffectively compete with current suppliers of incumbent materials or producersof competing products.**

 

The future growth and success of our bulkamorphous alloy business will depend in part on our ability to establish andretain a technological advantage over other materials for our targetedapplications. For many of our targeted applications, we will compete withmanufacturers of similar products that use different materials. For example, wehave targeted the cellular phone casing market as an application for bulkLiquidmetal alloys. In this market, we believe we will compete with othermanufacturers of cellular phone casings who use plastics or metal to constructtheir casings. In other markets, we will compete directly with suppliers of theincumbent material.  In addition, in each of our targeted markets,our success will depend in part on the ability of our customers to competesuccessfully in their respective markets. Thus, even if we are successful in replacingan incumbent material in a finished product, we will remain subject to the riskthat our customer will not compete successfully in its own market.

 

**Future advances inmaterials science could render Liquidmetal alloys obsolete.**

 

Academic institutions and business enterprisesfrequently engage in the research and testing of new materials, includingalloys and plastics. Advances in materials science could lead to new materialsthat have a more favorable combination of performance, processing, and costcharacteristics than our alloys. The future development of any such newmaterials could render our alloys obsolete and unmarketable or may impair ourability to compete effectively.

 

**Our growth depends uponour ability to retain and attract a sufficient number of qualified employees.**

 

Our future growth and success will depend inpart on our ability to retain key members of our management and scientificstaff, particularly John Kang, our Chairman of the board of directors,Professor William Johnson, a member of our board of directors and a professorat Caltech, and Dr. Atakan Peker, our Vice President of Technology. We do nothave “key man” or similar insurance on any of these individuals. If we losetheir services or the services of other key personnel, our financial results orbusiness prospects may be harmed. Additionally, our future growth and successwill depend in part on our ability to attract, train, and retain scientificengineering, manufacturing, sales, marketing, and management personnel. Wecannot be certain that we will be able to attract and retain the personnelnecessary to manage our operations effectively. Competition for experiencedexecutives and scientists from numerous companies and academic and otherresearch institutions may limit our ability to hire or retain personnel onacceptable terms. In addition, many of the companies with which we compete forexperienced personnel have greater financial and other resources than we do.Moreover, the employment of non-citizens may be restricted by applicable immigrationlaws.

 

**We may not be able tosuccessfully identify, consummate, or integrate strategic partnerships.**

 

As a part of our business strategy, we intend topursue strategic partnering transactions that provide access to newtechnologies, products, markets, and manufacturing capabilities. Thesetransactions could include licensing agreements, joint ventures, or evenbusiness combinations. For example, we may pursue transactions that will giveus access to new technologies that are useful in connection with thecomposition, processing, or application of Liquidmetal alloys. We may not beable to successfully identify any potential strategic partnerships. Even if wedo identify one or more potentially beneficial strategic partnering, we may notbe able to consummate these transactions on favorable terms or obtain thebenefits we anticipate from such a transaction.

 

15

----

 

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

 

We have relatively limited experience inmanufacturing our products and may be required to manufacture a range ofproducts in high volumes while ensuring high quality and consistency. Althoughwe currently own and operate a 166,000 square feet and a 14,400 square feetmanufacturing facilities in South Korea and China, respectively, we cannotguarantee that these facilities will be able to produce the intended productswith production yields, quality controls, and production costs that provide uswith acceptable margins or profitability or satisfy the requirements of ourcustomers.

 

**We expect to derive asubstantial portion of our revenue from sales outside the United States, andproblems associated with international business operations could affect ourability to manufacture and sell our products.**

 

We expect that we will continue to manufacture asubstantial portion of our initial bulk Liquidmetal alloy products in our SouthKorean facility. As a result, our manufacturing operations 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 sales to customers located outside of the United Stateswill account for a significant portion of our revenue in future periods andthat the trend of foreign customers accounting for an increasing portion of ourtotal sales may continue. Specifically, we expect to continue to derive asignificant amount of revenue from sales to customers located in Asia. Adownturn in the economies of Asian countries where our products will be sold,particularly South Korea’s economy, could materially harm our business.

 

Consequently, our operations and revenue likelywill be subject to a number of risks associated 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 North Korea;

 

•                                          potentially adverse tax consequences;

 

•                                          burden of complying with complex foreign lawsand treaties; and

 

•                                          tradeprotection laws, policies, and measures and other regulatory requirementsaffecting trade and investment, including loss or modification of exemptionsfor taxes and tariffs.  Moreover,customers may sell finished goods that incorporate our components and productsoutside of the United States, which exposes us indirectly to additional foreigncommerce risks.

 

**Our business is subjectto the potential adverse consequences of exchange rate fluctuations.**

 

We expect to conduct business in various foreigncurrencies and will be exposed to market risk from changes in foreign currencyexchange rates and interest rates. Fluctuations in exchange rates between theU.S. dollar and such foreign currencies may have a material adverse effect onour business, results of operations, and financial condition and couldspecifically result in foreign exchange gains and losses. The impact of futureexchange rate fluctuations on our operations cannot be accurately predicted. Tothe extent that the percentage of our non-U.S. dollar revenue derived frominternational sales increases in the future, our exposure to risks associatedwith fluctuations in foreign exchange rates will increase further. Moreover, asa result of operating a manufacturing facility in South Korea, a substantialportion of our costs are and will continue to be denominated in the SouthKorean won. Adverse changes in the exchange rates of the South Korean won tothe U.S. dollar will affect our costs of goods sold and operating margins andcould result in exchange losses.

 

16

----

 

**Our inability to protectour licenses, patents, and proprietary rights in the United States and foreigncountries could harm our business because third parties may take advantage ofour research and development efforts.**

 

We have an exclusive license from Caltech toseveral patents and patent applications relating to amorphous alloy technology,and we have obtained several of our own patents. We also have the exclusiveright to Caltech’s inventions, proprietary information, know-how, and othertechnology relating to bulk amorphous alloys existing as of September 1,2001. Our success depends in part on our ability to obtain and maintain patentand other proprietary right protection for our technologies and products in theUnited States and other countries. If we are unable to obtain or maintain theseprotections, we may not be able to prevent third parties from using ourproprietary rights. Specifically, we must:

 

•                                          protect and enforce our license agreementwith Caltech and our own patents and intellectual property;

 

•                                          exploit our license of the patentedtechnology under our license agreement with Caltech as well as our own patents;and

 

•                                          operate our business without infringing onthe intellectual property rights of third parties.

 

Caltech owns several issued United Statespatents covering the composition and method of manufacturing of the family ofLiquidmetal alloys. We also hold several United States and correspondingforeign patents covering the manufacturing processes of Liquidmetal alloys andtheir use. The patents relating to our coatings expire on various dates between2005 and 2017, and those relating to our bulk amorphous alloys between 2013 and2021. If we are unable to protect our proprietary rights prior to theexpiration of these patents, we may lose the advantage we have established asbeing the first to market bulk amorphous alloy products. In addition, the lawsof some foreign countries do not protect proprietary rights to the same extentas the laws of the United States, and we may encounter significant problems andcosts in protecting our proprietary rights in these foreign countries.

 

Patent law is still evolving relative to thescope and enforceability of claims in the fields in which we operate. Ourpatent protection involves complex legal and technical questions. Our patentsand those patents for which we have license rights may be challenged, narrowed,invalidated, or circumvented. We may be able to protect our proprietary rightsfrom infringement by third parties only to the extent that our proprietarytechnologies are covered by valid and enforceable patents or are effectivelymaintained as trade secrets. Furthermore, others may independently developsimilar or alternative technologies or design around our patented technologies.Litigation or other proceedings to defend or enforce our intellectual propertyrights could require us to spend significant time and money and could otherwiseadversely affect our business.

 

**Other companies mayclaim that we infringe their intellectual property rights, which could cause usto incur significant expenses or prevent us from selling our products.**

 

Our success depends, in part, on our ability tooperate without infringing on valid, enforceable patents or proprietary rightsof third parties and not breaching any licenses that may relate to ourtechnology and products. Future patents issued to third parties may containclaims that conflict with our patents and that compete with our products andtechnologies, and third parties could assert infringement claims against us.Any litigation or interference proceedings, regardless of their outcome, may becostly and may require significant time and attention of our management andtechnical personnel. Litigation or interference proceedings could also force usto:

 

•                                          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 agreementsthat may be unavailable on acceptable terms.

 

**The time and costassociated with complying with government regulations to which we could becomesubject could have a material adverse effect on our business.**

 

Some of the applications that we have identifiedor may identify in the future may be subject to government regulations. Forexample, any medical devices such as precision ophthalmic instruments andorthopedic devices made from our alloys likely will be subject to extensivegovernment regulation in the United States by the Food and Drug 

 

17

----

 

Administration, or FDA. Any medical device manufacturersto whom we sell Liquidmetal alloy products may need to comply with FDArequirements, including premarket approval or clearance underSection 510(k) of the Food Drug and Cosmetic Act before marketing in theUnited States Liquidmetal alloy medical device products. These medical devicemanufacturers may be required to obtain similar approvals before marketingthese medical devices in foreign countries. Any medical device manufacturerswith which we jointly develop and sell medical device products may not providesignificant assistance to us in obtaining required regulatory approvals. Theprocess of obtaining and maintaining required FDA and foreign regulatoryapprovals could be lengthy, expensive, and uncertain. Additionally, regulatoryagencies can delay or prevent product introductions. The failure to comply withapplicable regulatory requirements can result in substantial fines, civil andcriminal penalties, stop sale orders, loss or denial of approvals, recalls ofproducts, and product seizures.

 

In addition, the processing of beryllium, aminor constituent element of some of our alloys, can result in the release ofberyllium into the workplace and the environment and in the creation ofberyllium oxide as a by-product. Beryllium is classified as a hazardous airpollutant, a toxic substance, a hazardous substance, and a probable humancarcinogen under environmental, safety, and health laws, and various acute andchronic health effects may result from exposure to beryllium. We are requiredto comply with certain regulatory requirements and to obtain a permit from theU.S. Environmental Protection Agency or other government agencies to processberyllium. 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 extent that our products have thepotential for dual use, such as military and non-military applications, theymay be subject to import and export restrictions of the U.S. government, aswell as other countries. The process of obtaining any required U.S. or foreignlicenses or approvals could be time-consuming, costly, and uncertain. Failureto comply with import and export regulatory requirements can lead tosubstantial fines, civil and criminal penalties, and the loss of governmentcontracting and export privileges.

 

**We may requireadditional funding, which may not be available on favorable terms or at all.**

 

Our future capital requirements will depend onthe amount of cash generated by our operations. Our projections of cash flowsfrom operations and, consequently, future cash needs are subject to substantialuncertainty. If our available funds and cash generated from operations areinsufficient to satisfy our liquidity requirements, we may need additionalfunds in the future to support our working capital requirements and for otherpurposes, and we may seek to raise additional funds through public or privateequity financing, bank debt financing, or from other sources. Adequate fundsmay not be available when needed or may not be available on favorable terms. Ifwe raise additional funds by issuing equity securities, existing shareholdersmay be diluted. If funding is insufficient at any time in the future, we maynot be able to develop or enhance our products or services, take advantage ofbusiness opportunities, or respond to competitive pressures, any of which couldharm our business.

 

**Antitakeover provisionsof our certificate of incorporation and bylaws and provisions of applicablecorporate law could delay or prevent a change of control that you may favor.**

 

Provisions in our certificate of incorporation,our bylaws, and Delaware law could make it more difficult for a third party toacquire us, even if doing so would be beneficial to our shareholders. Theseprovisions could discourage potential takeover attempts and could adverselyaffect the market price of our shares. Because of these provisions, you mightnot be able to receive a premium on your investment. These provisions:

 

•                                          authorizeour board of directors, without shareholder approval, to issue up to 10,000,000shares of “blank check” preferred stock that could be issued by our board ofdirectors to increase the number of outstanding shares and prevent a takeoverattempt;

 

•                                          limit shareholders’ ability to call a specialmeeting of our shareholders;

 

•                                          provide for a classified board of directors;and

 

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

 

The provisions described above could delay ormake more difficult transactions involving a change in control of us or ourmanagement.

 

18

----

 

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

 

Our bulk amorphous alloy technology is a relatively newtechnology as compared to many other material technologies, such as plasticsand widely-used high-performance crystalline alloys.  Historically, the successfulcommercialization of a new materials technology has required the persistentimprovement and refining of the technology over a sometimes lengthy period oftime.  Accordingly, we believe that ourCompany’s future success will be dependent on our ability to continue expandingand improving our technology platform by, among other things, constantlyrefining and improving our manufacturing processes, optimizing our existingamorphous alloy compositions for various applications, and developing andimproving new bulk amorphous alloy compositions.  Our failure to further expand our technologybase could limit our growth opportunities and hamper our commercializationefforts.

 

**Our stock price may experience volatility.**

 

The trading price of our common stock could fluctuate widely due to:

 

•              quarter-to-quarter variations inresults of operations;

 

•              loss of a major customer;

 

•              announcements of technological innovationsby us or our potential competitors;

 

•              changes in, or our failure tomeet, the expectations of securities analysts;

 

•              new products offered by us or ourcompetitors;

 

•              announcements of strategicrelationships or strategic partnerships; or

 

•              other events or factors that maybe beyond our control.

 

In addition, the securities markets in general haveexperienced extreme price and trading volume volatility in the past. Thetrading prices of securities of many companies at our stage of growth have fluctuatedbroadly, often for reasons unrelated to the operating performance of thespecific companies. These general market and industry factors may adverselyaffect the trading price of our common stock, regardless of our actualoperating 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.

 

**Item 2. Properties**

 

Our principal executive offices and principalresearch and development offices are located in Lake Forest, California andconsist of approximately 30,000 square feet. This facility is occupied pursuantto a lease agreement that expires in June 2007. Prior to December 31, 2003, ourprincipal executive offices were located in Tampa, Florida; however, as anoutgrowth of various cost reduction measures in the fourth quarter of 2003,activities of the Tampa office were transferred to and consolidated with theLake Forest office.  In Conroe, Texas, welease an office and warehouse for our coatings business segment. This facility,which is approximately 10,000 square feet, is leased through September 2006.

 

Our principal prototyping and manufacturingfacility is in Pyongtaek, South Korea, and consists of approximately 166,000square feet. We lease the land on which this facility is located, although weown the buildings, fixtures, and all personal property located on the land. Theparcel of land consists of approximately four acres and is leased through 2022.We currently expect that this facility will meet our anticipated internalmanufacturing needs for the foreseeable future. Until June 2004 we also leased a facility in Incheon, South Korea, wherean equipment manufacturing division of the Company assembled die castingequipment. This facility is approximately 22,430 square feet, and its leaseexpired in February 2005; however, that die casting equipment division wasdivested as of June 14, 2004 and the lease was terminated.   On August 2004, we entered into a 3 yearlease for a post-processing facility located in Wehai, China, which consists ofapproximately 14,400 square feet, to facilitate our bulk alloy manufacturing.

 

**Item 3. Legal Proceedings**

 

Liquidmetal Technologies and certain of its presentand former officers and directors were named as defendants in nine purportedclass action complaints filed in the United States District Courts for theMiddle District of Florida, Tampa 

 

19

----

 

Division, and the Central District of California,Southern Division, alleging violations of Sections 11 and 15 of the SecuritiesAct of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934and Rule 10b-5 promulgated thereunder. In August 2004, four complaints wereconsolidated in the United States District Court for the Middle District ofFlorida under the caption *Primavera Investors v.Liquidmetal Technologies, Inc., et al.*, Case No.8:04-CV-919-T-23EAJ.  John Lee, ChrisCowley, Dwight Mamanteo, Scott Purcell and Mark Rabold, were appointed co-leadplaintiffs (the “Lead Plaintiffs”).  InSeptember 2004, the other five complaints filed in the Central District ofCalifornia were transferred to the Middle District of Florida for consolidationwith the *Primavera Investors* action.  The Lead Plaintiffs served their ConsolidatedAmended Class Action Complaint on January 12, 2005.  TheAmended Complaint alleges that the Prospectus issued in connection with theCompany’s initial public offering in May 2002 contained materialmisrepresentations and omissions regarding the Company’s historical financialcondition and regarding a personal stock transaction by the Company’s chiefexecutive officer.  The Lead Plaintiffsfurther generally allege that during the proposed Class Period of May 21, 2002,through May 13, 2004, the defendants engaged in improper revenue recognitionwith respect to certain of the Company’s business transactions, failed tomaintain adequate internal controls, and knowingly disclosed unrealistic butfavorable information about market demand for and commercial viability of theCompany’s products to artificially inflate the value of the Company’sstock.  The Amended Complaint seeks unspecified compensatory damages and otherrelief.  Defendants’ motion to dismiss will be due on March 28, 2005.  We intend to vigorously defend against the class action.  We cannot currently predict the impact orresolution of this litigation or reasonably estimate a range of possible loss,which could be material. The resolution of this lawsuit may harm our businessand have a material adverse impact on our financial condition.

 

**In addition to the above, certain present and former officers anddirectors of Liquidmetal Technologies, as well as Liquidmetal Technologies as anominal defendant, have been named in three shareholder derivativeactions.  Two shareholder derivativecomplaints were filed in California state court styled *Brian Clair,Derivatively on Behalf of Liquidmetal Technologies, Inc. v. John Kang, et al.*,Case No. 04CC00551, and *Joseph Durgin Derivativelyon 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 shareholderderivative complaint was filed in Florida federal court styled *Robert Story v. John Kang, et al.*, Case No.8:04-CV-1587-T23TBM, commenced in the Middle District of Florida, TampaDivision.  These shareholder derivativelawsuits allege that the defendants breached various fiduciary duties andotherwise violated state law based primarily upon the same underlying facts andcircumstances as alleged in the federal shareholder class action. Theplaintiffs seek unspecified compensatory damages, restitution and disgorgementof profits, equitable and/or injunctive relief as permitted by law and otherrelief.  The two shareholder derivativecomplaints in California state court have been consolidated.  Plaintiffs served a Consolidated ShareholderDerivative Complaint on October 12, 2004. The defendants served a Demurrer to the Consolidated ShareholderDerivative Complaint on November 22, 2004, seeking dismissal of thatcomplaint.  At a hearing on February 10, 2005,the court sustained the demurrer, dismissing the Consolidated ShareholderDerivative Complaint but giving the plaintiffs 45 days within which to amendthe complaint.  The amended complaint isdue on March 28, 2005.  In the Floridaderivative action, the Plaintiff filed a First Amended Shareholder DerivativeComplaint on November 22, 2004.  TheCompany’s Motion to Dismiss was filed on December 20, 2004.  Plaintiff’s Response and Objection to theMotion to Dismiss was filed on February 4, 2005.  We cannot anticipate when the Court will ruleon the Motion to Dismiss.  We intend tovigorously defend against the derivative actions.  We cannot currently predict the impact orresolution of this litigation or reasonably estimate a range of possible loss,which could be material. The resolution of these lawsuits may harm our businessand have a material adverse impact on our financial condition.**

** **

**Item 4. Submission ofMatters to a Vote of Security Holders**

 

No matters were submitted to a vote of oursecurity holders during the fourth quarter of 2004.

 

20

----

 

**PART II**

 

**Item 5. Market ForRegistrant’s Common Equity and Related Stockholder Matters**

 

Prior to July16, 2004, our common stock was quoted on the Nasdaq National Market under thesymbol “LQMT.”  On July 14, 2004, theCompany was notified by the Nasdaq Listing Qualifications Panel that theCompany’s common stock would be delisted from the Nasdaq National Marketeffective with the open of business on Friday, July 16, 2004.   The Company was delisted for its failure tocomply with Marketplace Rule 4310(c)(14) due to the Company’s inability to fileits Form 10-K for the fiscal year 2003 and Form 10-Q for the first quarter of2004.  As of July 19, 2004, the shares ofLiquidmetal Technologies, Inc. common stock commenced trading in the Over theCounter (OTC) Pink Sheets Market under the symbol “LQMT.PK”.  On January 13, 2005, the Company filedits Form 10-Q for the third quarter of 2004 and thus, became current on itsfilings.  Subsequently, the Company filedthe necessary forms with Nasdaq and is currently working with them to be listedon the Nasdaq (OTC) bulletin boards.

 

The following table sets forth, for the periods indicated, the high andlow sale prices for our common stock as reported by The Nasdaq National Market:

 

| ** **          | ** ** | **Fiscal 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 |   |

 

The closing price of our common stock asreported on The OTC Pink Sheets Market on February 1, 2005 was $1.55 per share.As of February 1, 2005, there were 238 holders of record of our common stock.

 

We have never paid a cash dividend on our commonstock. We do not anticipate paying any cash dividends on our common stock inthe foreseeable future, and we plan to retain our earnings to finance futuregrowth.

 

**Item 6. SelectedConsolidated Financial Data**

 

We derived the selected consolidated financial data below as of and foreach of the three years in the period ended December 31, 2004 from our auditedconsolidated financial statements and related notes thereto included elsewherein this annual report on Form 10-K. The following selected consolidated financial data should be read inconjunction with Liquidmetal Technologies, Inc.’s consolidated financialstatements and the related notes thereto, and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” included elsewherein this annual report on Form 10-K  In addition, readers should note the following information regarding theselected historical consolidated financial data presented below.

 

We have restated our previously reported consolidated financialstatements for the fiscal years ended December 31, 2002 and 2001.  The restatement adjustments resulted in acumulative net reduction to shareholders’ equity of $2.0 million as of December31, 2002 and an increase in previously reported net loss of $1.1 million and$0.9 million for the years ended December 31, 2002 and 2001, respectively.  Further, the 2003, 2002, and 2001 balancesfrom our 10-K filed on November 10, 2004 have been restated in order to conformwith the presentation of 2004 financial statements as a result of applicationof SFAS 144 over discontinued operations of our equipment manufacturingbusiness (see Note 17).  The selectedconsolidated financial data presented below includes all suchrestatements.  See Note 2 in the notes toconsolidated financial statements in the fiscal 2003 annual report on Form 10-Kfiled on November 10, 2004, which reflects the restatements of prior yeartransactions.

 

21

----

 
| ** **                                                                                                                  | ** ** | **For the Years Ended December 31,**       | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(unaudited)** | ** ** |
| ** **                                                                                                                  |       | **(in  thousands, except per share data)** |       |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Consolidated Statement of Operations Data:**                                                                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                                     |       | $                                          | 17,429     |   | $ | 13,658 |   | $ | 9,138 |   | $ | 3,882 |   | $ | 4,200 |   |
| Cost of sales                                                                                                               |       | 12,168                                     |       | 18,162 |   | 5,656 |   | 1,924 |   | 1,983 |   |
| Gross Profit                                                                                                                |       | 5,261                                      |       | (4,504 | ) | 3,482 |   | 1,958 |   | 2,217 |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Operating expenses:                                                                                                         |       |                                       |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                                                                         |       | 11,591                                     |       | 17,729 |   | 13,099 |   | 5,239 |   | 1,449 |   |
| Research and development                                                                                                    |       | 1,467                                      |       | 8,780 |   | 11,825 |   | 1,726 |   | 455 |   |
| Impairment of goodwill                                                                                                      |       | —                                     |       | 184 |   | — |   | — |   | — |   |
| Impairment of long lived assets                                                                                             |       | —                                     |       | 2,684 |   | — |   | — |   | — |   |
| Total operating expenses                                                                                                    |       | 13,058                                     |       | 29,377 |   | 24,924 |   | 6,965 |   | 1,904 |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) before interest, other  income, income taxes, minority interest and discontinued operations                   |       | (7,797                                     | )          | (33,881 | ) | (21,442 | ) | (5,007 | ) | 313 |   |
| Loss from extinguishments of debt                                                                                           |       | (1,663                                     | )          | — |   | — |   | — |   | — |   |
| Change in value of warrants, net                                                                                            |       | 747                                        |       | — |   | — |   | — |   | — |   |
| Other income                                                                                                                |       | 302                                        |       | — |   | — |   | — |   | — |   |
| Interest expense, net                                                                                                       |       | (3,566                                     | )          | (86 | ) | (603 | ) | (1,095 | ) | (188 | ) |
| Gain on sale of marketable securities  held-for-sale                                                                        |       | —                                     |       | 1,178 |   | 832 |   | — |   | — |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes, minority  interest and discontinued operations                                           |       | (11,977                                    | )          | (32,789 | ) | (21,213 | ) | (6,102 | ) | 125 |   |
| Income taxes                                                                                                                |       | —                                     |       | — |   | — |   | — |   | — |   |
| Minority interest in loss of consolidated  subsidiary                                                                       |       | —                                     |       | 21 |   | 118 |   | — |   | — |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                                                                    |       | (11,977                                    | )          | (32,768 | ) | (21,095 | ) | (6,102 | ) | 125 |   |
| Income (loss) from operations of  discontinued operations, net                                                              |       | (749                                       | )          | (964 | ) | 83 |   | (5,973 | ) | (8,938 | ) |
| Gain (loss) from disposal of discontinued operations,  net                                                                  |       | —                                     |       | 127 |   | 1,556 |   | (11,949 | ) | — |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                                                    |       | $                                          | (12,726    | ) | $ | (33,605 | ) | $ | (19,456 | ) | $ | (24,024 | ) | $ | (8,813 | ) |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Income (loss) per share from continuing operations  – basic and diluted                                                |       | $                                          | (0.29      | ) | $ | (0.79 | ) | $ | (0.54 | ) | $ | (0.18 | ) | $ | 0.00 |   |
|                                                                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Weighted average common shares used to compute  income (loss) per share from continuing operations – basic and diluted |       | 41,610                                     |       | 41,505 |   | 38,714 |   | 33,323 |   | 30,884 |   |

 

22

----

 
| ** **                                                    | ** ** | **As of December 31,**                    | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                    | ** ** | ** **                                | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(unaudited)** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| **Consolidated Balance Sheet Data:**                          |       |                                      |       |   |   |   |   |   |   |   |   |
|                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                     |       | $                                         | 742        |   | $ | 3,127 |   | $ | 25,058 |   | $ | 2,230 |   | $ | 124 |   |
| Restricted cash                                               |       | 754                                       |       | — |   | — |   | — |   | — |   |
| Marketable securities held-for-sale                           |       | —                                    |       | — |   | 3,068 |   | — |   | — |   |
| Working capital (deficiency)                                  |       | (9,691                                    | )          | (698 | ) | 24,845 |   | (9,573 | ) | (1,960 | ) |
| Total assets                                                  |       | 28,508                                    |       | 30,852 |   | 27,772 |   | 6,680 |   | 1,945 |   |
| Long-term debt and capital leases,  including current portion |       | 9,672                                     |       | 4,360 |   | 93 |   | 2,988 |   | 2,506 |   |
| Shareholders’ equity (deficiency)                        |       | 8,860                                     |       | 16,163 |   | (50,599 | ) | (7,504 | ) | (3,680 | ) |
|                                                               |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

23

----

 

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

 

*This management’s discussion and analysis should be read inthe conjunction with the condensed consolidated financial statements and notesincluded elsewhere in this report on Form 10-K.*

 

*This management’s discussion and analysis, as well as othersections 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 reliance shouldnot be placed on these statements. These risks and uncertainties include, butare not limited to, the matters discussed under the caption “Factors AffectingFuture Results” in Item 1 of this report and other risks and uncertaintiesdiscussed in filings made with the Securities and Exchange Commission(including risks described in subsequent reports on Form 10-Q,Form 10-K, Form 8-K, and other filings). Liquidmetal Technologies,Inc. disclaims any intention or obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events, orotherwise.*

 

##### **OVERVIEW**

##### ** **

Weare a materials technology company that develops and commercializes productsmade from amorphous alloys.  OurLiquidmetal® family of alloys consists of a variety of coatings, powders, bulkalloys, and composites that utilize the advantages offered by amorphous alloytechnology.  We develop, manufacture, andsell products and components from bulk amorphous alloys that are incorporatedinto the finished goods of our customers, and we also market and sell amorphousalloy industrial coatings.  We alsopartner with third-party licensees and distributors to develop andcommercialize Liquidmetal alloy products. We have the exclusive right to develop, manufacture, and sell what webelieve are the only commercially viable bulk amorphous alloys.

 

Amorphous alloys are unique materials that aredistinguished by their ability to retain a random atomic structure when theysolidify, in contrast to the crystalline atomic structure that forms inordinary metals and alloys when they solidify. Liquidmetal alloys possess acombination of performance, processing, and cost advantages that we believemakes them preferable to other materials in a variety of applications. The amorphousatomic structure of our alloys enables them to overcome certain performancelimitations caused by inherent weaknesses in crystalline atomic structures,thus facilitating performance and processing characteristics superior in manyways to those of their crystalline counterparts. For example, ourzirconium-titanium Liquidmetal alloys are approximately 250% stronger thancommonly used titanium alloys, such as Ti-6Al-4V, but they have processingcharacteristics similar in many respects to plastics. We believe theseadvantages could result in Liquidmetal alloys supplanting other incumbentmaterials in a wide variety of applications. Moreover, we believe theseadvantages will enable the introduction of entirely new products andapplications that are not possible or commercially viable with other materials.

 

Our revenues are derived from two principal operatingsegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloyproducts.  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. The historical operating informationfor fiscal year 2001 is based substantially on sales of Liquidmetal alloycoatings. In the second half of 2002, we began producing bulk Liquidmetal alloycomponents and products for incorporation into our customers’ finished goods.Bulk Liquidmetal alloy segment revenue includes sales of parts or components ofelectronic devices, medical products, and sports and leisure goods; tooling andprototype parts (including demonstration parts and test samples) for customerswith products in development; metal processing equipment (see Note 17 fordisclosure regarding the disposal of our equipment manufacturing business); andresearch and development revenue relating primarily to defense and medicalapplications.  We expect that thesesources of revenue will continue to significantly change the character of ourrevenue mix.

 

Thecost of sales for our Liquidmetal coatings segment consists primarily of thecosts of outsourcing 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 internallymanufacture many products derived from our bulk Liquidmetal alloys.

 

Selling, general, and administrative expenses currentlyconsist primarily of salaries and related benefits, severance costs, travel,consulting and professional fees, depreciation and amortization, insurance,office and administrative expenses, and other expenses related to ouroperations.

 

24

----

 

Researchand development expenses represent salaries, related benefits expense,stock-based compensation, depreciation of research equipment, consulting andcontract services, expenses incurred for the design and testing of newprocessing methods, expenses for the development of sample and prototypeproducts, and other expenses related to the research and development ofLiquidmetal alloys. Costs associated with research and development activitiesare expensed as incurred. We plan to enhance our competitive position byimproving our existing technologies and developing advances in amorphous alloytechnologies. We believe that our research and development efforts will focuson the discovery of new alloy compositions, the development of improvedprocessing technology, and the identification of new applications for ouralloys.

 

Impairmentof goodwill represents the write-down of the goodwill balance of DongyangYudoro (“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, we determined that the carryingvalue of our investment in Dongyang exceeded its fair value as of December 31,2003 in the amount of $184.  In March 2004, we sold our 51% investment inDongyang to the 49% minority shareholder.

 

Impairmentof Long-Lived Assets consists of a write-down of the building of ourmanufacturing facility in South Korea on the basis that the fair value of thisbuilding was determined to be less than the book value as of December 31,2003.  Our significant operationaldifficulties in 2003 along with our history of operating or cash flow lossesand uncertainty surrounding our future cash flows, led us to evaluate ourlong-lived assets for recoverability as of December 31, 2003.  As a result, we determined that the carryingvalue of our manufacturing plant in Pyongtaek, South Korea exceeded its fairvalue as of December 31, 2003 in the amount of $2,684.  The fair value of the building was based onthe average of two independent appraisals of the building obtained in the firstquarter of 2004.

 

Inconjunction with the divestiture of our Dongyang and Taesung subsidiaries inMarch and June 2004, respectively, the Company decided to discontinue ourequipment manufacturing business in order to conform our operations to ourbroader corporate business strategy (see Note 17).  Pursuant to Accounting Principles BoardOpinion No. 30,*Reporting the Resultsof Operations — Reporting the Effects of Disposal of a Segment of a Business,and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,*we reclassified our consolidated financial statements to reflect thediscontinuation of our equipment manufacturing operations. The revenue, costsand expenses, assets and liabilities, and cash flows of the equipmentmanufacturing business were segregated in our accompanying Consolidated BalanceSheets, Consolidated Statements of Operations and Comprehensive Loss, andConsolidated Statements of Cash Flows.

 

OnMay 21, 2003, we completed a reincorporation by transitioning from aCalifornia corporation to a Delaware corporation. The reincorporation waseffected through the merger of the former California entity into a newlycreated wholly owned Delaware subsidiary. The reincorporation changed the legaldomicile of our company but did not result in any change to our business,management, employees, fiscal year, assets or liabilities, or location offacilities. As part of the reincorporation, each share of the California corporationwas automatically converted into one share of the Delaware corporation.  In addition, total authorized shares decreased from 200,000,000 sharesto 100,000,000 shares.

 

OnAugust 4, 2004, the Company established a sub-assembly plant in the city of Weihaiin Shandong province of China under Weihai Liquidmetal Company Limited, whichis 100 percent owned by Liquidmetal Korea, to facilitate our bulk alloymanufacturing business.  WeihaiLiquidmetal is consolidated into Liquidmetal Technologies with all intercompanytransactions eliminated.

 

Thefollowing discussion and analysis of our financial condition and results ofoperations focuses on the historical results of our continuing operations andreflects the effect of restating our 2002 and 2003 (2003 quarterly filings)financial statements for proper revenue recognition as disclosed in Note 2 inthe notes to the consolidated financial statements in the fiscal 2003annual report on Form 10-K filed on November 10, 2004.

 

***Results of Operations***

 

***Comparison of the years endedDecember 31, 2004 and 2003***

 

*Revenue*. Revenue increased to $17.4 million in the twelve months endedDecember 31, 2004 from $13.7 million in the twelve months endedDecember 31, 2003. The increase was due to increases in revenue earned by our bulkLiquidmetal alloy and coatings segments in the twelve months endedDecember 31, 2004. This increase in revenue consisted of $3.8 millionfrom the sale and prototyping of parts manufactured from bulk Liquidmetalalloys, offset by a decrease of $1.9 million from research and developmentservices related primarily from reduced activity from defense and medicalapplications.  Our coatings businesscontributed $1.0 million to the increase in revenues as compared to the twelvemonths ended December 31, 2003 from increased demand for drill pipecoatings.

 

25

----

 

*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 manufacturinginfrastructure required to prepare for and support the anticipated growth ofour bulk Liquidmetal alloy business.  Thecost of sales for the products sold by the coatings business segment isgenerally consistent from year to year because the Liquidmetal coatingsproducts are produced by third parties and sold wholesale to variousindustries.

 

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses decreased to $11.6 million, or 66% of revenue, in the twelvemonths ended December 31, 2004 from $17.7 million, or 130% ofrevenue, in the twelve months ended December 31, 2003.  This decrease was primarily a resultof decrease in wages and related expense by $5.0 million, decreases intravel and communication expenses by $0.8 million, decreases in rent by $0.8million, decrease in relocation expenses by $0.7 million, offset by an increasein professional fees, consultant fees, and contract services by$0.8 million, and an increase in insurance costs by $0.4 million.  These and other decreases in selling, generaland administrative expenses represent the Company’s efforts to manage costs andfocus on our core business while continuing to build our corporateinfrastructure required to prepare for and support the anticipated growth ofour bulk Liquidmetal alloy business.

 

*Research and Development Expenses*. Research and development expenses decreasedto $1.5 million, or 8% of revenue, in the twelve months endedDecember 31, 2004 from $8.8 million, or 64% of revenue, in the twelvemonths ended December 31, 2003.  Thedecrease was primarily a result of decreases in salaries, wages and the relatedexpenses by $3.0 million, decrease in laboratory and prototyping expensesby $2.0 million, decrease in depreciation expense by $0.7 million,decrease in professional fees, consultant fees, and contract services by $0.6,decrease in research grants by $0.3 million, and decrease in travel relatedexpenses by $0.2 million.  The decreaseswere a result of the Company focusing primarily on our core business associatedwith our bulk Liquidmetal alloy business while managing our costs.  The Company continues to perform research anddevelopment efforts on new Liquidmetal alloys and related processingcapabilities, develop new manufacturing techniques, and contract withconsultants and provide research grants to various institutions to advance thedevelopment of Liquidmetal alloys.

 

*Impairment of Goodwill*. Impairment of goodwill was $184, or 1% of revenue, in the twelve 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.  During 2003, Dongyang experienced netlosses as a result of a continuing economic downturn in the market for itsmachinery products. These events along with Dongyang’s operating, and cash flowlosses, and uncertainty surrounding its future cash flows, led us to evaluateour investment for recoverability as of December 31, 2003.  As a result, we determined that the carryingvalue of our investment in Dongyang exceeded its fair value as of December 31,2003 in the amount of $184.  In March2004, we sold our 51% investment in Dongyang to the 49% minority shareholder(see Note 17).   There was no impairmentcharge to goodwill in the twelve monthsended December 31, 2004.

 

*Impairment of Long Lived Assets*. Impairment of long lived assets was $2.7 million, or 20% of revenue, inthe twelve months ended December 31, 2003. Impairment expense represents a write-down of the building of ourmanufacturing facility in South Korea. Due to the decreased production and usage of our Pyongtaek manufacturingoperation, we decided to obtain independent appraisals as to the fair value ofthis building.  Accordingly, the fairvalue of the building as determined by the average of the two independentappraisals was less than the carrying value of the building as of December 31,2003.   There was no impairment charge tolong lived assets in the twelve months ended December 31, 2004.

 

*Loss from Extinguishment of Debt.*Lossfrom extinguishment of debt was $1.7 million, or 10% of revenue, during thetwelve months ended December 31, 2004 due to the extinguishment of our MarchNotes as it relates to the exchange in August 2004.  There was no such loss recorded during twelvemonths 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 August2004 (see note 14).  There were no suchamounts recorded for the twelve months ended December 31, 2003.

 

*Other Income.*Otherincome was $0.3 million, or 2% of revenue, during the twelve months endedDecember 31, 2004 from certain stock transactions with John Kang, our Chairman,President, and Chief Executive Officer during 2002 (see Note 23).  There were no amounts recorded as otherincome for the twelve months ended December 31, 2003.

 

*Interest Expense*. Interest expense was $3.6 million, or 21% of revenue, in thetwelve months ended December 31, 2004 and was $0.4 million, or 3% ofrevenue, in the twelve months ended December 31, 2003.  During the twelve months ended December 31,2004, the interest expense was primarily due to the interest accrued,amortization of debt discount and deferred issuance costs on new seniorconvertible debt originally sold on March 3, 2004 and exchanged in August 2004,and interest accrued on Kookmin Bank loan funded on February 4, 2003.  Duringthe twelve months ended December 31, 2003, interest expense was primarilydue to interest accrued on the Kookmin Bank loan to our South Korean subsidiarymade on February 4, 2003.

 

26

----

 

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

 

*Gain from Sale ofInvestment.* In April 2003we sold our remaining shares of Growell Metal Co., Ltd. that were purchased inJuly 2002. We recognized a $1.2 million gain on the sale of these sharesduring the twelve months ended December 31, 2003.  There were no such gains in the twelve monthsended December 31, 2004.

 

***Comparison of the years endedDecember 31, 2003 and 2002***

 

*Revenue*. Revenue increased to $13.7 million in the twelve months endedDecember 31, 2003 from $9.1 million in the twelve months endedDecember 31, 2002. The increase was due to increases in revenue earned by ourbulk Liquidmetal alloy segment in the twelve months ended December 31,2003. This increase in our bulk Liquidmetal alloy segment revenue consisted ofa revenue increase of $1.8 million from the sale of metal processingequipment in the US, an increase of $0.1 million from the sale and prototypingof parts manufactured from bulk Liquidmetal alloys, and an increase of $2.2million from research and development services related primarily to defense andmedical applications. The increase in revenue earned by our bulk Liquidmetalalloy segment was offset by a decrease of $1.6 million in the revenueearned by our coatings business as compared to the twelve months endedDecember 31, 2002 due to a slowdown in demand for drill pipe coatings.

 

*Cost of Sales*. Cost of sales increased to $18.2 million, or 133% of revenue,during the twelve months ended December 31, 2003 from $5.7 million,or 62% of revenue, in the twelve months ended December 31, 2002. The costof sales as a percentage of revenue increased due to three primary factors:first, a higher percentage of plant operating costs allocated to manufacturingin the current period, as opposed to the same twelve month period in 2002 whenour manufacturing facility was in the final stages of construction andsignificant in-plant spending was directed to research and development tosupport the ramp-up of manufacturing operations; second, the impact ofunprofitable electronic casing components and prototypes moving through ourmanufacturing mix; and third, the impact of the write-down of excess rawmaterial in the amount of $1.0 million and the write-down of raw material andequipment inventory in the amount of $2.8 million in connection with asettlement of a dispute with Growell which was finalized in January 2004.

 

Although the cost to manufacture parts from our bulkLiquidmetal alloys is variable and differs based on the unique design of eachproduct, we expect gross margin to improve as we limit production andprototyping to select products that require the high-performance qualities ofLiquidmetal alloys and can be priced accordingly. Furthermore, we believe thatstrategic licensing agreements and other relationships to advance thedevelopment of our technology and processes that we will pursue could alsocontribute to improved gross margins. The cost of sales for the products soldby the coatings business is expected to remain generally consistent becauseLiquidmetal coatings products are produced by third parties and sold wholesaleto various industries.

 

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses increased to $17.7 million, or 130% of revenue, in the twelvemonths ended December 31, 2003 from $13.1 million, or 143% ofrevenue, in the twelve months ended December 31, 2002. This increase wasprimarily a result of costs incurred for closing our Tampa, Florida offices,which included: an increase in severance costs of $2.2 million for releasing asubstantial number of these employees as well as our expense and accrual of$0.8 million for terminating our office lease, due to the determination that wewill be unable to sublease this space over the remaining term; an increase inprofessional fees, consultant fees, and contract services of $0.8 million;an increase in insurance expense of $0.5 million; an increase in datacommunications expense of $0.2 million; an increase in depreciationexpense of $0.3 million; an increase of warranty expense of $0.5 million;and a $0.3 million increase in expenses associated with the disposition ofcertain assets in the twelve months ended December 31, 2003. The increasein selling, general and administrative expenses are associated with theaforementioned cost reduction measures, including the consolidation of offices,the staff reductions, and a corresponding shift in strategy for the continueddevelopment of our bulk Liquidmetal alloy business.  This was partially offset by a decrease inadvertising expense of $0.1 million; a decrease in bad debt expense of $0.9million; and a $0.7 million decrease in stock compensation expense.

 

*Research and Development Expenses*. Research and development expenses decreasedto $8.8 million, or 64% of revenue, in the twelve months endedDecember 31, 2003 from $11.8 million, or 129% of revenue, in thetwelve months ended December 31, 2002. This decrease was partially aresult of the maturing of our manufacturing process and related processingcapabilities, the consolidation of our facilities into our CaliforniaTechnology Center, and the discontinuation of certain prototyping anddevelopmental activities that occurred extensively while the Company wasidentifying our current technology capabilities and limitations.  These decreases were partially offset byincreases in providing research grants to various institutions to advance thedevelopment of Liquidmetal alloys. In the category of research and developmentexpenses: travel decreased by $0.2 million; professional fees, consultantfees, and contract services decreased by $1.6 million; laboratory andprototyping expenses decreased by $0.9 million; and stock compensationexpense decreased by $1.4 million.  Theseexpenses were partially offset by increases in depreciation of researchequipment of $0.4 million, increased research grants to educationalinstitutions of $0.1 million, and increase to salaries, wages andseverance net of $0.5 million.

 

27

----

 

*Impairment of Goodwill*. Impairment of goodwill representsthe write-down of the goodwill balance of 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 ofDecember 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 $184.  In March 2004, we sold our 51% investment inDongyang to the 49% minority shareholder.

 

*Impairment of Long Lived Assets*. Impairment expense represents a write-down of the building of ourmanufacturing facility in South Korea. Due to the decreased production and usage of our Pyongtaek manufacturingoperation, we decided to obtain independent appraisals as to the fair value ofthis building.  Accordingly, the fairvalue of the building as determined by the average of the two independentappraisal was less than the carrying value of the building as of December 31,2003.

 

*Interest Expense*. Interest expense was $0.4 million, or 3% of revenue, in thetwelve months ended December 31, 2003 and was $1.1 million, or 12% ofrevenue, in the twelve months ended December 31, 2002. During the twelvemonths ended December 31, 2003, interest expense was primarily due tointerest accrued on the Kookmin Bank loan to our South Korean subsidiary madeon February 4, 2003. During the twelve months ended December 31, 2002,interest expense was primarily due to the amortization of the fair value ofwarrants granted in connection with subordinated promissory notes we issued inFebruary 2001.

 

*Interest Income.* Interest income was $0.3 million, or 2% of revenue, in the twelvemonths ended December 31, 2003 due to interest earned on short-term,investment grade, interest-bearing securities. During the twelve months endedDecember 31, 2002, interest income was $0.5 million, or 6% ofrevenue, which was interest earned from the proceeds of our May 22, 2002initial public offering.

 

*Gain from Sale of Investment.* In April 2003 we sold our remaining shares ofGrowell Metal Co., Ltd. that were purchased in July 2002. We recognized a$1.2 million gain on the sale of these shares.

 

28

----

 

##### **QUARTERLYRESULTS**

##### ** **

The following information presents our unaudited quarterlyoperating results for 2004 and 2003. The data has been prepared by LiquidmetalTechnologies, Inc. on a basis consistent with the Consolidated Financial Statementsincluded elsewhere in this Form 10-K, and includes all adjustments,consisting of normal recurring accruals, that we consider necessary for a fairpresentation thereof.   Included in our2003 fourth quarter results are costs charged to our cost of sales for thewrite-down of raw materials of $1.0 million and a $2.8 million write-down ofinventory and equipment recorded in connection with a dispute settlement withGrowell.  In addition, as a result of theCompany’s cost reduction measures taken in the fourth quarter, our selling,general, and administrative expenses include severance costs of $2.4 millionand office relocation costs of $0.8 million. These operating results are not necessarily indicative of our futureperformance.

 

Duringthe fourth quart of 2004, although our revenues were comparable to prior year,we had a decrease in revenue of $2.1 million compared to the third quarter dueto an unanticipated and temporary decrease in orders from one of our customers,Samsung.  In addition, included in ourfourth quarter cost of sales is a $0.4 million charge related to certain hingefinished goods used in Samsung’s cell phone models which were nearing its endof life.  The Company experienced a grossloss of $0.4 million for the fourth quarter due to the one time charge of costof sales and also due to the fact that our cost of sales from our Liquidmetalbulk alloy segment includes primarily fixed costs from our labor and equipmentexpenses.

 

These statements should be read in conjunction with restatementfootnote 2 in the notes to consolidated financialstatements in the fiscal 2003 annual report on Form 10-K filed on November 10,2004, which reflects the restatements of prior year transactions.

 

Pursuantto Accounting Principles Board Opinion No. 30,*Reporting the Results of Operations — Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions,* we reclassified ourconsolidated financial statements to reflect the discontinuation of ourequipment manufacturing operations and retail golf business. The revenue, costsand expenses, assets and liabilities, and cash flows of the equipmentmanufacturing and our retail golf businesses were segregated in ouraccompanying Consolidated Balance Sheets, Consolidated Statements of Operationsand Comprehensive Loss, and Consolidated Statements of Cash Flows.  The net operating results, net assets, andnet cash flows of the equipment manufacturing and retail golf businesses werereported as discontinued operations in our annual consolidated financialstatements and in the condensed consolidated financial statements included inthis report on Form 10-K. (see Note 17)

 

29

----

 
| ** **                                                                                                         | ** ** | **For the Three Months Ended**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **12/31/04**                              | ** ** | **9/30/04** | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** |
|                                                                                                               |       | **(In thousands, except per share data)** |       |
| ** **                                                                                                         |       | ** **                                |       |
| **Consolidated  Statements of Operations Data:**                                                                   |       | ** **                                |       |
| 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                                                                                    |       | —                                    |       | (1,663 | ) |   |   |   |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Change in value of warrants, net                                                                                   |       | (99                                       | )          | (434 | ) | 694 |   | 586 |   |
| Other income (expense), net                                                                                        |       | —                                    |       | 302 |   | — |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Interest income (expense), net                                                                                     |       | (358                                      | )          | (1,805 | ) | (1,144 | ) | (259 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from operation before income taxes and  discontinued operations                                               |       | (3,701                                    | )          | (6,169 | ) | (1,759 | ) | (348 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Income taxes                                                                                                       |       | —                                    |       | — |   | — |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from continuing operations                                                                               |       | (3,701                                    | )          | (6,169 | ) | (1,759 | ) | (348 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from discontinued operations, net of  tax                                                                     |       | —                                    |       | — |   | (356 | ) | (393 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Net loss                                                                                                           |       | $                                         | (3,701     | ) | $ | (6,169 | ) | $ | (2,115 | ) | $ | (741 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss per share from continuing operations –  basic and diluted                                                |       | $                                         | (0.09      | ) | $ | (0.15 | ) | $ | (0.04 | ) | $ | (0.01 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Weighted average common shares used to  compute loss per share from continuing operations – basic and diluted |       | 41,610                                    |       | 41,610 |   | 41,610 |   | 41,610 |   |

 

30

----

 
| ** **                                                                                                         | ** ** | **For the Three Months Ended**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **12/31/03**                              | ** ** | **9/30/03** | ** ** | **6/30/03** | ** ** | **3/31/03** | ** ** |
| ** **                                                                                                         | ** ** | ** **                                | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| ** **                                                                                                         | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                                                                                         | ** ** | ** **                                | ** ** |
| **Consolidated Statements of Operations Data:**                                                                    |       |                                      |       |   |   |   |   |   |   |
| Revenue                                                                                                            |       | $                                         | 2,645      |   | $ | 3,281 |   | $ | 4,533 |   | $ | 3,199 |   |
| Cost of sales                                                                                                      |       | 6,761                                     |       | 4,595 |   | 4,146 |   | 2,660 |   |
| Gross profit (loss)                                                                                                |       | (4,116                                    | )          | (1,314 | ) | 387 |   | 539 |   |
| Operating expense:                                                                                                 |       |                                      |       |   |   |   |   |   |   |
| Selling, general, and administrative                                                                               |       | 5,435                                     |       | 3,661 |   | 4,571 |   | 4,062 |   |
| Research and development                                                                                           |       | 1,025                                     |       | 981 |   | 2,736 |   | 4,038 |   |
| Impairment of goodwill                                                                                             |       | 184                                       |       | — |   | — |   | — |   |
| Impairment of long-lived assets                                                                                    |       | 2,684                                     |       | — |   | — |   | — |   |
| Total operating expenses                                                                                           |       | 9,328                                     |       | 4,642 |   | 7,307 |   | 8,100 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from operations                                                                                               |       | (13,444                                   | )          | (5,956 | ) | (6,920 | ) | (7,561 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Interest income (expense), net                                                                                     |       | (86                                       | )          | (53 | ) | (12 | ) | 65 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Gain on sale of marketable securities  held-for-sale                                                               |       | —                                    |       | — |   | 1,178 |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from operations before income taxes,  minority interest and discontinued operations                           |       | (13,530                                   | )          | (6,009 | ) | (5,754 | ) | (7,496 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Income taxes                                                                                                       |       | —                                    |       | — |   | — |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Minority interest in loss (income) of  consolidated subsidiary                                                |       | (5                                        | )          | 23 |   | 10 |   | (7 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from continuing operations                                                                               |       | (13,535                                   | )          | (5,986 | ) | (5,744 | ) | (7,503 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Income (loss) from discontinued operations                                                                         |       | (412                                      | )          | (115 | ) | (317 | ) | 7 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Net loss                                                                                                           |       | $                                         | (13,947    | ) | $ | (6,101 | ) | $ | (6,061 | ) | $ | (7,496 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss per share from continuing operations –  basic and diluted                                                |       | $                                         | (0.33      | ) | $ | (0.14 | ) | $ | (0.14 | ) | $ | (0.18 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Weighted average common shares used to  compute loss per share from continuing operations – basic and diluted |       | 41,610                                    |       | 41,610 |   | 41,597 |   | 41,390 |   |

 

31

----

 

##### **LIQUIDITYAND CAPITAL RESOURCES**

##### ** **

Ouroperating activities, including our discontinued equipment manufacturingoperations, used cash of $6.3 million for the year ended December 31,2004.  Our operating activities,including our discontinued equipment manufacturing and retail golf operations,used cash of $26.5 million for the year ended December 31, 2003. Cash usedin operating activities for the year ended December 31, 2004 resulted fromnet cash used by continuing operations of $6.4 million offset by net cashprovided by discontinued operations of $0.1 million. Cash used in operatingactivities for the year ended December 31, 2003 resulted from net cashused by discontinued operations of $2.4 million and net cash used bycontinuing operations of $24.1 million. Our working capital (deficit) was$(9.7) million as of December 31, 2004.

 

Ourinvesting activities used cash of $0.3 million for the year endedDecember 31, 2004 for the acquisition of property and equipment of $0.1million and investment in patents and trademarks of $0.3 million.  These expenditures were offset by proceedsfrom sale of property and equipment of $0.1 million.

 

Our cash provided by financing activities was $3.9 millionfor the year ended December 31, 2004, which consists of $9.9 million inproceeds from borrowings from our senior convertible debt offset by $5.2million on repayment of borrowings, $0.1 million of repayment of otherliabilities, and increase in restricted cash of $0.8 million.

 

Weanticipate that our capital expenditures will be approximately less than $0.5million for the full year 2005 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, andthe success 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 our historical operatingresults and the continued development of our manufacturing capabilities andalloy compositions, there exists the possibility that these resources will notbe adequate to operate at the proposed business plan levels.  These expenses and capital expenditures couldconsume a material amount of our cash resources, but the amount of theserequirements will depend on the nature and amount of orders we receive for thepurchase of our bulk Liquidmetal alloy products.

 

Ourbusiness is based on commercializing an entirely new and unique technology, andour current business plan contains a variety of assumptions and expectationsthat are subject to uncertainty, including assumptions and expectations aboutorder flow, unit volumes, manufacturing efficiencies, product cost and pricing,continuing technology improvements, customer adoption practices, strategiclicensing relationships and other relevant matters. These assumptions take intoaccount recent significant cost reductions, as well as recent improvements toour manufacturing processes. We have experienced losses from continuingoperations during the last two fiscal years and have an accumulated deficit of$125.3 million as of December 31, 2004. Cash used in continuing operationsfor the years ended December 31, 2004 and December 31, 2003 was $6.4million and $24.1 million, respectively. At December 31, 2004, our principal source of liquidity was $0.7million of cash and cash equivalents and trade accounts receivables of $1.7 million.   Suchconditions raise substantial doubt that our Company will be able to continue asa going concern for a reasonable period of time without receiving additionalfunding.  These operating results occurred while we were developing and attemptingto commercialize and manufacture products from an entirely new and uniquetechnology. This business plan required significant spending related tostart-up costs and capital expenditures. These factors have placed asignificant strain on our financial resources. The ultimate success of the Company depends on our ability to continueto reduce operating costs, generate higher revenue, achieve positive cash flowfrom continuing operations and achieve profitability.

 

OnMarch 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 VentureCapital Co., Ltd, a South Korea-based institutional investment firm, and IndiGoVentures LLC, a New York-based investment firm that served as a financialadvisor to the Company for the transaction. The notes were convertible at any time into our common stock at a priceof $3.00 per share.  Investors in theprivate placement 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. In addition, the investors had the right to call for repayment of thenotes prior to maturity at any time after the second anniversary of the closingof the transaction. (see Note 14 to the Consolidated Financial Statements)

 

On August 19, 2004, the Company completed aprivate exchange offer for its March Notes.  Under terms of the exchange offer,approximately $5.5 million in aggregate principal amount of the March Noteshave been exchanged for an aggregate of (i) $2.75 million of 6% Senior SecuredNotes Due 2007 (the “Long-Term Notes”) and (ii) $2.75 million of 10% SeniorSecured Notes Due 2005 (the “Short-Term Notes”), collectively referred to as “ExchangeNotes”.  In addition, the Company 

 

32

----

 

redeemedapproximately $4.5 million of the March Notes in cash.  The ExchangeNotes are collateralized by certain patents owned by the Company and secondpriority mortgage interest in plant facilities and certain equipment at ourplant in South Korea.  The Short-TermNotes have a maturity date of July 29, 2005, and a conversion price of $2.00per share (compared to a conversion price of $3.00 per share under the MarchNotes).  The Long-Term Notes have amaturity date of July 29, 2007, and a conversion price of $1.00 per share.   Further, the exchange notes are convertibleinto Common Stock, at the option of the Company, if at any time after theissuance of the notes, the closing per share price of the Common Stock exceeds$4.00 (as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period.  Holders of the Long-Term Notes also have theright to call for repayment of the Long-Term Notes prior to maturity at anytime after the second anniversary of the completion of the exchange offer.  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.  As of December 31, 2004, we were in breach ofa covenant in the Note Exchange Agreement requiring us to becomecurrent in our SEC filings, as well as file a registration statement withthe SEC for the shares into which the notes are convertible, within 90days of the issue date of the new notes.  If written notice of default isdelivered to us for breach of this covenant, then we will have a period of30 days to cure the breach before it becomes an event of default under thenotes, and if the breach is not cured during such time period, the holdersof the notes will become entitled to accelerate the remaining balanceof their respective notes and declare them immediately due andpayable.  As of the date of the filing of this Form10-K, we have not received a notice for demand for payment as aresult of not meeting the registration and listing requirements.

 

Ourfuture success depends on our ability to continue reducing operating costs andultimately to generate higher revenue and attain profitability. We cannot becertain that additional capital, whether through selling additional debt orequity securities or obtaining a line of credit or other loan, will be availableto us or, if available, will be on terms acceptable to us. If we issueadditional securities to raise funds, these securities may have rights,preferences, or privileges senior to those of our common stock, and our currentstockholders may experience dilution.

 

In March 1996, we entered into a distribution agreementwhereby we granted to a third party exclusive rights to market and sell golfproducts incorporating Liquidmetal technology to certain Japanese sportingequipment companies. The third party paid us a $1.0 million distributionfee as part of this agreement, of which a portion was refundable according to aformula based on the gross profit earned by the third party. The remainingunearned distribution fee of $0.8 million has not been refunded as ofDecember 31, 2004, and we do not believe the third party is entitled to arefund. On March 28, 2003, the distribution agreement was terminated andwe entered into a new agreement to pay to the same third party a commission onthe net sales price of all Liquidmetal golf equipment that is shipped by ourCompany or its affiliates to Japanese golf companies for sale into the Japaneseend-market. This commission will apply to golf equipment shipped by our Companyor its affiliates during the period beginning on March 28, 2003 and endingon March 28, 2006. If, by March 28, 2006, we have not paid$0.4 million in commission payments, the balance between commissions paidand $0.4 million will be paid by April 30, 2006, thereby guaranteeingthe third party a $0.4 million minimum payment during the term of theagreement. We will recognize the unearned distribution fee of $0.8 millionas revenue proportionately with the payment of commissions under the letteragreement.

 

##### **USEOF PROCEEDS**

##### ** **

Pursuant to our Registration Statement on Form S-1(Registration No. 333-73716), as amended, initially filed with the Securitiesand Exchange Commission on November 20, 2001 and declared effectiveMay 21, 2002, we closed an initial public offering of 5,000,000 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 aggregate cash proceeds during the second quarter 2002 of$78.4 million. The net proceeds were $70.7 million after deductingunderwriting commissions of $5.5 million and other transaction fees of$2.2 million. The managing underwriters for the Offering were MerrillLynch & Co., UBS Warburg, and Robert W. Baird & Co.

 

As of December 31, 2003, we have used the$70.7 million of net proceeds from the Offering. In 2002, we usedapproximately $7.8 million of the net proceeds from the Offering to repayall outstanding promissory notes and accrued interest, $11.1 million tofund 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.

 

33

----

 

On March 3, 2004, the Company issued $9.9 million of 6.0% seniorconvertible notes due 2007, which was exchanged in August 2004, 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 (see Note 14).  The Company used $0.6 million of the proceedsto pay various agents as issuance costs of the notes in March 2004.  From June through August 2004, the Companyredeemed $4.5 million of the outstanding note balance in cash.   We used the remaining proceeds of $3.3million for working capital needs and used $0.8 million as collateral held incertificate of deposit to finance acertain insurance policy.   As ofDecember 31, 2004, $0.7 million of the proceeds are held as cash and cashequivalents.  The remaining proceeds of$0.7 million will be used for working capital needs.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

An off-balance sheet arrangement is any transaction,agreement or other contractual arrangement involving an unconsolidated entityunder which a company has (1) made guarantees, (2) a retained or a contingentinterest in transferred assets, (3) an obligation under derivative instrumentsclassified as equity, or (4) any obligation arising out of a material variableinterest in an unconsolidated entity that provides financing, liquidity, marketrisk or credit risk support to the company, or that engages in 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 our financialcondition, liquidity or results of operations. See Note 12 to the ConsolidatedFinancial Statements contained in this Annual Report on Form 10-K.

 

##### **CONTRACTUALOBLIGATIONS**

##### ** **

The following table of material debt and lease commitments at December31, 2004, summarizes the effect these obligations are expected to have on ourcash flow in the future periods set forth below (in thousands):

 
| ** **                  | ** ** | **Payments due by period**                | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                  | ** ** | **(in thousands, except per share data)** | ** ** |
| **Contractual Obligations** |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt              |       | $                                         | 9,460      |   | $ | 6,842 |   | $ | 2,618 |   | $ | — |   | $ | — |   |
| Capital lease obligation    |       | 212                                       |       | 134 |   | 78 |   | — |   | — |   |
| Operating leases and rents  |       | 2,240                                     |       | 1,215 |   | 952 |   | 73 |   | — |   |
| Growell settlement payable  |       | 3,246                                     |       | 3,246 |   | — |   | — |   | — |   |
| Consulting services payable |       | 172                                       |       | 172 |   |   |   |   |   |   |   |
| Dongyang payable            |       | 28                                        |       | 28 |   | — |   | — |   | — |   |
|                        |       |                                      |       |   |   |   |   |   |   |   |   |
| Total                       |       | $                                         | 15,358     |   | $ | 11,637 |   | $ | 3,648 |   | $ | 73 |   | $ | — |   |

 

##### **CRITICALACCOUNTING POLICIES AND ESTIMATES**

##### ** **

The preparation of consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires us to make estimates and assumptions that affect reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. These estimates and assumptions are basedon historical 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 themost critical to our consolidated financial statements since these policiesrequire significant judgment or involve complex estimates that are important tothe portrayal of our financial condition and operating results:

 

•                                          Our earnings and cash flows are subject tofluctuations due to changes in non-U.S. currency exchange rates. We are exposedto non-U.S. exchange rate fluctuations as the financial results of non-U.S.subsidiaries are translated into U.S. dollars. As exchange rates vary, thoseresults, when translated, may vary from expectations and adversely impactoverall expected profitability. The cumulative translation effects forsubsidiaries using functional currencies other than the U.S. dollar areincluded in accumulated foreign exchange translation in shareholders’ equity.Movements in non-U.S. currency exchange rates may affect our competitiveposition, as exchange rate changes may affect business practices and/or pricingstrategies of non-U.S. based competitors.

 

34

----

 

•                                          We record an accrual for potential productwarranty costs. Due to the lack of historical information for warranty expenserelated to bulk alloy products, management estimates product warranties as apercentage of bulk alloy product sales earned during the period. In the eventin future periods the actual product warranty costs consistently exceed theestimate for product warranty costs, an adjustment would be made and incomewould decrease in the period of such determination. Likewise, in the event wedetermine that actual product warranty costs are consistently lower than theestimate for product warranty costs, an adjustment would be made and incomewould increase in the period of such determination.

 

•                                          We record an allowance for doubtful accountsas a contra-asset to our trade receivables for estimated uncollectibleaccounts. Management estimates the amount of potentially uncollectible accountsby reviewing significantly past due customer balances relative to historicalinformation available for those customers. In the event, in future periods,actual uncollectible accounts exceed the estimate for uncollectible accounts,an adjustment would be made and income would decrease in the period of suchdetermination. Likewise, in the event, in future periods, actual uncollectibleaccounts are lower than the estimate for uncollectible accounts, an adjustmentwould be made and income would increase in the period of such determination.

 

•                                          We value inventories at lower of cost or netrealizable value. Management has determined net realizable value to be equal tothe selling price of the products to be produced and sold less the cost ofdisposal. In the event, in future periods, the actual selling prices exceed theestimate for selling prices less cost to sell, an adjustment would be made andincome would increase in the period of such determination. Likewise, in theevent, in future periods, actual selling prices are lower than the estimate forselling prices, an adjustment would be made and income would decrease in theperiod of such determination. During 2003 we reduced the carrying value of raw materials held by oursubsidiary, Liquidmetal Korea, by the amounts considered to be obsolete.  During 2003 we reduced the carrying value ofour inventories by $1.0 million as we determined that certain raw material andinventories exceeded their net realizable value as of December 31, 2003.   Additionally, we recorded a write-down of$2.8 million of raw material and machine inventory associated with thesettlement of a dispute with a customer, Growell, in December 2003.  Such write-down adjustments are includedwithin Cost of Sales. (see Note 6)

 

•                                          We record valuation allowances to reduce thedeferred tax assets to the amounts estimated to be realized. While we considertaxable income in assessing the need for a valuation allowance, in the event wedetermine we would be able to realize our deferred tax assets in the future inexcess of the net recorded amount, an adjustment would be made and incomeincreased in the period of such determination. Likewise, in the event wedetermine we would not be able to realize all or part of our deferred taxassets in the future, an adjustment would be made and charged to income in theperiod of such determination.

 

##### **RECENTACCOUNTING PRONOUNCEMENTS**

##### ** **

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 largely unchangedby the issuance of SAB 104, which was effective upon issuance. The adoption ofSAB 104 did not impact the consolidated financial statements.

 

In March 2004, the FASB approved theconsensus reached 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. InSeptember 2004, the FASB issued a FASB Staff Position (FSP) EITF 03-1-1 thatdelays the effective date of the measurement and recognition guidance in EITF03-1 until after further deliberations by the FASB. The disclosure requirementsare effective only for annual periods ending after June 15, 2004. The Companyhas evaluated the impact of the adoption of the disclosure requirements of EITF03-1 and does not believe the impact will be significant to the Company’soverall results of operations or financial position. Once the FASB reaches afinal decision on the measurement and recognition provisions, the company willevaluate the impact of the adoption of EITF 03-1.

 

In November 2004, the FASB issued SFAS No. 151 “InventoryCosts, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement151 clarify that abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials (spoilage) should be recognized as current-periodcharges and require the allocation of fixed production overheads to inventorybased on the normal capacity of the production facilities. The guidance iseffective for inventory costs incurred during fiscal years beginning after June15, 2005. Earlier application is permitted for inventory costs incurred duringfiscal years beginning after November 23, 2004. The Company has evaluated theimpact of the adoption of SFAS 151, and does not believe the impact will besignificant to the Company’s overall results of operations or financialposition.

 

35

----

 

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 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 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 nonmonetary assetexchanges occurring in fiscal periods beginning after the date of issuance. Theprovisions of this Statement shall be applied prospectively. TheCompany has evaluated the impact of the adoption of SFAS 153, and does notbelieve the impact will be significant to the Company’s overall results ofoperations or financial position.

 

In December 2004, the FASB issued SFAS No.123(revised 2004), “Share-Based Payment”. Statement 123(R) will provide investorsand other users of financial statements with more complete and neutralfinancial information by requiring that the compensation cost relating toshare-based payment transactions be recognized in financial statements. Thatcost will be measured based on the fair value of the equity or liabilityinstruments issued. Statement 123(R) covers a wide range of share-basedcompensation arrangements including share options, restricted share plans,performance-based awards, share appreciation rights, and employee sharepurchase plans. Statement 123(R) replaces FASB Statement No. 123, Accountingfor Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting forStock Issued to Employees. Statement 123, as originally issued in 1995,established as preferable a fair-value-based method of accounting forshare-based payment transactions with employees. However, that Statementpermitted entities the option of continuing to apply the guidance in Opinion25, as long as the footnotes to financial statements disclosed what net incomewould have been had the preferable fair-value-based method been used. Publicentities (other than those filing as small business issuers) will be requiredto apply Statement 123(R) as of the first interim or annual reporting periodthat begins after June 15, 2005. The Company has evaluated the impact of theadoption of SFAS 123(R), and does not believe the impact will be significant tothe Company’s overall results of operations or financial position.

 

In December 2004 the Financial Accounting Standards Board issued twoFASB Staff Positions—FSP FAS 109-1, *Applicationof FASB Statement 109 “Accounting for Income Taxes” to the Tax Deduction onQualified Production Activities Provided by the American Jobs Creation Act of2004*, and FSP FAS 109-2 *Accountingand Disclosure Guidance for the Foreign Earnings Repatriation Provision withinthe A**merican Jobs CreationAct of 2004.* Neither of these affected the Company as it does notparticipate in the related activities.

 

**Item 7A. Quantitative andQualitative Disclosures About Market Risks**

 

We are exposed to various market risks inconducting the business of the company, and we anticipate that this exposurewill increase as a result of our planned growth. In an effort to mitigatelosses associated with these risks, we may at times enter into derivativefinancial instruments, although we have not historically done so. These maytake the form of forward sales contracts, option contracts, foreign currencyexchange contracts, and interest rate swaps. We have not, and do not intend to,engage in the practice of trading derivative securities for profit.

 

*Interest Rates.*Weare exposed to market risks relating to changes in interest rates.  Although we do not currently have anyborrowings with variable interest rates, fluctuations in interest rates mayhave a negative impact to any future borrowings.

 

*Commodity Prices.*Weare exposed to price risk related to anticipated purchases of certaincommodities used as raw materials by our businesses, including titanium andzirconium. Although we do not currently enter into commodity future, forward,and option contracts to manage the fluctuations in prices of anticipatedpurchases, we may enter into such contacts in the future as our business growsand as our purchases of these raw materials increases.

 

*Foreign Exchange Rates.*As a result of our manufacturing presencein South Korea, a substantial portion of our costs will be denominated in SouthKorean won. Consequently, fluctuations in the exchange rates of the SouthKorean won to the U.S. dollar will affect our costs of goods sold and operatingmargins and could result in exchange losses. Although we do not currently enterinto foreign exchange hedge transactions, we may do so in the future as ourbusiness grows.

 

36

----

 

**Item 8. Financial Statementsand Supplementary Data**

 

The financial statements required by this itemare located beginning on page 59 of this report. The supplementary financialinformation required by this item is located under the caption “QUARTERLYRESULTS” in Item 7 of this report.

 

**Item 9. Changes in andDisagreements with Accountants on Accounting and financial Disclosures**

 

Information required by this Item may be found in our Form8-K filed May 6, 2004 in connection with the resignation of Deloitte &Touche LLP as our independent auditors and our Form 8-K filed on May 21, 2004,in connection with our appointment of Stonefield Josephson Inc. as ourindependent auditors.  Following is Item 4 of the respective Form 8-Ks:

 

****May6, 2004****

 

OnMay 6, 2004, Deloitte & Touche LLP (“Deloitte”), the Registrant’sindependent auditors, notified the Registrant that they were resigning from theclient-auditor relationship with the Registrant effective as of that date.

 

Deloittewas engaged by Registrant to serve as the Registrant’s independent auditors forthe fiscal year ended December 31, 2003, although Deloitte has not issued areport on the financial statements of the Registrant and its subsidiaries forthe 2003 fiscal year. The reports of Deloitte with respect to the Registrant’sfinancial statements for the fiscal years ended December 31, 2002 and 2001contained no adverse opinion or disclaimer of opinion and were not qualified ormodified as to uncertainty, audit scope or accounting principles. During thefiscal years ended December 31, 2003 and 2002 and the period from December 31,2003 through the date of Deloitte’s resignation, there were no disagreementsbetween the Registrant and Deloitte on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements, if not resolved to the satisfaction of Deloitte, wouldhave caused Deloitte to make reference to the subject matter of thedisagreements in connection with its report on the Registrant’s financialstatements for such year.

 

TheRegistrant previously announced that it expects to restate revenues and resultsof operations for the third and fourth quarters of 2002 and the first quarterof 2003 in connection with the Registrant’s sales of alloy melting and casting equipmentduring such quarters to Growell Metal Co., Ltd., a South Korea metalsprocessing company (“Growell”). The Registrant’s Audit Committee conducted aninternal inquiry at the request of Deloitte into the Registrant’s transactionswith Growell and found that the original revenue recognition on the Growellequipment sales did not take into account all relevant documentation relatingto the transactions. The Registrant announced in January 2004 that it enteredinto a dispute settlement agreement with Growell to resolve various outstandingclaims between the parties relating to the Registrant’s transactions withGrowell.

 

Inconnection with the Audit Committee’s inquiry into the Growell equipment salesand dispute settlement, the Audit Committee also reviewed the facts andcircumstances relating to a personal stock transaction between the Registrant’sCEO and Growell. In this transaction, as reported by the CEO, the CEO undertooka private sale of personal shares of Registrant common stock to Growell in February2002, prior to the Registrant’s initial public offering. As part of theinquiry, the CEO reported that this sale included a previously undisclosedpersonal agreement to ensure that the purchase price of the stock purchased byGrowell would be at a thirty percent discount to the Registrant’s initialpublic offering price, and he also provided information regarding hisfulfillment of this personal agreement.

 

Asof May 6, 2004, certain details of the foregoing transactions had not beenresolved to Deloitte’s satisfaction, and the audit for the 2003 fiscal year hastherefore not been completed. As a result of the expected restatements andthese unresolved issues, the Registrant’s previously issued financialstatements for the year ended December 31, 2002 and Deloitte’s audit reportthereon, as well as the Registrant’s quarterly financial statements for thethird quarter of 2002 and the first, second, and third quarters of 2003 (andDeloitte’s related review reports thereon), should no longer be relied upon.

 

Deloittehas communicated to the Registrant that it is unwilling to continue to rely onthe representations of the Registrant’s CEO. Deloitte has also previouslycommunicated to the Registrant that, in light of the facts and circumstancessurrounding the expected restatement, there were material weaknesses in theRegistrant’s internal accounting controls relating to the execution,administration, and accounting for contracts, particularly in the Registrant’sSouth Korean operations. The Registrant has taken and is continuing to takesteps to improve these internal controls.

 

Otherthan the foregoing, none of the reportable events described under Item304(a)(1)(v) of Regulation S-K occurred within the two most recent fiscal yearsof the Registrant ended December 31, 2003 and 2002 or within the subsequentinterim period through the date of Deloitte’s resignation.

 

37

----

 

TheRegistrant’s Audit Committee has discussed with Deloitte the matters disclosedabove. The Registrant has authorized Deloitte to respond fully to the inquiriesof the Registrant’s successor accountant concerning the mattersdisclosed above.

 

TheRegistrant has provided Deloitte with a copy of the foregoing disclosure andhas requested that Deloitte furnish it with a letter addressed to the SECstating whether or not it agrees with the above statements. A copy of thatletter will be filed with the SEC promptly upon receipt.  The Registrant’s Audit Committee has begunthe process of selecting new independent certified public accountants and willfile a Form 8-K upon the engagement of a new auditing firm. 

 

****May21, 2004****

 

OnMay 21, 2004, the Audit Committee of Liquidmetal Technologies, Inc. (the “Registrant”)appointed Stonefield Josephson, Inc. (“Stonefield Josephson”) as the Registrant’sindependent auditors. A copy of the press release announcing the engagement ofStonefield Josephson is filed as Exhibit 99.1 to this Current Report on Form8-K.

 

Duringthe two most recent fiscal years and through the date of this Current Report onForm 8-K, the Registrant did not consult Stonefield Josephson regarding (i) theapplication of accounting principles to a specific transaction, eithercompleted or proposed, or the type of audit opinion that may be rendered on theRegistrant’s financial statements, and neither a written report nor oral advicewas provided to the Registrant that Stonefield Josephson concluded was animportant factor considered by the Registrant in reaching a decision as to anyaccounting, auditing 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).

 

**Item 9A. Controls andProcedures**

 

Evaluation ofdisclosure controls and procedures.  During the course of the audit of ourfinancial statements for the fiscal years ended December 31, 2001, 2002, and2003, it was determined that revenues from certain equipment sales made by theCompany to Growell Metal Co., Ltd. in the third and fourth quarters of 2002 andthe first quarter of 2003 should not have been recognized in thoseperiods.  It was also determined thatcertain amounts relating to sales made to Samsung in December 2002, to JSTechnologies in September 2002, and AM Corporation in December 2002 should nothave been recognized.  It also  was 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 the associated restatement of previously issuedfinancial statements, as described more fully elsewhere in the Form 10-K forthe year ended December 31, 2003, filed on November 10, 2004, suggest that, atthe time of the subject transactions and the preparation of our financialstatements for the relevant periods, the Company’s disclosure controls and procedures(as defined in Rule 13a-15 under the Securities Exchange Act of 1934) wereineffective as of the period covered by the Form 10-K filed on November 10,2004 for purposes of ensuring that all information required to be disclosed bythe Company was adequately accumulated and communicated to the Company’smanagement at such time.    

 

Within the 90 days prior to thedate of this annual report, Liquidmetal Technologies (the “Company”) carriedout an evaluation, under the supervision and with the participation of theCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Officer, of the effectiveness as of December 31, 2004 of the designand operation of the Company’s disclosure controls and procedures pursuant toRule 13a-15 under the Securities Exchange Act of 1934, as amended.  Based on that evaluation, the Chief ExecutiveOfficer and Vice President Finance have concluded that these disclosurecontrols and procedures were ineffective by reason of the material weaknessesmentioned in more detail below in timely alerting them to material informationrelating to the Company, including its consolidated subsidiaries, required tobe included in this annual  report onForm 10-K.

 

Update onManagement’s Assessment of Internal Control Over Financial Reporting.The time and resources committed to the restatement of prior periods’ financialstatements as aforementioned delayed our internal timetable with respect to ourdocumentation, assessment and evaluation of internal control over financialreporting, which are required to be undertaken to comply with Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX404"). Due in part to the issues described in the foregoing paragraph,management’s assessment of the effectiveness of our internal control overfinancial reporting has been substantially delayed, which in turn has delayedthe Company’s independent registered public accounting firm, StonefieldJosephson, in performing  its audit ofmanagement’s assessment of the effectiveness of internal control over financialreporting pursuant to  SOX 404. 

 

Based on the foregoing, thisinitial filing of our Annual Report on Form 10-K does not include management’sassessment of internal controls over financial reporting nor StonefieldJosephson’s report relating to our assessment of the effectiveness of internalcontrol over financial reporting. Additionally, Stonefield Josephson has notified us that it may nothave  sufficient time to complete itswork relating to our internal controls by the 45-day extension deadline to filemanagement’s report on internal controls in an amended Form 10-K, which is  April 30, 2005.   

 

In making our assessment ofinternal control over financial reporting, management will use the criteriaestablished in “Internal Control - Integrated Framework” issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Todate, management has identified several control deficiencies, some of whichhave been determined to be material weaknesses on internal control overfinancial reporting.  As a result of thematerial weaknesses identified below, management has determined that when itfinishes its assessment, it will conclude that it did not maintain effectiveinternal control over financial reporting as of December 31, 2004, based on thecriteria established in COSO.   Inaddition, we 

 

38

----

 

expect that the materialweaknesses will result in an adverse opinion by our independent registeredpublic accounting firm on the effectiveness of our internal controls.  

 

While management has notcompleted its evaluation of our internal controls, and may identify additionalmaterial weaknesses, management has identified the following materialweaknesses as of March 20, 2005:

 

1. Lack of adequate segregationof duties in accounts payable and accounts receivable involving cash receiptsand deposits, bank reconciliations, cash disbursements, purchasing, andaccounts receivable reconciliations;

 

2. Lack of adequate controls andmonitoring of payroll and payroll processing, currently outsourced to a thirdparty provider; and

 

3. Lack of documentation toevidence reviews of certain reconciliations; lack of documentation ofauthorization of transactions; manual performance of numerous procedures thatcould be automated using current reporting systems. 

 

Management believes that it hastaken appropriate steps to address these material deficiencies subsequent toDecember 31, 2004, including hiring an independent consulting firm to identifyand propose remedial actions to address and mitigate the deficiencies.  However, management is not able to concludethat our internal control over financial reporting are effective as of December31, 2004 because the deficiencies were not identified and remedial actions werenot implemented until after  December 31,2004.  In addition, our auditors may nothave sufficient time to test our assertions over internal control and,therefore, expect to provide an adverse opinion on the effectiveness of ourinternal control over financial reporting. In addition, we cannot assure you that we will not discover andsubsequently report additional material internal control weaknesses anddeficiencies. 

 

Changes in internal controls.There were no changes in the Company’s internal controls over financialreporting that occurred during the quarter ended December 31, 2004.  The Company is currently in the process ofre-evaluating its internal controls pursuant to SOX 404 (see Item 9A Controlsand Procedures, Evaluations of disclosure controls and procedures).

 

39

----

 

**PART III**

 

**Item 10. Directors andExecutive Officers of the Registrant**

 

Set forth below is a table identifying our current directors andexecutive officers:

 
| **Name**               | ** ** | **Age** | ** ** | **Position**                                           |
|------------------------|------------|---------|------------|--------------------------------------------------------|
|                   |       |    |       |                                                   |
| John Kang              |       | 42      |       | Chairman of the Board                                  |
|                   |       |    |       |                                                   |
| John Thorne            |       | 64      |       | President and Chief Executive Officer                  |
|                   |       |    |       |                                                   |
| James Kang             |       | 44      |       | Director and Founder                                   |
|                   |       |    |       |                                                   |
| William Johnson, Ph.D. |       | 56      |       | Director                                               |
|                   |       |    |       |                                                   |
| Dean Tanella           |       | 44      |       | Director                                               |
|                   |       |    |       |                                                   |
| Vincent Addonisio      |       | 49      |       | Director (Audit Committee Chairman)                    |
|                   |       |    |       |                                                   |
| Robert Biehl           |       | 61      |       | Director                                               |
|                   |       |    |       |                                                   |
| CK Cho                 |       | 49      |       | Director                                               |
|                   |       |    |       |                                                   |
| David Binnie           |       | 55      |       | Senior Vice President of  Administration and Secretary |
|                   |       |    |       |                                                   |
| Tony Chung             |       | 35      |       | Vice President of Finance                              |

 

*John Kang* was re-elected as Chairman of ourBoard of Directors in August 2003.   Hehas been a director of our Company since 1994. From December 1994 to December 2000, he served as Chairman of our Boardof Directors in a non-employee capacity, and from December 2000 to June 2001 heserved as Chairman of our Board of Directors in an employee capacity.  From June 2001 to December 2004, he served asour Chief Executive Officer and President. From July 1996 to September 2000, Mr.Kang served variously as Chief Executive Officer, President, and a director ofMedical Manager Corporation, a public company traded on the Nasdaq NationalMarket until its sale in September 2000 to WebMD Corporation. From 1988 to1995, he was Chairman of the board of directors of Clayton Group, Inc., aprivate company engaged in the distribution of waterworks equipment.  Mr. Kang received a B.A. degree in Economicsfrom Harvard College in 1985.  Mr. Kangis the brother of James Kang, the former Chairman of our board of directors.

 

 *JohnThorne* joined Liquidmetal in November 2004 and began serving as ourPresident and Chief Executive Officer in January 2005. Mr. Thorne has more than 35 years ofleadership and management experience in fabrication, casting, productdevelopment, technical management and P&L responsibility withhigh-performance alloy and specialty metals companies, including RugerInvestment Casting Division of Sturm, Ruger & Co., Inc., IMI Titanium,Inc., Precision Castparts Corporation and Howmet Corporation. Currently, he isPresident and CEO of Thorne Technologies, LLC, an Arizona-based metallurgicalengineering and management consulting firm serving high technology metalsindustries. He holds a bachelor degree in Metallurgical Engineering and an MBAin Business Administration from Cornell University, and an MSE and Ph.D. inMetallurgical Engineering from the University of Michigan.

 

*James Kang*hasserved as a director since December 1994 and as executive Founder of ourcompany since August 2003.  From December1994 to June 2001, he served variously as our Chief Executive Officer,President, and Chairman.  Mr. Kangreceived a B.A. degree in Marketing from the University of Illinois in 1983,and an M.B.A. degree from the Kellogg School of Management at NorthwesternUniversity in 1985.  Mr. Kang is thebrother of John Kang, our Chairman of the Board of Directors, who was also ourChief Executive Officer and President during 2004.

 

*William Johnson, Ph.D*.*,*has served as a director since June 2000.  From October 2001 to September 2003, he wasemployed as our executive Vice Chairman of Technology.  Since 1997, Professor Johnson has been theMettler Professor of 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 consultant tothe Company.

 

40

----

 

*Dean G. Tanella*was elected 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 HarborLight Capital, LLC, both of whichare private investment firms.  Mr.Tanella received his bachelors degree from Princeton University and his MBAfrom the Harvard Graduate School of Business Administration.

 

*Vincent Addonisio* was elected as a director in May 2004. Mr. Addonisio is President and CEO of Regency Strategic Advisors,Inc., a firm he founded to advise select corporate clients on strategy,business development, and mergers and acquisitions. Previously, he served as adirector, executive vice president and chief administrative officer forIMRglobal Corp., a public company that was subsequently acquired in 2001.   Prior to joining IMRglobal, he was adirector, executive vice president and chief financial officer for ABRInformation Services, Inc., a public company which he also helped lead throughinitial and secondary public offerings and strategic acquisitions. A CPA,Addonisio began his career with an international accounting firm andsubsequently joined W.R. Grace, where he held positions of progressivemanagement responsibility.  He holds a BSdegree in accounting from Binghamton University and earned an MSM from GeorgiaInstitute of Technology in Atlanta.

 

*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 is also the CEO of Winvest VenturePartners Inc.  Mr. Cho received hisbachelors degree majoring in Business Administration and Material Sciences fromthe Korea University of Seoul.

 

*DavidBinnie*hasbeen Senior Vice President-Administration and Corporate Secretary sinceDecember 2003. Previously, he served as Senior Vice President for HumanResources, a position he had held since October 2001.  Prior to joining Liquidmetal Technologies,Binnie was a senior official with the School District of Hillsborough County,Florida, where he served as the Assistant Superintendent for Human Resources.Hillsborough County is currently the 10th largest school system in the UnitedStates with over 191,000 students and over 32,000 employees.  Mr. Binnie earned degrees at the Bachelors(Education 1971), Masters (Education, 1973) and Doctorate (EducationLeadership, 1985) levels at the University of South Florida.

 

**Tony Chung** has been our Vice President of Finance sinceOctober 2004, prior to which he served as our Director of Finance upon joiningthe Company in May 2004.  From September 1992 to May 2004, Mr. Chungserved in a variety of senior finance capacities at various companies includingEverdream Corporation, a startup venture specializing in IT outsourcing, andMAI Systems Corporation, a publicly traded company that developsand licenses hotel management software.  Mr. Chung is a Certified PublicAccountant and served eight years at KPMG as an Audit and Consulting Managerfor several large multinational companies.  He received his B.S. degreespecializing in accounting and finance from the University ofCalifornia at Berkeley in 1992 at The Haas School of Business. Mr. Chung iscurrently pursuing a Juris Doctorate Degree with Pacific Coast UniversitySchool of Law and expects to receive his degree in June 2006.

 

**Change in Principal FinancialOfficer**

 

On November 3, 2004, David Nail resigned as our VicePresident of Finance and ceased to be our principal financial officer.  On the same day, our board elected Tony Chungto serve as our Vice President of Finance and become our company’s principalfinancial officer.  Additionalinformation regarding Mr. Chung is set forth above in this Item 10.

 

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

###### ** **

**Terms of Directors**

 

**Our board ofdirectors is divided into three classes (designated “CLASS I,” “CLASS II,” and “CLASSIII”), as nearly equal in number as possible, with each class servingthree-year terms expiring at the third annual meeting of stockholders aftertheir elections or until their respective successors have been elected andqualified.  CLASS I currently consist ofthe 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 VincentAddonisio.**

 

41

----

 

**Audit Committee**

 

**Our board of directors has an Audit Committee thatis currently comprised of Mr. Addonisio and Mr. Tanella.  The Audit Committee is responsible forreviewing the independence, qualifications, and activities of our independentcertified accountants and our financial policies, control procedures, andaccounting staff.  The Audit Committee isalso responsible for the review of transactions between us and any officer,director, or entity in which an officer or director of Liquidmetal has amaterial interest.  Our board ofdirectors has determined that Mr. Addonisio and Mr. Tanella each qualify as “auditcommittee financial experts” as defined by the regulations of the Securitiesand Exchange Commission.  The AuditCommittee is governed by a written charter approved by the board of directors.**

** **

**CompensationCommittee**

** **

The Compensation Committee is comprised of Mr. Cho and Mr.Biehl. All of the members of the Compensation Committee are “independentdirectors,” as defined by the rules applicable to members of the CompensationCommittee. The Compensation Committee is responsible for establishing thecompensation of our senior management, including salaries, bonuses, terminationarrangements, and other executive officer benefits. The Compensation Committeealso administers our equity incentive plans.

 

**Corporate Governance and Nominating Committee**

** **

A CorporateGovernance and Nominating Committee (“the Committee”) was formed onFebruary 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 shareholders. The Committee is also responsible for selectingand recommending for approval by the Board and the Company’sshareholders a slate of director nominees forelection at each of the Company’s annual meetings of shareholders, 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:

 

•                                          developingand maintaining our corporate governance policy guidelines;

 

•                                          developingand maintaining our codes of conduct and ethics;

 

•                                          overseeingthe interpretation and enforcement of our Code of Conduct and our Code ofEthics for Chief Executive Officer and Senior Financial and AccountingOfficers; and

 

•                                          evaluatingthe performance of our board, its committees, and committee chairmen and ourdirectors.

 

•                                          selectingand recommending a slate of director nominees for election at each of theCompany’s annual meeting of the shareholders and recommending to the Boarddirector nominees to fill vacancies or new positions on the Board or itscommittees that may occur from time to time.

 

**Code of Ethics**

 

Our board of directors has adopted a Code ofEthics that is applicable to its principal executive officer, principalfinancial officer, principal accounting officer or controller, and personsperforming similar functions. The Code of Ethics is attached as Exhibit 14 tothe Annual Report on Form 10-K filed on November 10, 2004.

 

###### **BENEFICIAL OWNERSHIPREPORTING REQUIREMENTS**

###### ** **

During the year ended December 31, 2004, our executiveofficers and directors filed with the Securities and Exchange Commission on atimely basis all required reports relating to transactions involving shares ofour common stock beneficially owned by them, except that John Kang, Chairman,disposed of 188,700 shares during various dates in 2004 as gifts to variousindividuals and organizations and James Kang, Director and Founder, disposed of67,320 shares on January 5, 2004 as gifts to various individuals andorganization.  These disposals were reportedin John Kang’s Form 5 filed on February 17, 2005 and James Kang’s Form 4 filedon January 28, 2005.

 

42

----

 

**Item 11. ExecutiveCompensation**

 

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 during 2004(collectively, the “named executive officers”).

 
| ** **                  | ** ** | ** ** | ** ** | ** **              | ** ** | **Long-Term  Compensation**              | ** ** | ** **                  | ** ** |
|-----------------------------|------------|------------|------------|-------------------------|------------|------------------------------------------|------------|-----------------------------|------------|
| **Name and Positions**      | ** ** | **Year**   | ** ** | **Annual Compensation** | ** ** | **Shares  Underlying  Options  Granted** | ** ** | **All Other  Compensation** | ** ** |
| ** **                  | ** ** | ** ** | ** ** | **Other**               |
| ** **                  | ** ** | ** ** | ** ** | **Annual**              |
| **Salary**                  | ** ** | **Bonus**  | ** ** | **Compensation**        |
| John Kang (1)               |       | 2004       |       | $                       | 208,586    |                                     | —     |                        | —     |   | — |   | — |   |
| Chairman of the Board       |       | 2003       |       | $                       | 300,007    |                                     | —     |                        | —     |   | — |   | — |   |
|                        |       | 2002       |       | $                       | 116,671    |                                     | —     |                        | —     |   | — |   | — |   |
|                        |       |       |       |                    |       |                                     |       |                        |       |   |   |   |   |
| John Thorne (2)             |       | 2004       |       | $                       | 37,500     |                                     | —     |                        | —     |   | — |   | — |   |
| Chief Executive Officer     |       | 2003       |       | —                  |       | —                                   |       | —                      |       | — |   | — |   |
| and President               |       | 2002       |       | —                  |       | —                                   |       | —                      |       | — |   | — |   |
|                        |       |       |       |                    |       |                                     |       |                        |       |   |   |   |   |
| James Kang (3)              |       | 2004       |       | $                       | 300,004    |                                     | —     |                        | —     |   | — |   | — |   |
| Founder and Director        |       | 2003       |       | $                       | 280,011    |                                     | —     |                        | —     |   | — |   | — |   |
|                        |       | 2002       |       | $                       | 373,334    |                                     | —     |                        | —     |   | 2,877,420 |   | — |   |
|                        |       |       |       |                    |       |                                     |       |                        |       |   |   |   |   |
| David Binnie (4)            |       | 2004       |       | $                       | 142,506    |                                     | —     |                        | —     |   | — |   | — |   |
| Senior VP of Administration |       | 2003       |       | $                       | 140,005    |                                     | —     |                        | —     |   | 150,000 |   | — |   |
| and Secretary               |       | 2002       |       | $                       | 150,005    |                                     | —     |                        | —     |   | — |   | — |   |
|                        |       |       |       |                    |       |                                     |       |                        |       |   |   |   |   |
| Tony Chung (5)              |       | 2004       |       | $                       | 73,544     |                                     | —     |                        | —     |   | 80,000 |   | — |   |
| VP of Finance               |       | 2003       |       | —                  |       | —                                   |       | —                      |       | — |   | — |   |
|                        |       | 2002       |       | —                  |       | —                                   |       | —                      |       | — |   | — |   |

 

----

**(1)**          As of August 22, 2003, JohnKang was named Chairman of our board of directors, in addition to alreadyserving as Chief Executive Officer and President.  Mr. Kang ceased to be our Chief Executive Officer as of January 14, 2005

** **

**(2)**          As of January 14, 2005, JohnThorne was named Chief Executive Officer and President of the Company.  Previously during 2004, Mr. Thorne served asa consultant.

** **

**(3)**          As of August 22, 2003, JamesKang became the executive Founder of the Company and ceased to be the Chairmanof our board of directors.

** **

**(4)**          Mr. Binnie joined Liquidmetalin October 2001 as Vice President of Human Resources and assumed the positionof Senior Vice President of Administration and Secretary effective December2003.

** **

**(5)**          Mr. Chung joined Liquidmetalin May 2004 as Director of Finance and assumed the position of Vice President ofFinance effective November 2004.

 

43

----

 

The following table sets forth information with respect tothe aggregate stock option exercises by the executive officers named in theSummary Compensation Table during 2004 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** | ** ** |
|--------------|------------|--------------------------|------------|------------------|------------|------------------------------------------------|------------|
| ** **   | ** ** | **Exercise**             | ** ** | **Realized (1)** | ** ** | **Exercisable**                                | ** ** | **Unexercisable** | ** ** |
|         |       |                     |       |             |       |                                           |       |   |   |
| John Kang    |       | —                   |       | —           |       | 1,612,904                                      |       | — |   |
|         |       |                     |       |             |       |                                           |       |   |   |
| John Thorne  |       | —                   |       | —           |       | —                                         |       | — |   |
|         |       |                     |       |             |       |                                           |       |   |   |
| James Kang   |       | —                   |       | —           |       | 2,845,162                                      |       | 32,258 |   |
|         |       |                     |       |             |       |                                           |       |   |   |
| David Binnie |       | —                   |       | —           |       | 69,355                                         |       | 112,904 |   |
|         |       |                     |       |             |       |                                           |       |   |   |
| Tony Chung   |       | —                   |       | —           |       | —                                         |       | 80,000 |   |

 

----

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

** **

**EMPLOYMENTAGREEMENTS**

 

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

 

*John Kang. *OnDecember 31, 2000, we entered into an employment agreement with John Kang that,as amended, provides for his employment as our Chief Executive Officer andPresident, and on August 22, 2003, Mr. Kang was named Chairman of our Board ofDirectors.  Mr. Kang’s employmentagreement expires on December 31, 2005. Mr. Kang receives an annual base salary equal to $200,000 per year, andhis employment will terminate upon the earlier of his death, resignation,disability, or termination by the board of directors for any reason.  If we terminate Mr. Kang’s employment withoutcause, or if Mr. Kang terminates his own employment upon a change of control ofour company or for other good reason, as defined in the agreement, we areresponsible for paying Mr. Kang a lump-sum cash payment equal to 200% of Mr.Kang’s annual base salary plus the average cash bonus during the two fullfiscal years immediately preceding the termination.  Pursuant to the agreement, Mr. Kang wasissued options to purchase 1,612,904 shares of our common stock at an exerciseprice of $4.65 per share.  The optionsexpire on December 31, 2010 and vested immediately upon grant.  In addition, Mr. Kang is prohibited, duringhis employment with us and for one year after he is no longer employed by us,from soliciting any of our employees or competing with us in any manner.  Starting in May 2003, Mr. Kang and othermembers of senior management took a 10% voluntary decrease in their base salaryand returned to full salary in June 2004. Mr. Kang ceased to be our President and Chief Executive Officer as ofJanuary 14, 2005.

 

*John Thorne.* On January 14, 2005, we entered into an employment agreement with JohnThorne, which provides for his employment as the named Chief Executive Officerand President of our company.  Mr. Thorne’semployment expires April 30, 2005, and histerm may continue subsequent to the expiration date on a month-to-month basisat the same salary if mutually agreed in writing at least 2 weeks prior to eachextension.  His monthly salary is$20,834, and will receive 10,000 stock options on April 30, 2005, contingent onremaining as an employee until that time.

 

*James Kang. *OnMay 1, 2001, we entered into an employment agreement with James Kang that, asamended, provides for his employment as the named executive Founder of ourcompany.  Mr. Kang’s employment agreementexpires on May 1, 2006.  Mr. Kangreceives an annual base salary equal to $300,000 per year, and his employmentwill terminate upon the earlier of his death, resignation, disability, ortermination by the board of directors for any reason.  If we terminate Mr. Kang’s employment withoutcause, or if Mr. Kang terminates his own employment upon a change of control ofour company or for other good reason, as defined in the agreement, we areresponsible for paying Mr. Kang a severance benefit equal to a lump-sum cashpayment equal to 200% of Mr. Kang’s annual base salary plus the average cashbonus during the two full fiscal years immediately preceding thetermination.  Pursuant to the agreement,Mr. Kang was issued options to purchase 2,580,646 shares of our common stock atan exercise price of $6.20 per share. The options expire on April 30, 2011 and vest at a rate of 33% per yearfor three years, with the first 33% vesting on May 21, 2002 and an additional33% on May 21, 

 

44

----

 

2003 and 2004.  In addition, Mr.Kang is prohibited, during his employment with us and for two years after he isno 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.

 

*David Binnie.*  On October 1, 2001, we entered into anemployment agreement with David Binnie, which provides for his employment asthe named Senior Vice President for Human Resources.  Mr. Binnie’s employment expires September 30,2006, 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 100,000 stock options as part of the employment agreement.  In December 2003, Mr. Binnie was named as ourSenior Vice President of Administration and Secretary.

 

*Tony Chung.*  On November 3, 2004, we entered into anemployment agreement with Tony Chung, which provides for his employment as thenamed Vice President of Finance.  Mr.Chung’s employment expires November 2, 2007, and his term may continue subsequent to the expiration date on amonth-to-month basis at the same salary. His annual salary is $125,000, and he received 20,000 stock options aspart 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 ofJohn Thorne, 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 compensation opportunityshould be at risk and tied to company performance.  Our compensation package consists of threeprincipal components:**

** **

•  Base salaries, subject to minimums set forthin individual employment agreements;

 

•  Annual incentive bonus eligibility; and

 

•  Stock option grants and other forms ofequity-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 set forth in his employment agreement.   In 2004 and 2003, the Compensation Committeedid not increase the base salary of any of the executive officers.

 

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

 

The plan is designed to:

 

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

 

•                  be aligned withour mission, values and culture;

 

45

----

 

•                  be cost-effective andappropriately budgeted to allow for growth of our revenue as well as growth ofindividual compensation plans;

 

•                  be externally competitive bymatching or leading competitors; and

 

•                  be internally equitablethrough alignment with level of contribution, performance-based rewards, andadministrative capabilities.

 

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 2003 and 2004 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 tocontribute to our future success, and the other elements of such executiveofficer’s compensation. Generally, we use equity-based compensation to betteralign the interests of our executive officers with those of ourstockholders.  For 2004, the CompensationCommittee approved awards of options to executive officers and certain membersof senior management, with the sizes of the awards determined with reference tothe scope of the position and the employees’ relative contributions to theCompany.  In addition, three of ourexecutive officers, John Kang, our Chief Executive Officer, James Kang, ourexecutive Founder, and William Johnson, our Vice Chairman, own a significantamount of our common stock.**

** **

**CEO Compensation**

 

John Kang’s base salary for 2003, as our President and Chief ExecutiveOfficer, was originally set at $200,000, although Mr. Kang and other members ofsenior management took a 10% voluntary decrease in their base salary startingin May 2003, at which time Mr. Kang’s base salary was reduced to $180,000 peryear.  This represents a decrease overMr. Kang’s 2002 salary of $200,000.  Mr.Kang’s compensation reflects his status as a significant stockholder of theCompany.  Accordingly, his base salary islower than the base salary of CEOs of comparable companies.  Mr. Kang voluntarily waived his base salaryfrom January 2004 through May 2004 in support of the Company’s strategic cashobjectives.  In June 2004, Mr. Kangreturned to his base salary of $200,000 and received his differential retroactivepay in equal installments over the remaining months of 2004.  As a significant stockholder in the Company,his overall compensation is tied directly to sustained increases in the Company’svalue.

 

No bonus payments were made to Mr. Kang for 2003 and 2004because the Compensation Committee determined not to pay any bonuses to any ofour executive officers due to the Company missing its financial goals.  In addition, no options were granted to Mr.Kang in 2003 and 2004.  As of December31, 2004, Mr. Kang held options and warrants to purchase 1,935,485 shares ofour common stock, all of which were fully vested.

 

John Thorne’s base salary, as our President and Chief Executive Officer, effective January 14,2005, is $250,008.  As of December 31, 2004, Mr. Thorne did nothold any options to purchase our common stock.

 

**The InternalRevenue Code imposes a limitation on the deduction under Section 162(m) forcertain executive officers’ compensation unless certain requirements are met.Our policy is to have all compensation fully deductible; however, we reservethe right to pay compensation that is not deductible if it is in our bestinterests.**

** **

Compensation Committee of the Board of Directors

 

CK Cho

Robert Biehl

 

December 31, 2004

 

**The report ofthe Compensation Committee shall not be deemed incorporated by reference by anygeneral statement incorporating by reference this Annual Report on Form 10-Kinto any filing under the Securities Act of 1933 or under the SecuritiesExchange Act of 1934, except to the extent that we specifically incorporatethis information by reference, and shall not otherwise be deemed filed undersuch acts.**

 

46

----

 

**DIRECTORCOMPENSATION**

 

Ournon-employee directors receive an annual fee of $10,000 for their service toour board and are reimbursed for expenses incurred in attending board andcommittee meetings.  Non-employeedirectors are also entitled to receive a $10,000 annual cash stipend for eachstanding board committee (excluding the Audit Committee) on which the directorserves.  For Audit Committee service, theAudit Committee chairman is entitled to a $35,000 annual stipend, and the othermembers of the Audit Committee are entitled to a $27,500 annual stipend.  In addition to the annual stipends, eachnon-employee director is entitled to receive a per-meeting fee of $1,000 foreach meeting of the board of directors or any board committee attended inperson.  Effective May 2004, VincentAddonisio was elected as the lead independent director of the Company.  The lead independent director is entitled toa $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 directorwho is an employee will receive separate compensation for services rendered asa director.  However, our employeedirectors are eligible to participate in our 2002 Equity Incentive Plan

 

**Item 12. SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

 

**The followingtable sets forth certain information regarding the beneficial ownership of ourcommon stock as of December 31, 2004 by:**

** **

•  each of our directors and the executiveofficers identified in Item 10 above;

 

•  all directors and executive officers as agroup, and

 

•  each person known by us to own beneficiallymore than 5% of the common stock.

 

**Beneficialownership is determined under the rules of the Securities and ExchangeCommission and generally includes voting or investment power with respect tosecurities.  Unless otherwise indicated,each of the stockholders has sole voting and investment power with respect tothe shares beneficially owned, subject to applicable community propertylaws.  As of December 31, 2004, therewere 238 holders of record of our common stock. For purposes of calculating amounts beneficially owned by a stockholder,the number of shares deemed outstanding includes 41,609,652 shares of commonstock outstanding as of December 31, 2004. In addition, shares of common stock subject to options or warrants thatare currently exercisable or exercisable within 60 days of December 31, 2004are deemed to be outstanding and to be beneficially owned by the person holdingthe options or warrants for the purpose of computing the beneficial ownershipof that person but are not treated as outstanding for the purpose of computingthe beneficial ownership of any other person.**

 

47

----

 
| ** **                                                         | ** ** | **Beneficially Owned** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|
| **Name**                                                           | ** ** | **Shares**             | ** ** | **Percent** | ** ** |
| ** **                                                         | ** ** | ** **             | ** ** | ** ** | ** ** |
| John Kang (1)                                                      |       | 5,600,474              |       | 13 | % |
|                                                               |       |                   |       |   |   |
| James Kang (2)                                                     |       | 7,003,904              |       | 17 | % |
|                                                               |       |                   |       |   |   |
| William Johnson                                                    |       | 1,195,650              |       | 3 | % |
|                                                               |       |                   |       |   |   |
| David Binnie (3)                                                   |       | 75,115                 |       |   | * |
|                                                               |       |                   |       |   |   |
| Dean Tanella (4)                                                   |       | 26,120                 |       |   | * |
|                                                               |       |                   |       |   |   |
| Vincent Addonisio (5)                                              |       | —                 |       |   | * |
|                                                               |       |                   |       |   |   |
| Robert Biehl                                                       |       | 25,000                 |       |   | * |
|                                                               |       |                   |       |   |   |
| CK Cho (6)                                                         |       | 185,102                |       |   | * |
|                                                               |       |                   |       |   |   |
| John Thorne                                                        |       | —                 |       |   | * |
|                                                               |       |                   |       |   |   |
| Tony Chung (7)                                                     |       | 47,250                 |       |   | * |
|                                                               |       |                   |       |   |   |
| All directors and executive officers as a  group – 10 persons |       |                   |       | 34 | % |

 

----

*  Less than one percent.

 

(1)          As of August 22, 2003,John Kang was named Chairman of our board of directors, in addition to alreadyserving as Chief Executive Officer and President.  As of January 14, 2005, John Kang ceased tobe our Chief Executive Officer and President. The beneficial shares include:

 

(a) 1,612,904 shares that are issuablepursuant to outstanding stock options that are exercisable currently or within60 days of December 31, 2004.

 

(b) 322,581 shares issuable pursuant to awarrant held jointly by John Kang and Ricardo Salas (a former director of thecompany) that is currently exercisable; and(c) 127,800 shares held by Mr. Kang’s minor children.

 

(2)          Includes 2,845,162shares issuable pursuant to outstanding stock options that are exercisablecurrently or within 60 days of December 31, 2004.  Also includes 969 shares held by James Kang’sminor children. Does not include 32,258 shares issuable pursuant to outstandingstock options that are not exercisable currently or within 60 days of December31, 2004.

 

(3)          Includes 69,355 sharesissuable pursuant to outstanding stock options that are exercisable currentlyor within 60 days of December 31, 2004. Also includes 760 shares held by Mr. Binnie’s family. Does not include112,904 shares issuable pursuant to outstanding stock options that are notexercisable currently or within 60 days of December 31, 2004.

 

(4)          Includes 16,130 sharesheld by Mr. Tanella’s investment firm, HarborLight Diversified Fund, LP.  Also, includes 1,390 shares held by Mr.Tanella’s family.  Does not include50,000 shares that are issuable pursuant to outstanding stock options that arenot exercisable within 60 days.

 

(5)          Does not include 70,000shares that are issuable pursuant to outstanding stock options that are notexercisable within 60 days.

 

(6)          Includes 109,678 sharesheld by Mr. Cho’s Investment firm, Winvest.

 

(7)          Does not include 80,000shares that are issuable pursuant to outstanding stock options that are notexercisable within 60 days.

 

48

----

 

**Equity Compensation Plan Information**

 

The following table sets forth certain informationregarding the securities authorized for issuance under our equity compensationplans as of December 31, 2004.

 
| **Plan Category**                                            | ** ** | **Number of Securities To be  Issued upon Exercise of  Outstanding Options,  Warrants, and Rights** | ** ** | **Weighted Average Exercise  Price of Outstanding  Options,  Warrants, and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | ** **                                                                                          | ** ** | ** **                                                                          | ** ** | ** **                                                         | ** ** |
| Equity compensation plans approved by  security holders:     |       | 6,899,164                                                                                           |       | $                                                                                   | 4.95       |                                                               | 10,232,001 |   |
|                                                         |       |                                                                                                |       |                                                                                |       |                                                               |       |
| Equity compensation plans not approved by  security holders: |       | —                                                                                              |       | —                                                                              |       | —                                                             |       |
|                                                         |       |                                                                                                |       |                                                                                |       |                                                               |       |
| **Total**                                                    |       | 6,899,164                                                                                           |       | $                                                                                   | 4.95       |                                                               | 10,232,001 |   |

 

**Item 13. CertainRelationships and Related Transactions**

 

**In June 2003,the Company entered into an exclusive, ten-year license agreement with LLPG,Inc. (“LLPG”), a corporation headed by a former director of the Company.  Under the terms of the agreement, LLPG hasthe right to commercialize Liquidmetal alloys, particularly precious-metalbased compositions, in jewelry and high-end luxury product markets.  The Company, in turn, will receive royaltypayments over the life of the contract on all Liquidmetal products produced andsold by LLPG.  In conjunction with itstechnology licensing contract, LLPG purchased two proprietary Liquidmetal alloymelting machines and three proprietary Liquidmetal alloy casting machines for atotal purchase price of $2,000,000.  AtDecember 31, 2003, the Company had a remaining receivable balance of approximately$500,000 due from LLPG, which was paid in full in March 2004.**

** **

The Company is a partyto a license agreement with California Institute of Technology (“Caltech”)under which the Company exclusively licenses from Caltech certain inventionsand technology relating to amorphous alloys. Professor William Johnson, a member of the Company’s Board of Directors,is a professor at Caltech, and substantially all of the amorphous alloytechnology licensed to the Company under the Caltech license agreement wasdeveloped in Professor Johnson’s Caltech laboratory.   During 2003, the Company paid approximately$50,000 to Caltech representing the second and final installments on theapproximately $150,000 aggregate fees related to this agreement.  Additionally, the Company reimburses Caltechfor laboratory expenses incurred by Professor Johnson’s Caltech laboratory,which during the years ended December 31, 2004 and 2003, amounted to $0 andapproximately $22,000, respectively.

 

A company managed andpartially owned by one of the Company’s former directors provides technicalsupport services and computer equipment to the Company.  During the year ended December 31, 2003, theCompany incurred approximately $20,000 of expenses and equipment purchases relatedto this arrangement.  There were noexpenses and payables to this Company as of December 31, 2004.

 

We are aparty to a consulting agreement with Chitnis Consulting, Inc., which is owned100% by Shekhar Chitnis, a former director and executive officer of our company.  Under this agreement, we have engaged ChitnisConsulting to provide consulting services on an as-needed basis throughDecember 31, 2005.  During 2003, weincurred approximately $50,000 in consulting fees from Chitnis Consulting andincurred approximately $54,000 as of December 31, 2004.

 

**Soo Buchanan,the sister of John Kang and James Kang, was employed by our company and waspaid aggregate compensation of approximately $76,000 and $43,000 as of December31, 2003 and 2004.  Additionally, OtisBuchanan, the husband of Ms. Buchanan, was employed by the Company and was paidaggregate compensation of approximately $90,000 and $54,000 as of December 31,2003 and 2004, respectively.**

** **

In November 2004, we entered into an agreement with JohnKang, our Chairman, President, and Chief Executive Officer, in which Mr. Kangagreed that certain stock transactions by him in 2002 involving our 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 

 

49

----

 

in February 2002 (the purchases and dispositions incidentto this agreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-marketpurchases of an aggregate of 89,300 shares of our common stock made by Mr. Kangin 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 approximately $302,000.  Mr. Kang has acknowledged this liability, andin an agreement negotiated between Mr. Kang and the Audit Committee andapproved by the full Board, Mr. Kang will pay this liability through periodicinstallments in 2005 and 2006.  .  As a result, the Company accrued the $302,000receivable in other assets and other income as of December 31, 2004.  The above-described transactions involvingGrowell Metal were 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.**

** **

**Item 14. Principal AccountingFees and Services**

 

Prior to May 2004, Deloitte & Touche LLP was ourindependent public accountant; however, effective May 2004, Deloitte &Touche LLP resigned as our independent accountant.  Liquidmetal Technologies subsequently engagedStonefield Josephson, Inc.  Item 14includes the principal accounting fees and services for both Deloitte &Touche LLP and Stonefield Josephson, Inc.

 

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.

 

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

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

 

----

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

•                  Audit of theCompany’s annual financial statements for 2003, 2002, and 2001;

•                  Review and auditof the Company’s quarterly and annual financial statements for 2004,respectively.

 

Deloitte & Touche LLP

 

Thefollowing table summarizes the aggregate fees billed to the Company by Deloitte& Touche LLP for professional services performed in 2003:

 
| **Fees**       | ** ** | **2003** | ** ** |
|----------------|------------|----------|------------|
| Audit Fees (1) |       | $        | 296,021    |   |
| Tax Fees (2)   |       | 68,435   |       |
|           |       |     |       |
| Total          |       | $        | 364,456    |   |

 

----

(1) *Audit Fees.*Fees foraudit services billed in 2003 consisted of:

•                  Audit of theCompany’s annual financial statements;

•                  Reviews of theCompany’s quarterly financial statements;

•                  Comfort letters,statutory and regulatory audits, consents and other services related toSecurities and Exchange Commission matters;

•                  Consultationsabout accounting for settlement and fund raising; and

•                  Reviews ofSecurities and Exchange Commission documents associated with financing andrestructuring.

 

(2) *Tax Fees.*Fees for tax services billed in 2003 and 2002 consisted of tax compliance andtax planning/advice

 

50

----

 

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 Deloitte & Touche LLP and Stonefield Josephson, Inc.in 2004, 2003, and 2002 as identified above.

 

**PART IV**

 

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

 

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

 

1.*Financial Statements*. The Indexto our Consolidated Financial Statements is set forth on page 68 of thisreport.

 

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

 

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

 

(b)  *Reports onForm 8-K*. The following reports on Form 8-K were filed during thequarter ended December 31, 2004:

 
| **Date Filed**     | ** ** | **Date of Report** | ** ** | **Item**                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------------------|------------|--------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **         | ** ** | ** **         | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                              |
| October  19, 2004  |       | October  18, 2004  |       | The  Company filed a news release under Item 7.01 of Form 8-K announcing the  status of the company’s external audit and Form 10-K filing.                                                                                                                                                                                                                                                                                         |
|               |       |               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| November  10, 2004 |       | November  10, 2004 |       | The  Company filed a news release under Item 7.01 of Form 8-K announcing the status  of the company’s external audit and Form 10-K filing.                                                                                                                                                                                                                                                                                         |
|               |       |               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| November  23, 2004 |       | November  22, 2004 |       | The Company announced under Item 8.01 of Form 8-K that in a letter  and decision dated November 18, 2004, the Listing Council notified the  Company that it affirms the Panel’s decision to delist the Company’s  securities from The Nasdaq National Market.                                                                                                                                                                 |
|               |       |               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| December  17, 2004 |       | December  17, 2004 |       | The  Company filed a news release under Item 5.02 of Form 8-K announcing  the appointment of John K. Thorne as Interim President and Chief Executive  Officer.  Also included in the press release is the stepping down of  Thian-Song Tjoa as a member of our Board of Directors, and the elections of  Robert J. Biehl and C.K. Cho to the Board.  The appointment and elections  will become effective on January 1, 2005. |
|               |       |               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| December  23, 2004 |       | December  23, 2004 |       | The  Company filed a news release under Item 2.02 of Form 8-K announcing  the results of operations for the quarter ended March 31, 2004.                                                                                                                                                                                                                                                                                               |

 

(c)  *Exhibits*. The exhibits listed on theExhibit Index, which appears at the end of this Item 15, are filed aspart of, or incorporated by reference into, this report.

 

(d)  *FinancialStatement Schedules*. See Item 15(a)(2) above.

 

51

----

 

**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)                                                                                                                                                                                      |
| 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)).                                                                                              |

 

52

----

 
| 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.,  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                                                                                                                                                                                                         |

 

53

----

 
|   |   |   |   | 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.                                                                                                                                           |
| 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 Stonefield Josephson                                                                                                                                                                                                                  |
| 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  of Chief Executive Officer pursuant to 18 U.S.C. 1350.                                                                                                                                                                             |
| 32.2   |   | — |   | Certification  of Principal Financial Officer pursuant to 18 U.S.C. 1350.                                                                                                                                                                         |

 

----

*             Denotes a management contract or compensatory plan or arrangementrequired to be filed as an exhibit this Form 10-K.   

 

54

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized. 

 
|                  |   |   | Liquidmetal Technologies, Inc.         |   |
|-----------------------|--------|--------|----------------------------------------|--------|
|                  |   |   |                                   |   |
|                  |   |   |                                   |   |
|                  |   | By:    | /s/  John Thorne                  |   |
|                  |   |   | John  Thorne                           |   |
|                  |   |   | President  and Chief Executive Officer |   |
|                  |   |   |                                   |   |
| Date:  March 21, 2005 |   |   |                                   |   |
|                  |   |   |                                   |   |
|                  |   | By:    | /s/  Tony Chung                   |   |
|                  |   |   | Tony  Chung                       |   |
|                  |   |   | Vice  President of Finance             |   |
| Date:  March 21, 2005 |   |   |                                   |   |

 

55

----

 

**POWER OF ATTORNEY**

 

KNOW ALL THESE PERSONS BY THESE PRESENTS, thateach person whose signature appears below constitutes and appoints John Thorneand Tony Chung and each of them, jointly and severally, his attorneys-in-fact,each with full power of substitution, for him in any and all capacities, tosign any and all amendments to this Report on Form 10-K, and to file thesame, with exhibits thereto and other documents in connection therewith, withthe Securities and Exchange Commission, hereby ratifying and confirming allthat each said attorneys-in-fact or his substitute or substitutes, may do orcause to be done by virtue hereof.

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this Report on Form 10-K has been signed below by thefollowing persons on behalf of the Registrant and in the capacities and on thedates indicated: 

 
| **Signature**               | ** ** | **Title**                                                                  | ** ** | **Date**       |
|-----------------------------|------------|----------------------------------------------------------------------------|------------|----------------|
|                        |       |                                                                       |       |           |
| /s/  John Kang         |       | Chairman  of the Board  and  Director                                 |       | March 21, 2005 |
| John  Kang                  |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/  John Thorne       |       | Chief  Executive Officer and President  (Principal Executive Officer) |       | March 21, 2005 |
| John  Thorne                |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/  James Kang        |       | Founder  and Director                                                      |       | March 21, 2005 |
| James  Kang                 |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/  William Johnson   |       | Director                                                                   |       | March 21, 2005 |
| William  Johnson            |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/  Robert Biehl      |       | Director                                                                   |       | March 21, 2005 |
| Robert  Biehl               |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/ Vincent Addonisio  |       | Director                                                                   |       | March 21, 2005 |
| Vincent Addonisio           |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/ Dean Tanella            |       | Director                                                                   |       | March 21, 2005 |
| Dean Tanella                |       |                                                                       |       |           |
|                        |       |                                                                       |       |           |
| /s/ CK Cho             |       | Director                                                                   |       | March 21, 2005 |
| CK Cho                      |       |                                                                       |       |           |

 

 

Certificationsprovided as Exhibits.

 

56

----

 

**INDEX TO CONSOLIDATED FINANCIAL 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                        |   |

 

57

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

** **

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

 

We have audited the accompanying consolidated balance sheets ofLiquidmetal Technologies, Inc. and subsidiaries (the “Company”) as of December31, 2004 and 2003, and the related consolidated statements of operations andcomprehensive loss, shareholders’ equity (deficiency), and cash flows for eachof the three years in the period ended December 31, 2004.  Our audit also included the financialstatement schedule listed at index in Item 15(a) as of and for the years endedDecember 31, 2004.  Our responsibility isto express an opinion on the financial statements and financial statementschedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures 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 believe that our audits provide areasonable 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, 2004 and 2003, and the results oftheir operations and cash flows for each of the three years in the period endedDecember 31, 2004, in conformity with accounting principles generally acceptedin 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 2 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 2. The consolidated financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

 

 

Irvine, California

Certified Public Accountants

 

March 3, 2005

 

58

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share data)**

 
| ** **                                                                                                                                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                                                                                                                                                                |       |             |       |   |   |
| **ASSETS**                                                                                                                                                          | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                          | ** ** | ** **       | ** ** | ** ** | ** ** |
| CURRENT ASSETS:                                                                                                                                                     |       |             |       |   |   |
|                                                                                                                                                                |       |             |       |   |   |
| Cash and cash equivalents                                                                                                                                           |       | $                | 742        |   | $ | 3,127 |   |
| Restricted cash                                                                                                                                                     |       | 754              |       | — |   |
| Trade accounts receivable, net of allowance for  doubtful accounts of $108 and $127                                                                                 |       | 1,668            |       | 3,748 |   |
| Inventories                                                                                                                                                         |       | 2,353            |       | 2,060 |   |
| Prepaid expenses and other current assets                                                                                                                           |       | 930              |       | 395 |   |
| Assets available for sale, net                                                                                                                                      |       | —           |       | 827 |   |
| Total current  assets                                                                                                                                               |       | 6,447            |       | 10,157 |   |
|                                                                                                                                                                |       |             |       |   |   |
| PROPERTY, PLANT AND EQUIPMENT, NET                                                                                                                                  |       | 16,434           |       | 17,743 |   |
| IDLE EQUIPMENT                                                                                                                                                      |       | 1,906            |       | 1,671 |   |
| LONG-TERM INVENTORY                                                                                                                                                 |       | 1,810            |       | — |   |
| OTHER INTANGIBLE ASSETS, NET                                                                                                                                        |       | 1,143            |       | 984 |   |
| OTHER ASSETS                                                                                                                                                        |       | 768              |       | 297 |   |
| Total assets                                                                                                                                                        |       | $                | 28,508     |   | $ | 30,852 |   |
|                                                                                                                                                                |       |             |       |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                       | ** ** | ** **       | ** ** | ** ** | ** ** |
| ** **                                                                                                                                                          | ** ** | ** **       | ** ** | ** ** | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                |       |             |       |   |   |
|                                                                                                                                                                |       |             |       |   |   |
| Accounts payable and accrued expenses                                                                                                                               |       | $                | 4,969      |   | $ | 3,683 |   |
| Settlement payable                                                                                                                                                  |       | 3,246            |       | 2,765 |   |
| Deferred revenue                                                                                                                                                    |       | 900              |       | 1,435 |   |
| Long-term debt, current portion                                                                                                                                     |       | 5,991            |       | 1,032 |   |
| Other current liabilities                                                                                                                                           |       | 1,032            |       | 1,940 |   |
| Total current liabilities                                                                                                                                           |       | 16,138           |       | 10,855 |   |
|                                                                                                                                                                |       |             |       |   |   |
| LONG-TERM DEBT, NET OF CURRENT PORTION                                                                                                                              |       | 2,618            |       | 3,015 |   |
| OTHER LIABILITIES                                                                                                                                                   |       | 892              |       | 814 |   |
| Total liabilities                                                                                                                                                   |       | 19,648           |       | 14,684 |   |
|                                                                                                                                                                |       |             |       |   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                       |       |             |       |   |   |
|                                                                                                                                                                |       |             |       |   |   |
| MINORITY INTEREST                                                                                                                                                   |       | —           |       | 5 |   |
|                                                                                                                                                                |       |             |       |   |   |
| SHAREHOLDERS’ EQUITY:                                                                                                                                          |       |             |       |   |   |
|                                                                                                                                                                |       |             |       |   |   |
| Common stock, $0.001 par value per share,  100,000,000 shares authorized; 41,609,652 shares issued and outstanding at  December 31, 2004 and December 31, 2003 |       | 42               |       | 42 |   |
| Additional paid in capital                                                                                                                                          |       | 132,160          |       | 128,581 |   |
| Unamortized stock-based compensation                                                                                                                                |       | —           |       | (128 | ) |
| Accumulated deficit                                                                                                                                                 |       | (125,313         | )          | (112,587 | ) |
| Accumulated other comprehensive income                                                                                                                              |       | 1,971            |       | 255 |   |
| Total shareholders’ equity                                                                                                                                     |       | 8,860            |       | 16,163 |   |
| Total liabilities and shareholders’ equity                                                                                                                     |       | $                | 28,508     |   | $ | 30,852 |   |

 

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

 

59

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

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

 
| ** **                                                                                           | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                           | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                           | ** ** | ** **                   | ** ** | ** ** | ** ** | **(restated)** | ** ** |
|                                                                                                 |       |                         |       |   |   |   |   |
| REVENUE, Net                                                                                         |       | $                            | 17,429     |   | $ | 13,658 |   | $ | 9,138 |   |
| COST OF SALES                                                                                        |       | 12,168                       |       | 18,162 |   | 5,656 |   |
| Gross (loss) profit                                                                                  |       | 5,261                        |       | (4,504 | ) | 3,482 |   |
| OPERATING EXPENSES:                                                                                  |       |                         |       |   |   |   |   |
| Selling, general and administrative                                                                  |       | 11,591                       |       | 17,729 |   | 13,099 |   |
| Research and development                                                                             |       | 1,467                        |       | 8,780 |   | 11,825 |   |
| Impairment of goodwill                                                                               |       | —                       |       | 184 |   | — |   |
| Impairment of long lived assets                                                                      |       | —                       |       | 2,684 |   | — |   |
| Total operating expenses                                                                             |       | 13,058                       |       | 29,377 |   | 24,924 |   |
| LOSS BEFORE INTEREST, OTHER INCOME,  INCOME TAXES MINORITY INTEREST AND DISCONTINUED OPERATIONS |       | (7,797                       | )          | (33,881 | ) | (21,442 | ) |
| Loss from extinguishments of debt                                                                    |       | (1,663                       | )          | — |   | — |   |
| Change in value of warrants, net                                                                     |       | 747                          |       | — |   | — |   |
| Other income                                                                                         |       | 302                          |       | — |   | — |   |
| Other expense                                                                                        |       | —                       |       | — |   | — |   |
| Interest expense                                                                                     |       | (3,603                       | )          | (390 | ) | (1,109 | ) |
| Interest income                                                                                      |       | 37                           |       | 304 |   | 506 |   |
| Gain on sale of marketable securities held-for-sale                                                  |       | —                       |       | 1,178 |   | 832 |   |
| LOSS BEFORE INCOME TAXES, MINORITY INTEREST  AND DISCONTINUED OPERATIONS                             |       | (11,977                      | )          | (32,789 | ) | (21,213 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Income taxes                                                                                         |       | —                       |       | — |   | — |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| LOSS BEFORE MINORITY INTEREST AND  DISCONTINUED OPERATIONS                                           |       | (11,977                      | )          | (32,789 | ) | (21,213 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| Minority interest in loss of consolidated  subsidiary                                                |       | —                       |       | 21 |   | 118 |   |
|                                                                                                 |       |                         |       |   |   |   |   |
| LOSS FROM CONTINUING OPERATIONS                                                                      |       | (11,977                      | )          | (32,768 | ) | (21,095 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| DISCONTINUED OPERATIONS:                                                                             |       |                         |       |   |   |   |   |
| Income (loss) from operations of discontinued  operations, net                                       |       | (749                         | )          | (964 | ) | 83 |   |
| Gain (loss) from disposal of discontinued  operations, net                                           |       | —                       |       | 127 |   | 1,556 |   |
| NET LOSS                                                                                             |       | (12,726                      | )          | (33,605 | ) | (19,456 | ) |
| OTHER COMPREHENSIVE GAIN (LOSS):                                                                     |       |                         |       |   |   |   |   |
| Foreign exchange translation gain (loss) during the  period                                          |       | 1,716                        |       | 211 |   | (28 | ) |
| Net unrealized gain (loss) on marketable securities  available-for-sale                              |       | —                       |       | (1,668 | ) | 1,668 |   |
| COMPREHENSIVE LOSS                                                                                   |       | $                            | (11,010    | ) | $ | (35,062 | ) | $ | (17,816 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |
| PER COMMON SHARE BASIC and DILUTED:                                                                  |       |                         |       |   |   |   |   |
| Loss from continuing operations                                                                      |       | $                            | (0.29      | ) | $ | (0.79 | ) | $ | (0.54 | ) |
| Gain (Loss) from discontinued operations                                                             |       | $                            | (0.02      | ) | $ | (0.02 | ) | $ | 0.04 |   |
| Net loss                                                                                             |       | $                            | (0.31      | ) | $ | (0.81 | ) | $ | (0.50 | ) |
|                                                                                                 |       |                         |       |   |   |   |   |   |   |   |
| Number of weighted average shares – basic  and diluted                                          |       | 41,610                       |       | 41,505 |   | 38,714 |   |

 

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

 

60

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF SHAREHOLDERS’EQUITY (DEFICIENCY)**

**(inthousands, except share data)**

 
| ** **                                                             | ** ** | **Preferred  Shares** | ** ** | **Preferred  Stock** | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Stock-based  Compen-  sation** | ** ** | **Accumu-  lated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|--------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|-----------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                                             | ** ** | ** **            | ** ** | ** **           | ** ** | ** **         | ** ** | ** **        | ** ** | **(restated)**                   | ** ** | **(restated)**                                | ** ** | **(restated)**              | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                                                             | ** ** | ** **            | ** ** | ** **           | ** ** | ** **         | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **                                    | ** ** | ** **                  | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Balance,  December 31, 2001 (as restated)                         |       | 456,857               |       | $                    | 5,577      |               | 35,023,515 |              | $          | 29,752                           |       | $                                             | 23,915     |                        | $          | (7,294                                               | )          | $          | (59,526    | ) | $ | 72 |   | $ | (7,504 | ) |
| Common stock  issued                                                   |       | —                |       | —               |       | 5,229,000          |       | 78,435            |       | —                           |       | —                                        |       | —                      |       | —                                               |       | 78,435     |       |
| Transaction expenses  of initial public offering including commissions |       | —                |       | —               |       | —             |       | (7,714            | )          | —                           |       | —                                        |       | —                      |       | —                                               |       | (7,714     | )          |
| Stock options  exercised                                               |       | —                |       | —               |       | 299,873            |       | 504               |       | —                           |       | —                                        |       | —                      |       | —                                               |       | 504        |       |
| Conversion of  preferred stock to common stock                         |       | (456,857              | )          | (5,577               | )          | 456,857            |       | 5,577             |       | —                           |       | —                                        |       | —                      |       | —                                               |       | —     |       |
| Stock-based  compensation                                              |       | —                |       | —               |       | —             |       | —            |       |                             |       | 4,694                                         |       | —                      |       | —                                               |       | 4,694      |       |
| Unamortized stock  option based compensation                           |       | —                |       | —               |       | —             |       | —            |       | (2,340                           | )          | 2,340                                         |       | —                      |       | —                                               |       | —     |       |
| Foreign exchange  translation loss                                     |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                                        |       | —                      |       | (28                                                  | )          | (28        | )          |
| Net unrealized  gain on marketable securities                          |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                                        |       | —                      |       | 1,668                                                |       | 1,668      |       |
| Net loss (as  restated)                                                |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                                        |       | (19,456                     | )          | —                                               |       | (19,456    | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                                          |       |                        |       |                                                 |       |       |       |
| 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-based compensation                                  |       | —                |       | —               |       | —             |       | —            |       | (113                             | )          | 113                                           |       | —                      |       | —                                               |       | —     |       |
| Beneficial  conversion feature                                         |       | —                |       | —               |       | —             |       | —            |       | 3,424                            |       | —                                        |       | —                      |       | —                                               |       | 3,424      |       |
| Warrants  cancelled                                                    |       | —                |       | —               |       | —             |       | —            |       | 7                                |       | —                                        |       | —                      |       | —                                               |       | 7          |       |
| Foreign exchange  translation gain                                     |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                                        |       | —                      |       | 1,716                                                |       | 1,716      |       |
| Net loss                                                               |       | —                |       | —               |       | —             |       | —            |       | —                           |       | —                                        |       | (12,726                     | )          | —                                               |       | (12,726    | )          |
|                                                                   |       |                  |       |                 |       |               |       |              |       |                             |       |                                          |       |                        |       |                                                 |       |       |       |
| Balance, December  31, 2004                                            |       | —                |       | $                    | —     |               | 41,609,652 |              | $          | 42                               |       | $                                             | 132,160    |                        | $          | —                                               |       | $          | (125,313   | ) | $ | 1,971 |   | $ | 8,860 |   |

 

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

 

61

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands,except share data)**

 
| ** **                                                                          | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                          | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                          | ** ** | ** **                   | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| OPERATING ACTIVITIES:                                                               |       |                         |       |   |   |   |   |
| Net loss                                                                            |       | $                            | (12,726    | ) | $ | (33,605 | ) | $ | (19,456 | ) |
| Add (gain) loss from operations and loss on  disposition of discontinued operations |       | 749                          |       | 837 |   | (1,639 | ) |
| Loss from continuing operations                                                     |       | (11,977                      | )          | (32,768 | ) | (21,095 | ) |
| Adjustments to reconcile net loss to net cash used  by operating activities:        |       |                         |       |   |   |   |   |
| Impairment of long lived assets                                                     |       | —                       |       | 2,684 |   | — |   |
| Impairment of goodwill                                                              |       | —                       |       | 184 |   | — |   |
| Loss from Growell settlement                                                        |       | —                       |       | 2,765 |   | — |   |
| Gain on sale of marketable securities  held-for-sale                                |       | —                       |       | (1,178 | ) | (832 | ) |
| Gain on disposal of property and equipment                                          |       | 4                            |       | — |   | — |   |
| Minority interest                                                                   |       | —                       |       | (21 | ) | (118 | ) |
| Bad debt expense                                                                    |       | 84                           |       | (28 | ) | 921 |   |
| Warranty expense                                                                    |       | 288                          |       | (297 | ) | 237 |   |
| Depreciation and amortization                                                       |       | 3,444                        |       | 4,354 |   | 1,513 |   |
| Loss on extinguishments of debt                                                     |       | 1,663                        |       | — |   | — |   |
| Amortization of debt discount                                                       |       | 2,860                        |       | — |   | 912 |   |
| Stock-based compensation                                                            |       | 276                          |       | 123 |   | 2,203 |   |
| Gain from change in value of warrants                                               |       | 747                          |       | — |   | — |   |
| Changes in operating assets and liabilities:                                        |       |                         |       |   |   |   |   |
| Trade accounts receivable                                                           |       | 1,996                        |       | 1,660 |   | (5,319 | ) |
| Inventories                                                                         |       | (2,103                       | )          | (100 | ) | (1,432 | ) |
| Prepaid expenses and other current assets                                           |       | (535                         | )          | 1,689 |   | (990 | ) |
| Other assets                                                                        |       | (869                         | )          | 83 |   | (189 | ) |
| Accounts payable and accrued expenses                                               |       | 414                          |       | (5,969 | ) | 5,990 |   |
| Deferred revenue                                                                    |       | (535                         | )          | 38 |   | 567 |   |
| Other liabilities                                                                   |       | (2,154                       | )          | 2,661 |   | — |   |
| Net cash used by continuing operations                                              |       | (6,397                       | )          | (24,120 | ) | (17,632 | ) |
| Net cash provided (used) by discontinued  operations                                |       | 73                           |       | (2,429 | ) | (2,756 | ) |
| Net cash used by operating activities                                               |       | (6,324                       | )          | (26,549 | ) | (20,388 | ) |
| INVESTING ACTIVITIES:                                                               |       |                         |       |   |   |   |   |
| Purchases of property and equipment                                                 |       | (73                          | )          | (2,329 | ) | (23,527 | ) |
| Proceeds from sale of property and equipment                                        |       | 38                           |       | — |   | — |   |
| Purchase of marketable securities held-for-sale                                     |       | —                       |       | — |   | (2,000 | ) |
| Proceeds from sale of marketable securities  held-for-sale                          |       | —                       |       | 2,578 |   | 1,432 |   |
| Acquisition of subsidiary, net of cash received                                     |       | —                       |       | — |   | 74 |   |
| Investment in patents and trademarks                                                |       | (273                         | )          | (298 | ) | (144 | ) |
| Net cash used by investing activities                                               |       | (308                         | )          | (49 | ) | (24,165 | ) |
| FINANCING ACTIVITIES:                                                               |       |                         |       |   |   |   |   |
| Proceeds from borrowings                                                            |       | 9,924                        |       | 5,488 |   | 3,500 |   |
| Repayment of borrowings                                                             |       | (5,184                       | )          | (1,441 | ) | (7,400 | ) |
| Repayment of other liabilities                                                      |       | (135                         | )          | (72 | ) | (14 | ) |
| Restricted cash                                                                     |       | (754                         | )          | — |   | — |   |
| Proceeds from issuance of common stock, net of  offering costs                      |       | —                       |       | — |   | 70,721 |   |
|                                                                                |       |                         |       |   |   |   |   |
| Stock options exercised                                                             |       | —                       |       | 899 |   | 504 |   |
| Proceeds from issuance (repurchase) of common stock  by subsidiaries, net           |       | —                       |       | 5 |   | — |   |
| Net cash provided by financing activities                                           |       | 3,851                        |       | 4,879 |   | 67,311 |   |
| EFFECT OF FOREIGN EXCHANGE TRANSLATION                                              |       | 396                          |       | (212 | ) | 70 |   |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                               |       | (2,385                       | )          | (21,931 | ) | 22,828 |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                                   |       | 3,127                        |       | 25,058 |   | 2,230 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                          |       | $                            | 742        |   | $ | 3,127 |   | $ | 25,058 |   |
|                                                                                |       |                         |       |   |   |   |   |   |   |   |
| SUPPLEMENTAL CASH FLOW INFORMATION                                                  |       |                         |       |   |   |   |   |
| Interest paid                                                                       |       | $                            | 640        |   | $ | 443 |   | $ | 52 |   |
| Taxes paid                                                                          |       | $                            | —     |   | $ | — |   | $ | — |   |

 

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

 

62

----

 

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 93,758shares of the Company’s common stock in lieu of cash payment for the optionexercise price of $250 and income taxes payable by the option holder of$403.  The Company immediately canceledthe common shares received in lieu of cash payment upon receipt of the shares.

 

In 2003 the Company reclassified $1,477 ofmachines from property, plant and equipment to machines held by customer.

 

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

 

In  2002,$2,570 in notes payable and accrued interest were converted to the Company’scommon stock.

 

In 2002, the Company recorded a net addition toshareholders’ equity of $2,492 comprised of stock compensation and discounts onconvertible notes payable in the discontinued retail golf operations. In 2002,there was a $98 foreign exchange loss effect in the discontinued retail golfoperations.

 

In 2002, the Company entered into a leaseagreement for $107 of office furniture that was recorded as a capital leaseobligation.

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

63

----

 

**LIQUIDMETAL TECHNOLOGIES, INC ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**For the Years Ended December 31, 2004, 2003,and 2002**

**(in thousands, except share data)**

 

**1. Description ofBusiness**

 

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 Company also partners with third-partylicensees and distributors to develop and commercialize Liquidmetal alloyproducts.

 

The Company classifies operations into tworeportable segments: Liquidmetal alloy industrial coatings and bulk Liquidmetalalloys. Liquidmetal alloy industrial coatings are used primarily as aprotective coating for industrial machinery and equipment, such as drill pipeused by the oil drilling industry and boiler tubes used by coal-burning powerplants. Bulk Liquidmetal alloys include potential market opportunities tomanufacture and sell products and components for electronic devices, medicaldevices, defense applications, 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 3 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 apost-processing plant in the city of Weihai in Shandong province of China underWeihai Liquidmetal Company Limited, which is 100 percent owned by LiquidmetalKorea, to facilitate our bulk alloy manufacturing business.  Weihai Liquidmetal is consolidated intoLiquidmetal Technologies with all intercompany transactions eliminated.

 

**2. Going Concern /Liquidity**

 

The Company has experienced losses fromcontinuing operations during the last two fiscal years and has an accumulateddeficit of $125,313 as of December 31, 2004. Cash used for continuing operations for the year ended December 31, 2004was $6397 and cash flow from continuing operations may be negative throughoutfiscal year 2005.  At December 31, 2004,the Company’s principal source of liquidity is $742 of cash and cashequivalents and trade accounts receivable of $1,668.  Such conditions raise substantial doubt thatthe Company will be able to continue as a going concern for a reasonable periodof time.  These operating resultsoccurred while the Company was developing and attempting to commercialize andmanufacture products from an entirely new and unique technology.  This business plan required significantspending related to start-up costs and capital expenditures.  These factors have placed a significantstrain on the financial resources of the Company.  The ultimate success of the Company dependson its ability to continue reducing operating costs, generate higher revenue,and achieve positive cash flow from continuing operations andprofitability.  The consolidatedfinancial statements do not include any adjustments that might result from theoutcome 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, and the resourcesdevoted to develop and support Liquidmetal alloy products.  However, the Company anticipates capitalexpenditures in the next 12 months will be less than $0.5 million. The Companyexpects to continue to devote limited capital to our research and developmentactivities, to further develop and strengthen our manufacturing capabilities,and for working capital and other general corporate purposes.

 

Our cash flow projections from operationsand, consequently, future cash needs are subject to uncertainty.  If our available funds and cash generatedfrom operations are insufficient to satisfy our liquidity requirements, we mayneed to raise additional capital to fund our operations and capital expenditurerequirements.  We cannot be certain thatadditional capital, whether through selling additional debt or equitysecurities or obtaining a line of credit or other loan, will be available to usor, if available, will be on terms acceptable to us.  If we issue additional securities to raisefunds, these securities may have rights, preferences, or privileges senior tothose of the rights of our common stock and our stockholders may experience additionaldilution.

 

**3. Summary of SignificantAccounting Policies**

 

*Principles ofConsolidation.*Theconsolidated financial statements include the accounts of LiquidmetalTechnologies, Inc. and its wholly-owned subsidiaries, Liquidmetal Korea Co.,Ltd. (“LMT Korea”), located in South Korea, Chusik Hoesa Dongyang Yudoro (“Dongyang”),now accounted for as a discontinued operations, and Liquidmetal Golf and itssubsidiaries, which included the retail golf segment, now accounted for as adiscontinued operations. The Company acquired its 51% interest in Dongyang in2002.  The aggregate purchase price was$333 in cash.  As of March 2004, theCompany divested of its 51% ownership in Dongyang to the minority shareholder.  In June 2004, the Company sold assets andliability of its Taesung equipment manufacturing division in Korea to a thirdparty. Accordingly, the results of Dongyang andTaesung’s operations have been reclassified in the consolidated financial 

 

64

----

 

statements as discontinued operations (see Note17).  Previously, the results of Donyangand Taesung’s operations have been included in the consolidated financialstatements from the acquisition date. All intercompany balances and transactions have been eliminated. Aminority interest in Liquidmetal Golf is included in the consolidated financialstatements as a component of the loss from operations of the discontinuedretail golf segment (see Note 17).  Effective in 2003, management closed the Japan operations and the Seoul office,which did not result in a significant impact on the financial position orresults of operations for any of the periods presented.   Also, effective in December 2003, managementclosed the Tampa office (see Note 12).  InAugust 2004, the Company established a post-processing plant in the city ofWeihai in Shandong province of China under Weihai Liquidmetal Company Limited,which is 100 percent owned by Liquidmetal Korea, to facilitate our bulk alloymanufacturing business.

 

*Sales of Stock bySubsidiaries.*Gains on salesof stock by Liquidmetal Golf are recognized as components of the Company’sshareholders’ equity (deficiency).

 

*Revenue Recognition.*Revenueis recognized pursuant to applicable accounting standards including Securitiesand Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 101 (SAB101), *“Revenue Recognition in FinancialStatements”*, and *SAB 104, RevenueRecognition*. SAB 101 as amended and SAB 104 summarize certain pointsof the SEC staff’s views in applying generally accepted accounting principlesto revenue recognition 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 recognition policy complies with the requirementsof SAB 101 and SAB 104. Revenue is recognized at the time the Company ships itsproducts, as this is when title passes to the customer and all other incidencesof a sale have occurred. Revenue is deferred and included in liabilities whenthe Company receives cash in advance for services not yet performed or goodsnot yet delivered. Revenue from research and development contracts isrecognized under the percentage of completion method.

 

*Cash and CashEquivalents.*The Companyconsiders all highly liquid investments with maturity dates of three months orless when purchased to be cash equivalents. The Company limits the amount ofcredit exposure to each individual financial institution and places itstemporary cash into investments of high credit quality. There are nosignificant concentrations of credit risk to the Company associated with cashand cash equivalents.

 

*Restricted Cash.* The Companyconsiders all cash and cash equivalents held under restrictive accounts asrestricted cash.

 

*Marketable Securities.*TheCompany follows Statement of Financial 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 AccountsReceivables.*The Companygrants credit to its customers generally in the form of short-term tradeaccounts receivable. The creditworthiness of customers is evaluated prior tothe sale of inventory.  As of December31, 2004, two customers represented 30%, or $497, of the total outstandingtrade accounts receivable.  Two customersrepresent 95%, or $3,540, of total outstanding trade accounts receivable as ofDecember 31, 2003.

 

The allowance for doubtful accounts reflectsmanagement’s best estimate of probable losses inherent in the trade accountsreceivable.  Management primarily determines the allowance based on theaging of accounts receivable balances, historical write-off experience,customer concentrations, customer creditworthiness and current industry andeconomic trends.  The Company’s provisions for uncollectible receivablesare included in selling, general and administrative expense in the accompanyingconsolidated statements of operations and comprehensive loss.

 

*Inventories.*Inventoriesare accounted for using the moving average basis and reported at the lower ofcost or market. Inventories consist of raw materials, work in process, andfinished goods. The Company records write-offs for inventory obsolescence whenit is deemed that there is impairment of the value of the inventories on hand.

 

*Property, Plant andEquipment.*Property, plantand equipment are stated at cost less accumulated depreciation andamortization. Additions and major renewals are capitalized. Repairs andmaintenance are charged to expense as incurred. Upon disposal, the related costand accumulated depreciation are removed from the accounts, with the resultinggain or loss included in operating income. Depreciation is provided principallyon the straight-line method over the estimated useful lives of the assets,which range from two to twenty years.

 

Leased property meeting certain criteria iscapitalized and the present value of the related lease payments is recorded asa liability. Amortization of capitalized leased assets is provided on thestraight-line method over the estimated useful lives of the assets, which isfive years.

 

65

----

 

*Intangible Assets.*Intangibleassets consist of the costs incurred to purchase patent rights and costsincurred to internally develop patents and trademarks. Intangible assets arereported net of accumulated amortization. Patents and trademarks are amortizedusing the straight-line method over a period based on their contractual livesranging from eleven to seventeen years.

 

*Goodwill. *Beginning January 1, 2002, the Companyadopted Statement of Financial 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 ofLong-lived Assets.*The Companyreviews long-lived assets to be held and used in operations for impairmentwhenever events or changes in circumstances indicate that the carrying value ofan asset may be impaired. An impairment loss is recognized when the estimatedfair value of the assets is less than the carrying value of the assets.  During 2003, the Company recognized animpairment of long-lived assets in the amount of $2,684 (see Note 7).  There were no such impairment losses in 2004.

 

*Fair Value of FinancialInstruments.*The estimatedfair value of amounts reported in the consolidated financial statements havebeen determined using available market information and valuation methodologies,as applicable. The carrying amount of cash and cash equivalents, accountsreceivable, accounts payable, and all other current assets and liabilitiesapproximate their fair value because of their short term maturities atDecember 31, 2004 and 2003, unless otherwise stated. The fair value ofnon-current assets and liabilities approximate their carrying value unlessotherwise stated.  The fair value of theCompany’s long-term debt is based on interest rates that would be available tothe Company for the issuance of debt with similar terms.

 

*Research andDevelopment Expenses.*Research anddevelopment expenses represent salaries, related benefits expense, expensesincurred for the design and testing of new processing methods and otherexpenses related to the research and development of Liquidmetal alloys.Development costs incurred in research and development activities are expensedas incurred.

 

 *Advertisingand Promotion Expenses.*Advertising and promotion expenses areexpensed when incurred. Advertising and promotion expenses were $239, $136, and$127 for the years ended December 31, 2004, 2003 and 2002, respectively.

 

*Debt DiscountAmortization.*Debt discountsfor notes payable are amortized to interest expense, using a method thatapproximates the interest method over the term of the related debt instruments.

 

*Stock-BasedCompensation.*The Companyapplies Accounting Principles Board (“APB”) Opinion No. 25 for options when theexercise price of options granted to employees is less than the fair value ofthe underlying stock on the date of grant. The Company applies Statement of Financial Accounting Standards (“SFAS”)No. 123 for options granted to non-employees who perform services for theCompany.

 

Had the Company determined employee stock-basedcompensation cost based on the fair value at the grant date for stock optionsconsistent with the method of SFAS No. 123, the Company’s net loss and basicand diluted net loss per share would have been as follows:
| ** **                                                                                                            | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2004**                             | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                            | ** ** | ** **                           | ** ** | ** ** | ** ** | **(restated)** | ** ** |
|                                                                                                                  |       |                                 |       |   |   |   |   |
| Net loss from Continuing Operations:                                                                                  |       |                                 |       |   |   |   |   |
| As reported                                                                                                           |       | $                                    | (11,977    | ) | $ | (32,768 | ) | (21,095 | ) |
| Add: stock-based employee compensation  expense included in reported net loss, net of related tax effects             |       | 276                                  |       | 123 |   | 2,203 |   |
| Deduct: total stock-based employee  compensation expense determined under the fair value based method for all  awards |       | (4,201                               | )          | (5,427 | ) | (7,664 | ) |
| Proforma net loss from continuing operations                                                                          |       | $                                    | (15,902    | ) | $ | (38,072 | ) | $ | (26,556 | ) |
|                                                                                                                  |       |                                 |       |   |   |   |   |
| Basic and diluted net loss per share:                                                                                 |       |                                 |       |   |   |   |   |
| As reported                                                                                                           |       | $                                    | (0.29      | ) | (0.79 | ) | (0.54 | ) |
| Proforma                                                                                                              |       | (0.38                                | )          | (0.92 | ) | (0.69 | ) |
|                                                                                                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |

 

66

----

 

*Income Taxes.*Incometaxes are provided under the asset and liability method as required by SFASNo. 109, *Accounting for Income Taxes*.Under this method, deferred income taxes are recognized for the taxconsequences of “temporary differences” by applying enacted statutory tax ratesapplicable to future years to differences between the financial statement carryingamounts and the tax basis of existing assets and liabilities. The effect of atax rate change on deferred taxes is recognized in operations in the periodthat the change in the rate is enacted. Valuation allowances are establishedwhen necessary to reduce net deferred tax assets to the amount expected to berealized.

 

*Translation of ForeignCurrency.*Uponconsolidation of the Company’s foreign subsidiaries into the Company’sconsolidated financial statements, any balances with the subsidiariesdenominated in the foreign currency are translated at the exchange rate at yearend. The financial statements of LMT Korea have been translated based uponKorean Won as the functional currency. LMT Singapore’s and LMT Korea’s assets and liabilities were translatedusing the exchange rate at year end and income and expense items weretranslated at the average exchange rate for the year. The resulting translationadjustment was included in other comprehensive income (loss).

 

The Company applies **FASB No. 52, Foreign Currency Translation**,for translating foreign currency into US dollars in ourconsolidation of the financial statements.  Due to our restatement of 2002financial statements, certain footnote disclosures and previously reportedfinancial statements were adjusted to conform to retroactive applications ofFASB No. 52.  These adjustments did not have a material impact in thefinancial statements. See Note 2in the notes to consolidated financial statements in the fiscal 2003 annualreport on Form 10-K filed on November 10, 2004, which reflects the restatementsof prior year transactions.

 

*Earnings Per Share.*Basicearnings per share (“EPS”) is computed by dividing earnings(losses) attributable to common shareholders by the weighted averagenumber of common shares outstanding for the periods. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock.

 

*Use of Estimates.*Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reported periods. Actual results could differ from those estimates.These management estimates are primarily related to impairment of long-livedassets, inventory valuation, product warranty, and the allowance for bad debtaccount balances.

 

*Reclassifications.*Certainamounts from prior years have been reclassified to conform to the current year’spresentation.

 

*New AccountingPronouncements.*

 

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.

 

In March 2004, the FASB approved theconsensus reached 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. InSeptember 2004, the FASB issued a FASB Staff Position (FSP) EITF 03-1-1 thatdelays the effective date of the measurement and recognition guidance in EITF03-1 until after further deliberations by the FASB. The disclosure requirementsare effective only for annual periods ending after June 15, 2004. The Companyhas evaluated the impact of the adoption of the disclosure requirements of EITF03-1 and does not believe the impact will be significant to the Company’soverall results of operations or financial position. Once the FASB reaches afinal decision on the measurement and recognition provisions, the company willevaluate the impact of the adoption of EITF 03-1.

 

In November 2004, the FASB issued SFAS No. 151 “InventoryCosts, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement151 clarify that abnormal amounts of idle facility expense, freight, handlingcosts, and wasted materials (spoilage) should be recognized as current-periodcharges and require the allocation of fixed production overheads to inventorybased on the normal capacity of the production facilities. The guidance iseffective for inventory costs incurred during fiscal years 

 

67

----

 

beginning after June 15,2005. Earlier application is permitted for inventory costs incurred duringfiscal years beginning after November 23, 2004. The Company has evaluatedthe impact of the adoption of SFAS 151, and does not believe the impact will besignificant to the Company’s overall results of operations or financialposition.

 

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 an equivalentinterest in the same or similar productive asset should be based on therecorded amount of the asset relinquished. Opinion 29 provided an exception toits 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. TheCompany has evaluated the impact of the adoption of SFAS 153, and does notbelieve the impact will be significant to the Company’s overall results ofoperations or financial position.

 

In December 2004,the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”. Statement123(R) will provide investors and other users of financial statements with morecomplete and neutral financial information by requiring that the compensationcost relating to share-based payment transactions be recognized in financialstatements. That cost will be measured based on the fair value of the equity orliability instruments issued. Statement 123(R) covers a wide range ofshare-based compensation arrangements including share options, restricted shareplans, performance-based awards, share appreciation rights, and employee sharepurchase plans. Statement 123(R) replaces FASB Statement No. 123,Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees. Statement 123, as originally issuedin 1995, established as preferable a fair-value-based method of accounting forshare-based payment transactions with employees. However, that Statementpermitted entities the option of continuing to apply the guidance in Opinion25, as long as the footnotes to financial statements disclosed what net incomewould have been had the preferable fair-value-based method been used. Publicentities (other than those filing as small business issuers) will be requiredto apply Statement 123(R) as of the first interim or annual reporting periodthat begins after June 15, 2005. The Company has evaluated the impact ofthe adoption of SFAS 123(R), and does not believe the impact will besignificant to the Company’s overall results of operations or financialposition.

 

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 by the American Jobs Creation Act of 2004*,and FSP FAS 109-2 *Accounting and DisclosureGuidance for the Foreign Earnings Repatriation Provision within the A**merican Jobs Creation Act of 2004.* Neitherof these affected the Company as it does not participate in the relatedactivities.

 

**4.Marketable Securities**

 

On July 29, 2002,the Company invested $2,000 in Growell Metal, Inc. (“Growell”), a metalsprocessing company located in South Korea and publicly traded on South Korea’sKOSDAQ stock market. The Company acquired 891,100 shares (or approximately5%) of Growell’s outstanding common stock in this transaction. During the fourthquarter of 2002, Growell’s spin-off of its electronics division resulted in thecreation of a new company named Growell Electronics, Inc. (“GrowellElectronics”). As a result of the spin-off, 30% of the Company’s 891,100 commonshares of Growell were exchanged for an equal number of shares in the commonstock of Growell Electronics. During the year ended December 31, 2002, theCompany sold its shares in Growell Electronics for approximately $1,432, whichwas based on the market price of the stock on the KOSDAQ stock market on thedate of 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 thestock owned in Growell, which resulted in a realized gain of $1,178.  A reclassification adjustment of ($1,668) fornet realized gains included in net loss is included in “Other comprehensiveloss” on the accompanying Statement of Operations and Comprehensive Loss forthe year ended December 31, 2003.

 

68

----

 

**5.Trade accounts receivable**

 

Trade accounts receivablesfrom continuing operations were comprised of the following:

 
| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                             | ** ** | ** **            | ** ** | ** ** | ** ** |
| Trade  accounts receivable             |       | $                     | 1,776      |   | $ | 3,875 |   |
| Less:  Allowance for doubtful accounts |       | (108                  | )          | (127 | ) |
| Trade  accounts receivable, net        |       | $                     | 1,668      |   | $ | 3,748 |   |

 

**6.Inventories**

 

Inventories werecomprised of the following:

 
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                 | ** ** | ** **            | ** ** | ** ** | ** ** |
| Raw  materials             |       | $                     | 1,688      |   | $ | 643 |   |
| Work in  process           |       | 352                   |       | 284 |   |
| Finished  goods            |       | 313                   |       | 442 |   |
| Machines  held by customer |       | —                |       | 691 |   |
| Total  current inventories |       | 2,353                 |       | 2,060 |   |
| Long-term  inventories     |       | 1,810                 |       | — |   |
| Total  inventories         |       | $                     | 4,163      |   | $ | 2,060 |   |

 

During 2003, the Company experienced significant operationaldifficulties as a result of problems and delays encountered in manufacturingbulk amorphous parts.  These issues ledthe Company to begin assessing its long-term strategy.  As a result of changes made to the Company’smanufacturing objectives, the Company determined that it held excessive volumesof certain raw materials at December 31, 2003.  Accordingly, the Company reduced the carryingvalue of raw materials held by its subsidiary, Liquidmetal Korea, by theamounts considered to be obsolete.  Thewrite-downs amounted to $1,004 and are included in “Cost of Sales” in theaccompanying Statement of Operations and Comprehensive Loss for the year ended December 31,2003.  As of December 31, 2004, thewrite-downs included in “Cost of Sales” in the accompanying Statement ofOperations and Comprehensive Loss amounted to $605, which includes a $406 chargeincurred during the fourth quarter of 2004 related to certain hingefinished goods used in our customer’s cell phone models which were nearing itsend of life.

 

Machines held by customer represent machines conditionally sold toGrowell in 2002 and 2003.  These machinesare subject to put options whereby Growell has the right to require the Companyto buy back the machines if certain conditions are not met.   The Company recorded a write-down of $2,765of raw material and machine inventory associated with the settlement of adispute with Growell in December 2003 (see Note 11).    These amounts are included in “Cost ofSales” in the accompanying Statement of Operations and Comprehensive Loss forthe years ended December 31, 2003 and 2002 respectively.

 

The Company maintainscertain of its raw material inventory in amounts excess of our operating cycleof one year due to the nature of our manufacturing process, production leadtime, and the recyclability of our raw material.  Therefore, the Company has determined andallocated $1,810 of raw material as long term inventory in 2004.  Long term inventory was $0 in 2003 as ourbusiness strategy of selling Liquidmetal ingots that were included in rawmaterial inventory were within our one year operating cycle.

 

**7. Property,Plant and Equipment**

 

Property, plant andequipment consists of the following:

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | ** ** | ** ** |
| Machinery  and equipment                        |       | $                     | 12,600     |   | $ | 11,122 |   |
| Computer  equipment                             |       | 1,357                 |       | 1,355 |   |
| Office  equipment, furnishings and improvements |       | 1,910                 |       | 1,838 |   |
| Buildings                                       |       | 9,719                 |       | 8,503 |   |
| Total                                           |       | 25,586                |       | 22,818 |   |
| Accumulated  depreciation                       |       | (9,152                | )          | (5,075 | ) |
| Total  property, plant and equipment, net       |       | $                     | 16,434     |   | $ | 17,743 |   |

 

69

----

 

Depreciation expenseis classified as follows:

 
| ** **                           | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| ** **                           | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of  sales                       |       | $                                 | 2,623      |   | $ | 2,908 |   | $ | 403 |   |
| Selling,  general and administrative |       | 700                               |       | 627 |   | 229 |   |
| Research and  development            |       | 8                                 |       | 730 |   | 799 |   |
| Total  depreciation expense          |       | $                                 | 3,331      |   | $ | 4,265 |   | $ | 1,431 |   |

 

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 thecarrying value of its manufacturing plant in Pyongtaek, South Korea exceededits fair value as of December 31, 2003 in the amount of $2,684.  The fair value of the building was based onthe average of two independent appraisals of the building.  This impairment loss is recorded in operatingexpenses as “Impairment of long lived assets” in the accompanying ConsolidatedStatement of Operations and Comprehensive Loss for the year ended December 31,2003.

 

**8.Idle Equipment**

 

Idle equipmentconsists of certain equipment held by the Company for use in expansion of bulkalloy parts manufacturing in 2005.  Theequipment was presented as machines held by a customer in 2003 as inventory, whichrepresented machines conditionally sold to Growell in 2002 and 2003 (see Note6).  Theequipment was included in inventory as of December 31, 2003 as the Companywas anticipating the sale of the equipment to a customer in 2004.  However, the anticipated sale did not takeplace during 2004.  While the Company isactively marketing the equipment for ultimate sale, the equipment may be usedinternally to meet future capacity requirements for expansion of ourbusiness.  As of December 31, 2004,the idled equipment includes a foreign currency translation gain of $235.

 

**9.Other Intangible Assets**

 

Intangible assets consist of the following:

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Purchased  and licensed patent rights |       | $                     | 555        |   | $ | 517 |   |
| Internally  developed patents         |       | 1,056                 |       | 824 |   |
| Trademarks                            |       | 85                    |       | 83 |   |
| Total                                 |       | 1,696                 |       | 1,424 |   |
| Accumulated  amortization             |       | (553                  | )          | (440 | ) |
| Total intangible assets, net          |       | $                     | 1,143      |   | $ | 984 |   |

 

Amortization expensewas $113, $100, and $82, for the years ended December 31, 2004, 2003, and2002, respectively.   The estimatedaggregate amortization expense for each of the five succeeding years is asfollows:

 
| **December 31,** | ** ** | **Aggregate Amortization Expense** | ** ** |
|-----------------------|------------|------------------------------------|------------|
| 2005                  |       | $                                  | 107        |   |
| 2006                  |       | 104                                |       |
| 2007                  |       | 102                                |       |
| 2008                  |       | 100                                |       |
| 2009                  |       | 98                                 |       |
|                       |            |                                    |            |  |

 

70

----

 

AccumulatedAmortization for the years ended December 31, 2004 and 2003 is as follows:

 
| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                            | ** ** | ** **            | ** ** | ** ** | ** ** |
| Purchased  and licensed patent rights |       | $                     | (181       | ) | $ | (126 | ) |
| Internally  developed patents         |       | (352                  | )          | (302 | ) |
| Trademarks                            |       | (20                   | )          | (12 | ) |
| Total                                 |       | $                     | (553       | ) | $ | (440 | ) |

 

Theweighted average amortization periods for each of the years ended December 31,2004, 2003, and 2002 is as follows:

 
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2004**              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                           | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| 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 |   |
| Total  weighted                      |       | 13.5                  |       | 13.5 |   | 13.5 |   |

 

Purchased patentrights represent the exclusive right to commercialize the bulk amorphous alloyand other amorphous alloy technology acquired from California Institute ofTechnology (“Caltech”), a shareholder, through a license agreement with Caltech(“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 nine issued patents and four 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 fromsubstantially all amorphous alloy technology that is developed in ProfessorWilliam Johnson’s Caltech laboratory during the period September 1, 2001through August 31, 2005. All fees and other amounts payable by the Companyfor these rights and licenses have been paid or accrued in full, and no furtherroyalties, license fees or other amounts will be payable in the future underthe License Agreements.

 

In addition to thepatents and patent applications under the License Agreement with Caltech, theCompany has internally developed patents. Internally developed patents includelegal and registration costs incurred to obtain the respective patents. TheCompany currently holds various patents and numerous pending patent applicationsin the United States, as well as numerous foreign counterparts to these patentsoutside of the United States.

 

**10.Goodwill**

 

During2002, the Company completed an impairment review and did not recognize anyimpairment of goodwill.  Accordingly, for2002, the Company has forgone all related goodwill amortization expense.   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 loss, cashflow losses and uncertainty surrounding its future cash flows, led the Companyto evaluate its investment for recoverability as of December 31,2003.  As a result, the Companydetermined that the carrying value of its investment in Dongyang exceeded itsfair value as of December 31, 2003 in the amount of $184.  This impairment loss is recorded in operatingexpenses as “Impairment of Goodwill” in the accompanying Statement ofOperations and Comprehensive Loss for the year ended December 31, 2003.

 

InMarch 2004, the Company sold its 51% investment in Dongyang to the 49%minority shareholder (see Note 17).

 

**11.Settlement Payable**

 

Thesettlement payable balance consists of payables to Growell Metal Co.,Ltd., a South Korean metals processing company (“Growell”), as a result of a settlement agreementexecuted in January 2004.  Underterms of the January 2004 settlement of the dispute over certain salestransactions from 2003 and 2002 between Liquidmetal Korea and Growell,Liquidmetal Korea agreed to pay Growell $4,895 to purchase Growell’s investmentin alloy inventories, proprietary alloying equipment purchased from LiquidmetalKorea, and supporting equipment purchased from other suppliers.  Also as part of the settlement, Growellsatisfied in full a balance of $2,058 owed to Liquidmetal Korea for the diecasting machines Growell purchased from Liquidmetal Korea in the first quarterof 2003 as part of a license agreement to manufacture Liquidmetal alloy partsfor the South Korean automotive industry. 

 

71

----

 

****The remaining settlement payable of $2,837 and tradeaccounts payable of $14 were to be paid to Growell (in cash or stock at theCompany’s discretion) by December 31, 2004.  As of December 31, 2004, the settlementpayable was not paid to Growell due to Growell’s breach of warranty onequipment repurchased by Liquidmetal Korea. The outstanding balance of payables to Growell from the settlement as ofDecember 31, 2004 was $3,246, net of foreign exchange translationloss.   In January 2005, Growell wasacquired by a third party and the Company is currently in negotiations tosettle this balance with the third party.****

 

**The Companyrecorded a loss on the settlement at December 31, 2003 of $2,765 which isincluded in “Cost of Sales” in the December 31, 2003 ConsolidatedStatements of Operations and Comprehensive Loss.  The loss on settlement reflects thewrite-down of the assets received in the settlement to their fair market value.  The sale of the die casting machines toGrowell was reflected in the first quarter of 2004.  Under the settlement agreement between theparties, the Company and Growell granted to the other party (and the otherparty’s affiliates) a release of all known and unknown claims of any nature arisingbetween the parties through the date of settlement, as well as a releaseagainst future claims under agreements between the parties that were terminatedas a part of the settlement.  Thesettlement agreement provided that all agreements of any nature between theparties and their respective affiliates were terminated as of the date ofsettlement, with the exception of certain confidentiality agreements, aLiquidmetal coatings distribution agreement, and future rights under the diecasting agreement pursuant to which Growell purchased the die casting machinesand obtained a license to make auto parts from Liquidmetal alloys.  The settlement agreement also includes**, as an accommodation to Growell, if the Company becomes aware ofany prospective customer that desires to purchase a proprietary Company castingmachine at a time when Growell desires to sell any of its Liquidmetal diecasting machines, then the Company will not sell such die casting machine tothe prospective customer unless the Company first directs the prospectivecustomer to Growell and encourages the prospective customer to purchase themachine from Growell.

** **

**12.Other Liabilities**

 

The other liabilitiesbalance consists of accrued severance and operating lease costs associated withthe Company’s cost reduction measures for the Tampa, Florida executive offices,the accrued loss on the settlement with a customer (see Note 11), a capitallease obligation for office furniture and furnishings and capital leaseobligations for a SEM Microscope and a JSM Electron Microscope used in thelaboratory in Lake Forest, California, and warrant payable from the convertibledebt issued during 2004 (see note 14).

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2004**              | ** ** | **2003** | ** ** |
| ** **                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Accrued  severance                                 |       | $                     | 579        |   | $ | 1,683 |   |
| Accrued  operating lease costs                     |       | 596                   |       | 758 |   |
| Accrued  capital lease costs                       |       | 213                   |       | 348 |   |
| Warrant  payable                                   |       | 550                   |       | — |   |
| Total                                              |       | 1,938                 |       | 2,789 |   |
|                                               |       |                  |       |   |   |
| Imputed  interest                                  |       | (14                   | )          | (35 | ) |
| Total                                              |       | 1,924                 |       | 2,754 |   |
| Less current  portion                              |       | (1,032                | )          | (1,940 | ) |
| Other long  term liabilities, less current portion |       | $                     | 892        |   | $ | 814 |   |

 

During2003, the Company initiated activities to substantially reduce the number ofemployees and consolidate manufacturing and administrative facilities toimprove operational effectiveness and efficiency and reduce expenses.  During the year ended December 31, 2003,there was a total of 225 employees terminated. The total amount of severance granted to the terminated employees is$2,718 which is included in Cost of Sales in the amount of $199, Selling,general and administrative in the amount of $2,253, and Research andDevelopment in the amount of $266 in the accompanying Consolidated Statement ofOperations for the year ended December 31, 2003.  The amount of severance paid was $1,104, and$1,035 as of December 31, 2004 and 2003, respectively.  The remaining severance owed to theterminated employees is $579 and $1,683 as of December 31, 2004 and 2003,respectively.  The total severancegranted to terminated employees of $2,718 is separated into the followingreportable segments as of December 31, 2003: Coatings at $75 and Bulkalloy at $2,643.  The categories ofemployees that were eliminated include the following:  Product management positions at variouslevels, including Vice President; entry level technicians; accounting andfinance positions from entry level through executive; marketing mid to seniorlevel positions; engineering mid to senior levels positions; informationtechnology support; administrative, legal and executive support; seniorinternal legal counsel; human resources and senior executives.  Also, there are other relocation expensesassociated with relocating the Tampa, Florida office to Lake Forest, Californiatotaling $759, which includes the accrual of all remaining facility andtelecommunication lease payments for the Tampa, Florida office.  Total liability accrued from the relocationand terminations in 2003, including the severance and lease accruals, were$1,175 and $2,441 as 

 

72

----

 

of December 31, 2004 and 2003, respectively.  The Company has substantially concluded allcost reduction and restructuring activities as of March 31, 2004. Thecurrent portion of the 2003 termination and relocation liability is $909 andthe long-term portion of the liability is $266 at December 31, 2004. At December 31, 2003, the current portion of the 2003 terminationand relocation liability was $1,826 and the long-term portion of the liabilitywas $615.

 

All leases with aninitial term greater than one year are accounted for under SFAS No. 13 *Accounting for Leases.*These leases areclassified as either capital leases or operating leases, as appropriate.  Assets under capital leases are capitalizedusing interest rates appropriate at the inception of each lease. At December 31,2004, the cost recorded for the office furniture and furnishings, the SEMMicroscope and the JSM 6360 Electron Microscope under the capital lease was$107, $47 and $289, respectively, and the accumulated amortization was $57, $22and $89, respectively.  At December 31,2003, the cost recorded for the office furniture and furnishings, the SEMMicroscope and the JSM 6360 Electron Microscope under the capital lease was$107, $47 and $289, respectively and the accumulated amortization was $36, $17and $31, respectively.  Future minimumlease payments for the above assets under capital leases during subsequentyears are as follows.

 
| **December 31,**                             | ** ** | **Minimum  Payments** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| 2005                                              |       | $                     | 134        |   |
| 2006                                              |       | 71                    |       |
| 2007                                              |       | 7                     |       |
| Total                                             |       | 212                   |       |
| Imputed  interest                                 |       | (14                   | )          |
| Total                                             |       | 198                   |       |
| Less current  portion                             |       | (123                  | )          |
| Capital  lease obligation, net of current portion |       | $                     | 75         |   |

 

**13.Product Warranty**

 

Management estimatesproduct warranties as a percentage of bulk alloy product revenues. During theyears ended December 31, 2003 and 2004, the Company’s product warrantyaccrual balance had the following activity:

 
| Balance, December 31,  2002 |   | $    | 237    |   |
|----------------------------------|--------|------|--------|--------|
| Expense  accrual                 |   | (297 | )      |
| Warranty  charges                |   | 363  |   |
| Balance, December 31,  2003 |   | $    | 303    |   |
| Expense  accrual                 |   | 288  |   |
| Warranty  charges                |   | (72  | )      |
| Balance, December 31,  2004 |   | $    | 519    |   |

 

The product warrantyaccrual balance was included in accounts payable and accrued expenses at December 31,2004 and December 31, 2003.

 

**14.Notes Payable**

 

Senior Convertible Note

 

On March 3,2004, the Company issued $9.9 million of 6.0% senior convertible notes due 2007(the “March Notes”) to investor groups in a transaction led by MichiganVenture Capital Co., Ltd, a South Korea-based institutional investment firm,and IndiGo Ventures LLC, a New York-based investment firm (the “PlacementAgents”) that served as a financial advisor to the Company for thetransaction.  The notes werecollateralized by the patents held by the Company and second priority mortgageinterest in plant facilities and certain equipment in South Korea.  The notes were convertible at any time intocommon stock at a price of $3.00 per share. Investors in the private placement and the Placement Agents receivedwarrants to purchase an aggregate amount of up to approximately 1.2 millionshares of common stock, exercisable at $3.00 per share for varying periods butno later than 100 days following the effectiveness of a registration statementcovering the resale of shares issuable upon exercise of the warrants.  In addition, the investors had the right tocall for repayment of the notes prior to maturity at any time after the secondanniversary of the closing of the transaction.

 

73

----

 

The fairvalue of the 1.2 million warrants totaled $1,883 and was computed using theBlack-Scholes pricing model under the following assumptions: (1) expectedlife of 3 years; (2) volatility of 82%, (3) risk free interest of0.95% and dividend rate of 0%.  Inaddition, since this debt is convertible into equity at the option of the noteholder at beneficial conversion rates, an embedded beneficial conversionfeature was recorded as a debt discount and will be amortized using theeffective interest rate method over the life of the debt in accordance withEmerging Issues Task Force No. 00-27, “Application of Issue No. 98-5to Certain Convertible Instruments.”  In March 2004,total cost of beneficial conversion feature of $3,395 and the relative fairvalue of the 0.6 million warrants issued to investors of $584 were recorded asdiscounts of the convertible note.  Inaddition, $718 relating to the fair value of the 0.6 million warrants issued tothe Placement Agents and $581 direct costs incurred relating to issuance of theconvertible note were recorded as debt issuance cost as a contra liabilityaccount in warrant liability and other assets, respectively.

 

From June throughAugust 2004, the Company redeemed $4,465 of the outstanding note balancein cash.  The redemption resulted in awrite down of debt issuance costs and debt discount of $2,071 to interestexpense during the year ended December 31, 2004.  Further, 500,000 of warrants originallyissued to a financial advisor for the transaction expired during June 2004and 163,748 of unexercised warrants originally issued to investors were cancelledas a result of the Company’s redemption of the note balances during the yearended December 31, 2004.  The663,748 total expired and canceled warrants immediately prior to the expirationand cancellation resulted in a reduction of warrant liability of $7 and $279 topaid in capital and change in value of warrants, respectively, during the yearended December 31, 2004.

 

On August 19,2004, the Company completed a private exchange offer for its March Noteswith the remaining holders after the redemption.  Under terms of the exchange offer,approximately $5.5 million in aggregate principal amount of the March Noteshave been exchanged for an aggregate of (i) $2.75 million of 6% SeniorSecured Notes Due 2007 (the “Long-Term Notes”) and (ii) $2.75 million of 10%Senior Secured Notes Due 2005 (the “Short-Term Notes”), collectively referredto as “Exchange Notes”.  The ExchangeNotes are collateralized by certain patents owned by the Company and secondpriority mortgage interest in plant facilities and certain equipment at ourSouth Korea plant.  The Short-Term Noteshave a maturity date of July 29, 2005, and a conversion price of $2.00 pershare (compared to a conversion price of $3.00 per share under the March Notes).  The Long-Term Notes have a maturity date of July 29,2007, and a conversion price of $1.00 per share.   Further, the exchange notes are convertibleinto Common Stock, at the option of the Company, if at any time after theissuance of the notes, the closing per share price of the Common Stock exceeds$4.00 (as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period.  Holders of the Long-Term Notes also have theright to call for repayment of the Long-Term Notes prior to maturity at anytime after the second anniversary of the closing 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—have been amended to provide for an extended expirationdate of March 1, 2006.

 

Theexchange offer was treated as an extinguishment of the March Notes inaccordance with Emerging Issues Task Force No. 96-19, “Debtors Accountingfor a Modification or Exchange of Debt Instruments.”  The exchange resulted in a $1,663 loss fromextinguishment of the March Notes, write down of $352 of deferred issuecosts in other assets, $189 of contra liability deferred issuance costs, and$1,122 of debt discount as a result of the change in carrying value ofexchanged notes.

 

Inconnection with the private exchange offer, the Company issued $250 of privateplacement notes to certain Placement Agents as issuance costs.  Of the $250 notes issued, $125 was paid inthe form of long-term notes which is due in 2007 with interest rate of 6% perannum (Long-Term Notes) and $125 was paid in the form of short-term notes whichis due in 2005 with interest rate of 10% per annum (Short-Term Notes).  The Short-Term and Long-Term Notes areconvertible into Common Stock at $2.00 and $1.00, respectively, and have thesame terms as the Exchange Notes issued to the investors.  Further, a beneficial conversion feature wasrecorded from the $125 Long-Term Notes issued to Placement Agents of $29 duringAugust 2004.

 

As of December 31,2004, our gross outstanding loan balance totaled $5,709, un-amortized discountsfor beneficial conversion feature and warrants totaled $851 and other assetdebt issuance costs totaled $183. Interest expense for the amortization of debt issuance cost and discounton note was $789 for the year ended December 31, 2004.  As of December 31, 2004, the effectiveinterest rates for the Short-Term and the Long-Term Notes were 22% and 32%,respectively.

 

TheCompany was obligated, pursuant to a Registration Rights Agreement, as amendedby the Exchange Notes, between the Company, the Placement Agents and the noteholders to file a registration statement with the Securities and ExchangeCommission (“SEC”) to register the shares of Common Stock issuable uponconversion of the notes payable and the related warrants within 90 

 

74

----

 

daysfollowing the effective closing date of the exchange notes (July 29,2004), and to use best efforts to cause such registration statement to becomeeffective within 60 days following the SEC’s first written comments on theregistration statement.  Further, if theCompany is not in compliance with the registration or listing requirements, theholders have rights to late registration payments equal to 2 percent of thepurchase price paid for the unconverted notes for the first 30 business days oflate registration, and 1 percent for each 30 business days thereafter, but nomore than 10 percent of the purchase price of the unconverted notebalance.  The $5,709 balance of the noteand un-amortized discounts for beneficial conversion feature and warrants of $851is presented as short-term liability as of December 31, 2004 as the noteholders have the right to call for payment on demand as the registrationstatement has not been filed in accordance with the amended Registration RightsAgreement.  As of the filing of thisreport, the Company has not received any demands for payment from the noteholders.

 

Pursuantto EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original relative fairvalues of the warrants of $1,302 have been recorded as other liability as theCompany has not yet filed the registration statement.  In addition, the Company is required toreport a value of the warrant as a fair value and record the fluctuation to thefair value of the warrant liability to current operations.  The change in the relative fair value of thewarrants resulted in a net gain of $747 for the year ended December 31,2004.  The fair value of warrantsoutstanding at December 31, 2004 of $550 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 1.17 years; (2) volatilityof 124%, (3) risk free interest of 3.08% and dividend rate of 0%.

 

**The following is a repayment schedule ofthe Short-Term and Long-Term Notes based on maturity date of the notes:**

 
| **Senior Convertible Notes  Repayment Schedule  December 31,** | ** ** | **Minimum  Payments** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | ** **            | ** ** |
| 2005                                                                |       | $                     | 2,854      |   |
| 2006                                                                |       | —                |       |
| 2007                                                                |       | 2,855                 |       |
| Total                                                               |       | $                     | 5,709      |   |

 

Kookmin Note

 

On February 4,2003, our Korean subsidiary received 6,500,000 in South Korean Won, orapproximately $5,488, under a loan from Kookmin Bank of South Korea.  The loan bears interest at an annual rate of7.1%.  In the event of delayed repayment,the interest increases to a maximum of 21%, depending on the length of time therepayment is delayed.  This loan iscollateralized by the plant facilities and certain equipment in SouthKorea.  During the first eighteen monthsfrom the origination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873of principal at the request of Kookmin Bank due to the sale of machines thathad been part of the collateral on the loan. Subsequent to October 31, 2003, Kookmin Bank requested that theCompany pay an additional $866 of principal by February 2004 due to theCompany’s current credit rating.  TheCompany made two payments on the requested additional loan pay down in November andDecember 2003 of $320 and $205, respectively.  The remaining payment of $341 wassubsequently made in February 2004. Beginning in September 2004, the Company is required to make equalmonthly installments of principal and interest to repay the remaining balanceof the loan over a 36-month period.  Forthe year ended December 31, 2004, principal payments made to Kookmin Banktotaled $296, which includes $422 of foreign exchange translation loss.

 

75

----

 

The notes payable fromKookmin Loan as of December 31, 2004 and 2003 and the activity for theyear ended December 31, 2004 is shown in the following table:

 
| ** **                           | ** ** | **December 31,  2003** | ** ** | **Borrowings** | ** ** | **Repayments** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|----------------|------------|----------------|------------|-----------------------------|------------|
| Kookmin Loan  7.1%, principal $5,488 |       | $                           | 4,047      |           | $          | —         |       | $                           | (296       | ) | $ | 3,751 |   |
|                                      |            |                             |            |                |            |                |            |                             |            |  |  |  |  |

 
| **Kookmin Repayment Schedule  December 31,** | ** ** | **Minimum  Payments** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | ** **            | ** ** |
| 2005                                              |       | $                     | 1,208      |   |
| 2006                                              |       | 1,208                 |       |
| 2007                                              |       | 1,208                 |       |
| 2008                                              |       | 127                   |       |
| Total                                             |       | $                     | 3,751      |   |

 

ShinhanCredit Agreement

 

On August 23,2003, the Company entered into a short-term credit agreement with Shinhan Bankof South Korea in the amount of $1,000, which expired on May 30,2004.  The credit agreement is solely forthe issuance of a letter of credit to vendors when the Company’s Koreansubsidiary imports raw materials and other goods into South Korea.  The facility is secured by any raw materialor goods financed through the credit facility. As of December 31, 2003, there were no borrowings outstanding underthis agreement, and the Company has not renewed the agreement as of December 31,2004.

 

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

 

*InitialPublic Offering.*Pursuant to theCompany’s Registration Statement (Registration No. 333-73716) on Form S-1,as amended, initially filed with the Securities and Exchange Commission on November 20,2001 and declared effective May 21, 2002, the Company closed an initialpublic offering of 5,000,000 registered shares of common stock on May 28,2002, plus an additional 229,000 shares on June 10, 2002 pursuant to anover allotment option, at a price of $15.00 per share (which sale is referredto herein as the “Offering”). The Offering generated net cash proceeds for theCompany during the second quarter 2002 of approximately $70,721, net ofunderwriting commissions of $5,490 and other transaction fees of approximately$2,224.

 

*StockSplit.*On June 29, 2001 the Companydeclared a ten-for-one stock split to its common shareholders of record on June 29,2001. This stock split was effected in the form of a stock dividend. On April 4,2002, the Company declared a one-for-3.1 reverse stock split to its commonshareholders of record on April 4, 2002. The consolidated financialstatements and accompanying notes have been retroactively adjusted to reflectthe effects of the split and reverse 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 to May 21,2003.

 

*PreferredStock.*As of December 31, 2001, the Companyreceived net proceeds of $5,577 from the sale of the preferred stock at a pershare price of $12.40, as adjusted for the revised stock split. Upon thecompletion of the Offering, each share of preferred stock was convertedautomatically into one share of Class A common stock pursuant to the termsof the preferred stock issued.

 

Warrants

 

As of December 31,2004, outstanding warrants to acquire shares of the Company’s common stock areas follows:

 
| **Number of  Shares** | ** ** | **Exercise  Price** | ** ** | **Expiration Date**    | ** ** |
|-----------------------|------------|---------------------|------------|------------------------|------------|
| 645,162               |       | 4.65                |       | December 31, 2005 |       |
| 563,151               |       | 3.00                |       | March 1, 2006     |       |
| 1,208,313             |       |                |       |                   |       |

 

76

----

 

**16.Stock Compensation Plan**

 

Under the Company’s1996 Stock Option Plan (“1996 Company Plan”) the Company could grant toemployees, directors or consultants options to purchase up to 12,903,226 sharesof common stock as adjusted for the reverse stock split. The stock options areexercisable over a period determined by the Board of Directors or theCompensation Committee, but no longer than 10 years.

 

On April 4, 2002,our shareholders and board of directors adopted the 2002 Equity Incentive Plan(“2002 Equity Plan”). The 2002 Equity Plan provides for the grant of stockoptions to officers, employees, consultants and directors of the Company andits subsidiaries. In addition, the plan permits the granting of stockappreciation rights with, or independently of, options, as well as stockbonuses and rights to purchase restricted stock. A total of 10,000,000 sharesof our common stock may be granted under the 2002 Equity Plan.  As of December 31, 2004, there are1,505,379 options outstanding under the 2002 Equity Plan.

 

Prior to the approvalof the 2002 Equity Plan, options were primarily granted under the Company’s1996 Stock Option Plan (“1996 Company Plan”). On April 4, 2002, our boardof directors terminated the 1996 Company Plan. The termination will not affectany outstanding options under the 1996 Company Plan and all such options willcontinue to remain outstanding and be governed by the Plan. No additionaloptions may be granted under the 1996 Company Plan. As of December 31,2004, there were 3,426,622 options outstanding under the 1996 Company Plan.

 

On April 4, 2002,our shareholders and board of directors adopted the 2002 Non-employee DirectorStock Option Plan (“2002 Director Plan”). Only non-employee directors areeligible for grants under the 2002 Director Plan. A total of 1,000,000 sharesof the Company’s Common Stock may be granted under the 2002 Director Plan.There are 122,000 options outstanding under the 2002 Director Plan as of December 31,2004.

 

Additionally, theCompany has 1,845,163 options outstanding at December 31, 2004 which weregranted outside the 1996 Company Plan, 2002 Equity Plan and 2002 Director Plan.

 

The Company appliesAPB Opinion No. 25 for options when the exercise price of options grantedto employees is less than the fair value of the underlying stock on the date ofgrant. The Company applies SFAS No. 123 for options granted tonon-employees who perform services for the Company. Stock-based compensationexpense was recognized as follows for the year ended December 31, 2004:

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

 

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

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

 

     Stock-basedcompensation expense was recognized as follows for the year ended December 31,2002 (as restated):

 
| ** **                  | ** ** | **In accordance with**       | ** ** |
|-----------------------------|------------|------------------------------|------------|
| ** **                  | ** ** | **APB Opinion  No. 25** | ** ** | **SFAS  No. 123** | ** ** | **Total** | ** ** |
| ** **                  | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative |       | $                            | 50         |   | $ | 655 |   | $ | 705 |   |
| Research and  development   |       | —                       |       | 1,498 |   | 1,498 |   |
| Total                       |       | $                            | 50         |   | $ | 2,153 |   | $ | 2,203 |   |
|                             |            |                              |            |  |  |  |  |  |  |  |  |

 

77

----

 

The fair value of eachoption grant is estimated on the date of the grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants for the years ended December 31, 2004, 2003, and 2002,respectively: expected volatility of 100% for all periods; dividend yield of0.0% for all periods; expected option life of approximately 5 years; andrisk-free interest rate ranging from 2.57% and 6.38%, as appropriate.

 

The following tablesummarizes the Company’s stock option transactions for the three years ended December 31,2004:

 
| ** **                                     | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|
| ** **                                     | ** ** | ** **            | ** ** | ** **                             | ** ** |
| Options  outstanding at December 31, 2001 |       | 8,053,155             |       | $                                      | 4.55       |   |
| Granted                                        |       | 643,202               |       | 13.71                                  |       |
| Exercised                                      |       | (299,873              | )          | 1.68                                   |       |
| Forfeited                                      |       | (79,297               | )          | 8.39                                   |       |
| 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                                        |       | 695,843               |       | 1.82                                   |       |
| Exercised                                      |       | —                |       | —                                 |       |
| Forfeited                                      |       | (1,968,140            | )          | 4.54                                   |       |
| Options  outstanding at December 31, 2004 |       | 6,899,164             |       | $                                      | 4.95       |   |

 

The weighted averagefair value of options granted during the years ended December 31, 2004,2003, and 2002 was $1.29, $2.41, and $10.42 respectively. There were 5,752,412options with a weighted average exercise price of $5.22 exercisable at December 31,2004, 5,080,557 options with a weighted average exercise price of $5.12exercisable at December 31, 2003 and 4,353,030 options with a weightedaverage exercise price of $4.36 exercisable at December 31, 2002.

 

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 at December 31,2004; 1,327,314 with a weighted average fair value of $4.96 were outstanding atDecember 31, 2003; and 1,343,444 with a weighted average fair value of$5.01 were outstanding at December 31, 2002.

 

The following table summarizes theCompany’s stock options outstanding and exercisable by ranges of option pricesas of December 31, 2004:

 
| **Options Outstanding**       | ** **  | **Options Exercisable**            | ** ** |
|-------------------------------|-------------|------------------------------------|------------|
| **Range of  Exercise Prices** | ** **  | **Number of options  Outstanding** | ** ** | **Weighted Average  Remaining Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| ** **                    | ** **  | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $0.00 -                       |  1.55  |                               | 380,359    |   | 9.5 |   | $ | 1.34 |   | 0 |   | $ | — |   |
| 1.56 -                        |  3.10  |                               | 1,713,024  |   | 6.9 |   | 2.52 |   | 1,202,026 |   | 2.54 |   |
| 3.11 -                        |  4.65  |                               | 1,853,357  |   | 6.2 |   | 4.61 |   | 1,766,485 |   | 4.65 |   |
| 4.66 -                        |  6.20  |                               | 2,592,810  |   | 6.4 |   | 6.20 |   | 2,559,853 |   | 6.20 |   |
| 7.76 -                        |  9.30  |                               | 11,507     |   | 7.9 |   | 8.80 |   | 4,602 |   | 8.80 |   |
| 9.31 -                        |  10.85 |                               | 12,613     |   | 6.4 |   | 9.83 |   | 4,613 |   | 9.87 |   |
| 10.86 -                       |  12.40 |                               | 222,585    |   | 6.6 |   | 12.40 |   | 165,803 |   | 12.40 |   |
| 13.95 -                       |  15.50 |                               | 112,909    |   | 6.9 |   | 15.00 |   | 49,030 |   | 15.00 |   |
| Total                         |        | 6,899,164                          |       |   |   |   |   | 5,752,412 |   |   |   |
|                               |             |                                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

78

----

 

**17.Discontinued Operations**

 

*Dongyang*

 

On June 28,2002, the Company acquired a 51% 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 of December 31,2003 in the amount of $184.  Thisimpairment loss was recorded in operating expenses for the year ended December 31,2003.

 

In March 2004,the Company sold its 51% investment in Dongyang to the 49% minorityshareholder.  The selling price of theCompany’s 51% interest in Dongyang was $80, which was equal to the Company’snet carrying value for the 51% ownership held. Further, the Company agreed to pay Dongyang $155 for the purchase of areceivable balance from Growell.  Thetransaction resulted in net payable to Dongyang of $75 and a loss of $46 fromtransfer of the Company’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 hasadopted SFAS 144 and as a result the 2003 balances have been restated in orderto conform with the presentation of 2004 financial statements.  Dongyang is reported as part of the assetsavailable for sale on the balance sheet for 2003.

 

As Donyang was soldprior to December 31, 2004, and there are no assets and liabilities ofDongyang as of December 31, 2004. The following is a listing of the major classes of assets andliabilities of Dongyang as of December 31, 2003.

 
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2003**              | ** ** |
| **Current  Assets:**                       | ** ** | ** **            | ** ** |
| Cash and  cash equivalents                 |       | $                     | 1          |   |
| Accounts  receivable, net                  |       | 181                   |       |
| Inventories                                |       | 1,572                 |       |
| Prepaid  expenses and other current assets |       | 56                    |       |
| Total  current assets                      |       | 1,810                 |       |
|                                       |       |                  |       |
| Property,  plant and equipment, net        |       | $                     | 58         |   |
| Other Assets                               |       | 29                    |       |
| Total assets                               |       | $                     | 1,897      |   |
|                                       |       |                  |       |
| Current  Liabilities:                      |       |                  |       |
| Accounts  payable and accrued expenses     |       | $                     | 233        |   |
| Deferred  revenue                          |       | 1,583                 |       |
| Total  current liabilities                 |       | $                     | 1,816      |   |

 

Summarized operatingresults of Dongyang’s discontinued operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                             | ** ** | **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 an Asset Purchase Agreement whereby all theassets and liabilities of its Taesung equipment manufacturing division in Koreawere sold to a third party for $345 which is payable by the third party in fourequal installments with the last installment being due on June 30,2005.  The sale resulted in a loss of$184 and is included in the loss from discontinued equipment manufacturingoperations as of December 31, 2004. The loss from operations for the year ended December 31, 2004totaled $653 and is included in the loss from discontinued equipmentmanufacturing operations for the period.

 

79

----

 

The Company hasadopted SFAS 144 and as a result the 2003 balances have been restated in orderto conform with the presentation of 2004 financial statements.

 

As Taesung was soldduring the period ended June 30, 2004, there are no assets and liabilitiesof Taesung as of December 31, 2004. The following is a listing of the major classes of assets andliabilities of Taesung as of December 31, 2003.

 
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2003**              | ** ** |
| **Current Assets:**                        | ** ** | ** **            | ** ** |
| Cash and  cash equivalents                 |       | $                     | 1          |   |
| Accounts  receivable, net                  |       | 256                   |       |
| Inventories                                |       | 477                   |       |
| Prepaid  expenses and other current assets |       | 113                   |       |
| Total  current assets                      |       | 847                   |       |
| Property,  plant and equipment, net        |       | $                     | 157        |   |
| Other Assets                               |       | 100                   |       |
| Total assets                               |       | $                     | 1,104      |   |
|                                       |       |                  |       |
| Current  Liabilities:                      |       |                  |       |
| Accounts  payable and accrued expenses     |       | $                     | 358        |   |

 

Summarized operatingresults of Taesung’s operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended Ended December,** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                             | ** ** | **2004**                       | ** ** | **2003** | ** ** |
|                                                                   |       |                           |       |   |   |
| Revenue                                                                |       | $                              | 172        |   | $ | 2,177 |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | (653                           | )          | (696 | ) |
|                                                                        |            |                                |            |  |  |  |  |

 

*LiquidmetalGolf*

 

On April 30,2002, management terminated the operations of the retail golf segment by meansof liquidating substantially all of the retail golf assets and liabilities. Thedisposition of the retail golf operations represents the disposal of a businesssegment. Accordingly, the accompanying consolidated financial statementsreflect the retail golf segment as a discontinued operation for all periodspresented.

 

For the year ended December 31,2003, there was a net gain of $127 in the estimate of expenses associated withthe disposal of the discontinued retail golf operations.  The change resulted from reducing the netliabilities of the discontinued operations to $0 as there are no additionalexpenditures associated with the discontinued retail golf operations.  There were no assets associated withdiscontinued retail golf operations at December 31, 2003 and 2004.

 

For the year ended December 31,2002, the Company had a net gain change in estimate of $1,556 on the disposalof the discontinued retail golf segment that was primarily due to a change inestimated value of stock-based compensation. The change in estimated value ofthe stock-based compensation was a result of the cumulative decrease in thefair market value of the common shares underlying the options granted to PaulAzinger of $2,129 and a decrease of $250 in the estimate of fees related to thetermination of the endorsement agreement. Additionally, there was a $98 gaindue to the reversal of the accumulated foreign exchange gains after theliquidation of Liquidmetal Golf Europe Inc, and a decrease in the estimatedwarranty cost of $128. These gains were partially offset by other changes inthe estimated loss on disposal that included $530 of additional operatingexpenses, a $57 increase in the allowance for doubtful accounts and $462primarily for the reduction of the estimated disposal value of work-in-processinventory and equipment.

 

80

----

 

The results ofoperations for all periods presented have been restated for discontinuedoperations. The operating results of the discontinued operations are asfollows:

 
| ** **                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                  | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net gain  (loss) on disposal                                |       | —                            |       | 127 |   | 1,556 |   |
| Foreign  exchange translation gain (loss) during the period |       | —                            |       | — |   | (98 | ) |
| Comprehensive  gain (loss)                                  |       | $                                 | —     |   | $ | 127 |   | $ | 1,458 |   |
|                                                             |            |                                   |            |  |  |  |  |  |  |  |

 

*StockCompensation Plan.*Historically,Liquidmetal Golf granted its own options to employees, directors andconsultants under a stock option plan (“1997 Golf Plan”) approved byLiquidmetal Golf’s Board of Directors pursuant to which Liquidmetal Golf couldhave granted stock options exercisable over a period determined by the Board ofDirectors to purchase up to 500,000 shares of common stock of Liquidmetal Golf.In connection with the Company’s plan to discontinue the retail golfoperations, the Company does not intend to issue additional options under the1997 Golf Plan.

 

Liquidmetal Golfapplies APB Opinion No. 25 and related interpretations in accounting forits plans. Accordingly, Liquidmetal Golf recognized compensation when theexercise price of the options was less than the fair value of the underlyingstock on the date of grant.  There was nocompensation expense recorded during the years ended December 31, 2004,2003, and 2002.

 

Had compensation costbeen determined based on the fair value at the grant dates for awards underthose plans consistent with the method of SFAS No. 123, Liquidmetal Golf’snet loss would have been as follows:

 
| ** **  | ** ** | **Years e****nded December 31,** | ** ** |
|-------------|------------|---------------------------------------|------------|
| ** **  | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **  | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| As reported |       | $                                     | —     |   | $ | 127 |   | $ | 1,556 |   |
| Pro forma   |       | $                                     | —     |   | $ | 15 |   | $ | 1,405 |   |

 

The fair value of eachoption grant is estimated on the date of the grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants for the fiscal years ended December 31, 2004, 2003, and 2002:expected volatility of 100% for all periods; dividend yield of 0.0% for allperiods; expected option life of approximately 5 years; and a risk-freeinterest rate ranging from 5.2% to 6.2%, as appropriate.

 

The following tablesummarizes Liquidmetal Golf’s stock option transactions for the three yearsended December 31, 2004:

 
| ** **                                     | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Price** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | ** **            | ** ** | ** **                   | ** ** |
| Options  outstanding at December 31, 2001 |       | 253,000               |       | 5.71                         |       |
| Granted                                        |       | —                |       | —                       |       |
| Exercised                                      |       | —                |       | —                       |       |
| Forfeited                                      |       | (137,500              | )          | 3.53                         |       |
| 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       |   |
|                                                |            |                       |            |                              |            |  |

 

There were 88,700options with a weighted average exercise price of $8.80 exercisable at December 31,2004.  There were 98,700 options with aweighted average exercise price of $8.72 exercisable at December 31, 2003and 115,500 options with a weighted average exercise price of $8.31 exercisableat December 31, 2002.

 

81

----

 

Included in the abovetables are certain options granted where their exercise prices were below thefair market value of the common stock at the grant date. Such options totaled10,000, 131,250 and 131,250 with weighted average fair values of $5.74, $5.74and $5.74 were outstanding at December 31, 2004, 2003 and 2002,respectively.

 

The following summarizesLiquidmetal Golf’s stock options outstanding and exercisable by the differentexercise prices at December 31, 2004:

 
| **Exercise Price** | ** ** | **Number of Options  Outstanding at  December 31, 2003** | ** ** | **Weighted Average  Remaining Contract  Life (Years)** | ** ** | **Number of Options  Exercisable at  December 31, 2004** | ** ** |
|--------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| $                  | 0.50       |                                                          | 10,000     |                                                   | 2.33       |                                                          | 10,000     |   |
| $                  | 8.00       |                                                          | 63,000     |                                                   | 4.81       |                                                          | 63,000     |   |
| $                  | 16.00      |                                                          | 13,200     |                                                   | 3.33       |                                                          | 13,200     |   |
| $                  | 24.00      |                                                          | 2,500      |                                                   | 3.58       |                                                          | 2,500      |   |
|               |       | 88,700                                                        |       |                                                   |       | 88,700                                                        |       |

 

**18.Income Taxes**

 

For all financialstatement periods presented, there was no provision for domestic incometaxes.  However, there was approximately$8 and $123 of tax expense during the twelve months ended December 31,2003 and 2002, respectively, related to foreign taxes incurred by Dongyang, a51% owned subsidiary, which is included as part of loss from discontinuedoperations on the consolidated statements of operations and comprehensive loss(see Note 17).

 

The significantcomponents of deferred tax assets were as follows:

 
| ** **                         | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                         | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Non-employee  stock compensation   |       | $                                 | 109        |   | $ | 51 |   | $ | 103 |   |
| Allowance  for bad debt            |       | 37                                |       | 44 |   | 52 |   |
| Loss from  discontinued operations |       | —                            |       | — |   | — |   |
| Loss carry  forwards               |       | 31,403                            |       | 27,202 |   | 24,175 |   |
| Other                              |       | 1,244                             |       | 1,569 |   | 1,071 |   |
| Total  deferred tax asset          |       | 32,793                            |       | 28,866 |   | 25,401 |   |
| Valuation  allowance               |       | (32,793                           | )          | (28,866 | ) | (25,401 | ) |
| Total  deferred tax asset, net     |       | $                                 | —     |   | $ | — |   | $ | — |   |

 

The following tableaccounts for the differences between the actual tax provision and the amountsobtained by applying the statutory U.S. Federal income tax rate of 34% toincome (loss) before income taxes:

 
| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal tax  expense                      |       | (34.00                            | )%         | (34.00 | )% | (34.00 | )% |
|                                      |       |                              |       |   |   |   |   |
| State tax  expense, net                   |       | (4.79                             | )%         | (1.62 | )% | (3.40 | )% |
| Foreign  income not subject to income tax |       | 4.96                              | %          | 24.16 | % | 13.36 | % |
|                                      |       |                              |       |   |   |   |   |
| Other                                     |       | 0.79                              | %          | 0.36 | % | 1.26 | % |
| Increase in  valuation allowance          |       | 33.04                             | %          | 11.13 | % | 22.82 | % |
|                                      |       |                              |       |   |   |   |   |
| Total tax  provision                      |       | 0.0                               | %          | 0.03 | % | 0.04 | % |

 

82

----

 

As of December 31,2004, the Company had approximately $86,000 of net operating loss (“NOL”) carryforwards for U.S. federal income tax purposes expiring in 2005 through 2024. Inaddition, the Company has state NOL carryforwards of approximately $39,000expiring in 2005 through 2009. The Company and Liquidmetal Golf filed on aseparate company basis for federal income tax purposes. Accordingly, thefederal NOL carryforwards of one legal entity are not available to offset federaltaxable income of the other. As of December 31, 2004, LiquidmetalTechnologies, Inc. had approximately $48,000 in federal NOL carryforwards,expiring in 2005 through 2024 and approximately $16,000 in state NOLcarryforwards, expiring in 2005 through 2009. Liquidmetal Golf, Inc. hadapproximately $38,000 of federal NOL carryforwards, expiring in 2012 through2023 and approximately $23,000 in state NOL carryforwards expiring in 2004through 2008.

 

As of December 31,2004, the Company had approximately $317 of Research & Development (“R&D”)credit carryforwards for U.S. federal income tax purposes expiring in 2016through 2018.  In addition, the Companyhas California R&D credit carryforwards of approximately $279, which do notexpire under current California law.

 

Section 382 ofthe Internal Revenue Code (“IRC”) imposes limitations on the use of NOL’s andcredits following changes in ownership as defined in the IRC. The limitationcould reduce the amount of benefits that would be available to offset futuretaxable income each year, starting with the year of an ownership change. TheCompany has not completed the complex analysis required by the IRC to determineif an ownership change has occurred.

 

The ability to realizethe tax benefits associated with deferred tax assets, which includes benefitsrelated to NOL’s, is principally dependent upon the Company’s ability togenerate future taxable income from operations. The Company has provided a full valuation allowance for its net deferredtax assets due to the Company’s net operating losses.

 

**19.Segment Reporting and Geographic Information**

 

SFAS No. 131,*Disclosures about Segments of an Enterprise andRelated Information,*requires companies to provide certaininformation about their operating segments. In April 2002, the Company began classifying operations into tworeportable segments: Liquidmetal alloy industrial coatings and bulk Liquidmetalalloys.  The 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 by coal burning power plants. Bulk Liquidmetal alloys include market opportunities to manufacture andsell casing components for electronic devices, medical devices, sporting goods,tooling, prototype sampling, defense applications and metal processingequipment.  The expenses incurred by thebulk Liquidmetal alloy segment are manufacturing, research and developmentcosts, and selling expenses associated with identifying and developing marketopportunities.  Bulk Liquidmetal alloyproducts can be distinguished from Liquidmetal alloy coatings in that the bulkLiquidmetal alloy can have significant thickness, up to approximately one inch,which allows 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 3 above.

 

Summarized financialinformation concerning the Company’s reportable segments is shown in thefollowing tables:

 
| ** **                                                                            | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment  Totals** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------|------------|----------------|------------|---------------------|------------|
| ** **                                                                            | ** ** | ** **   | ** ** | ** **     | ** ** | ** **          | ** ** |
| 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  (loss)                                                                  |       | 1,466        |       | (5,970         | )          | (4,504              | )          |
| Total  segment income (loss)                                                          |       | 369          |       | (21,140        | )          | (20,771             | )          |
| Total  identifiable assets at end of period                                           |       | 959          |       | 23,832         |       | 24,791              |       |
|                                                                                  |       |         |       |           |       |                |       |
| Year ended December 31,  2002 (restated):                                        | ** ** | ** **   | ** ** | ** **     | ** ** | ** **          | ** ** |
| Revenue to  external customers                                                        |       | $            | 4,587      |           | $          | 4,551               |       | $ | 9,138 |   |
| Gross profit                                                                          |       | 2,171        |       | 1,311          |       | 3,482               |       |
| Income  (loss) before minority interest, interest expense and discontinued operations |       | 1,425        |       | (13,179        | )          | (11,754             | )          |
| Total  identifiable assets at end of period                                           |       | 1,969        |       | 29,441         |       | 31,410              |       |

 

83

----

 

Reconcilinginformation for the statements of operations between reportable segments and theCompany’s consolidated totals is shown in the following table:

 
| ** **                                                                                                     | ** ** | **For the Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                     | ** ** | ** **                                | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Total  segment income (loss) before minority interest, interest expense and  discontinued operations           |       | $                                         | 3,557      |   | $ | (20,771 | ) | $ | (11,754 | ) |
| General and  administrative expenses, excluded                                                                 |       | (11,354                                   | )          | (13,110 | ) | (9,688 | ) |
| Consolidated  loss before interest, other income, income taxes, minority interest and  discontinued operations |       | (7,797                                    | )          | (33,881 | ) | (21,442 | ) |
| Loss from  extinguishments of debt                                                                             |       | (1,663                                    | )          | — |   | — |   |
| Change in  value of warrants, net                                                                              |       | 747                                       |       | — |   | — |   |
| Other income                                                                                                   |       | 302                                       |       | — |   | — |   |
| Interest  expense                                                                                              |       | (3,603                                    | )          | (390 | ) | (1,109 | ) |
| Interest  income                                                                                               |       | 37                                        |       | 304 |   | 506 |   |
| Gain on sale  of marketable securities held-for-sale                                                           |       | —                                    |       | 1,178 |   | 832 |   |
| Income taxes                                                                                                   |       | —                                    |       | — |   | — |   |
| Minority  interest in loss of consolidated subsidiary                                                          |       | —                                    |       | 21 |   | 118 |   |
| Gain (loss)  from discontinued operations, net                                                                 |       | (749                                      | )          | (837 | ) | 1,639 |   |
| Consolidated  net loss                                                                                         |       | $                                         | (12,726    | ) | $ | (33,605 | ) | $ | (19,456 | ) |

#  

Excludedgeneral and administrative expenses are attributable to the Company’s corporateheadquarters.  These expenses primarilyinclude corporate salaries, consulting, professional fees and facilitycosts.  Research and development expensesare included in the operating costs of the segment that performed the researchand development.

 

Included in our bulkalloy revenue to external customers are equipment sales from our Dongyangsubsidiary and Taesung equipment division in Korea, both of which were divestedin March and June 2004 respectively. External revenue from our discontinued equipment manufacturingoperations includes $3.2 million and $0.2 million for the years ended December 31,2003 and 2004, respectively.

 

Reconcilinginformation for the balance sheets between reportable segments and the Company’sconsolidated totals is shown in the following table:

 
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
|                                       |       |                  |       |   |   |
| Total  segment assets                      |       | $                     | 23,477     |   | $ | 24,791 |   |
| Cash and  cash equivalents                 |       | 742                   |       | 3,127 |   |
| Restricted  cash                           |       | 754                   |       | — |   |
| Prepaid expenses  and other current assets |       | 801                   |       | 322 |   |
| Other  property, plant and equipment       |       | 975                   |       | 1,563 |   |
| Intangibles,  net                          |       | 1,143                 |       | 984 |   |
| Other assets                               |       | 616                   |       | 65 |   |
| Total  Consolidated Assets                 |       | $                     | 28,508     |   | $ | 30,852 |   |

 

Assets excluded fromsegments include assets attributable to the Company’s corporate headquarters.The largest asset represents the Company’s intangible assets, consistingprimarily of the Company’s patents and trademarks.

 

84

----

 

Certain customersaccounted for more than 10% of revenues from continuing operations as follows:

 
| ** **                | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                | ** ** | ** **                       | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Samsung                   |       | 5                                | %          | 10 | % | 15 | % |
| Charm Tech                |       | 32                               | %          | — |   | — |   |
| Pntel                     |       | 30                               | %          | 2 | % | — |   |
| United  States Government |       | 10                               | %          | 16 | % | 16 | % |
| Growell  Metal            |       | 12                               | %          | — |   | — |   |
| LLPG                      |       | —                           |       | 12 | % | — |   |

 

The revenue related tothe United States Government was earned under three defense-related researchand development contracts.

 

Revenues from sales tocompanies in the United States of America were $5,546 and $6,050 during theyears ended December 31, 2004 and 2003, respectively.  The revenue related to the United States ofAmerica was earned under three defense-related research and developmentcontracts and sales of coatings products.

 

During the year ended December 31,2004, the Company had revenue on sales to companies outside of the UnitedStates of $11,883 of which $9,545 represented sales to companies located inSouth Korea.  During the year ended December 31,2003, the Company had revenue on sales to companies outside of the UnitedStates of $7,608, of which $4,559 represented sales to companies located inSouth Korea.  During the year ended December 31,2002,  the Company did not generatesignificant sales to companies located outside of the United States.

 

Long-lived assetsinclude net property, plant, and equipment and net intangible assets. TheCompany had long-lived assets of $1,594 and $2,547 located in the United Statesat December 31, 2004 and 2003, respectively. The Company had long-livedassets of $15,422 and $16,395 located in South Korea at December 31, 2004and December 31, 2003, respectively.  Of the assets located in South Korea at December 31,2003, $215 was from long-lived assets of our discontinued equipmentmanufacturing business.   Further, theCompany has long lived assets of $47 at December 31, 2004 located in Chinaas a result of a new plant opened during August 2004 (see Note 1).

 

**20.Income (Loss) Per Common Share**

 

Basic EPS is computedby dividing earnings (loss) attributable to common shareholders by theweighted average number of common shares outstanding for the periods. DilutedEPS reflects the potential dilution of securities that could share in theearnings. A reconciliation of the number of common shares used in calculation ofbasic and diluted EPS is presented below:

 
| ** **                       | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------|------------|-----------------------------------|------------|
| ** **                       | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                       | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted  average basic shares   |       | 41,609,652                        |       | 41,505,218 |   | 38,713,878 |   |
| Effect of  dilutive securities:  |       |                              |       |   |   |   |   |
| Stock  options                   |       | —                            |       | — |   | — |   |
| Conversion  of notes payable     |       | —                            |       | — |   | — |   |
| Weighted  average diluted shares |       | 41,609,652                        |       | 41,505,218 |   | 38,713,878 |   |

 

Options to purchaseapproximately 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 were notincluded 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 at December 31,2003, but were not included in the computation of diluted EPS for the sameperiod because the inclusion would have been antidilutive. Options to purchaseapproximately 8,317,187 shares of common stock at prices ranging from $0.78 to$15.50 per share were outstanding at December 31, 2002, but were notincluded in the computation of diluted EPS for the same period because theinclusion would have been antidilutive.

 

85

----

 

Warrants to purchase1,208,313 shares of common stock between $3.00 and $4.65 per share wereoutstanding at December 31, 2004 but were not included in the computationof diluted EPS for the same period because the inclusion would have beenantidilutive.  Warrants to purchase645,162 shares of common stock at $4.65 per share were outstanding at December 31,2003 and December 31, 2002.

 

**21.Commitments and Contingencies**

 

During September 2004, as part of asecurity agreement to finance a certain insurance policy, the Company usedcertificates of deposits with maturities of less than one year ascollateral.  The $754 held incertificates of deposits is presented as restricted cash at December 31,2004.

 

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.

 

Liquidmetal Technologies and certain of its presentand former officers and directors were named as defendants in nine purportedclass action complaints filed in the United States District Courts for theMiddle District of Florida, Tampa Division, and the Central District ofCalifornia, Southern Division, alleging violations of Sections 11 and 15 of theSecurities Act of 1933 and Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934 and Rule 10b-5 promulgated thereunder. In August 2004,four complaints were consolidated in the United States District Court for theMiddle District of Florida under the caption *PrimaveraInvestors 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”).  In September 2004,the other five complaints filed in the Central District of California weretransferred to the Middle District of Florida for consolidation with the *Primavera Investors* action. The Lead Plaintiffs served their Consolidated Amended Class ActionComplaint on January 12, 2005.  The Amended Complaint alleges that theProspectus issued in connection with the Company’s initial public offering in May 2002contained material misrepresentations and omissions regarding the Company’shistorical financial condition and regarding a personal stock transaction bythe Company’s chief executive officer. 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 the Company’s businesstransactions, failed to maintain adequate internal controls, and knowinglydisclosed unrealistic but favorable information about market demand for andcommercial viability of the Company’s products to artificially inflate thevalue of the Company’s stock.  The Amended Complaint seeks unspecifiedcompensatory damages and other relief.  Defendants’ motion to dismiss will be due on March 28,2005.  The Company intends to vigorously defend against the class action.  The Company cannot currently predict theimpact or resolution of this litigation or reasonably estimate a range ofpossible loss, which could be material.

 

In addition to the above, certain present and former officers anddirectors of Liquidmetal Technologies, as well as Liquidmetal Technologies as anominal defendant, have been named in three shareholder derivative actions.  Two shareholder derivative complaints werefiled in California state court styled *Brian Clair, Derivativelyon Behalf of Liquidmetal Technologies, Inc. v. John Kang, et al.*,Case No. 04CC00551, and *Joseph Durgin Derivativelyon Behalf of Liquidmetal Technologies, Inc.  v. John Kang, et al.,* Case No. 04CC00553, bothcommenced in the Superior Court of Orange County, California.  A third shareholder derivative complaint wasfiled in Florida federal court styled *Robert Story v. John Kang,et al.*, Case No. 8:04-CV-1587-T23TBM, commenced in the MiddleDistrict of Florida, Tampa Division. These shareholder derivative lawsuits allege that the defendantsbreached various fiduciary duties and otherwise violated state law basedprimarily upon the same underlying facts and circumstances as alleged in thefederal 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 court havebeen consolidated.  Plaintiffs served aConsolidated Shareholder Derivative Complaint on October 12, 2004.  The defendants served a Demurrer to theConsolidated Shareholder Derivative Complaint on November 22, 2004,seeking dismissal of that complaint.  Ata hearing on February 10, 2005, the court sustained the demurrer,dismissing the Consolidated Shareholder Derivative Complaint but giving theplaintiffs 45 days within which to amend the complaint.  The amended complaint is due on March 28,2005.  In the Florida derivative action,the Plaintiff filed a First Amended Shareholder Derivative Complaint on November 22,2004.  The Company’s Motion to Dismisswas filed on December 20, 2004. Plaintiff’s Response and Objection to the Motion to Dismiss was filed onFebruary 4, 2005.  The Companycannot anticipate when the Court will rule on the Motion to Dismiss.  The Company intends to vigorously defendagainst the derivative actions.  Wecannot currently predict the impact or resolution of this litigation orreasonably estimate a range of possible loss, which could be material.

 

In March 1996,the Company entered into a distribution agreement whereby it granted to a thirdparty exclusive rights to market and sell golf products incorporatingLiquidmetal Technology to certain Japanese sporting equipment companies.  The third party paid the Company a $1.0million distribution fee as part of this agreement, of which a portion wasrefundable according to a formula based on the gross profit earned by the thirdparty.  The remaining unearneddistribution fee of $830 has not been refunded as of December 31, 2004.

 

86

----

 

On March 28,2003, the distribution agreement was terminated and the Company entered into anew agreement to pay to the same third party a commission on the net salesprice of all Liquidmetal golf equipment that is shipped by the Company or itsaffiliates to Japanese golf companies for sale into the Japaneseend-market.  This commission will applyto golf equipment shipped by the Company or its affiliates during the periodbeginning on March 28, 2003 and ending on March 28, 2006.  If, by March 28, 2006, the Company hasnot paid $350 in commission payments, the balance between commission paid and$350 will be paid by April 30, 2006, thereby guaranteeing the third partya $350 minimum payment during the term of the agreement.  The Company will recognize the unearneddistribution fee of $830 as revenue proportionately with the payment ofcommissions under the new agreement.  Asof December 31, 2004, the unearned distribution fee remained unchanged at$830.

 

In August 2004,the Company entered into a consulting agreement whereby the Company was toreceive services from a third party to improve the Company’s bulk alloymanufacturing process.  The service is tobe provided from 2004 through February 2006.  The total amount of service fees is $172, ofwhich $15 was included in trade accounts payable as of December 31, 2004.

 

***Operating Leases***

 

The Company leases itsoffices and warehouse facilities under various lease agreements, certain ofwhich are subject to escalations based upon increases in specified operatingexpenses or increases in the Consumer Price Index. Future minimum leasepayments under non-cancelable operating leases during subsequent years are asfollows:

 
| **December 31,** | ** ** | **Minimum  Payments** | ** ** |
|-----------------------|------------|-----------------------|------------|
| ** **            | ** ** | ** **            | ** ** |
| 2005                  |       | $                     | 1,215      |   |
| 2006                  |       | 530                   |       |
| 2007                  |       | 317                   |       |
| 2008                  |       | 105                   |       |
| 2009                  |       | 73                    |       |
| Total                 |       | $                     | 2,240      |   |

 

Rent expense was $479,$1,419, and $955 for the years ended December 31, 2004, 2003, and 2002,respectively.

 

**22. 401(k)Savings Plan**

 

The Company has atax-qualified employee savings and retirement plan, or 401(k) plan, whichcovers all of its United States- based employees. Our Korean employees arecovered under a government sponsored pension program and do not participate inthe U.S. based 401(k) program.

 

Under the U.S. based401 (k) plan, participants may elect to reduce their current compensation, on apre-tax basis, by up to 15% of their taxable compensation or of the statutorilyprescribed annual limit, whichever is lower, and have the amount of thereduction contributed to the 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, the Company did not make employer contributions to the 401(k)plan during any of the periods presented in the accompanying consolidatedfinancial statements.

 

**23.Related Party Transactions**

 

**In June 2003,the Company entered into an exclusive, ten-year license agreement with LLPG, Inc.(“LLPG”), a corporation headed by a former director of the Company.  Under the terms of the agreement, LLPG hasthe right to commercialize Liquidmetal alloys, particularly precious-metalbased compositions, in jewelry and high-end luxury product markets.  The Company, in turn, will receive royaltypayments over the life of the contract on all Liquidmetal products produced andsold by LLPG.  In conjunction with itstechnology licensing contract, LLPG purchased two proprietary Liquidmetal alloymelting machines and three proprietary Liquidmetal alloy casting machines for atotal purchase price of $2,000.  At December 31,2003, the Company had a remaining receivable balance of $500 due from LLPG,which was paid in full in March 2004.**

** **

The Company is a party to a license agreement with California Instituteof Technology (“Caltech”) under which the Company exclusively licenses fromCaltech certain inventions and technology relating to amorphous alloys.  Professor William Johnson, a member of theCompany’s Board of Directors, is a professor at Caltech, and substantially allof the amorphous alloy technology licensed to the

 

87

----

 

Company under the Caltech license agreement was developed in ProfessorJohnson’s Caltech laboratory.   During2003, the Company paid $50 to Caltech representing the second and finalinstallments on the $150 aggregate fees related to this agreement.  Additionally, the Company reimburses Caltechfor laboratory expenses incurred by Professor Johnson’s Caltech laboratory,which during the years ended December 31, 2004 and 2003, amounted to $0and $22 in reimbursements, respectively.

 

A company managed and partially owned by one of the Company’s formerdirectors provides technical support services and computer equipment to theCompany.  During the year ended December 31,2003, the Company incurred $20 of expenses and equipment purchases related tothis arrangement.  There were no expensesand payables to this Company as of December 31, 2004.

 

We are a party to a consulting agreement withChitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of our company. Under this agreement, we have engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  During 2003, we incurred $50 in consultingfees from Chitnis Consulting and incurred $54 as of December 31, 2004.

 

**Soo Buchanan,the sister of John Kang and James Kang, was employed by our company and waspaid aggregate compensation of $76 and $43 as of December 31, 2003 and 2004.  Additionally, Otis Buchanan, the husband of Ms. Buchanan,was employed by the Company and was paid aggregate compensation of $90 and $54as of December 31, 2003 and 2004, respectively.**

** **

In November 2004,we entered into an agreement with John Kang, our Chairman, President, and ChiefExecutive Officer, in which Mr. Kang agreed that certain stock transactionsby him in 2002 involving our common stock should have resulted in a liabilityunder Section 16(b) of the Securities Exchange Act of 1934, asamended (“Section 16(b)”).  Thesetransactions include Mr. Kang’s private sale of 285,715 shares of hispersonal Liquidmetal Technologies common stock to Growell Metal Co., Ltd. in February 2002,prior to our initial public offering. They also include Mr. Kang’s subsequent indirect purchase anddisposition of Liquidmetal Technologies common stock in order to satisfy apersonal agreement Mr. Kang made to Growell Metal in February 2002regarding the guaranteed minimum value of the stock purchased by Growell Metalin February 2002 (the purchases and dispositions incident to thisagreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-marketpurchases of an aggregate of 89,300 shares of our common stock made by Mr. Kangin August 2002.

 

**The Audit Committee of our Boardof Directors conducted an independent inquiry into the above-describedtransactions with the aid of independent legal counsel and, as a result of suchinquiry, the Audit Committee concluded that the transactions should haveresulted in a liability to the Company under Section 16(b) in theamount of $302.  Mr. Kang hasacknowledged this liability, and in an agreement negotiated between Mr. Kangand the Audit Committee and approved by the full Board, Mr. Kang will paythis 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 reportedon a timely basis in August 2002.**

** **

**24.Fourth Quarter Adjustments and Transactions**

 

During the fourth quarter of 2004, the Company recognized $406write-downs of inventory included in “Cost of Sales” in the accompanyingStatement of Operations and Comprehensive Loss related to certain hingefinished goods used in our customer’s cell phone models which were nearing itsend of life (see Note 6).

 

88

----

 

**Schedule II – Valuation and Qualifying Accounts**

** **
| ** **                                | ** ** | **Balance at  Beginning  of Period** | ** ** | **Additions  Charged to  Expenses** | ** ** | **Write-offs  and  Payments** | ** ** | **Balance at  End of  Period** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| Allowance  for doubtful accounts          |       |                                 |       |                                |       |                          |       |                           |       |
| Year ended December 31,  2004        |       | $                                    | 127        |                                | $          | 84                            |       | $                              | (103       | ) | $ | 108 |   |
| Year ended December 31,  2003        |       | 450                                  |       | (28                                 | )          | (295                          | )          | 127                            |       |
| Year ended December 31,  2002        |       | 30                                   |       | 921                                 |       | (501                          | )          | 450                            |       |
|                                      |       |                                 |       |                                |       |                          |       |                           |       |
| Product  warranty accrual                 |       |                                 |       |                                |       |                          |       |                           |       |
| Year ended December 31,  2004        |       | $                                    | 303        |                                | $          | 288                           |       | $                              | (72        | ) | $ | 519 |   |
| Year ended December 31,  2003        |       | 237                                  |       | (297                                | )          | 363                           |       | 303                            |       |
| Year ended December 31,  2002        |       | —                               |       | —                              |       | —                        |       | —                         |       |
|                                      |       |                                 |       |                                |       |                          |       |                           |       |
| Deferred tax  asset valuation allowance * |       |                                 |       |                                |       |                          |       |                           |       |
| Year ended December 31,  2004        |       | $                                    | 28,866     |                                | $          | 3,927                         |       | $                              | —     |   | $ | 32,793 |   |
| Year ended December 31,  2003        |       | 25,401                               |       | 3,465                               |       | —                        |       | 28,866                         |       |
| Year ended December 31,  2002        |       | 23,796                               |       | 1,605                               |       | —                        |       | 25,401                         |       |

 

----

*                                         Thedeferred tax asset valuation allowance represents a 100% reserve against thedeferred tax asset accounts at December 31, 2004, 2003 and 2002,respectively.

 

89

----